Student Loans: Potential Effects of Raising Statutory Audit Threshold

Published by the Government Accountability Office on 1997-05-20.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

United States
w-n,          l&c. 20646

Health, Edncation, and

May 20, 1997
The Honorable Thomas W. Ewing
House of Representatives
                              .                                  .
Subject: Student Loans: Potentml Effects of Raising Statutorv Au&t Threshold

Dear Mr. Ewing:

The Higher Education Amendments of 1992required all lenders who
participated in the Federal Family Education Loan Program (FFELP) to obtain
an annuai audit examining compliance with program rules and regulations.
Typically, these lenders are banks and other institutions that make FFELP
student loans that are ultimately guaranteed by the government against default
or nonpayment. In the approptiations acts for the Department of Education for
fiscal years 1996 and 1997,the Congress exempted from the audit requirement
those lenders with loan portfolios of $5 million or less (that is, the lender audit
threshold was $5 mUlion). The Department has directed that lenders with loan
portfolios of between $5 million and $10 million to submit their audit reports to
the Department only if they contain findings that require corrective action. For
those lenders whose portfolios exceed $10 million, the Department requires
submission of all audit reports.

You asked us for information about the potential effects of raising the audit
threshold to lenders with loan portfolios that exceed $10 million. As agreed
with your office, we focused on identifying
- the number of lenders with loan portfolios between $5 million and $10
  milhon, and the total loan volume in these lenders’ portfolios; and
- the number, types, monetary impact, and disposition of audit findings
  reported to the Department of Education by lenders with loan portfolios in
  that range.
We obtained
   .  .     data for our analyses from the Department of Education, which
adnnmsters FFELP. Student loan volwnes were as of the end of fiscal year
1995,the most recent year for which data for such an analysis were available.

                                      GAOIHEHS-97-111lZ   FFELP   Lender   Audit   Threshold

We conducted our work between January and March 1997in accordance with
generally accepted government auditing standards.

If the loan volume audit exemption was extended to lenders with loan portfolios
between $5 nrillion and $10 million, relatively few of the more than 5,700
lenders participating in FFELP would be affected. In fiscal year 1995, 193
FFELB lenders (about 3 percent) had loan portfolios between $5 million and $10
million. These lenders held less than 2 percent of the total outstanding FF’ELB
loan volume. If the audit threshold had been $10 million for fiscal year 1995,
the audit requirement would have applied to a total of about 9 percent of
 FF’ELBlenders-lenders that collectively held about 96 percent of outstanding
 FFELP loan volume in fiscal year 1995.
Sixteen of the 193lenders with loan portfolios between $5 million and $10
million submitted audit reports that contained findings requiring corrective
action. Lenders with portfolios of this size do not have to submit audit reports
to the Department unless they contain these kinds of findings. The 16 audit
reports contained 31 findings covering such areas as missing documents in loan
files, incorrect billing calculations, and improper classifications of loans. Three
reports had findings with a monetary impact-collectively, the Department owed
lenders $8,751. As of January 1997,all but 1 of the 16 lenders had taken
corrective action.


FFELP is the largest federal student loan program. Under the program,
participating lenders make loans to eligible borrowers. The Department,
through state-designatedagencies,guaranteesthe loans against default. In
fiscal year 1995,lenders made FFELP loans that totaled nearly $22 billion.

For some time, the Congress and the Department have considered how audit
requirements should apply to FFELI? lenders. The 1992amendmentsrequired
every FFELP lender to obtain an annual audit examining compliance with
program rules and regulations. However, lenders with smaller student loan
portfolios complained that the cost of conducting the audit could exceed their
profit on the portfolios. Fiscal years’ 1996and 1997appropriations acts
directed the Department not to use federal funds to enforce the audit
requirement for lenders with annual loan portfolios of $5 million or less.

                                       GAOflBEHS-97-111R   FFRLP Lender   Audit   Threshold
Two bills introduced in the 104th Congressproposed a more permanent
legislative revision than the temporary change contained in the two
appropriations acts. Both bills would have amendedthe Bigher Education Act
to eliminate audits of lenders with loan portfolios of $10 million or less. The
topic remains under congressional consideration as the 105th Congress begins
deliberating the reauthorization of the Bigher Education Act.

Lenders with outstanding loan portfolios between $5 million and $10 million
constitute a relatively small potion of FFELP lenders. Department of
Education records show that as of September30,1995, 5,765lenders were
participating in FFELP.l Of these, 193lenders (3.3 percent) had portfolios
between $5 million and $10 million. In comparison, about 38 percent of lenders
had loan portfolios of less than $5 million (accounting for 2.9 percent of the
total amount of outstanding loans), and current appropriations law excludes
them from the audit requirement.

Lenders with FFELP portfolios between $5 million and $10 million also held a
small portion of the total amount of outstanding loans. In aggregate,these
lenders’ portfolios had about $1.4 billion in FFELP loans, about 1.5 percent of
the $93 billion in FFELP loans held by all lenders at the end of fiscal year 1995.
By contrast, the relatively few lenders with loan portfolios of $10 million or
more held nearly 96 percent of outstanding FFELP loans. Thus, as figure 1
shows, (1) the current audit requirement extends to relatively few lenders, but
covers the vast majority of loan volume, and (2) audit coverage would not be
appreciably changed if the audit threshold was raised to $10 million.

‘This figure is based on the number of lender identification numbers contained
in “Lender’s Interest and Special Allowance Requestand Reports” (ED form 799)
on file with the Department as of September30, 1995. The actual number of
lenders may be somewhat lower than 5,765,according to Department officials,
because some lenders, especially those with large volumes of loans, may have
more than one identification number.

3                                    GAOIEEHS-97-1llR   F’FELP Lender   Audit   Threshold
Figure 1: Distribution of Lenders and Their Loan Volume bv
Size of Lender Portfolios in Fiscal Year 1995
Number of Lenders                                                             Loan Volume (in Billions)
5500         1                  Proposed Exemption -.                                            -     100

5000                                                                                             -    90

4500 -
                                                                                                 -    80
4000 -
                                                                                                 -    70
3500 -
                                                                                                 -    60
3000 -
                                                                                                 -    50
2500 -
                                                                                                 -    40
2000 -
                                                                                                 -    30
1500 -

                                                                                                 -    20
1000 -

 500 -                                                                                           -     10

     0                                                                                               i 0
                   Less Than $5 Million     $5 Million to $10 Million   $10 Million or More
         Size of Outstanding    Loan Portfolio

         m       Total Loan Volume


The Department requires lenders that have loan portfolios above $5 million to
have audits conducted. And the Department instructed lenders with portfolios
between $5 million and $10 million to submit their audit reports to the
Department by September30, 1995,only if their reports issued for the previous
2 years contained findings that require corrective action. The Department
received audit reports from 16 lenders whose loan portfolios were within the $5
million and $10 ntillion threshold, and that had audits requiring corrective

 4                                                            GAOEIEHS-97-1llR        FFCELP Lender          Audit   Threshold
action in calendar years 1993or 1994.2 The aggregateloan portfolio for these
lenders was about $95 million and $117mihion, respectively, in calendar years
 1993and 1994.

The 16 audit reports contained 31 findings that required corrective action. The
number of findings in each report ranged from one (seven lenders) to four (two
lenders). The Department classified the 31 findings into 15 categories, as
shown in table 1. The most common finding (noted in four reports) was the
improper recording of prior-period adjustments of special allowance payments.3
For this finding, the audit reports questioned whether lenders properly recorded
billing codes and used the correct loan principal and billing days.
Table 1: Audit Reuort Firings, bv Cateaorv, Calendar Years
1993and 1994

                               Flndixlg                                          Frequency
    Prior period special allowance adjustments were improperly                                 4
    Form 799 (Lender’s Interest and Special Allowance Request
    and Report) information did not agree with information in
    lender’s summary accounting records.
    Form 799 contained improperly classified loan types or
    incorrect loan status.

II  Lender’s loan files missing documents required to support form

II  Form 799 showed inaccurate average daily balances of loans in
    lender’s nortfolio.                                           I

department guidance provides that reports from the initial round of compliance
audits were to be submitted by September 30, 1995, and were to cover the 2
years ending December 31, 1994.
%peeial allowance is a payment of interest on a student loan that the
government makes to lenders when borrowers’ interest rates do not meet a
certain level of return, as provided by the Higher Education Act of 1965,as
5                                         GAO/HfZHS-97-11I.R   FFELP   Lender   Audit   Threshold

  Form 799 showed lender’s improper recording of prior-period                            3
  kijustment of interest benefits.
  Form 799 did not agree with loan disbursement, origination                             2
  Fee,or loan fee records.
  Form 799 contained inaccurate information on change in loan                            2
  principal and analysis of loan portfolio.
  Form 799 loan information did not agree with billing                                   2
  information provided by third-party loan servicer.
  Lender improperly calculated loan origination fees.                                    1
  Lender did not stop billing the Department for interest                                1
  payments on the same date the loan entered repayment.
  Lender misclassified loan or used improper tune period for                              1
  special allowance billing on form 799.
  Lender improperly calculated loan balancesusing a monthly                               1
  rather than a daily average.
  Lender failed to exclude from form 799 special allowance                                1
  billings for loans that had outstanding loan servicing violations.
  Lender did not adequately segregateduties (for internal control                         1
  purposes) in its student lending operation.
  Total findings                                                                        31   d

The Department’s review of the 16 audit reports identified three lenders whose
findings had questioned the dollar amount paid to lenders. The audits showed
that two of these lenders owed the Department $5,168and $4,809,respectively.
However, the audit of the third lender revealed that the lender understated the
interest payment it was due by $18,728. As a result, the net impact of the
findings noted in the three reports was that the Department owed lenders an
additional $8,751.
 As of January 1997,the Deparunent had verified that 15 of the 16 lenders had
 taken corrective action as specified in the audit reports. A Department review
 showed that the remaining lender had not completed its corrective action plan,
 which called for five actions to improve the data the lender reported to the
 Department. The Department’s review also uncovered several other
 deficiencies that were not noted in the audit report, such as the lender failing to
 pay about $9,500in required lender fees to the Department. Department
 6                                     GAO/HJZHS-97-1llR   FF’ELP Lender   Audit   Threshold
off&& have requested the Department’s Office of Inspector General to further
review this case and the work of the lender’s independent auditor.
To help ensure that lenders with loan portfolios between $6 million and $10
million comply with Department requirements, in February 1997the Department
requested copies of audit reports from 25 randomly selected lenders from this
group. As of April 30, 1997,the Department had received all but two of the
requested reports, and its evaluation of these reports indicated that lenders had
complied with the lender audit requirement.

On April 18, 1997,the Department of Education provided comments on a draft
of this correspondence. The Department agreed with our correspondence and
provided a number of technical comments, which we incorporated where

We are sending copies of this correspondenceto appropriate congressional
committees, the Secretary of Education, and other interested parties.

If you have any questions about this correspondence,please contact me on
(202) 6127014. Major contributors included Joseph J. Eglin, Jr., Assistant
Director; Robert B. Miller; and Charles M. Novak.
Sincerely yours,

Carlotta C. Joyner
Director, Education and
 Employment Issues


7                                   GAOBIEHS-97.1llB   F’FELP Lender   Audit   Threshold
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