ARCHIVED INFORMATION -- Annual Accountability Report Fiscal Year 1996

Federal Family Education Loan Program


Education Needs to Complete Steps Underway for Improving Oversight of Guaranty Agencies. (material weakness)

Guaranty Agencies (GAs) play a critical role in carrying out FFEL Program operations. There are approximately 41 GAs participating in the program. These State and not-for-profit institutions are responsible for reviewing student applications and approving loans, reviewing and paying claims to lenders when defaults occur, and for collecting on defaulted loans. Depending on their claims experience and the year the loan originated, GAs are reimbursed by Education for up to 100% (98% for loans disbursed on or after October 1, 1993) of claims they pay to lenders. At Education's discretion, GAs are also reimbursed for administrative expenses incurred in carrying out FFEL Program operations (equal to 1% of the new loan volume). GAs are required to remit to Education up to 73% of amounts collected on defaulted loans. They are permitted to retain the remaining portion of collected amounts to cover expenses associated with collection. But the amounts not remitted to Education and not used for collection and other allowable expenses are required to be held in a reserve account, known as the "Guaranty Reserve," an account which, by statute, is considered an asset of the Department.

Because the GAs are crucial intermediaries in delivering guaranteed loans to students, and because their financial and credit management activities so closely interact with those of Education, it is important that sufficient internal controls be in place to monitor their operations and properly account for transactions and assets executed or held on Education's behalf. However, we found instances where internal controls need to be strengthened, or where Education needs to complete action plans it has already initiated to address internal control weaknesses.

Additional Controls Over GA Billings Are Needed

GAs submit monthly billings (Form No. 1189) to Education for reimbursement of amounts paid for claims and administrative expenses, net of collections on defaulted loans. Aggregate GA billings to Education were as follows for fiscal year 1995.

Exhibit 3: GA Billings
GA Billings to Education for FY 1995
(in thousands)
Reimbursements on defaults paid $2,521,173  
Mandatory administrative expenses $257,862  
Less collections on defaulted loans ($1,058,801)*
Net payments to GAs $1,720,234  

* The difference between this amount and collections reported in Education's financial statements ($2,013,058) is the exclusion of collections from ED's Debt Collection Service and from IRS offsets.

While Education can review GA billings for obvious errors or significant fluctuations, its automated systems are incapable of independently checking detailed supporting information for the billings. Instead, to a large degree, Education relies upon audits of GAs performed by private Independent Public Accountants (IPA) and State Auditors (auditors) to ensure the integrity of billings from GAs. The General Accounting Office (GAO) and Education's Office of Inspector General (OIG), in conjunction with their financial statement audits of the FFEL Program for fiscal years 1992 - 1994, reviewed the extent of the auditors' coverage of the GAs billings to Education. The GAO and OIG reported (GAO/AIMD-94-131) that based on interviews with the auditors and review of their working papers, that the "... auditors conducted only limited tests of the accuracy of the billings reports of the guaranty agencies." The GAO and OIG reported this condition as a material weakness for fiscal years 1992 - 1994. Based upon work performed during our 1995 audit, this condition has not yet been resolved.

It appears as though IPAs and auditors did not focus their testing on GA billings to the degree Education desires. Even though OMB guidance indicated that billing information should be tested, we believe the requirements were not specific enough with respect to the level of desired testing. Recognizing this, Education is developing improved audit guidance to be distributed to the auditors of the GAs that would specifically require testing of GA billings to Education. Education has substantially completed development of the new audit guide; however, it has not yet been issued. Until the guidance is issued and implemented, we continue to report this condition as a material weakness for fiscal year 1995.

Commencing in late fiscal year 1995, Education performed on-site operational and financial reviews of GAs, that included limited testing of GA billings to Education. These reviews, which had not been conducted in prior years, were initiated as an additional control over guaranty agency operations. However, the workpapers documenting the results of the testing performed and conclusions reached are still in process. Thus, we do not know the extent to which the propriety of GA billings to Education was considered during these reviews or whether the reviews provided any assurance about their accuracy.

Receivables for Defaulted Loans Must Reconcile to GA Records

When students default on loans, lenders submit claims and are reimbursed by the GAs. When Education subsequently reimburses GAs, in most cases for almost the full amount of the claims paid, Education records an asset in its financial records to reflect the money it is now owed by the students who defaulted. On Education's behalf, GAs initiate collection efforts on the defaulted loans and are required to remit up to 73% of any amounts collected to Education. In effect, GAs are performing a loan servicing function for Education. But despite what organization performs the servicing, defaulted loans are an asset of the Department and controls must be in place to ensure the amounts owed and collections recovered are accurately reflected in Education's accounting records.

At the time of our audit, Education had $12.3 billion in gross loans receivable recorded on its general ledger related to defaulted loans for which the GAs were applying collection procedures. However, on the monthly status reports submitted by GAs (ED Form 1130), the loans reported by the 41 GAs aggregated $11.4 billion. A difference of approximately $888 million existed that cannot be explained other than anecdotally. (Education believes that the difference arose during periods prior to FY 1992 due to incorrect transaction tables for collections, contained in its general ledger system.) Education did adjust its general ledger balance to agree to the guaranty agency records, however, in the absence of sufficient information to ascertain whether the $888 million difference constitutes money Education is owed, or whether it simply represents errors or lags in reporting data to Education, we cannot be assured that the gross loan receivable balance is reasonably stated.

Accountability Over Reserves Maintained by GAs Would Be Improved if Accrual-Basis Information Were Also Required

Education provided the initial funding to establish the GAs and is the principal source of ongoing GA funding. Generally, assets accumulated by the GAs in carrying out their duties for Education that are not required to be immediately remitted, are retained by the GAs in a reserve account. But even though Education does not hold these reserves, they are still considered assets of the Department. The Higher Education Act (Sec. 422 (g) (1)) states:
"Notwithstanding any other provision of law, the reserve funds of the guaranty agencies, and any assets purchased with such reserve funds, regardless of who holds or controls the reserves or assets, shall be considered to be the property of the United States..."
The Higher Education Act also specifies conditions under which the Secretary can require the GAs to return these funds. These conditions have been exercised in the past whereupon the Secretary has required return to the Federal government all or a portion of GA reserve funds. Information furnished by GAs indicated that reserves they held approximated $1.8 billion as of September 30, 1995 ($1.6 billion net of an allowance for loss). However, these reserves are reported to Education, as defined by 34 CFR Chapter VI Section 682 using the cash instead of accrual basis of accounting. We believe controls over GA reserves would be strengthened if the Department mandated that accrual accounting be used for purposes of reporting reserve balances to Education.

Education is Implementing Many Needed Improvements

Education recognized the need to improve GA oversight before our audit commenced. Many corrective actions are underway to address the conditions herein reported. In addition to drafting expanded guidance to be used by the external auditors that perform the audits of the GAs, Education is also in the process of implementing its National Student Loan Data System (NSLDS). The NSLDS will track all activity and balances for individual loans. Once implemented and completely populated with data, this system can be used for determining the reasonableness of billings from GAs and to better control Education's assets (i.e., loans receivable and reserves) held by the GAs. While portions of NSLDS have already been implemented, Education does not anticipate being able to use the system to determine the reasonableness of GA billings until fiscal year 1997.

Recommendations

We recommend that Education:

  1. Establish an internal process for reviewing IPA reports and for documenting how matters or errors reported will be addressed and resolved.

  2. Aggressively move forward with the issuance of its expanded guidance to IPAs and other auditors. This guidance should:

  3. To the extent internally initiated reviews of GAs covered billings, summarize the amount and nature of errors noted and use this information as the basis for targeting internal and external testing to areas that are susceptible to error or abuse.

  4. By individual GA, isolate differences between loans receivable reported by GAs versus those reflected in Education's records. Investigate any differences greater than 5%. Institute a process going forward in which claims paid and collections received by Education are reconciled to the loans receivable balance.

  5. Consider mandating accrual accounting for purpose of reporting guaranty reserves to Education.

  6. Assure that information produced by the new NSLDS accommodates the billing analysis discussed above.


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