Department of Education's Federal Direct Loan Program
Status of Recommendations to Improve Cost Estimates and Presentation of Updated Cash Flow Information
Gao ID: GAO-04-567R March 29, 2004
Under the Department of Education's Federal Direct Loan Program (FDLP), students or their parents borrow money directly from the federal government through the vocational, undergraduate, or graduate schools that students attend. FDLP offers four loan types, including consolidation loans, which allow borrowers to combine multiple loans, possibly from different federal student loan programs, into a single loan with one monthly payment and a fixed borrower interest rate. The other three FDLP loan types provide variable borrower interest rates. The reported outstanding gross balance of FDLP loans to borrowers was $84.5 billion as of September 30, 2003, and the related allowance for subsidy--or the cost Education expected to incur on the outstanding loans--was $657 million. The key driver of the FDLP cost to the government is the difference between the borrower interest rate and Education's financing cost or borrowing rate from Treasury. Because of concerns about Education's reliance on estimates to project FDLP costs and a lack of historical information on which to base those estimates, the House Committee on the Budget previously asked us to review key aspects of Education's cost estimates for FDLP. Our January 2001 report identified the need for Education to improve its cost estimation process to provide more meaningful information. Recently, at the request of the Committee's Chairman, we assessed Education's progress in addressing our January 2001 recommendations and we updated certain cash flow information related to FDLP. This letter summarizes the information provided during our briefing on February 18, 2004.
In January 2001, we reported on several key aspects of Education's cost estimates for FDLP, including its financing and cash flows. Our work identified the need for Education to make a number of improvements to provide Congress and program decision makers with more meaningful cost estimate information upon which to make timely and well-informed judgments concerning FDLP. As a result, we made five recommendations for Education to improve its subsidy cost estimate information. Since our last report, we found that Education has taken actions that substantially addressed three of our five prior recommendations. To address our recommendation to develop a method to acquire actual FDLP cash flow data on the same basis as the cash flow model, Education implemented a data system to readily acquire such FDLP actual data that could be used to facilitate a detailed comparison of estimated and actual loan performance. To address our recommendation to develop an approach to directly factor consolidations into the cash flow model, Education conducted an analysis of loan payoff patterns resulting from consolidations and used this analysis to develop prepayment assumptions that directly factor consolidations into the cash flow model. To address our recommendation to prepare interest rate reestimates, Education implemented procedures to prepare interest rate reestimates for its budget submissions and financial statements. While Education made important improvements to its cost estimate information, it has not taken action to fully resolve our recommendations to (1) formalize sensitivity analysis of its cash flow model assumptions to ensure that the most significant assumptions are identified, or (2) develop and implement a method of comparing detailed estimated and actual cash flows to more thoroughly assess loan performance estimates over time. Education officials agreed that additional procedures related to sensitivity analysis and comparing estimated and actual loan performance would be beneficial. We updated FDLP cash flow information presented in our 2001 report. Amounts borrowed from Treasury totalled $137 billion from fiscal years 1995 through 2003, of which about $92 billion was outstanding as of September 30, 2003. Appropriations received, which are meant to cover the estimated subsidy cost of the program, totalled about $2.7 billion for loans approved during fiscal years 1995 through 2003. From fiscal years 1995 through 2003, total cash outflows exceeded total cash inflows by about $10.7 billion, mainly because interest Education paid to Treasury was significantly greater than interest receipts from borrowers. Over this same period, FDLP's actual key cash flows (principal receipts, interest receipts, origination fees, and collections on defaults) were less than estimated by about $4.2 billion. Over the course of our work, we noted that Education did not disclose in its fiscal year 2003 financial statements an explanation of significant factors affecting a reestimate of about $5.1 billion, as required by Statement of Federal Financial Accounting Standards No. 18. While this information was available, agency officials told us that it was not included in the financial statement disclosures because the disclosures were already very lengthy.
Recommendations
Our recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
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GAO-04-567R, Department of Education's Federal Direct Loan Program: Status of Recommendations to Improve Cost Estimates and Presentation of Updated Cash Flow Information
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March 29, 2004:
The Honorable Jim Nussle:
Chairman, Committee on the Budget:
House of Representatives:
Subject: Department of Education's Federal Direct Loan Program: Status
of Recommendations to Improve Cost Estimates and Presentation of
Updated Cash Flow Information:
Dear Mr. Chairman:
Under the Department of Education's Federal Direct Loan Program (FDLP),
students or their parents borrow money directly from the federal
government through the vocational, undergraduate, or graduate schools
that students attend. FDLP offers four loan types, including
consolidation loans, which allow borrowers to combine multiple loans,
possibly from different federal student loan programs, into a single
loan with one monthly payment and a fixed borrower interest rate. The
other three FDLP loan types provide variable borrower interest rates.
The reported outstanding gross balance of FDLP loans to borrowers was
$84.5 billion as of September 30, 2003, and the related allowance for
subsidy[Footnote 1]--or the cost Education expected to incur on the
outstanding loans--was $657 million. The key driver of the FDLP cost to
the government is the difference between the borrower interest rate and
Education's financing cost or borrowing rate from Treasury.
Because of concerns about Education's reliance on estimates to project
FDLP costs and a lack of historical information on which to base those
estimates, the Committee previously asked us to review key aspects of
Education's cost estimates for FDLP. Our January 2001 report[Footnote
2] identified the need for Education to improve its cost estimation
process to provide more meaningful information. Recently, at your
request, we assessed Education's progress in addressing our January
2001 recommendations and we updated certain cash flow information
related to FDLP. This letter summarizes the information provided during
our briefing to your office on February 18, 2004. The enclosed briefing
slides highlight the results of our work and the information provided
at the briefing.
Results in Brief:
In January 2001, we reported on several key aspects of Education's cost
estimates for FDLP, including its financing and cash flows. Our work
identified the need for Education to make a number of improvements to
provide Congress and program decision makers with more meaningful cost
estimate information upon which to make timely and well-informed
judgments concerning FDLP. As a result, we made five recommendations
for Education to improve its subsidy cost estimate
information.[Footnote 3] Since our last report, we found that Education
has taken actions that substantially addressed three of our five prior
recommendations. To address our recommendation to develop a method to
acquire actual FDLP cash flow data on the same basis as the cash flow
model,[Footnote 4] Education implemented a data system to readily
acquire such FDLP actual data that could be used to facilitate a
detailed comparison of estimated and actual loan performance. To
address our recommendation to develop an approach to directly factor
consolidations into the cash flow model, Education conducted an
analysis of loan payoff patterns resulting from consolidations and used
this analysis to develop prepayment assumptions that directly factor
consolidations into the cash flow model. To address our recommendation
to prepare interest rate reestimates,[Footnote 5] Education implemented
procedures to prepare interest rate reestimates for its budget
submissions and financial statements.
While Education made important improvements to its cost estimate
information, it has not taken action to fully resolve our
recommendations to (1) formalize sensitivity analysis[Footnote 6] of
its cash flow model assumptions to ensure that the most significant
assumptions are identified, or (2) develop and implement a method of
comparing detailed estimated and actual cash flows to more thoroughly
assess loan performance estimates over time. Education officials agreed
that additional procedures related to sensitivity analysis and
comparing estimated and actual loan performance would be beneficial and
a recently formed working group will consider additional procedures
related to these issues.
We updated FDLP cash flow information presented in our 2001 report
related to (1) borrowing from Treasury, (2) appropriations received,
(3) cash inflows and outflows, and (4) comparisons of estimated and
actual key cash flows. Amounts borrowed from Treasury, which are
expected to be repaid using borrower payments in future years, totalled
$137 billion from fiscal years 1995 through 2003, of which about $92
billion was outstanding as of September 30, 2003. Appropriations
received, which are meant to cover the estimated subsidy cost of the
program, totalled about $2.7 billion for loans approved during fiscal
years 1995 through 2003.[Footnote 7] From fiscal years 1995 through
2003, total cash outflows exceeded total cash inflows by about $10.7
billion,[Footnote 8] mainly because interest Education paid to Treasury
was significantly greater than interest receipts from borrowers. This
is primarily because Education is required to make interest payments to
Treasury, even if borrowers are not making interest payments to
Education, which could occur when borrowers are in school or in a grace
or deferment period. Over this same period, FDLP's actual key cash
flows (principal receipts, interest receipts, origination fees, and
collections on defaults) were less than estimated by about $4.2
billion, primarily because Education overestimated interest receipts by
about $6.1 billion. According to Education officials, interest receipts
are a difficult cash flow to estimate because of complexities
associated with periods during which students are not required to make
interest payments. However, they told us that they would continue to
analyze the interest calculations in the cash flow model in order to
improve the estimates.
Over the course of our work, we noted that Education did not disclose
in its fiscal year 2003 financial statements an explanation of
significant factors affecting a reestimate of about $5.1 billion, as
required by Statement of Federal Financial Accounting Standards No. 18,
Amendments to Accounting Standards for Direct Loans and Loan
Guarantees. While this information was available, agency officials told
us that it was not included in the financial statement disclosures
because the disclosures were already very lengthy. Financial statement
disclosures that explain significant factors contributing to
reestimates, including changes in borrower rates, would provide
Congress and other program decision makers with more meaningful cost
estimation information about FDLP.
Recommendation:
To provide more meaningful cost estimate information that can be
effectively used by Congress and program decision makers to make timely
and well-informed judgments about FDLP, we are making one new
recommendation. We recommend that the Department of Education's Chief
Financial Officer take the following action:
Provide additional financial statement disclosures that explain the
significant factors, including the effect of changes in borrower
interest rates, contributing to reestimates of FDLP, as required by
established accounting guidance.
Agency Comments:
In oral comments the director of Education's Cost Estimation and
Analysis Division agreed with the findings, conclusions, and
recommendation in our briefing slides.
Scope and Methodology:
To determine what steps Education has taken to address our prior
recommendations, we:
* interviewed knowledgeable Education officials to obtain an
understanding of the actions they had taken since our prior report,
* obtained and evaluated supporting documentation provided by Education
to determine if Education's actions resolved the previously identified
weaknesses, and:
* used guidance issued by the Office of Management and Budget to
determine if Education's actions comply with applicable budget
guidance.
To update cash flow information from our prior report, we:
* reviewed Education's audited financial statements for fiscal years
2000 to 2003 and Appendices to the President's Budget for fiscal years
2002 to 2005, and:
* obtained schedules of original FDLP subsidy estimates and reestimates
for fiscal years 2000 to 2004 and schedules of estimated and actual
FDLP cash flows (principal receipts, interest receipts, loan
origination fees, and collections on defaults) for fiscal years 2000 to
2003 from Education.
We verified the updated cash flow information to Education's financial
statements, budget documents, or other available source documents. We
did not test the reliability of data included in Education's new data
system or data used by Education to develop new assumptions.
We conducted our work from October 2003 through February 2004 in
accordance with generally accepted government auditing standards. We
requested and received oral comments on a draft of our briefing slides
from cognizant Education officials.
We are sending copies of this report to the Secretary of Education, the
Chief Financial Officer, and other interested parties.
This report is available at no charge on our home page at http://
www.gao.gov. If you have any questions about this report, please
contact me at (202) 512-8341 or Phil McIntyre, Assistant Director, at
(202) 512-4373. You may also reach us by e-mail at calboml@gao.gov or
mcintyrep@gao.gov. Key contributors to this assignment were Marcia
Carlsen and Brooke Whittaker.
Sincerely yours,
Linda M. Calbom:
Director, Financial Management and Assurance:
Enclosure:
[See PDF for slides]
[End of section]
FOOTNOTES
[1] The allowance for subsidy is a financial statement reporting
account used to recognize the costs of a loan program that are not
expected to be recovered from borrowers, including default costs,
subsidized interest payments, and financing costs.
[2] U.S. General Accounting Office, Department of Education: Key
Aspects of the Federal Direct Loan Program's Cost Estimates, GAO-01-197
(Washington, D.C.: January 2001).
[3] As agreed with your office, our review did not include assessing
Education's actions to address our January 2001 recommendation related
to Education's administrative cost system.
[4] The cash flow model uses assumptions, data, and calculations to
estimate future loan performance and the estimated cost of the program.
[5] Agencies are required to periodically update or "reestimate" loan
program costs. An "interest rate reestimate" adjusts the cost for the
effect of changes in interest rates while loans are disbursing. The
"technical/default reestimate" adjusts the cost for the effect of
changes in loan performance, as well as changes in interest rates,
after loans are substantially disbursed (more than 90 percent).
[6] Sensitivity analysis is a process used to identify the cash flow
assumptions, which, when adjusted, have the greatest impact on the
estimated subsidy cost.
[7] The estimated FDLP subsidy cost could fluctuate (increase or
decrease) significantly in the future depending on actual loan
performance and changes in interest rates.
[8] Our January 2001 report defined cash inflows for FDLP as loan
origination fees and interest receipts from borrowers and defined cash
outflows as net interest payments on Treasury borrowing. The same
definitions were used for our briefing.
