This is the accessible text file for GAO report number GAO-04-567R entitled 'Department of Education's Federal Direct Loan Program: Status of Recommendations to Improve Cost Estimates and Presentation of Updated Cash Flow Information' which was released on March 29, 2004. This text file was formatted by the U.S. General Accounting Office (GAO) to be accessible to users with visual impairments, as part of a longer term project to improve GAO products' accessibility. Every attempt has been made to maintain the structural and data integrity of the original printed product. Accessibility features, such as text descriptions of tables, consecutively numbered footnotes placed at the end of the file, and the text of agency comment letters, are provided but may not exactly duplicate the presentation or format of the printed version. The portable document format (PDF) file is an exact electronic replica of the printed version. We welcome your feedback. Please E-mail your comments regarding the contents or accessibility features of this document to Webmaster@gao.gov. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. Because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately. 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.