Higher Education: Trustee Arrangements Serve Useful Purpose in Student
Loan Market (Letter Report, 09/25/2000, GAO/HEHS-00-170).

Pursuant to a congressional request, GAO provided information on student
loan trustee arrangements, focusing on the: (1) number and cost of
trustee arrangements and their shared characteristics; (2) benefits and
protections afforded the federal government through use of trustee
arrangements; and (3) effect of trustee arrangements on market
participation and the availability of student loans.

GAO noted that: (1) the Department of Education reports that
approximately 125 trustee arrangements exist between 16 eligible lender
trustees and 31 ineligible lenders for the purpose of originating or
purchasing student loans; (2) these arrangements account for $25.3
billion in outstanding loans--approximately 19 percent of the
outstanding balance of all Federal Family Education Loan Program (FFELP)
loans as of December 1999; (3) costs of trustee arrangements fall into
two categories--costs to initiate the arrangement and annual costs to
maintain it; (4) ineligible lenders GAO interviewed said, that the costs
did not prohibit them from conducting business in the student loan
market; (5) the amount charged by an eligible lender for its trustee
services varied and was based on the volume of loans the ineligible
lender was anticipated to originate and on the number and kind of other
services the trustee provided; (6) both eligible and ineligible lenders
reported little, if any, change in the availability of lenders to serve
as trustees or the costs of these arrangements since 1998; (7) several
characteristics were common among the trustee arrangements GAO reviewed,
including the criteria used by trustees to evaluate ineligible lenders
before they entered into trustee arrangements, the various elements of
the trustee arrangement contracts, and the day-to-day interaction
between the trustee and the ineligible lender; (8) trustee arrangements
come with some protections to ensure the federal government's investment
in FFELP is secure while allowing ineligible lenders to participate in
the program; (9) most financial institutions that serve as eligible
lender trustees are subject to federal oversight; (10) because most
eligible lender trustees also hold student loans in their own name and
receive regular FFELP-related payments from the government for those
loans, the federal government has recourse for recovering any repayments
due the government on ineligible lenders' loans that lose the federal
guarantee; (11) Education officials stated that because ineligible
lenders are generally not subject to financial safety and soundness
reviews by government agencies, Education lacks assurance that these
lenders would be able to meet their financial obligations in the
program; and (12) both eligible and ineligible lenders said they believe
that market participation and loan availability are positively affected
by trustee arrangements which allow lenders to make and hold loans.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  HEHS-00-170
     TITLE:  Higher Education: Trustee Arrangements Serve Useful
	     Purpose in Student Loan Market
      DATE:  09/25/2000
   SUBJECT:  Student loans
	     Risk management
	     Internal controls
	     Lending institutions
	     Loan repayments
IDENTIFIER:  Federal Family Education Loan Program

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GAO/HEHS-00-170

Appendix I: Scope and Methodology

18

Appendix II: Comments From the Department of Education

20

Appendix III: GAO Contacts and Staff Acknowledgments

21

22

Table 1: Outstanding Balance of Student Loans Held via Trustee Arrangements
9

FFELP Federal Family Education Loan Program

HEA Higher Education Act of 1965

SAP special allowance payments

Health, Education, and
Human Services Division

B-284774

September 25, 2000

The Honorable James M. Jeffords
Chairman, Committee on Health, Education,
Labor, and Pensions
United States Senate

Dear Mr. Chairman:

In fiscal year 1999, approximately $20 billion in loans were made to student
borrowers to help meet their college expenses by lenders participating in
the Federal Family Education Loan Program (FFELP).1 However, because some of
these lenders do not meet the definition of an eligible lender in the Higher
Education Act (HEA) of 1965 and its amendments, they can only participate in
the program via a trustee arrangement with an eligible lender. In 1998, HEA
was amended to include a provision stating that eligible lenders that serve
as trustees are responsible for meeting statutory and regulatory
requirements for the loans they hold as trustees.2

Recently, your Committee raised concerns about the use of trustee
arrangements and whether the trustee requirements under the 1998 amendments
to HEA have led to a reduced number of eligible lenders willing to serve as
trustees and to increased costs for ineligible lenders entering into these
arrangements. Because of these concerns and questions regarding the
usefulness of trustee arrangements, you asked us to determine (1) the number
and cost of trustee arrangements and their shared characteristics, (2) the
benefits and protections afforded the federal government through use of
trustee arrangements, and (3) the effect of trustee arrangements on market
participation and the availability of student loans. In conducting this
work, we interviewed a variety of key participants in the student loan
market, including federal officials, eligible lenders, ineligible lenders,
guaranty agencies, and loan servicing organizations. We also surveyed
eligible and ineligible lenders participating in trustee arrangements to
verify their current status and to determine the nature of their
participation in the student loan program. We conducted our work between
November 1999 and July 2000 in accordance with generally accepted government
auditing standards. (A more detailed discussion of our scope and methodology
appears in app. I.)

The Department of Education reports that approximately 125 trustee
arrangements exist between 16 eligible lender trustees and 31 ineligible
lenders for the purpose of originating or purchasing student loans.3 These
arrangements account for $25.3 billion in outstanding loans--approximately
19 percent of the outstanding balance of all FFELP loans as of December
1999. Costs of trustee arrangements fall into two categories--costs to
initiate the arrangement and annual costs to maintain it. According to the
ineligible lenders we interviewed, the costs--which ranged from $2,500 to
$20,000 for initiation fees and from $4,500 to $75,000 for annual fees--did
not prohibit them from conducting business in the student loan market. The
amount charged by an eligible lender for its trustee services varied and was
based on the volume of loans the ineligible lender was anticipated to
originate and on the number and kind of other services the trustee provided.
In addition, both eligible and ineligible lenders reported little, if any,
change in the availability of lenders to serve as trustees or the costs of
these arrangements since 1998. Several characteristics were common among the
trustee arrangements we reviewed, including the criteria used by trustees to
evaluate ineligible lenders before they entered into trustee arrangements,
the various elements of the trustee arrangement contracts, and the
day-to-day interaction between the trustee and the ineligible lender. For
example, most trustees consider the business reputation of the ineligible
lender and the loan servicing organization chosen by the ineligible lender
in deciding whether to enter into an arrangement.

Trustee arrangements come with some protections to ensure the federal
government's investment in FFELP is secure while allowing ineligible lenders
to participate in the program. For example, HEA holds eligible lenders fully
responsible for any loans they hold as trustees for ineligible lenders,
including loans that lose the federal guarantee due to problems such as
lender negligence. Because these problems may not be discovered until after
the government has paid the guaranteed amount, this HEA provision allows the
federal government to recoup any losses from the eligible lender trustee
rather than the ineligible lender. Education officials believe the
government is likely to recover its losses from trustees for two reasons.
First, most financial institutions that serve as eligible lender trustees
are subject to federal (and in many instances, state) oversight. For
example, bank regulators promulgate regulations and policies that prescribe
safe and sound banking activities and examine banks to assess their safety
and soundness. Second, because most eligible lender trustees also hold
student loans in their own name and receive regular FFELP-related payments
from the government for those loans, the federal government has recourse for
recovering any repayments due the government on ineligible lenders' loans
that lose the federal guarantee. Education officials stated that because
ineligible lenders are generally not subject to financial safety and
soundness reviews by government agencies, Education lacks assurance that
these lenders would be able to meet their financial obligations in the
program.

Both eligible and ineligible lenders said they believe that market
participation and loan availability are positively affected by trustee
arrangements because such arrangements allow lenders that do not meet HEA's
eligible lender definition to make and hold loans. These lenders said that
the presence of additional lenders in the market increases competition and
thus helps to enhance the products and services lenders offer to students.
However, ineligible lenders said that two factors--HEA requirements and the
general evolution of financial markets--could affect their continued
participation in the future. For example, HEA currently limits the
proportion of student loans certain eligible lenders can hold in relation to
other holdings, and strict application of this provision would require
eligible lenders to include loans held as a trustee in their calculations.
Education officials acknowledged that Education currently interprets the
provision as not including trustee-held loans but has inconsistently applied
this provision in the past, resulting in confusion among eligible and
ineligible lenders as to which lenders can serve as a trustee. In addition,
ineligible lenders reported that the number of available trustees has
decreased as banks have merged with each other in recent years. We are
recommending that Education formally clarify the agency's interpretation of
the HEA trustee-related provision. In commenting on this report, Education
agreed with this recommendation.

Education administers and oversees federal student aid programs authorized
by HEA, monitors participants' activities, and establishes program
requirements. Among these financial aid programs is FFELP. The five
principal entities involved in FFELP are students, schools, lenders,
guaranty agencies,4 and Education. At schools participating in FFELP,
students apply to a participating lender for a loan. The school verifies the
student's eligibility and determines the loan amount the student is eligible
to receive. The student then receives the loan from the lender. The guaranty
agency guarantees the loan against default. The guaranty agency is the
intermediary between Education and the lender, insuring the loan against
default and making certain that the lender and the school meet program
requirements. The lender is responsible for servicing and collecting the
loan, and, if the student defaults on the loan, the lender files a claim
with the guaranty agency for reimbursement of most of its loss.5 Education
reimburses guaranty agencies for most of their claims paid to lenders for
defaulted loans and for some of their administrative costs. Most lenders
contract with a third-party entity to service the loan and collect payments
from borrowers.

HEA designates which entities are eligible to make FFELP loans to students.
In general, an eligible lender is defined as

ï¿½ under certain circumstances, a national or state chartered bank, a mutual
savings bank, a savings and loan association, a stock savings bank, or a
credit union;

ï¿½ a pension fund as defined in the Employee Retirement Income Security Act;

ï¿½ an insurance company that is subject to examination and supervision by an
agency of the United States or a state;

ï¿½ in any state, a single agency of the state or a single nonprofit private
agency designated by the state;

ï¿½ under certain circumstances, an eligible institution6;

ï¿½ under certain circumstances, the Student Loan Marketing Association or the
Holding Company of the Student Loan Marketing Association, including any
subsidiary of the Holding Company, or an agency of any state functioning as
a secondary market;

ï¿½ under certain circumstances, a guaranty agency;

ï¿½ a Rural Rehabilitation Corporation;

ï¿½ under certain circumstances, any nonprofit private agency functioning in
any state as a secondary market; and

ï¿½ a consumer finance company subsidiary of a national bank.

The majority of organizations making loans to students fall into one of
these eligible lender categories. However, organizations that do not meet
HEA criteria may still participate in FFELP by contracting with an eligible
lender to serve as its trustee.7 These ineligible lenders fall into two
categories: (1) secondary markets8 that have not been designated as an
eligible lender for a state and (2) private companies that wish to make and
hold student loans.9

Ineligible lenders generally contract with trustees for three purposes.
First, ineligible lenders contract with trustees to allow the ineligible to
originate student loans or to purchase them from another originating lender.
Second, ineligibles use trustees to securitize portfolios of student
loans.10 Third, trustees are used when ineligibles need to raise the capital
necessary to make or purchase student loans without securitizing other
loans. For example, some secondary markets raise capital by selling
tax-exempt bonds to investors. This report is concerned primarily with
trustee arrangements used to enable ineligible lenders to make and hold
student loans.

At FFELP's outset the government expected to share the program's financial
risks with state-designated guaranty agencies. However, when states failed
to establish such agencies, the Congress enacted legislation with several
incentives to increase lender and guaranty agency participation. For
example, the Congress provided federal funds for guaranty agencies to use as
seed money to pay claims to lenders. In providing these incentives, the
Congress kept the financial risk almost entirely with the federal
government. The Congress has since shifted some risk back to the guaranty
agencies and lenders by reducing the maximum reimbursement and insurance
rates on defaulted loans. These actions were intended to encourage both
lenders and guaranty agencies to work with borrowers to prevent them from
defaulting on their loans. Apart from the defaults that occur when borrowers
fail to repay their loans, some loans lose their federal guarantee because
lenders, servicers, or guaranty agencies fail to follow the Department's
requirements for making, servicing, and collecting loans or because of
fraudulent activity at these organizations. When these latter circumstances
occur, Education may assess penalties, refuse to make future payments, or
recover payments already made to lenders and agencies for such things as
interest subsidies and insurance claims. In 1998, HEA was amended to include
a provision stating that eligible lenders that act as trustees are
responsible for meeting statutory and regulatory requirements for the loans
they hold as trustees.

Loss of the federal guarantee due to servicer problems has occurred under
the auspices of trustee arrangements in the past. For example, in the late
1980s, Bank of America served as trustee for the California Student Loan
Finance Corporation--a California secondary market. Education determined
that the loan servicer, United Education and Software Company, failed to
transfer certain information to its new computer system and then created a
computer program that falsely added collection activity information for a
large volume of loans held by the secondary market. As a result, student
loans totaling approximately $400 million lost their federal guarantee.
However, servicer problems that may result in loan guarantee loss can also
occur on loans held by eligible lenders and are not unique to trustee
arrangements.

and Share Several Characteristics

The Department of Education reports that approximately 125 trustee
arrangements exist between eligible and ineligible lenders. These
arrangements account for $25.3 billion in outstanding loans--approximately
19 percent of the outstanding balance of all FFELP loans as of December
1999.11 The 125 arrangements represent liaisons between 16 eligible lender
trustees and 31 ineligible lenders. Ineligible lenders can be further
grouped as 17 secondary markets and 14 other ineligibles. Table 1 shows the
outstanding balance of loans held via trustee arrangements for the two
categories of ineligible lenders.

 Category of ineligible lendera Outstanding loan balanceb
 Secondary markets (17)         $11.2 billion
 Other ineligible lenders (14)  $14.1 billion

aNumbers in parentheses indicate number of lenders in category.

bAs of December 1999 (the most complete information available from Education
as of July 2000).

Source: Department of Education FFELP Lender Database.

Costs of trustee arrangements fall into two categories--payments to initiate
the agreement and annual fees to maintain it. The ineligible lenders we
interviewed reported that initiation costs were generally a flat fee ranging
between $2,500 and $20,000. Some of these ineligible lenders, such as some
secondary markets, reported that their trustee (who serves as trustee for
raising capital as well as for originating and purchasing loans) charged
this initiation fee each time they issued bonds to raise capital. Annual
trustee fees reported by ineligible lenders ranged between $4,500 and
$75,000, depending on a number of factors. These lenders reported that the
fees could be a flat fee or calculated as a percentage of outstanding loan
balances or on the outstanding balance of bond issues. Ineligible lenders
reported that annual costs are used to maintain the arrangement and cover
the necessary services provided by the trustee, such as transferring
documents between the trustee and the ineligible lender for signature,

handling paperwork associated with the guarantors and servicers involved in
the loan transactions, and carrying out administrative activities associated
with obtaining financing to originate or purchase loans. Some eligible and
ineligible lenders reported that a variety of other factors could influence
the size of both initiation and annual fees. Some of these factors included

ï¿½ the structure of the trustee arrangement and the complexity of the
proposed transactions,

ï¿½ the geographic region in which the trustee and ineligible lender are
located,12

ï¿½ the trustee's decision to charge administrative fees on a per-loan basis
rather than as a flat fee,

ï¿½ the additional services the trustee will perform for the ineligible
lender, such as payroll services, and

ï¿½ the strength of the trustee's relationship with the ineligible lender.

Although some ineligible lenders feared that the provision of HEA that makes
trustees fully responsible for trustee-held loans might have an impact on
costs, they reported that costs did not significantly increase or decrease
after the 1998 amendments were enacted and that they did not see a change in
the role of the trustee.13 According to ineligible lenders we interviewed,
current initiation and annual trustee fees do not prohibit them from
conducting business in the student loan market.

The trustee arrangements we reviewed shared several characteristics.
Trustees and ineligible lenders reported similar (1) criteria used by
trustees to evaluate ineligibles before they entered into arrangements, (2)
elements in trustee arrangement contracts, (3) amounts of review performed
of ineligible lenders, and (4) amounts of day-to-day interaction between the
trustee and the ineligible lender. For example, trustees reported that most
important in deciding whether to enter an arrangement is the business

reputation of the ineligible lender14 and the reputation of the loan
servicing organization it has chosen. In addition, some trustees review the
structure of the financing method used by the ineligible lender to raise the
capital necessary to originate or purchase loans. This review might include
examining a rating agency's report on the transaction.15

Trustees and ineligible lenders also reported that their contracts included
similar clauses covering trustee and ineligible lender resignations and
requirements placed on the ineligible lender. For example, they reported
that trustee resignation clauses allow the trustee to resign from the
arrangement by giving a specific number of days' notice to the ineligible
lender, such as 60 or 90 days. If the ineligible lender is unable to locate
another trustee within that time period, the resignation clause sometimes
provides for additional time to obtain a new trustee. In any event, most
trustees and ineligible lenders reported that the trustee would probably
remain in place until a new one can be engaged, even if the designated time
periods have elapsed. The trustee arrangements we reviewed were also similar
in the requirements placed on the ineligible lender and the amount of
monitoring the trustee performed. For example, trustees generally require
ineligible lenders to abide by HEA requirements and to oversee the loan
servicer, but the trustees perform limited monitoring activities. One
trustee reported that the monitoring is not specific or regular and mostly
involves a review of annual reports and audits. Other trustees reported
limiting their monitoring to a review of financial statements. Eligible
lender trustees and ineligible lenders reported limited day-to-day
interaction. For example, some trustees reported that they interact with the
ineligible lender only when it is necessary to sign forms, such as quarterly
reports that must be submitted to the Department of Education. One trustee
reported no daily interaction.

Investment in Student Loan Program

Trustee arrangements come with some protections to ensure the federal
government's investment in FFELP is secure while allowing ineligible lenders
to participate in the program. The most direct protection comes from an HEA
provision that holds eligible lenders fully responsible for any loans they
hold as trustees should the loans lose the federal guarantee. For example,
although Education officials and other FFELP participants believe the
probability of large-scale problems is low, a loan may lose its guarantee
because of servicing errors or because of negligence on the part of the
servicer or the lender. When these problems occur, the federal government
will not reimburse the guarantor or the lender for the associated dollar
loss. However, because some problems may not be found until after the
federal government has already provided reimbursement, the government may
have to recover these monies from the parties involved.

According to Education officials, the HEA provision that holds trustees
responsible for an ineligible lender's loans allows the federal government
to recoup the losses from the eligible lender trustee rather than the
ineligible lender. Education officials further stated the ability to recoup
losses from a trustee is important since they believe they do not have
direct oversight authority of ineligible lenders. These officials believe
the federal government is likely to recover its losses from trustees for two
reasons. First, most financial institutions that serve as eligible lender
trustees are subject to federal (and in many instances, state) oversight.
For example, bank regulators16 promulgate regulations and policies that
prescribe safeand sound banking activities and examine banks to assess their
safety and soundness. Among the most important of these regulations are
those dealing with minimum capital standards. These capital standards
provide benchmarks against which regulators can assess the safety and
soundness of a bank's operations as well as its financial condition.
Education officials stated that because ineligible lenders are generally not
subject to financial safety and soundness reviews by government agencies,
Education lacks assurance that these lenders would be able to meet their
financial obligations in the program. Second, because most eligible lender
trustees also hold student loans in their own name and receive regular
FFELP-related payments from the government for those loans, the federal
government has additional sources from which to recover any repayments due
the government on ineligible lenders' loans that lose their guarantee. For
example, lenders usually receive special allowance payments (SAP) and
interest subsidies17 for the FFELP loans they hold. If the government were
owed monies on an ineligible lender's loans, it could recover those funds by
withholding the SAP on the eligible lender trustee's self-originated loans.
Because ineligible lenders do not receive any payments directly from
Education, it does not have an ability to collect liabilities by offset.

Loan Market, Although Some Have Concerns Over Future Trustee Availability

Both eligible and ineligible lenders reported that trustee arrangements have
had a positive effect on the student loan market. For example, both
participant groups believe that market participation and loan availability
are positively affected since trustee arrangements allow lenders that do not
meet HEA's eligible lender definition to make and hold loans, thus
increasing the amount of loan capital available to students. These trustee
arrangements allow ineligible lenders not only to originate loans, but also
to purchase loans that other lenders have originated. This purchasing
role--the primary role for many ineligible secondary markets--permits
originating lenders to free up capital to make new loans to students.
Eligible and ineligible lenders agree that participation by ineligible
lenders increases competition among lenders and can, in turn, contribute to
improved service and lower costs for student borrowers.

Some ineligible lenders, however, believe that two factors--HEA requirements
and the general evolution of financial markets--could affect their
participation in the student loan market in the future. HEA currently states
that a bank functioning as an eligible lender cannot have as its primary
consumer credit function the making or holding of student loans. Education,
in its FFELP regulations, interprets the act to mean that the lender's FFELP
loans--or in the case of a bank holding company, the FFELP loans of the
company's wholly owned subsidiaries as a group--cannot total more than
one-half of the lender's combined consumer credit loan portfolio, including
home mortgages held by the lender or its subsidiaries. This provision is
commonly known as the 50-percent rule. Strict application of this rule would
require eligible lenders to include loans they hold as a trustee for an
ineligible lender in this calculation, although the regulations do not
specifically address these loans. Education officials told us that although
Education has inconsistently applied the regulations in the past, it
currently interprets the provision as excluding trustee-held loans in
determining the lender's primary consumer credit function, but has not
formally promulgated its interpretation. Lenders have expressed confusion
regarding application of the rule. For example, some ineligible lenders and
other student loan market participants believe that the 50-percent rule
applies to loans held as a trustee and thus believe that only a handful of
large banks have sufficient consumer credit capacity to serve as a trustee.
Similarly, while a few eligible lender trustee representatives interpreted
the rule as not applying to trustee-held loans, some other representatives
were not sure how the rule should be interpreted. Of those who were unsure,
one trustee representative was not concerned because either
calculation--including or excluding the loans--would place the bank in
compliance with the act. Representatives of one bank incorrectly interpreted
an exception to the 50-percent rule.18 On the other hand, a representative
of another bank stated he had turned down eligible lender trustee business
because the additional trustee-held loans would put the bank above its
50-percent allocation of student loans.

A second factor that is perceived by ineligible lenders as having the
potential to limit their participation in FFELP is evolution in the
financial markets. Most ineligible lenders we interviewed stated that the
number of available trustees has decreased as eligible lender banks have
merged with each other in recent years. Recent mergers include First
National Bank of Chicago and Bank One, Norwest and Wells Fargo, and Firstar
Bank with Star Bank and Mercantile Bank (St. Louis); financial market
analysts expect this consolidation activity to continue. Four ineligible
lenders reported they had a difficult time obtaining their current trustee
arrangement, one taking over a year to do so. Several others said that
finding a trustee in the future would become more problematic. Ineligible
lender representatives also expressed concern that because trustees also
originate student loans for themselves, trustees may decide to end their
eligible lender trustee services rather than continue to provide the
mechanism for a competitor to do business. A few ineligible lenders stated
they were uncomfortable with trustees having the final say as to which
ineligible lenders can participate in the student loan market. Given these
issues, some ineligible lenders believe their market presence could diminish
in the future.

Given current law and the federal regulations that govern FFELP, trustee
arrangements between eligible and ineligible lenders serve an important role
in enabling ineligible lenders to participate in FFELP, and in protecting
the federal government's investment in the program. The presence of an
eligible lender from whom the government can recoup its financial losses is
critical since Education has no direct oversight authority to ensure that
ineligible lenders are operating their programs in accordance with HEA.
Obtaining a trustee arrangement does not appear to be a widespread problem
among ineligible lenders to date. However, if eligible lenders remain
unclear and therefore continue to interpret the 50-percent rule as applying
to loans they hold as a trustee, and if the financial industry continues to
consolidate, the number of trustees could decline. This decline could, in
turn, reduce competition in the student loan market.

To clarify eligible lenders' capacity to serve as trustees for ineligible
lenders, the Secretary of Education should formally clarify Education's
interpretation of how the HEA provision prohibiting banks or their
subsidiaries from holding FFELP loans that total more than one-half of their
combined consumer credit loan portfolio applies to loans held by the trustee
for an ineligible lender.

Education agreed with our recommendation that it clarify its interpretation
of how the HEA provision applies to loans held by the trustee for an
ineligible lender. Education said that it has not yet decided which policy
to establish nor how to formalize the decision once it is made. Education
did not say when it expected to implement our recommendation. Education also
provided technical comments, which we incorporated where appropriate. (See
app. II for a copy of Education's comments.)

We are sending copies of this report to the Honorable Richard Riley,
Secretary of Education; eligible lender trustees; ineligible lenders; and
other interested parties. Copies will also be made available to others on
request.

If you or your staff have any questions about this report, please call me at
(202) 512-7215. Other major contributors to this report are listed in
appendix III.

Sincerely yours,
Barbara D. Bovbjerg
Associate Director, Education, Workforce,
and Income Security Issues

Scope and Methodology

We focused our review on trustee arrangements created to allow ineligible
lenders to originate or purchase student loans. To determine the number of
existing trustee arrangements, we obtained data from Education's lender
database, including the names of the parties involved in each trustee
arrangement, the lender identification number19 associated with each
arrangement, and the outstanding loan balances. These data represent the
best information available, and an Education official acknowledged that the
list might be incomplete. To verify the parties involved in the identified
arrangements and to determine the type of student loan transactions that
made up the outstanding balance associated with a particular lender
identification number, we surveyed eligible and ineligible lenders. For each
lender identification number on the trustee arrangement list, we asked the
lenders to verify whether the account was used for originations and/or
purchases of student loans, securitizations, or some combination of these
transactions. We also asked lenders to provide us with information on any
additional identification numbers used for trustee arrangements. We
conducted follow-up interviews as necessary to ensure that we received
accurate information. In determining the total outstanding balance of loans
associated with trustee arrangements, we included information only for
arrangements that allow ineligible lenders to originate or purchase student
loans and securitizations of these loans. Further, we included balance
information only for the Student Loan Marketing Corporation's privatized
business and the ineligible lenders it owns, such as Nellie Mae Corporation,
because these organizations must use a trustee to originate or purchase
loans. To obtain detailed information on the identified trustee
arrangements, the costs associated with them, and the key characteristics
they shared, we interviewed Education officials, eligible lender trustee
representatives, and representatives of ineligible secondary markets and
other ineligible lenders. In addition, we conducted joint interviews with
three sets of trustees and ineligible lenders involved in trustee
arrangements and obtained a written response from another. Further, we
obtained information through interviews about the impact of the 1998
amendments to HEA on the number of eligible lenders willing to serve as
trustees and on the costs of trustee arrangements.

To determine the protections offered the federal government by trustee
arrangements, we identified and synthesized applicable legislation and
regulations and reviewed sample documents for trustee arrangements. We also
interviewed eligible and ineligible lenders, guaranty agencies, servicers,
Education officials, and other student loan market participants on the
responsibilities of an eligible lender trustee and the process Education
uses to oversee market participants and to recoup any losses it may incur on
defaulted loans.

To determine the effects of trustee arrangements on participation in the
student loan market and the availability of student loans, we interviewed
eligible and ineligible lenders, secondary markets, guaranty agencies,
servicers, Education officials, and other student loan market participants.
We obtained the perspectives of participants on whether trustee arrangements
have a positive or negative effect on lenders' participation in the student
loan market and identified past, current, and potential problems lenders
faced in using trustee arrangements. Because of the competitive nature of
the student loan market, information obtained from the lender community was
sometimes general in nature. We also obtained Education officials'
interpretation of applicable laws and their views on the effects of past
rulings regarding trustee arrangements.

Comments From the Department of Education

GAO Contacts and Staff Acknowledgments

Barbara D. Bovbjerg, Associate Director, (202) 512-7215
Diana M. Pietrowiak, Assistant Director, (202) 512-6239

Patricia Bundy, Evaluator
George Bogart, Senior Attorney

Related GAO Products

Major Management Challenges and Program Risks: Department of Education
(GAO/OCG-99-5, Jan. 1999 ).

Risk-Based Capital: Regulatory and Industry Approaches to Capital and Risk
(GAO/GGD-98-153, July 20, 1998 ).

High-Risk Series: Student Financial Aid (GAO/HR-97-11, Feb. 1997 ).

Student Loan Lenders: Information on the Activities of the First Independent
Trust Company (GAO/HRD-90-183FS, Sept. 25, 1990).

(104985)

Table 1: Outstanding Balance of Student Loans Held via Trustee Arrangements
9
  

1. FFELP, authorized under the Higher Education Act of 1965, as amended, is
one of two major federal student loan programs and was formerly known as the
Guaranteed Student Loan Program. FFELP provides loans through private
lenders, such as banks. These loans are insured against default by guaranty
agencies, which use federal funds to pay claims and which are reimbursed by
Education.

2. This HEA provision codified an existing regulatory requirement
promulgated in 1992.

3. Trustees and ineligible lenders may be party to one or more arrangements;
thus the number of trustees and the number of ineligible lenders do not add
to 125.

4. A guaranty agency is a state or private nonprofit organization that
administers a loan guarantee program under HEA.

5. Guaranty agencies use their federal fund to reimburse lender claims. When
a claim for a defaulted loan is made by a lender to the guaranty agency,
regulations require the agency to pay the lender 98 percent of the loss
amount. Education then reimburses the guaranty agency for up to 95 percent
of the loss amount. In certain cases, such as the death or disability of the
student, the reimbursement is 100 percent for both the lender and the
guaranty agency.

6. An eligible institution is generally an institution of higher education.

7. A trustee is a person or entity, such as a bank, holding legal title to
property in order to administer it for a beneficiary. In the case of student
loans, eligible lender trustees hold title to the loans that ineligible
lenders originate or purchase, thus allowing them to participate in FFELP.
As of July 2000, all but one trustee was a bank.

8. Secondary markets are lending institutions that purchase guaranteed
student loans from originating lenders to provide the lenders with funds to
make new loans. Twenty of the approximately 37 secondary markets are
designated as eligible lenders and do not need a trustee to originate or
purchase student loans.

9. These entities are referred to in this report as "other ineligible
lenders."

10. Portfolios of student loans--originated or purchased by eligible or
ineligible lenders--can be used as collateral to issue securities to
investors. The proceeds of these transactions are then used by the lender to
originate new loans to students. This process is known as securitization.

11. We included outstanding loan balances for originations and purchases, as
well as securitizations of the loans originated or purchased by ineligible
lenders. We also included outstanding loans made under the Student Loan
Marketing Corporation's privatized operations because a trustee is needed to
originate and purchase loans in this circumstance.

12. One eligible lender representative reported that the trustee might
charge a lower fee if the ineligible lender were located in an area where
the eligible lender wished to build a market presence.

13. In commenting on this report, Education stated that the 1998 statutory
change may not have had a significant effect because the change merely
codified existing regulations.

14. Some ineligible lenders served in other roles prior to becoming a
lender, such as a guaranty agency or a servicer.

15. Rating agencies assess credit risks on bonds and other financial
instruments. Such ratings help investors, such as those who purchase bonds,
to manage their credit risk by providing risk analysis and evaluation
information.

16. Financial regulators for banks include the Office of the Comptroller of
the Currency, the Federal Reserve System, the Federal Deposit Insurance
Corporation, and state banking regulators.

17. Education pays a special allowance to lenders on eligible FFELP loans to
bridge the gap between borrower interest rates set by statute and the
interest rate a lender could charge if the loan funds were used for
commercial purposes. The special allowance is a percentage of the average
unpaid principal balance of the loan, including capitalized interest,
computed in accordance with federal regulations. Interest subsidies are
interest payments made to lenders on subsidized loans while the borrower is
in school or in deferment.

18. One exception to the 50-percent rule is "a bank which is subject to
examination and supervision by an agency of the United States, makes student
loans as a trustee pursuant to an express trust, operated as a lender under
[the Stafford loan program] prior to January 1, 1975, and which meets the
requirements of this provision prior to [July 23, 1992]." 20 U.S.C. section
1071(d)(1)(A)(ii). An Education official indicated that these criteria apply
to only one specific bank, which is not the bank we interviewed.

19. Education tracks student loan activity primarily via information
reported for a specific lender identification number. Education issues
lender identification numbers to each eligible lender wishing to participate
in the student loan program. When a trustee arrangement is created,
Education issues a new number to reflect the loan activity of the ineligible
lender via its trustee.
*** End of document. ***