Department of Education's Federal Direct Loan Program: Status of 
Recommendations to Improve Cost Estimates and Presentation of	 
Updated Cash Flow Information (29-MAR-04, GAO-04-567R). 	 
                                                                 
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.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-04-567R					        
    ACCNO:   A09611						        
  TITLE:     Department of Education's Federal Direct Loan Program:   
Status of Recommendations to Improve Cost Estimates and 	 
Presentation of Updated Cash Flow Information			 
     DATE:   03/29/2004 
  SUBJECT:   Cost analysis					 
	     Direct loans					 
	     Financial statements				 
	     Loan interest rates				 
	     Projections					 
	     Student loans					 
	     Subsidies						 
	     Aid for education					 
	     Cost estimates					 
	     Dept. of Education Federal Direct Loan		 
	     Program						 
                                                                 

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GAO-04-567R

United States General Accounting Office Washington, DC 20548

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 subsidy1-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 report2 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

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).

                        GAO-04-567R FDLP Cost Estimates

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.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,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,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 analysis6 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

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.

Page 2

GAO-04-567R FDLP Cost Estimates

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
2003.7 From fiscal years 1995 through 2003, total cash outflows exceeded
total cash inflows by about $10.7 billion,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:

o  	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.

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.

Page 3

GAO-04-567R FDLP Cost Estimates

Scope and Methodology

To determine what steps Education has taken to address our prior
recommendations, we

o  	interviewed knowledgeable Education officials to obtain an
understanding of the actions they had taken since our prior report,

o  	obtained and evaluated supporting documentation provided by Education
to determine if Education's actions resolved the previously identified
weaknesses, and

o  	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

o  	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

o  	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 [email protected] or
[email protected]. Key contributors to this assignment were Marcia Carlsen
and Brooke Whittaker.

Sincerely yours,

Linda M. Calbom Director, Financial Management and Assurance

Enclosure

Page 4

GAO-04-567R FDLP Cost Estimates

(190121)

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