Federal credit programs provide assistance to borrowers through two principal methods: direct loans and loan guarantees. Direct loans are a disbursement of funds by the government to a nonfederal borrower under a contract that requires the repayment of such funds with or without interest. Loan guarantees are any guarantees, insurance, or other pledges with respect to the payment of all or a part of the principal or interest on any debt obligation of a nonfederal borrower to a nonfederal lender. As of September 30, 2015, 21 federal agencies reported that they had direct loans or loan guarantees outstanding. As shown in figure 1, Education (largely through its Direct Student Loan Program) and HUD (largely through its single-family mortgage guarantee program or the MMI Fund) held the largest share of federal direct loans and loan guarantees outstanding, respectively. Twenty-five years ago, the enactment of FCRA changed the method used to budget for the cost of federal credit programs. Before fiscal year 1992, when FCRA took effect, the cost of credit programs was recorded in the budget on a cash basis (the expected amount of cash paid out minus the cash received in a given year). As a result, the budget cost associated with a loan guarantee was not recorded until a default occurred, which may have been many years after the guarantee was made. Further, direct loans appeared to cost the same as grants because the total amount of a loan was recorded as a cost when the loan was made and loan repayments were not recorded until the year received. Both were inaccurate and provided policymakers with distorted information for comparing credit programs to noncredit programs and to each other. This also created a bias in favor of loan guarantees over direct loans because loan guarantees appeared to be less expensive than direct loans, regardless of the actual lifetime cost to the government. FCRA was enacted with the intent of improving the accuracy of the cost of federal credit programs reported in the budget by requiring agencies to measure the government’s net long-term cost of federal credit programs to permit better cost comparisons both among credit programs and between credit and noncredit programs. The policies enacted under FCRA, sometimes referred to simply as credit reform, recognized that the actual cost of a direct loan or loan guarantee is not captured by its cash flows in any one year, but rather is the net present value—worth in terms of money paid immediately—of its cash flows over the life of the loan. Therefore, FCRA specified an approach using estimates of expected cash flows, including future loan repayments and defaults as elements of the cost to be recorded in the budget. FCRA requires agencies to estimate the net long-term cost to the government of extending or guaranteeing credit. This cost, referred to as subsidy cost, equals the net present value of estimated cash flows from the government minus estimated cash flows to the government, over the life of the loan and excluding administrative costs. This approach puts direct loans and loan guarantees on an equal footing in terms of cost in the federal budget and permits the costs of credit programs to be compared with each other and with the costs of noncredit programs. Figure 2 illustrates the types of cash flows that affect the subsidy costs for direct loans and loan guarantees. If the present value of estimated cash outflows exceeds cash inflows, there is a subsidy cost. If the present value of estimated cash inflows exceeds cash outflows, there is a negative subsidy cost, referred to as subsidy income. The subsidy cost represents the net present value cost of making or guaranteeing new loans and is included in the President’s Budget for the year the direct loan or loan guarantee is made. FCRA requires that agencies have budget authority to cover a program’s subsidy cost to the government in advance—before new direct loan obligations are incurred and new loan guarantee commitments are made. The data used for budgetary subsidy cost estimates are generally updated—or reestimated—annually after the end of the fiscal year to reflect actual loan performance and to incorporate any changes in assumptions about future loan performance. Reestimates that increase subsidy costs are referred to as upward reestimates (an agency would need additional funds), while reestimates that decrease subsidy costs are referred to as downward reestimates (an agency would return funds). Agencies do not need to request additional appropriations to cover upward reestimates because FCRA provides permanent indefinite budget authority for this purpose. To implement FCRA and calculate subsidy costs, agencies estimate the expected cash outflows and inflows over the life of the loans for each cohort of direct loans obligated or loan guarantees committed in the cohort year. The efforts to make reasonable subsidy cost estimates begin with establishing and using reliable records of historical credit performance data and taking into consideration current and forecasted economic conditions. Agency management is responsible for accumulating relevant, sufficient, and reliable data on which to base the estimates. Further, according to the primary accounting standard for direct loans and loan guarantees, subsidy cost estimates should be based on a systematic methodology to project expected cash flows into the future. To accomplish this task, an agency develops a cash flow model, which is a mathematical model that generally uses historical information and various assumptions related to future loan performance, including loan repayments, prepayments, defaults, recoveries, and the timing of these events. Such a cash flow model, which is based on sound economic, financial, and statistical theory, identifies factors that affect loan performance. In addition to using historical data, other relevant factors may be considered by agencies when estimating future loan performance. These factors may include (1) economic conditions that may affect loan performance, (2) financial and other relevant characteristics of borrowers, (3) the value of the collateral to loan balance, (4) changes in recoverable value of collateral, and (5) newly developed events that would affect loan performance. In addition, when new programs are established or changes are made to existing programs, historical supporting documentation for cash flow assumptions may not exist. In the absence of valid, relevant historical experience, the agency may use relevant experience from other federal or private sector loan programs, as well as informed opinion. Various budgeting and accounting guidance related to estimating subsidy costs requires agencies to establish internal controls over the calculations, including establishing and documenting policies and procedures and maintaining supporting documentation for subsidy cost estimates. Agencies develop subsidy cost estimates based on relevant budgeting and accounting guidance. FCRA assigned to the Office of Management and Budget (OMB) the responsibility for coordinating the cost estimates required by the act. OMB is authorized to delegate to lending agencies the authority to estimate costs, based on OMB’s written guidelines. These guidelines are primarily contained in OMB Circular No. A-11, Preparation, Submission, and Execution of the Budget. Further, the Federal Accounting Standards Advisory Board (FASAB) developed the primary accounting standard for federal credit programs, Statement of Federal Financial Accounting Standards (SFFAS) No. 2, Accounting for Direct Loans and Loan Guarantees, which became effective in fiscal year 1994. This standard established financial accounting guidance consistent with FCRA for estimating the cost of direct loan and loan guarantee programs, and for recording direct loans receivable and the liability for loan guarantees for financial reporting purposes. While OMB Circular No. A-11 and SFFAS No. 2 provide general guidance for agencies to develop subsidy cost estimates, detailed guidance on the preparation of subsidy cost estimates is contained in FASAB’s Accounting and Auditing Policy Committee’s Technical Release 6 Preparing Estimates for Direct Loan and Loan Guarantee Subsidies under the Federal Credit Reform Act. This technical release provides detailed guidance and specific practices that if fully implemented by federal agencies, should enhance their ability to reasonably estimate credit program costs. In addition, GAO’s Cost Estimating and Assessment Guide: Best Practices for Developing and Managing Capital Program Costs provides detailed guidance on developing cost estimates. We identified the following practices discussed in Technical Release 6 and the cost estimating guide as the key elements of the subsidy cost estimation process based on relevance to creating credible cost estimates: Historical data validation: Management should accumulate sufficient, relevant, and reliable supporting data on which to base cash flow projections, such as data on prepayments, defaults, and recoveries. Subsidy cost estimates should be based on the best available data at the time the estimates are made. Informed opinion documentation: In certain limited instances, when relevant historical data, modeling capabilities, or both are not available, informed opinion may be used to support cash flow projections. When informed opinion is used, management should document the expert’s qualifications. In addition, the basis for the stated opinion must be articulated and documented in detail, including an explanation for why the particular projection is appropriate for the program. Cash flow assumption documentation: Documentation must be developed to support the assumptions used by agencies in the subsidy cost calculations, including the data sources and calculation methods. Assumptions should also be coordinated between program and accounting offices. Cash flow model documentation: Management should ensure that its cash flow models used to estimate subsidy cost estimates are well organized; documented; and, to reduce the chance of errors, require minimal manual data entry. Documentation should include the rationale for using the specific model; the mechanics of the model, including how to use and update the model and formulas and other mathematical functions within the model; and sources of supporting data. Management should also document the controls over the model, including management review and approval of the model. Often, because of the complexity of cash flow models, management will hire a private firm to conduct an independent verification and validation of the model, which entails ensuring that the model’s calculations are accurate and consistent with the model documentation. Program design comparison: Based on the laws and regulations that govern the credit program, management should document a comparison of the cash flow model and assumptions to relevant program design factors, such as fees, grace periods, and maximum loan amounts.