Federal Student Loans
Flexible Agreements with Guaranty Agencies Warrant Careful Evaluation Gao ID: GAO-02-254 January 31, 2002The relationship between the Department of Education and state-designated guaranty agencies that run the largest federal student loan program is changing in order to achieve program and cost efficiencies and improve delivery of student financial aid. These state or private not-for-profit agencies guarantee payment if students fail to repay loans obtained through the Federal Family Education Loan programs. The 1998 Amendments to the Higher Education Act authorize the Secretary of Education to enter into "voluntary flexible agreements" (VFA) with individual guaranty agencies. These agreements allow a guaranty agency to waive or modify some of the federal requirements that apply to other guaranty agencies. GAO found that the process for developing the agreements did not fully meet the needs of the guaranty agencies and other program participants. The process frustrated guaranty agency officials GAO talked to, especially those who ultimately chose not to apply for a VFA and those who were not granted a VFA. Agency officials said that Education's communication about the VFA development process was poor and that Education was unable to meet its own timetable. The VFAs generally complied with most of the legislative requirements. However, one of the four agreements does not conform to the requirement that projected federal program costs not increase due to the agreements. The key changes implemented under the VFAs include incentive pay structures for guaranty agencies and waivers of certain statutory and regulatory requirements. Each VFA contains provisions for paying the guaranty agency incentive amounts on the basis of specific performance measures, such as default rates. Education is not prepared to assess the effects of VFAs because it lacks a way to adequately measure changes in guaranty agency performance. The lack of uniform measures makes it difficult to distinguish the results of the VFAs from the effects of other factors, such as the general condition of the economy. Although the Department is required to report on the status of the VFA by September 2001, no reports have been issued so far.
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Director: Team: Phone:GAO-02-254, Federal Student Loans: Flexible Agreements with Guaranty Agencies Warrant Careful Evaluation
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United States General Accounting Office:
GAO:
Report to the Honorable James M. Jeffords, U.S. Senate:
January 2002:
Federal Student Loans:
Flexible Agreements with Guaranty Agencies Warrant Careful Evaluation:
GAO-02-254:
Contents:
Letter:
Results in Brief:
Background:
VFA Development Process Did Not Fully Meet Participants‘ Needs:
Most VFA Provisions Complied with Legislative Requirements; However,
Compliance with the Projected Federal Cost Requirement Is Questionable:
Changes Offer Potential for Improved Performance:
Education Is Not Fully Prepared to Evaluate VFAS:
Conclusions:
Recommendations for Executive Action:
Agency Comments:
Appendix I: Scope and Methodology:
Appendix II: Comparison of Projected Federal Costs with California
Trigger Default Rate at 2.6 or 3 Percent:
Appendix III: Summary of VFA Financial Provisions:
Appendix IV: Comments from the Department of Education:
Appendix V: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Staff Acknowledgments:
Tables:
Table 1: Status of VFA Proposals from the Nine Guaranty Agencies That
Applied:
Table 2: Education‘s Projected Increase (Decrease) in Net Federal
Program Costs as a Result of Voluntary Flexible Agreements:
Table 3: Estimated Present Value Noninterest Federal Costs for
California Loans That Would Default at a 3 and a 2.6 Percent Trigger
Default Rate in Fiscal Year 2001-27:
Table 4: Summary of VFA Financial Provisions:
Figures:
Figure 1: National Trigger Loan Default Rate[A] Declined until an
Increase in Fiscal Year 2001:
Figure 2: VFA and Non-VFA Guaranty Agencies Experienced Trigger Default
Rate Declines through 2000:
Abbreviations:
FDLP: William D. Ford Direct Loan program:
FFEL: Federal Family Education Loan Program:
HEA: Higher Education Act:
VFAs: voluntary flexible agreements:
[End of section]
United States General Accounting Office:
Washington, DC 20548:
January 31, 2002:
The Honorable James M. Jeffords:
United States Senate:
Dear Senator Jeffords:
In an attempt to achieve program and cost efficiencies and improve
delivery of student financial aid, the relationship between the
Department of Education (Education) and state-designated guaranty
agencies that administer the nation‘s largest federally supported
student loan program continues to change. These state or private not-
for-profit agencies, which guarantee payment to banks and other lending
institutions if students fail to repay loans obtained through the
Federal Family Education Loan Program, operate under federal
regulations issued by Education and agreements with Education. The 1998
amendments to the Higher Education Act (HEA) authorize the secretary of
Education to enter into ’voluntary flexible agreements“ (VFAs) with
individual guaranty agencies. Each VFA provides a guaranty agency
flexibility to implement new business practices by waiving or modifying
some of the requirements established under federal regulations that
apply to other guaranty agencies. As of November 2001, Education had
signed VFAs with four of the nation‘s 36 guaranty agencies. Five other
guaranty agencies applied, but were not selected, withdrew, or did not
reach agreement with Education.
Although the 1998 VFA legislation gave Education flexibility in
developing these agreements with the guaranty agencies, it also imposed
some restrictions. For example, while the agreements could potentially
change almost any aspect of how the guaranty agencies are compensated
for services by Education, the VFA legislation prohibited the
agreements from increasing projected federal program costs.
Additionally, the agreements could change how the guaranty agencies
process loans, but the VFA legislation prohibited the agreements from
changing the statutory terms and conditions of loans, such as the
borrowers‘ interest rate. Some guaranty agencies and other program
participants, such as representatives of lender and loan servicing
groups, told us that Education could have done a better job in
developing the agreements and some expressed concern that the
agreements may not have entirely complied with the restrictions
contained in law. You asked us to examine these matters. Specifically,
as agreed, we focused on answering the following questions:
1. To what extent did the VFA development process meet the needs of
guaranty agencies and other program participants?
2. To what extent do VFAs comply with requirements in the VFA
legislation?
3. What changes are being implemented under the VFAs?
4. How well prepared is Education to assess the effects of the VFAs?
For this study, we interviewed Education officials involved in the
development of the VFAs as well as officials at each of the 9 guaranty
agencies that applied for an agreement and 10 of the guaranty agencies
that chose not to apply. We also discussed the VFAs with other program
participants, such as representatives of lender and loan servicing
groups. We reviewed the four, signed agreements for compliance with the
provisions in the VFA legislation. We used Education‘s analyses to
determine whether the VFAs complied with the requirement not to
increase projected federal program costs. We performed our work between
February and December 2001 in accordance with generally accepted
government auditing standards. For details concerning our scope and
methodology, see appendix I.
Results in Brief:
The VFA development process did not fully meet the needs of the
guaranty agencies and other program participants. The overall process,
which began when Education invited all guaranty agencies to submit a
VFA proposal, frustrated guaranty agency officials we talked to,
especially those who ultimately chose not to apply for a VFA and those
that were not granted a VFA. Frustrations stemmed, in part, from
Education‘s insufficient communication regarding the VFA development
process and its inability to meet its own timetable”the first VFA was
not signed until almost a year after Education‘s scheduled date. Most
of the officials from agencies that submitted proposals expressed some
dissatisfaction with the delays and the lack of communication from
Education about their proposals”especially with respect to how the cost
analyses were performed by Education. In addition, program participants
other than guaranty agencies said that Education provided them
insufficient opportunities and information to examine and comment on
the proposed agreements. These participants were also concerned about
the absence of a more formal process for determining VFA selection
criteria and for inviting VFA proposals.
The VFAs generally complied with most of the legislative requirements.
For example, we found that as required by the VFA legislation, the
agreements made no changes to the statutory terms and conditions of the
loans. However, one of the four agreements does not conform to the
requirement that the projected federal program costs not increase due
to the agreements. The agreement increased projected costs for the
guaranty agency by about $1 million per year”an increase Education
considered insignificant when compared with the federal cash flows
being estimated. In addition, Education limited the projected cost
comparisons of the VFAs to the first 3 years; by doing this, Education
concluded that the agreements complied with the statutory requirement
that the VFAs not increase projected federal program costs. This may
not be a valid conclusion because three of the four VFAs last for an
indefinite period of time, and after year 3, Education‘s analysis
showed that projected costs for these agreements would increase
substantially.
The key changes implemented under the VFAs include incentive pay
structures for guaranty agencies and waivers of certain statutory and
regulatory requirements. Each VFA contains provisions for paying the
guaranty agency incentive amounts based on specific performance
measures, such as default rates. The VFA agencies are establishing
programs aimed at enhancing performance to earn incentive payments. The
VFAs also waive certain statutory and regulatory requirements for
servicing loans and processing claim payments for defaulted loans to
test whether alternative processes are more effective. In contrast,
guaranty agencies without VFAs do not receive similar incentive
payments for improved performance and do not have regulatory
requirements waived; however, officials from several of these agencies
told us they have efforts under way to reduce defaults.
Education is not fully prepared to assess the effects of VFAs. The
agreements went into effect without Education having established a way
to adequately measure changes in guaranty agency performance as a
result of the VFA through comparisons with past performance and with
the performance of other guaranty agencies. For example, Education does
not have a way to uniformly measure the net effect of activities such
as customer service or agencies‘ efforts to keep delinquent loans from
defaulting. For the latter, a commonly used measure is the ’cure rate“
(the rate at which guaranty agencies and lenders keep borrowers who are
delinquent in their payments from defaulting on their loans). How this
measure is calculated currently varies from guaranty agency to guaranty
agency. Without uniform measures it would be difficult to distinguish
the results of the VFAs from the effects of other factors, such as the
general condition of the economy. The VFA legislation did require that,
by September 30, 2001, Education report on the status of the VFAs,
including a description of the standards by which each agency‘s
performance under the agreement was assessed and the degree to which
each agency achieved the performance standards. However, as of this
time, no report had been issued.
We are making recommendations to the secretary of Education to improve
the four current VFAs and the development of any additional VFAs. We
provided Education a draft of this report for comment. In a letter
dated January 23, 2002, Education indicated that they had some concerns
about the report. In general, Education had concerns about our
characterization of the VFA development process, and our conclusions
related to the cost analyses and about the need for additional uniform
measures of performance. For example, Education said that in its view
the VFAs comply with the requirement that projected federal costs not
increase due to the VFAs. We continue to question this view and
maintain that a reassessment of projected costs is needed. We discuss
these and other comments from Education and where appropriate, we made
changes to the report to address Education‘s comments. (See app. IV for
a copy of Education‘s letter).
Background:
The federal government supports two major loan programs for
postsecondary students under Title IV of HEA: the Federal Family
Education Loan Program (FFELP) and the William D. Ford Direct Loan
Program (FDLP). In 2000, FFELP and FDLP provided approximately $23
billion and $10 billion, respectively, in loans and loan guarantees to
postsecondary students and their parents. Both programs provide
subsidized and unsubsidized Stafford loans, Parent Loans for
Undergraduate Students and Consolidation loans. Under the FFELP,
private lenders, such as banks, provide loan capital. The federal
government guarantees the loans but uses 36 guaranty agencies to
administer many aspects of the program. With federal funding, these
guaranty agencies generally provide insurance to the lenders for 98
percent of the unpaid amount of defaulted loans.[Footnote 1] The
guaranty agencies also work with lenders and borrowers to prevent loan
defaults and collect on the loans after default. In contrast, under the
FDLP the federal government provides the loan capital to borrowers.
For over a decade, GAO has included student aid programs on a list of
’high-risk“ federal programs. These programs are designated high-risk
primarily because of deficiencies in Education‘s maintenance of the
financial and management information required to administer the student
aid programs and the internal controls needed to maintain the integrity
of the programs. Over the years Education has addressed many of the
high-risk issues identified by GAO; however, these long-standing
conditions continue to plague the student aid programs.
To achieve FFEL program and cost efficiencies, and to improve the
availability and delivery of loans, the VFA legislation of 1998
authorized VFAs between Education and the state-designated guaranty
agencies. The VFA legislation restricted Education to six VFAs through
fiscal year 2001, and as of January 2002, Education had entered into
agreements with four guaranty agencies. Five other guaranty agencies
applied for VFAs but either were not selected or failed to reach
agreement with Education (see table 1). Since the beginning of fiscal
year 2002, Education has had the authority to enter into VFAs with all
of the guaranty agencies.
Table 1: Status of VFA Proposals from the Nine Guaranty Agencies That
Applied:
Guaranty agency: Great Lakes Higher Education Guaranty Corporation
serving Minnesota, Ohio, Puerto Rico, Wisconsin, and the Virgin
Islands;
Status of VFA: Agreement signed November 27, 2000; effective October 1,
2000.
Guaranty agency: California Student Aid Commission;
Status of VFA: Agreement signed March 15, 2001; effective January 31,
2001.
Guaranty agency: The Massachusetts Higher Education Assistance
Corporation (American Student Assistance) serving the District of
Columbia and Massachusetts;
Status of VFA: Agreement signed March 15, 2001; effective January 1,
2001.
Guaranty agency: Texas Guaranteed Student Loan Corporation;
Status of VFA: Agreement signed March 15, 2001, effective March 15,
2001, with financial provisions effective October 1, 2000.
Guaranty agency: Pennsylvania Higher Education Assistance Agency
serving Delaware, Pennsylvania, and West Virginia;
Status of VFA: Withdrew application.
Guaranty agency: Colorado Student Loan Program;
Status of VFA: Selected, but negotiations did not result in an
agreement.
Guaranty agency: New York State Higher Education Services
Corporation[A];
Status of VFA: Not selected.
Guaranty agency: Illinois Student Assistance Commission[A];
Status of VFA: Not selected.
Guaranty agency: Georgia Higher Education Assistance Corporation;
Status of VFA: Withdrew application.
[A] The New York and Illinois guaranty agencies submitted a joint
application.
[End of table]
In May 1999, Education officials discussed VFAs with guaranty agency
representatives who were attending a conference hosted by the National
Council of Higher Education Loan Programs, Inc. Two months later,
notice of invitation for any of the 36 guaranty agencies to apply for a
VFA appeared in the Federal Register. The Register Notice included five
’criteria“ Education planned to use in its evaluation of the proposals
for the VFAs, including (1) how the agency‘s proposed VFA could be
extrapolated and easily used by other FFEL participants; (2) how the
proposal would improve the ’system“ for delivering and servicing of
loans for borrowers and schools; (3) if and how the proposal uses new
technology; (4) the impact the proposal would have on overall operating
costs for the agency and its partners, including Education; and (5) a
description of any proposed waiver of the prohibited inducement
restrictions (prohibited inducements are efforts by guaranty agencies
to encourage schools, borrowers, or lenders to submit applications for
loan guarantees through direct or indirect premiums, payments, or, for
example, uncompensated services such as loan processing services
normally performed by lenders).
VFA Development Process Did Not Fully Meet Participants‘ Needs:
The VFA development process did not fully meet the needs of guaranty
agencies and other program participants. Most of the guaranty agency
officials we talked to indicated frustration in one or more steps of
the process, which began when Education invited all guaranty agencies
to submit VFA proposals. Guaranty agency officials were particularly
dissatisfied with Education‘s lack of communication about the VFA
development process and its inability to meet its own timetable.
Program participants other than guaranty agencies, such as
representatives of lender and loan servicing groups, said that the
opportunities for examining the proposed agreements were insufficient.
Also, these program participants criticized Education for not using a
more formal process for determining VFA selection criteria and inviting
VFA proposals. In response to these criticisms, Education explained
that some of the delay in the VFA development process was the result of
broader changes at Education and turnover of key staff assigned to the
VFA project. Additionally, Education noted that it had taken extra
actions”such as posting the draft agreements to an Internet site”to
facilitate public comment on the VFA draft agreements. In commenting on
a draft of the report it also noted that some guaranty agencies and
other program participants that we consulted had been opposed to the
VFA legislation from its inception.
Guaranty Agencies Criticize Education‘s Efforts during VFA Development
Process:
According to the guaranty agency officials we talked to, after the
invitation process, Education did not communicate adequately with
guaranty agencies after failing to stay on schedule. Most of these
guaranty agency officials, including those that were generally
supportive of Education, expressed a variety of concerns about
Education‘s communication efforts during the VFA development process.
For instance, several guaranty agencies indicated a need for more
information on Education‘s methodology for analyzing the projected
federal program costs of the VFAs, or on Education‘s five criteria for
selecting the VFAs.
Furthermore, the established timetable was not met. Education indicated
it would select the six initial guaranty agencies within two weeks
after the application deadline of August 27, 1999, but the notice of
selections did not occur until February 2000. Education set December 1,
1999, as the target date for signing the VFAs; however, the first VFA
was not signed until November of 2000 and the other three were not
signed until March 2001. Guaranty agency officials told us that
criticisms of Education‘s failure to meet its own timetable would have
been somewhat mitigated if Education had done a better job in
communicating the status of the VFAs to the guaranty agencies. In
response to these criticisms, Education officials explained that the
process was hampered by organizational changes and staff turnover that
occurred during the VFA development process. For instance, officials
told us that delays were partially the result of Education‘s decision
to place a higher priority on developing regulations for implementing
other 1998 HEA amendments and on reorganizing the Office of Student
Financial Assistance as a performance-based organization.[Footnote 2]
Education officials also indicated that turnover of key personnel
assigned to the VFA project as well as disagreements within Education
concerning, for example, evaluations of the costs of VFAs contributed
to the delays in the VFA development process.
Other Program Participants Also Had Concerns about the Development
Process:
Although Education provided opportunity for public comment, program
participants other than guaranty agencies”for instance, representatives
of lender groups such as the Consumer Bankers Association”said these
opportunities were insufficient. Education posted each draft agreement
for about a 2-week period on the Internet in order to allow interested
third parties the opportunity to comment on the agreements. However,
some third parties told us that information available on the Web site
was insufficient to evaluate the draft agreements and that Education
did not provide responses to those who commented on the draft
agreements. In response to this, Education officials told us that the
Internet posting was not required by the VFA legislation, but that they
did so to increase opportunities for public comment. Additionally,
Education staff have recently begun meeting with a variety of student
loan industry participants to discuss ongoing VFA concerns.
Program participants other than guaranty agencies also criticized
Education for not using a more formal process in determining VFA
selection criteria and inviting VFA proposals. A couple of third party
participants we talked to said the selection criteria should have been
developed through a rulemaking process similar to that used to develop
federal regulations. Another participant said that VFA proposals should
have been solicited through a more formal process, such as those used
in federal contracting procedures. According to Education, however,
because the agreements were specifically authorized by statute and
involved state-designated, not competitively selected, entities,
Education was not subject to legal requirements applicable to the
rulemaking process and that it was not required to use the more formal
contracting process.
In commenting on a draft of this report, Education noted that some
guaranty agencies and third party program participants had been opposed
to the VFA legislation from its inception, and not surprisingly
continued to be dissatisfied with the implementation of the VFAs.
Most VFA Provisions Complied with Legislative Requirements; However,
Compliance with the Projected Federal Cost Requirement Is Questionable:
VFA provisions complied with most of the legislative requirements. For
instance, we found that as required by the VFA legislation, the
agreements made no changes to the statutory terms and conditions of the
loans. However, we were not convinced that the agreements conform to
the requirement that the projected program cost to the government not
increase due to the VFAs. For one VFA, Education projected federal
program costs would increase each year of the 3-year analysis period.
Furthermore, the agreements appear to have violated the cost
requirement if Education‘s cost determination had been based on a
different time period, or if the analyses had been based on changes in
assumptions about certain factors, such as default rates.
The authorizing statute specifies, ’in no case may the cost to the
Secretary of the agreement, as reasonably projected by the Secretary,
exceed the cost to the Secretary, as similarly projected, in the
absence of the agreement.“ Education‘s budget service analyzed each of
the four VFAs in the course of Education‘s negotiations with the
guaranty agencies and concluded that each agreement met the
requirement. However, Education‘s analysis of the Texas VFA projected
that federal costs will increase an average of about $1 million a year.
Budget service staff indicated that they regarded this amount as
insignificant compared with total federal cash flows being estimated.
Education‘s estimates for the Texas agency show that the projected
amount of collections on defaulted loans less federal program costs is
an average of $161 million per year over fiscal years 2001 to 2003. An
alternative basis of comparison could be to use the projected net
amount of the agency‘s receipts from federal sources and its retentions
of collections (an average of $71 million per year over the same time
period). In either case, the projected increase is not consistent with
the VFA legislative requirement that the projected federal program
costs not increase due to the VFA.
Our review of Education‘s analyses raised two additional questions
about Education‘s conclusion that the VFAs would not increase projected
federal costs.
Costs considered for first 3 years only. First, Education based its
conclusion on projected costs for only the first 3 years, while
Education‘s projections show that costs for three VFAs would increase
substantially in years 4 and 5. As table 2 shows, during the first 3
years, only the Texas agreement (discussed above) was projected to
cause an increase in federal costs. By including projections for the
fourth year or for both the fourth and fifth year, however, costs for
three of the four VFAs would rise, with costs for the Texas and Great
Lakes guaranty agencies rising substantially. These increases would
occur as the size of these guaranty agencies‘ loan volumes and the
cumulative size of their portfolios increase.
Table 2: Education‘s Projected Increase (Decrease) in Net Federal
Program Costs as a Result of Voluntary Flexible Agreements:
Projected cumulative cost increase (decrease) beginning fiscal year
2001:
VFA guaranty agency: California Student Aid Commission:
3-year period: $0;
4-year period: $0;
5-year period: $0.
VFA guaranty agency: American Student Assistance:
3-year period: $(122,184);
4-year period: $101,886;
5-year period: $259,849.
VFA guaranty agency: Texas Guaranteed Student Loan Corporation:
3-year period: $2,972,499
4-year period: $4,624,526
5-year period: $6,206,608.
VFA guaranty agency: Great Lakes Higher Education Guaranty Corporation:
3-year period: $(1,000,000);
4-year period: $5,000,000;
5-year period: $11,000,000.
VFA guaranty agency: Total:
3-year period: $1,850,315
4-year period: $9,726,412
5-year period: $17,466,457
Education officials and Office of Management and Budget officials said
they took this approach because they viewed the VFAs as demonstration
programs of limited duration to be evaluated by the Congress during the
next reauthorization of HEA. This act is due for reauthorization at the
end of fiscal year 2003. Although the American Student Assistance VFA
specifies a termination date at the end of fiscal year 2003, the other
three agreements have no specified termination date. They each remain
in effect until either the guaranty agency or Education chooses to
withdraw with advanced written notice.
Effects of changes in performance not adequately considered. Second,
budget service officials reached their conclusions about the cost
effects of the VFAs using a set of base year assumptions that did not
adequately consider the effect of changes in guaranty agency
performance”that is, they assumed that such things as default rates,
collection rates, and delinquency rates would remain unchanged in
future years. The VFAs were designed to improve guaranty agency
performance and under the agreements, doing so would mean higher
payments to the guaranty agencies for their improved performance. Thus,
analyzing the proposed payment structures to estimate how such
improvements would affect net federal costs”in the form of lower
default rates, for example” seems warranted. However, according to
budget service officials this happened in only one case and to a
limited extent.
In that particular case, budget service staff analyzed the effect of a
decline in loan defaults for the California VFA, and its estimates
illustrate the importance of considering the effect of changes in
guaranty agency performance on federal costs. A provision in the
California VFA provides an incentive payment to the guaranty agency for
achieving lower default payments. At the time this VFA was being
developed Education staff calculated that California‘s fiscal year 1998
’trigger default rate“[Footnote 3] –was 3.1 percent compared with the
aggregate national rate of 2.9 percent. In an effort to encourage the
California guaranty agency to reduce its trigger default rate, the VFA
provides for a payment from Education to the guaranty agency equal to
half of the amount of claims payments avoided by having a trigger rate
below 3 percent. Budget service staff then analyzed the effects of a
decline in trigger default rates below 3 percent” to see how much the
payment would be in the event the agency was able to reduce it‘s
trigger default rate that much. Education found that the payment to
California would be greater than the savings from the reduced
defaults”and thus would result in increases in federal costs. However,
in doing their formal analysis of the California‘s VFA, budget service
staff did not include the results of their default analysis and instead
assumed no change in the base-year 3.1 percent trigger default rate;
thus as table 2 shows, there are no projected increases or decreases to
the costs for that VFA. Subsequently, California‘s trigger default rate
did drop below 3 percent”down to 2.6 percent for fiscal year 2001. Our
analysis based on Education‘s estimates shows that the California
guaranty agency‘s fiscal year 2001 trigger rate of 2.6 percent entitles
it to a VFA incentive payment of about $17.3 million”an amount
approximately $2.6 million greater than the estimated total the
government saved due to the lower volume of defaulted loans. Because
there were no other projected cost considerations for this VFA, the
decline in loan defaults under the VFA resulted in an increase in
projected net federal costs. Appendix II discusses this analysis in
more detail.
Changes Offer Potential for Improved Performance:
All four agreements contain provisions for incentive payments for
improved guaranty agency performance, and all four grant waivers to
certain statutory and regulatory requirements. For the most part these
changes are designed to enhance agency performance, such as reduce
delinquencies and defaults, while increasing guaranty agency
efficiencies. At the same time, however, guaranty agencies without VFAs
told us that they have efforts under way to improve their agencies‘
performance” efforts that did not require the incentive payment
structure or waivers granted for the VFA agencies.
Incentive Payments Reward Improved Performance:
The VFAs establish incentive payments that reward a guaranty agency for
better performance.[Footnote 4] The use of these incentive payments
offers an alternative to the traditional guaranty agency payment
structure”a structure some participants describe as containing a
perverse payment incentive for the guaranty agencies. Under the
traditional payment structure that continues to be used for the non-VFA
agencies, it is financially more beneficial for a guaranty agency to
allow borrowers to default on their loans and to subsequently collect
on the loans than to prevent defaults in the first place. A guaranty
agency currently retains 24 percent of the money that it recovers from
borrowers whose loans are in default”that is, the borrowers who are
more than 270 days behind in making payments. According to some
guaranty agency officials, this percentage is typically higher than a
guaranty agency‘s actual cost of collecting on defaulted loans. As a
result, a non-VFA guaranty agency has more financial incentive to
’allow“ borrowers to default than to prevent the default upfront.
Three of the four VFAs have incentive provisions that reduce the
guaranty agencies‘ share of collections on defaulted loans. To
compensate for this lower collection retention rate, the VFAs have
enhanced incentives for better performance. For example, the American
Student Assistance VFA reduces the collection retention rate from 24
percent to 18.5 percent for regular collections on defaulted loans in
exchange for potentially greater incentive payments for lower defaults.
To implement such incentive provisions, VFA agencies have created
programs aimed at improving their performance, particularly in the
areas of reducing delinquencies and net defaults. For example:
* To help borrowers with defaulted loans, American Student Assistance
created Bright Beginnings. This program focuses on providing support to
the borrowers and finding solutions to loan default instead of making
payment demands and threatening sanctions for nonpayment, such as wage
garnishment and negative reports to credit bureaus. Help may involve,
for example, working with the borrowers on a strategy to get the
education or training necessary to obtain employment that would provide
the income needed to repay their loans. Additionally, the program
points out to borrowers the advantages of making payments on their
loans. For example, if borrowers make nine consecutive monthly payments
they will be eligible for rehabilitation, a process by which the
guaranty agency sells the defaulted loan back to a lender.
Rehabilitation is important because, in addition to being current on
their loan payments, the borrowers become eligible for additional Title
IV student financial aid.
* To avert defaults by borrowers who withdraw from school without
completing their educational program, the California Student Aid
Commission is planning an early-withdrawal counseling program.
Individuals who withdraw from school early are at high risk of
defaulting on their loans and the Commission believes that early
intervention by the guaranty agency is more likely to result in the
borrowers being able to avoid default. Under current regulations, a
guaranty agency provides default aversion assistance to borrowers only
after they become 60 or more days delinquent on their loan. Under the
early-withdrawal counseling program, the Commission will contact
borrowers as soon as they withdraw from school. The program plans to
educate borrowers through a variety of services and provide information
about their responsibilities and options for avoiding default.
* To help keep delinquent borrowers from defaulting, Great Lakes Higher
Education Guaranty Corporation and the Texas Guaranteed Student Loan
Corporation are both requiring lenders to submit requests for default
aversion assistance between the 60th and the 70th day of delinquency.
[Footnote 5] Under current regulation lenders can submit requests as
soon as the 60th day or as late as the 120th day to submit such a
request. Great Lakes and Texas guaranty agency officials believe that
by helping to contact delinquent borrowers earlier, they have a better
chance to prevent defaults.
Statutory and Regulatory Waivers Are Aimed at Enhancing Guaranty Agency
Performance:
The statutory and regulatory waivers granted under VFAs attempt to
improve guaranty agency performance in two ways”by eliminating
duplicate or less effective fiscal, administrative, and enforcement
requirements; and by substituting more efficient and effective
alternatives. For example:
* The Great Lakes VFA allows for the elimination of some duplicative
collection efforts that lenders or loan servicers and the guaranty
agency are both required to perform when a borrower became delinquent.
Officials from Great Lakes explained that they were concerned that the
duplication of effort can be confusing and unnecessarily frustrating to
borrowers.
* The American Student Assistance VFA grants authority to replace
certain administrative requirements for collection efforts on defaulted
loans with new, more targeted approaches. Current regulations specify
in considerable detail what collection actions must be taken and during
what time periods. For example, after 45 days of delinquency, the
guaranty agencies must ’diligently attempt to contact the borrower by
telephone.“ Between 46 and 180 days of delinquency, the agencies must
’send at least three written notices to the borrower forcefully
demanding immediate commencement of repayment.“ Under the VFA, American
Student Assistance has flexibility to develop procedures it considers
to be more efficient utilizing best practices common to the financial
services industry. Agency officials told us of plans to study borrower
behavior to determine the characteristics of borrowers that are most
apt to respond to particular default aversion or collection efforts.
Guaranty Agencies without VFAs Also Taking Steps to Improve
Performance:
While VFAs represent a new approach to such matters as reducing
perverse payment incentives and allowing guaranty agencies to be more
innovative in efforts to prevent defaults, they are not the only avenue
through which important attempts are being made to seek improvements
and innovations in the FFEL program. Guaranty agencies without VFAs are
introducing efforts to reduce delinquencies and defaults. Some of the
non-VFA guaranty agency officials we contacted indicated that they were
uncertain that VFAs are needed in order to improve performance. They
believe their mission provides sufficient motivation to increase
efforts to prevent defaults by, for example, devoting more resources to
work with delinquent borrowers and improving the exchange of
information between guaranty agencies, lenders, schools, and Education.
They also said that any innovations in customer service could be
accomplished under current regulations. For example, the largest
guaranty agency, USA Funds, Inc., is working in cooperation with other
guaranty agencies on electronic data exchange and electronic signature
authority. The agency is also implementing a program to provide
students with current and historical student financial aid information
from guarantors, lenders, and secondary-markets, as well as to deliver
services over the Internet.
For most of the guaranty agencies, the trend in recent years has been a
decline in default rates. As figure 1 shows, trigger default rates
decreased steadily through fiscal year 2000. The reasons for this
reduction are likely multiple, including a low unemployment rate
(giving more people jobs to pay off their student loans) resulting from
generally favorable economic conditions during that period. Although
many observers also credit the decline to the effect of more diligent
or effective efforts by guaranty agencies, how much these efforts have
contributed is unclear. We were not able to identify any study that has
isolated the effects of these influences on default rates.
Figure 1: National Trigger Loan Default Rate[A] Declined until an
Increase in Fiscal Year 2001:
[Refer to PDF for image]
This figure is a line graph depicting the following data:
Fiscal year: 1997;
Approximate percentage: 3.4%.
Fiscal year: 1998;
Approximate percentage: 2.8%.
Fiscal year: 1999;
Approximate percentage: 2.3%.
Fiscal year: 2000;
Approximate percentage: 1.7%.
Fiscal year: 2001;
Approximate percentage: 2.3%.
[A] The trigger default rate, generally, is the amount of defaulted
loans as a percent of the amount of guaranteed loans in repayment. See
footnote 3 on page 11 for details.
[End of figure]
Education Is Not Fully Prepared to Evaluate VFAS:
Education is not fully prepared to evaluate the results of the VFA
agreements. The agreements went into effect without Education having
developed a clear way to measure changes in guaranty agency
performance. For example, Education does not have a way to uniformly
measure satisfaction among the agencies‘ customers. Furthermore, it
cannot adequately determine what has happened as a result of the VFAs
through, for instance, comparisons with the results of past efforts to
cure delinquent loans and comparisons of the results of similar efforts
by other guaranty agencies. For the latter, a commonly used measure is
the ’cure rate“ (the rate at which guaranty agencies and lenders keep
borrowers who are delinquent in their payments from defaulting on their
loans). This measure currently varies from guaranty agency to guaranty
agency. It is likely to be difficult to distinguish the results of the
VFAs from the effects of other factors, such as the general condition
of the economy, but without uniform measures the task becomes even more
difficult.
To measure and compare the benefits that result from VFAs, Education
needs uniform performance measures. The data Education routinely
collects from guaranty agencies will provide several comparable
measures of guaranty agencies‘ performance, such as certain default
rates and the delinquency status of guaranteed loans in repayment.
According to an Education official, Education is working with a
consulting firm to develop additional evaluation measures.
Additionally, in commenting on a draft of this report, Education noted
that it is establishing common measures to evaluate the performance of
each VFA. These measures should provide useful data for comparing non-
VFA and VFA guaranty agencies. However, other measures of VFA guaranty
agency performance might not be as easily compared across the guaranty
agencies. For example, Education currently lacks a means of calculating
the cost of the VFAs. Specifically, it cannot calculate the amount by
which VFA provisions increase federal payments to the VFA agencies,
because it does not have a way to determine the amount of default
aversion fees[Footnote 6] that each agency would have received in the
absence of the VFA agreements. Also, the Great Lakes guaranty agency
plans to measure VFA performance, in part, by measuring customer
satisfaction. However, according to guaranty agency and Education
officials, no effort is under way to measure other guaranty agencies‘
customer satisfaction in a similar manner, thus making comparisons
difficult.
Another example is the lack of uniformity in calculating a cure rate.
Although two of the VFAs specify cure rates as performance measures,
these two guaranty agencies calculate cure rates differently and
another guaranty agency uses a third method to calculate a cure rate.
[Footnote 7] A uniformly calculated cure rate could be a useful
indicator of guaranty agencies‘ success in preventing defaults for
loans that are prone to default (delinquent loans).[Footnote 8] The
current inconsistencies in methods of calculating cure rates make
systematic evaluation of VFA results difficult.
The VFA legislation required that Education report on the status of the
VFAs, including a description of the standards by which each agency‘s
performance under the agreement was assessed and the degree to which
each agency achieved the performance standards. Additionally, Education
was required to include an analysis of the fees paid by the secretary,
and the costs and efficiencies achieved under each agreement. The
report was due no later than September 30, 2001; however, as of this
time, no report has been issued.
Conclusion:
The VFA development process did not fully meet the needs of the
guaranty agencies or other program participants. Despite circumstances
at Education that hampered VFA development, such as turnover of key
staff, Education might have been able to develop the VFA with fewer
frustrations had officials better communicated with participants,
particularly with respect to how the cost projections were done.
Additionally, a more realistic initial timetable might have lessened
some of the criticism from guaranty agency officials.
Education‘s evaluation of the cost effects of the current agreements
raises concerns about whether the federal program costs of current VFAs
will grow in the years ahead to the point that they exceed projected
costs in the absence of the agreements. In particular, we question the
time period Education used for making the cost estimates and the fact
that Education did not generally consider potential changes in agency
performance for the cost estimates. Although projected cost increases
were relatively small in comparison with the total amount of program
costs during the first 3 years, estimates for years 4 and 5 showed
substantial growth. Also, the general lack of a more thorough analysis
of VFA costs”including an analysis of how factors, such as changing
default rates might change projected costs”could leave the government
vulnerable to greater than projected costs for the VFAs.
VFAs are principally aimed at improving guaranty agency performance
through innovative incentive payment structures and in granting waivers
to statutory and regulatory procedures that might be hampering agency
performance. To that end, the VFAs afforded the guaranty agencies the
opportunity to try new ways of operating. Whether the incentive
payments and waivers used by the VFA agencies improve guaranty agency
performance more than the self-initiated efforts of the non-VFA
agencies remains to be determined.
Measuring the benefits of the VFAs is central in deciding if more VFAs
should be entered into and if current VFA practices should be
replicated at other guaranty agencies. We found that Education is not
fully prepared to evaluate the success of VFAs in part because it does
not have adequate standardized performance measures, such as delinquent
loan cure rates. Without adequate performance measures Education is not
well positioned to judge the success or failure of the VFA provisions.
Recommendations for Executive Action:
To improve the VFA development process for any future VFAs, we
recommend that the secretary of Education develop:
* a plan to more regularly communicate with guaranty agencies
concerning the status of VFA development efforts, including disclosing
to program participants the planned methods for projecting the federal
program cost effects of VFAs; and;
* a timetable for selection, negotiation, and completion of agreements
based on experience developing the first four VFAs.
In order to ensure that all VFAs are in compliance with statutory
requirements, we recommend that the secretary of Education:
* renegotiate the Texas VFA as soon as practicable to obtain changes
necessary to ensure that the VFA does not increase projected federal
costs;
* renegotiate the California VFA as soon as practicable to obtain
changes necessary to ensure that the VFA does not increase projected
federal costs, with or without changing the trigger default rate;
* renegotiate the Great Lakes and American Student Assistance VFAs for
time periods after fiscal year 2003 to ensure that the VFAs do not
increase projected federal program costs; and;
* improve projections of the cost effects of renegotiated VFAs and any
future VFA proposals by (1) requiring that each VFA specify an
effective time period, (2) conducting a cost analysis covering that
period, and (3) conducting analyses to project the cost effects of
changes in assumptions regarding guaranty agency performance, such as
default rates, in making the cost projections.
To ensure that the results of the VFAs can be effectively evaluated, we
recommend that the secretary of Education:
* develop specific evaluation plans enabling Education to compare VFA
guaranty agency performance with past performance and the performance
of other guaranty agencies using uniformly defined performance
measures, including delinquent loan cure rates.
Agency Comments:
We provided a draft of this report to Education for comment. In its
response, Education indicated that it had a number of concerns about
the report.
Education stated that our mention of GAO‘s designation of the student
financial assistance programs as ’high-risk“ (in the Background
section) was beyond the scope of our review and that it detracts from
the analysis in the report. We disagree. The report contains analyses
and descriptive information on many aspects of the FFEL program, which
provided approximately $23 billion of loans for postsecondary students
in fiscal year 2000. The mention of the student loan programs as high
risk and the ensuing discussion are important to help establish the
significance that any changes”including the VFAs”might have on the
program.
Regarding the development of the VFAs, Education said that it appears
that our conclusions were based primarily on conversations with
individual guaranty agencies that did not apply for a VFA and
representatives of various interest groups, many of which had
consistently opposed the VFAs. In fact, as indicated in our report, our
conclusions are largely based on comments from representatives of 18
guaranty agencies”including representatives from all four agencies with
VFAs; representatives from those agencies that had unsuccessfully
sought a VFA; representatives from agencies that did not seek a VFA,
but may wish to in the future; and representatives from agencies that
had opposed the VFA legislation from the beginning.
Concerning the cost effects of the VFAs, Education stated that it had,
in keeping with its standard procedures for estimating costs, (1) used
a closed time period (in this case, 3 years) to project costs; (2) not
considered the impact of possible changes to borrower or institutional
behavior in projecting costs; and (3) appropriately treated the $1
million per year projected cost increase for the Texas VFA as
’insignificant.“
First, in looking at the 3-year time period, Education said that its
conclusions about the cost effects of the VFAs were appropriately
limited to the first 3 years because there was no reason to expect that
the agreements would necessarily remain in effect beyond the time
period for reauthorization of HEA, which may bring changes that could
alter any cost analyses. We agree that the projected increases in
federal costs in the fourth and fifth years would not be relevant if
the current agreements no longer remain in effect after the end of
fiscal year 2003. However, since three of the VFAs are open-ended,
there is reason to believe they could extend beyond three years.
Therefore, to ensure that projected federal costs do not increase due
to the VFAs, Education would need to renegotiate the VFAs for the time
period beyond 3 years. Education‘s statement that, "GAO's
interpretation of the statute as requiring strict 'cost neutrality'
over a long period of time is not supported in the statute or the
legislative history," is incorrect. We did not interpret the statute in
this manner. Instead, our reading of the statute is that the period of
time to be examined should correspond to the projected life of the
agreement. As mentioned above, three of the agreements we reviewed were
for an open-ended period of time. Education chose a 3-year period for
their cost analysis, which is within its discretion and not
inconsistent with the statute. However, the report was intended to make
clear that, given the open-ended nature of the agreements, a decision
by Education not to terminate the agreements after 3 years would
warrant a reassessment of the cost projections and a renegotiation of
the agreements, if necessary.
Second, Education stated that it does not base cost estimates on
behavioral assumptions that cannot be supported by available data. We
agree that this is appropriate for baseline estimates, however one of
the purposes of the VFAs is to improve guaranty agency performance, and
thus the cost effects of potential improvements need to be considered
in Education‘s cost projections. Accordingly, we recommended that
Education supplement baseline estimates with sensitivity analyses in
order to avoid provisions that increase federal costs when an agency‘s
performance improves, by reducing default rates for example.
Third, with respect to Education‘s assertion that the projected
increase of $1 million per year for the Texas VFA is ’insignificant,“
we disagree. Education based its assertion on a comparison of the $1
million to the total federal cash flows being estimated. The projected
amount of collections on defaulted loans less federal program costs
averaged $161 million per year for the 3-year period”an amount lower
than the ’hundreds of million of dollars per year“ Education cited in
its comments. Additionally, an alternative basis of comparison could be
to use the projected net amount of the agency‘s receipts from federal
sources and its retentions of collections (an average of $71 million
per year for the 3-year period). In either case, the projected increase
is not consistent with the VFA legislative requirement that the
projected federal program costs not increase due to the VFAs.
Regarding preparations to evaluate the VFAs, Education said that it is
establishing common, general measures to evaluate the performance of
each VFA and, whenever possible, to compare VFA guaranty agency
performance with other non-VFA guaranty agencies. Education noted that
it has had preliminary discussions with representatives of the 36
guaranty agencies regarding uniform performance measures. Also, it
noted that the guaranty agencies are in the process of establishing an
eight-member task force to assist in determining the specific formula
for measuring VFA performance. As our report indicates, Education does
currently have several possible uniform measures of agency performance.
We welcome its efforts to develop additional measures, but conclude
that a uniform cure rate measure would assist in evaluating the
performance of the VFAs, considering that two guaranty agencies with
VFAs specifically identified a cure rate as a performance indicator.
We reviewed these and additional Education comments and modified the
draft as appropriate. Education‘s comments are included in appendix IV.
We are sending copies of this report to Honorable Roderick R. Paige,
secretary of Education; appropriate congressional committees; the
guaranty agencies with VFAs; and other interested parties. Please call
me at (202) 512-8403 if you or your staff have any questions about this
report. Key contacts and staff acknowledgements for this report are
listed in appendix V.
Sincerely yours,
Signed by:
Cornelia M. Ashby:
Director, Education, Workforce, and Income Security:
[End of section]
Appendix I: Scope and Methodology:
As agreed with your office, we focused our review of voluntary flexible
agreements (VFA) on addressing the following questions:
1. To what extent did the VFA development process meet the needs of
guaranty agencies and other program participants?
2. To what extent do VFAs comply with requirements in the VFA
legislation?
3. What changes are being implemented under the VFAs?
4. How well prepared is Education to assess the effects of the VFAs?
To determine the extent to which Education‘s VFA development process
met the needs of guaranty agencies and other program participants, we
interviewed Education officials involved in the development of the
VFAs, officials at each of the nine guaranty agencies that submitted an
application for a VFA, and nine guaranty agencies that did not submit
applications. The nine guaranty agencies that did not submit
applications included the five guaranty agencies with the largest
amounts of loan guarantees and four randomly selected smaller guaranty
agencies that did not submit applications.[Footnote 9] We also reviewed
VFA proposals and comments Education received during the public comment
period.
To determine the extent to which the VFAs complied with statutory
requirements we reviewed the VFA agreements, provisions of the Higher
Education Act (HEA) concerning the Federal Family Education Loan
Program (FFELP), and related regulations. We also discussed the
agreements with Education and guaranty agency officials, and
representatives of industry associations including the National Council
of Higher Education Loan Programs, Inc. and the Consumer Bankers
Association. To review Education‘s methods for projecting the costs of
the VFA agreements, we examined computerized schedules Education used
to project each VFA guaranty agency‘s costs and financial data compiled
by Education staff from submissions by the guaranty agencies. We also
discussed these projections with Education‘s budget service staff and
Congressional Budget Office and Office of Management and Budget
officials.
To identify changes being implemented under the VFAs we reviewed the
VFAs and discussed them with the guaranty agency officials and reviewed
documents they provided concerning their programs.
In addition, to determine how well prepared Education is to identify
the effects of the VFAs, we discussed plans for evaluation of the VFAs
with guaranty agency officials and Education officials responsible for
collecting and analyzing data from guaranty agencies.
[End of section]
Appendix II: Comparison of Projected Federal Costs with California
Trigger Default Rate at 2.6 or 3 Percent:
On the basis of budget service subsidy rate estimates, we projected the
level of noninterest federal costs for $263 million of loans”the amount
of loans that would default if the California guaranty agency‘s trigger
default rate[Footnote 10] were 3 percent in fiscal year 2001. As shown
in table 3 below, we estimated the net federal costs of these loans
(excluding interest subsidy costs that the budget service indicated
would not be affected) under four different scenarios: (1) a 3 percent
trigger default rate with all $263 million of these loans defaulting
without the VFA in effect, (2) a 3 percent trigger default rate with
the VFA in effect, (3) a 2.6 percent trigger default rate with $228
million of the $263 million of loans defaulting without the VFA in
effect, and (4) a 2.6 percent trigger default rate with the VFA in
effect. As shown in table 3, federal noninterest costs for these loans
would be about $107 million under either scenario 1 or scenario 2. In
scenario 3, federal costs would decline by about $15 million to $92
million as trigger basis defaults decline from 3 percent to 2.6
percent.
Under scenario 4, however, Education would benefit from lower loan
defaults, but it would also have to pay the California guaranty agency
half of the $34.7 million reduction in the amount of claims payments to
lenders (a $17.3 million VFA fee). Because the VFA fee exceeds the
benefit Education would realize from the lower level of defaults,
federal costs would increase by an estimated $2.6 million.
Table 3: Estimated Present Value Noninterest Federal Costs for
California Loans That Would Default at a 3 and a 2.6 Percent Trigger
Default Rate in Fiscal Year 2001 (Millions of dollars[A]):
At a 3.0% trigger default rate[B]: Net default costs[C];
Without VFA–scenario 1: $111.3;
With VFA–scenario 2: $111.3;
Difference: $0.
At a 3.0% trigger default rate[B]: VFA fee for default rate below 3
percent[D];
Without VFA–scenario 1: Not applicable;
With VFA–scenario 2: 0;
Difference: 0.
At a 3.0% trigger default rate[B]: Default aversion fees[E];
Without VFA–scenario 1: 0;
With VFA–scenario 2: 0;
Difference: 0.
At a 3.0% trigger default rate[B]: Account maintenance fees[F];
Without VFA–scenario 1: $1.2;
With VFA–scenario 2: $1.2;
Difference: 0.
At a 3.0% trigger default rate[B]: Other[G];
Without VFA–scenario 1: ($5.7);
With VFA–scenario 2: ($5.7);
Difference: 0.
At a 3.0% trigger default rate[B]: Total[H];
Without VFA–scenario 1: $106.8
With VFA–scenario 2: $106.8
Difference: $0.0.
At a 2.6% trigger default rate[B]: Net default costs[C];
Without VFA–scenario 1: $96.7;
With VFA–scenario 2: $96.7;
Difference: 0.0.
At a 2.6% trigger default rate[B]: VFA fee for default rate below 3
percent[D];
Without VFA–scenario 1: Not applicable;
With VFA–scenario 2: $17.3;
Difference: $17.3.
At a 2.6% trigger default rate[B]: Default aversion fees[E];
Without VFA–scenario 1: $0.3;
With VFA–scenario 2: $0.3;
Difference: 0.0.
At a 2.6% trigger default rate[B]: Account maintenance fees[F];
Without VFA–scenario 1: $1.4;
With VFA–scenario 2: $1.4;
Difference: 0.0.
At a 2.6% trigger default rate[B]: Other[G];
Without VFA–scenario 1: ($6.3);
With VFA–scenario 2: ($6.3);
Difference: 0.0.
At a 2.6% trigger default rate[B]: Total[H];
Without VFA–scenario 1: $92.1;
With VFA–scenario 2: $109.4;
Difference: $17.3.
Increase (decrease) in costs due to decline in trigger default
rate from 3 percent to 2.6 percent;
Without VFA–scenario 1: $(14.7);
With VFA–scenario 2: $2.6;
Difference: $17.3.
[A] The present value of a series of future payments is the sum of the
payments, with each payment discounted by an appropriate interest rate
over the number of years in the future that payment occurs. Budget
service estimates indicate that interest costs, including interest
benefits covering students‘ share of interest while in school and
during the grace period, would be the same with or without the VFA.
These estimates are based on budget service subsidy calculations in
March 2000 using a 6.77 percent discount rate. As of March 2000 the
applicable discount rate for FY 2001 was 6.25 percent. The use of a
lower discount rate would result in lower subsidy rates for defaulted
loans, as collections in the future would be discounted at a lower
rate. Although the budget service subsidy estimates upon which these
estimates were based were calculations for subsidized Stafford loans
(loans for which the federal government rather than the borrower bears
interest costs while the student is in school and during a grace
period), budget service staff explained that the subsidy rates for
other loan types would be similar apart from the interest subsidy
costs. The figures shown are expressed in present value terms as of FY
2001 and the calculations reflect adjustments for the effect of loan
cancellations.
[B] A 3.0 percent trigger default rate in fiscal year 2001 would
correspond to net default claims of $263 million. A 2.6 percent rigger
default rate would correspond to net default claims of $228 million.
[C] Net default costs are the federal costs associated with default
adjusted for the present value of subsequent collections on the loans.
[D] The VFA fee is calculated based on a provision in the California
VFA agreement. Budget service staff estimated that none of the
California VFA provisions would change federal program costs under
baseline conditions assuming that the guaranty agency‘s trigger default
rate remained above 3 percent.
[E] Guaranty agencies receive a default aversion fee equal to 1 percent
of the principal and interest amount of delinquent loans for efforts to
prevent defaults. Amounts of any loan defaults are deducted from these
payments.
[F] Guaranty agencies receive from Education account maintenance fees
equal to 0.1 percent of the original principal amount of outstanding
loans guaranteed. These fees are not paid on loans for which the
guaranty agency has paid default claims.
[G] Other costs include origination fees and federal payments for
death, disability, and bankruptcies.
[H] The totals may not be equal to the sum of items shown due to
rounding.
[End of table]
The VFA default rate incentive payment, one-half of the claims payments
avoided with a trigger default rate below 3 percent, was identified in
the VFA agreement as ’50% of the savings in claim payments resulting
from its default aversion activities under this VFA.“ This calculation,
however, fails to take into account two potentially significant
factors. First, the federal cost of loan default is mitigated in part
by subsequent collections on the defaulted loan. If the guaranty agency
receives payment on a loan after the loan defaults it generally is
allowed to retain 24 percent of the amount collected.[Footnote 11] The
remaining 76 percent must be remitted to Education. Budget service
staff looked to see how the present value of these payments would
affect the present value of program costs for Subsidized Stafford
loans. They concluded that the federal cost (aside from federal
administrative costs) on a subsidized Stafford loan that defaults is on
average about 47.5 percent of the amount of the loan. The comparable
figure for the same loan without default, but with the VFA incentive
payment was 51.7 percent. In other words, the incentive payment to
California‘s guaranty agency exceeded the present value of the federal
cost of the default adjusted for the subsequent collections on the
loan. Instead of benefiting from fewer defaults of loans guaranteed by
the California guaranty agency, Education stands to benefit from
increases in defaults until the guaranty agency‘s trigger default rate
reaches 3 percent. Above that point the guaranty agency would not
receive an incentive payment and Education would not benefit from
higher levels of defaults.
The second reason for questioning the provision‘s definition of federal
cost savings resulting from the VFAs default aversion activities is
that the entire decline in default costs may not be solely attributable
to the VFA. Default rates change for many reasons. According to
guaranty agency and Education officials, declines in default rates are
due to such factors as a change in definition of default from 180 to
270 days of delinquency brought by the VFA legislation, increased
default aversion assistance activities by all guaranty agencies,
enhancements in loan servicing methods, and a prosperous economy. The
VFA incentive payment to California rewards the guaranty agency for any
decline in default rates whether it is due to VFA prompted efforts or
to other factors.
As shown in figure 2 below, generally guaranty agencies have seen
declines in trigger default rates. Guaranty agencies that received VFAs
and guaranty agencies that did not both saw declines in default rates
from fiscal year 1997 to fiscal year 2000, with increases in fiscal
year 2001. For example, the largest guaranty agency, USA Funds, Inc.
had a higher default rate than California‘s in fiscal years 1997 and
1998. However, by fiscal year 2001, its default rate was slightly lower
than California‘s.
Figure 2: VFA and Non-VFA Guaranty Agencies Experienced Trigger Default
Rate Declines through 2000:
[See PDF for image]
This figure is a multiple line graph depicting trigger default rate
declines through 2000 for the following agencies:
California;
United Student Aid Funds, Inc.
Other VFA Agencies;
Other Non-VFA Agencies.
[End of figure]
[End of section]
Appendix III: Summary of VFA Financial Provisions:
Table 4: Summary of VFA Financial Provisions:
Place federal reserve funds in escrow and receive reimbursement for
100% of claims payments:
California: No;
Massachusetts: Yes;
Texas: Yes;
Wisconsin: Yes;
Guaranty agencies without VFAs: No.
Loan Processing and Issuance:
California: Yes;
Massachusetts: Yes;
Texas: Yes;
Wisconsin: No[A];
Guaranty agencies without VFAs: 0.65% of net commitments to 0.4% in
2004.
Account Maintenance Fee:
California: Yes;
Massachusetts: No;
Texas: Yes;
Wisconsin: No[A];
Guaranty agencies without VFAs: 0.1% of the original principal amounts
of all outstanding guarantees.
Default Aversion Fee:
California: Yes[B];
Massachusetts: No;
Texas: Variable;
Wisconsin: No[A];
Guaranty agencies without VFAs: 1% of principal and interest on cured
loans, but only once per loan.
Guaranty agency Share of Collections:
California: Variable;
Massachusetts: 18.5% on regular collections, rehabilitated loans and
consolidations of delinquent and defaulted loans;
Texas: Variable;
Wisconsin: Equal to collection cost;
Guaranty agencies without VFAs: 24%; 23% beginning in FY 2004; 18.5%
for rehabilitated loans and consolidation of defaulted loans.
New ED payments to guaranty agencies with VFAs;
California: 50% of claims savings if trigger rate is below 3%;
Massachusetts: Wellness fee calculated as a percentage of the loans not
delinquent; base fee equal to 22 basis amount of points; variable fee
equal to 0.25 basis points for each percentage point improvement in
defaults relative to national trigger default rates;
Texas: Default aversion fee from 1.25% to 4% depending on performance;
Wisconsin: Performance fee based on cure rate from 25.9 to 31.9 basis
points of the original principal amount of guaranteed loans;
Guaranty agencies without VFAs: Not applicable.
California: If the California guaranty agency‘s collection rate exceeds
the national average it receives the normal retention percentage plus a
percentage equal to the percent improvement in its collection recovery
rate;
Massachusetts: Reduction in wellness fee for poorer than specified
accuracy in data provided to the National Student Loan Data System;
Texas: Guaranty agency share of collections varies with the recovery
rate; 19.5% to 23% for regular and 18.5% to 20% for rehabilitation and
consolidations; Delinquency prevention fee; 0.05% to .12% of rate loans
in repayment w/o default aversion request.
[A] Components of the performance fee for Great Lakes have these
labels, but they are computed differently under the VFA.
[B] California‘s guaranty agency receives a default aversion fee when
the borrower begins receiving early separation counseling with or
without delinquency.
[End of table]
[End of section]
Appendix IV: Comments from the Department of Education:
United States Department Of Education:
The Deputy Secretary:
400 Maryland Ave., S.W.
Washington, D.C. 20202-0500:
[hyperlink, http://www.ed.gov]:
"Our mission is to ensure equal access to education and to promote
educational excellence throughout the Nation."
January 23, 2002:
Ms. Cornelia Ashby:
Director, Education, Workforce, and Income Security Issues:
United States General Accounting Office:
Washington, DC 20548:
Dear Ms. Ashby:
I am writing in response to your request for comment on the draft GAO
report to Senator Jeffords on the Voluntary Flexible Agreements (VFAs)
between the United States Department of Education (ED) and certain
guaranty agencies in the Federal Family Education Loan (FFEL) program.
The draft report is entitled, "Federal Student Loans: Flexible
Agreements With Guaranty Agencies Warrant Careful Evaluation." We have
a few concerns with the report, as discussed below.
Cover Letter And Background:
As you note in your cover letter to Senator Jeffords, the relationship
between ED and state-designated guaranty agencies that administer the
nation's federally supported student loan program is changing. In fact,
that relationship has been changing since the mid-1980s and will
continue to change as every administration attempts to achieve program
and cost efficiencies and improved student aid delivery. During the
1990s, both The Student Loan Reform Act of 1993 and The Higher
Education Amendments of 1998 (HEA Amendments) significantly changed the
existing relationship between ED and guaranty agencies. The Student
Loan Reform Act created a new loan program in direct competition with
the FFEL program, while the HEA Amendments established a new method for
paying guaranty agencies for services rendered. In addition, the HEA
Amendments gave ED the opportunity to test, through the use of VFAs,
new and innovative methods for carrying out the types of activities
currently required of guaranty agencies. After careful evaluation and
rather lengthy negotiations, ED and four guaranty agencies entered into
VFAs. Careful evaluation of the outcomes attributable to the VFAs will
be a priority of ED as we prepare for the reauthorization of the Higher
Education Act (HEA).
The "Background" section of the draft report discusses the student
financial assistance programs' placement on the GAO "high-risk" list.
Although resolving the issues that placed the student financial
assistance programs on GAO's high-risk list is a high priority for the
Secretary, the high-risk issue is well beyond the scope of the report
as described by GAO and only detracts from the analysis contained in
your report.
VFA Development:
GAO states that the VFA development process did not fully meet the
needs of the guaranty agencies or other program participants. It
appears that GAO came to this conclusion based primarily on
conversations with individual guaranty agencies that did not apply for
a VFA and representatives of other program participants. However, the
report fails to acknowledge that many of these individual agencies and
other program participants opposed the VFA concept from its inception.
Based on that knowledge, no one should be surprised that these same
parties were dissatisfied with many aspects of the process as well as
the results. Although not required, ED gave all guaranty agencies,
lenders, and other program participants a significant opportunity for
participation, including a specific opportunity to review and comment
on all the draft agreements.
Complaints about delays in the process are understandable. It did take
a long time to evaluate and analyze proposals and negotiate final
agreements. However, ED was concerned about selecting valid proposals
that met the legislative requirements. Your report notes that most VFA
provisions complied with the legislative requirements so I believe the
extra time devoted to the process was not wasted.
In addition, ED recognized that implementing a new concept like the
VFAs would be of great interest to participants in the student loan
program. On its own initiative, ED invited public participation in the
process. ED provided this opportunity for review and comment even
though the agreements between ED and the selected guaranty agencies
were not subject to the legal requirements applicable to the rulemaking
process. If the VFA negotiations had been subject to standard
rulemaking procedures, as some groups would have liked, there would
have been further delays, and it is very possible that the primary goal
of providing useful information for the upcoming reauthorization of the
HEA would not have been met.
Compliance With Federal Cost Requirement:
GAO's primary criticisms regarding the VFAs relate to ED's compliance
with legislative requirements related to cost estimation issues.
Specifically, GAO is concerned that (1) ED only considered costs for
the first three years of the VFA; (2) changes in behavior may alter
costs; and (3) ED did not consider projected increased federal costs of
$1 million as significant. We believe the cost estimations for each VFA
comply with the legislative requirements.
ED projected the cost to the government associated with each agreement.
The cost projections included a federal cost summary for each agreement
as well as more detailed tables showing projected cash flows for
specific agency operating revenues and expenses under the current and
proposed agreements. Under these projections, ED determined that none
of the agreements would exceed the cost under the standard guaranty
agency model.
The statute requires the Secretary to "reasonably project" the costs of
each VFA. In making these projections, ED used cost estimation rules it
consistently applies in other budget analysis situations: it used
certain closed periods (in this case, 3 years) to calculate costs; it
did not treat insignificant federal costs as violating cost neutrality
requirements; and it did not consider the impact of changes in behavior
in calculating costs. It is certainly reasonable for ED to apply these
general rules to this situation.
With respect to the period of time considered, three years is
consistent with ED's understanding of the goals of the statute. That
is, the VFAs would be evaluated to inform the next reauthorization of
the HEA, and possible changes at that time would significantly alter
any cost analyses of the agreements. Using longer time horizons would
have been incorrect in this case since there was no reason to expect
that the agreements would necessarily remain in effect beyond the
reauthorization time period. GAO's interpretation of the statute as
requiring strict "cost neutrality" over a long period of time is not
supported in the statute or the legislative history.
With regard to GAO's comments on the effect of behavioral changes, ED
does not base its cost estimates on behavioral assumptions that cannot
be supported by available data. In the absence of any supporting
evidence, ED assumes that current trends in borrower and institutional
behavior will continue. Under these assumptions, ED's cost estimate of
the California VFA is cost neutral and in compliance with statutory
requirements.
Finally, in the case of the Texas VFA cost estimate, the increase in
cost (roughly $1 million per year) was compared to the total federal
cash flows being estimated (hundreds of millions of dollars per year)
and was judged to be insignificant from a statistical point of view.
This type of judgment is a routine aspect of cost estimation in which
uncertainty with regard to future events plays such a large role.
Evaluation Of The VFAs:
GAO states that ED "cannot determine what has happened as a result of
the VFA through, for instance, comparison with past performance and
comparisons with the performance of other guaranty agencies."
ED is establishing common, general measures to evaluate the performance
of each VFA and, whenever possible, to compare VFA guaranty agency
performance with other non-VFA guaranty agencies. These measures
include:
* Analyzing the dollar percentage of loans in good standing in order to
determine the success of a guaranty agency's ability to decrease
defaults.
* Determining guaranty agency effectiveness in collections recoveries
in order to monitor the guaranty agency's ability to recover funds from
its defaulted loan portfolio.
* Assessing the ability of guaranty agencies and ED to effectively
administer the guaranty agency program without guaranty agency
reserves.
* Measuring the fees that would have been paid under the standard
guaranty agency model versus the fees that are paid under the VFAs.
* Monitoring the percentage of National Student Loan Data System
records entered correctly by the VFAs as a percentage of the total
number of possible entry records in order to measure data integrity.
In order to provide a basis for evaluating the performance of the VFA
guaranty agencies under the agreements, the performance measures will
be compared to benchmark information. For example, the measure of the
dollar percentage of loans in good standing as of a certain date does
not provide much interpretative value by itself. The performance
measure, instead, will be compared to the VFA guaranty agency's prior
period percentage in order to assess whether the VFA guaranty agency's
performance has improved or deteriorated. To the extent possible, the
VFA guaranty agency's results will be compared to the other VFA
guaranty agencies as well as to the non-VFA guaranty agencies.
ED will determine whether the terms and conditions established in each
VFA process are scalable and transferable to the wider FFEL community.
Additionally, ED will consult lenders and schools participating in each
guaranty agency's program to determine how they are affected by VFAs.
ED will also consult with guaranty agencies that are not participating
in a VFA to determine if the agreements have had an adverse impact on
other guaranty agencies.
ED has had preliminary discussions with representatives of the 36
guaranty agencies regarding the uniform performance measures. Further,
the guaranty agencies are in the process of establishing an eight-
member task force that includes VFA as well as non-VFA guaranty
agencies to assist in determining the specific formula for measuring
VFA performance. As these discussions progress, ED and the guaranty
agencies will be in a better position to determine what measures
require government mandates.
As noted in the report, the four VFAs currently in place offer the
potential for improved performance. If they lead us to more efficient
and effective methods for managing the student loan program, the
project will have been a success as envisioned in the HEA Amendments.
Thank you for this opportunity to comment on the draft report on
voluntary flexible agreements.
Sincerely,
Signed by:
William D. Hansen:
[End of section]
Appendix V: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Kelsey M. Bright, (202) 512-9037 Benjamin P. Pfeiffer, (206) 287-4832
Staff Acknowledgments:
In addition to the individuals named above, Jonathan H. Barker, Daniel
R. Blair, Christine E. Bonham, Richard P. Burkard, Timothy A. Burke,
Aaron M. Holling, Stanley G. Stenersen, and James P. Wright made key
contributions to this report.
[End of section]
Footnotes:
[1] For eligible loans first disbursed before October 1, 1993, 100
percent of the amount of the loan is insured.
[2] Authorized by the 1998 HEA amendments, the performance-based
organization concept creates a ’results-driven“ organizational
structure that uses incentives to encourage high performance while
establishing explicit performance objectives to enhance accountability.
This approach allows for greater managerial flexibility in an effort to
seek innovations and achieve efficiencies.
[3] The trigger default rate is used to calculate the level of federal
reinsurance payments to guaranty agencies. Higher default rates trigger
lower rates of reinsurance payments” payments from Education to
guaranty agencies‘ Federal funds reimbursing them for payments to
lenders for defaulted loans. The trigger default rate differs from the
more commonly used ’cohort default rates,“ which generally are the
rates at which borrowers default on their loans within 2 years of
beginning repayment.
[4] The cost of these payments was included in Education‘s overall cost
projections for the VFAs, assuming no change in agency performance.
[5] The Texas agency allows 5 additional days for receipt of the
request by mail.
[6] HSA provides for default aversion payments of one percent of the
amount of delinquent loans that the guaranty agency helps keep from
defaulting. The amounts received by each agency are subject to
independent audit requirements and Departmental audit, but Education
cannot independently calculate the amounts of the default aversion
payments based on data the guaranty agencies routinely provide to
Education.
[7] The Great Lakes calculation in based on numbers of accounts cured,
not the dollar amounts involved, and the calculation includes
delinquent loans for which default is averted whether or not the loan
had been cured before. The Texas cure rate is based on the dollar
amount of cured loans including loans that had been cured at least 12
months earlier. Texas counts loans as cured as long as they do not
result in a default claim by the end of the claim-filing deadline. The
guaranty agency with the largest portfolio of loan guarantees, United
Student Aid Funds, Inc, calculates cure rates by dividing the number of
60-day-or-more delinquent loans that become less than 60 days
delinquent by the total number of 60-day-or-more delinquent loans for
which lenders requested default aversion assistance.
[8] Uniform cure rates could be useful whether or not VFAs specify
uniquely calculated cure rates for calculating federal payments.
[9] One of five smaller guaranty agencies selected did not respond to
GAO request for input.
[10] The trigger default rates are calculated by dividing the total
annual amount of reinsurance payments for defaulted loans (adjusted for
loans brought back from default into repayment status) by the original
principal amount of loans in repayment at the end of the preceding
fiscal year.
[11] The Higher Education Act provides that this retention rate will
decline to 23 percent after fiscal year 2003. If a defaulted loan is
consolidated in the form or either a FFELP or a FDLP consolidated loan,
the agency may retain 18.5 percent.
[End of section]
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