E8-28632. Federal Family Education Loan Program (FFELP)

AGENCY:

Department of Education, Department of the Treasury, Office of Management and Budget.

ACTION:

Notice of terms and conditions of additional purchase of loans under the Ensuring Continued Access to Student Loans Act of 2008.

SUMMARY:

Under the authority of section 459A of the Higher Education Act of 1965, as amended (“HEA”), as enacted by the Ensuring Continued Access to Student Loans Act of 2008 (Pub. L. 110-227) and amended by Pub. L. 110-315 and Pub. L. 110-350, the Department of Education (“Department”) may purchase, or enter into forward commitments to purchase, Federal Family Education Loan Program (“FFELP”) loans made under sections 428 (subsidized Stafford loans), 428B (PLUS loans), or 428H (unsubsidized Stafford loans) of the HEA, on such terms as the Secretary of Education (“Secretary”), the Secretary of the Treasury, and the Director of the Office of Management and Budget (collectively, “Secretaries and Director”) jointly determine are “in the best interest of the United States” and “shall not result in any net cost to the Federal Government (including the cost of servicing the loans purchased).”

The Secretary initially exercised this authority in accordance with a notice published in the Federal Register on July 1, 2008 (73 FR 37422). This notice (a) establishes the terms and conditions that will govern certain additional loan purchases made under section 459A of the HEA, as extended by Pub. L. 110-350 (Short-term Purchase Program), (b) outlines the methodology and factors that have been considered in evaluating the price at which the Department will purchase these additional FFELP loans, and (c) describes how the use of those factors and methodology will ensure that the additional loan purchases do not result in any net cost to the Federal Government. The Secretaries and Director concur in the publication of this notice and have jointly determined that the purchase of additional loans as described in this notice is in the best interest of the United States and shall not result in any net cost to the Federal Government (including the cost of servicing the loans purchased).

DATES:

Effective Date: The terms and conditions governing the purchase of additional loans under the Short-term Purchase Program are effective December 1, 2008.

FOR FURTHER INFORMATION CONTACT:

U.S. Department of Education, Office of Federal Student Aid, Union Center Plaza, 830 First Street, NE., room 111G3, Washington, DC 20202. Telephone: [phone] or by e-mail: [e-mail].

If you use a telecommunications device for the deaf (TDD), call the Federal Relay Service (FRS), toll free, at 1-800-877-8339.

Individuals with disabilities can obtain this document in an accessible format (e.g., braille, large print, audiotape, or computer diskette) on request to the contact person listed under FOR FURTHER INFORMATION CONTACT.

SUPPLEMENTARY INFORMATION:

Introduction

The Department's purchase of FFELP loans is intended to ensure that students and parents continue to have access to FFELP Stafford and PLUS loans for the remainder of the 2008-2009 academic year and the 2009-2010 academic year, including second and subsequent disbursements of loans which have already had a first disbursement. The Department initially offered lenders the opportunity to participate in a Loan Participation Purchase Program (“Participation Program”) and a Loan Purchase Commitment Program (“Purchase Program”) (collectively, “Programs”). Pursuant to section 459A of the HEA, the Secretaries and Director established the terms and conditions that govern the Participation Program and the Purchase Program in a notice published in the Federal Register on July 1, 2008 (73 FR 37422). Minor revisions to this notice were published in the Federal Register on July 17, 2008 (73 FR 41048).

Under the Participation Program, the Department has purchased participation interests in eligible loans that are held by an eligible lender acting as a sponsor under a Master Participation Agreement. To participate in the Participation Program, each sponsor entered into a Master Participation Agreement with the Department and a third-party custodian.

Under the Purchase Program, the Department has purchased eligible loans that are held by eligible lenders. To participate in the Purchase Program, each eligible lender entered into a Master Loan Sale Agreement with the Department and agreed to deliver to the Department or its agent the fully executed master promissory note (or all electronic records evidencing the same) evidencing each eligible loan that the lender wished to sell to the Department and any and all other documents and computerized records relating to all such loans.

Subsequent to the announcements of the Purchase Program and Participation Program in July, the Secretaries of Education and Treasury have concluded that additional actions are necessary to ensure students and parents have access to FFELP for the remainder of the 2008-2009 academic year. Specifically, the Secretaries believe some lenders may not be able to obtain capital to make second disbursements even for the short-term necessary before lenders can utilize the existing programs. Through the Short-term Purchase Program, the Department is extending the offer to purchase loans to include eligible loans made for the 2007-2008 academic year under the terms and conditions established in this notice, including the appended Master Loan Sale Agreement-2007-2008, dated November 24, 2008. The Department plans to purchase these loans on or about December 1, 2008 and will continue purchasing them through February 28, 2009 or the date on which one or more conforming Asset-Backed Commercial Paper (ABCP) conduit(s) for purchasing FFELP loans becomes operational, whichever occurs earlier. The Department will expend up to $500 million to purchase eligible loans each week during this period, for a potential total aggregate amount of up to $6.5 billion. The Department will only accept offers from lender requests for the Department to purchase loans under the Short-term Purchase Program once each week. Details of how a lender must submit such offers will be provided by the Department by postings to its official Web site at http://www.federalstudentaid.ed.gov/​ffelp.

The Department will purchase no loans from a lender in a given week unless the average outstanding principal balance of the loans offered by the lender for that week is at least $3,000. The Department will calculate the total amount of the outstanding principal balance of the loans offered for sale for the week by lenders that submit offers that meet the $3,000 minimum balance requirement, and will purchase all such loans if the amount needed to purchase them does not exceed the $500 million offered amount.

If the amount needed to purchase all loans in qualifying offers in a given week exceeds $500 million, the Department will initially designate for purchase from each lender an amount that is the lesser of its outstanding balance of loans offered for sale or the total outstanding balance of the loans offered by such lender multiplied by a percentage that is the ratio of that lender's 2007-2008 loan volume to the 2007-2008 loan volume of all lenders that submitted qualifying offers to sell loans in the same week. If this process fails to spend the entire $500 million in a given week, the Department will determine the percentage that the amount of loans offered by each lender that was not initially designated for purchase bears to the total amount offered but not so designated from all lenders for that week, and it will multiply the remainder of the $500 million by this percentage to designate for purchase an additional amount of loans from each lender. The Department will purchase from each lender an amount that is the sum of its initial plus additional designated amounts. In no case will the Department purchase an amount that exceeds a lender's offered amount. Moreover, no lender shall receive more than 85 percent of the weekly offering until all lenders wishing to sell loans to the Department have been satisfied.

Terms and Conditions

Under the Short-term Purchase Program, the Department will purchase fully disbursed FFELP loans (subsidized Stafford loans, unsubsidized Stafford loans, and PLUS loans) originated for academic year 2007-2008. FFELP Consolidation loans are not eligible for purchase by the Department under this program. To participate in the Short-term Purchase Program, each eligible lender must enter into a separate Master Loan Sale Agreement—2007-2008, dated November 24, 2008 (attached as Appendix A to this notice) with the Department and deliver to the Department or its agent the fully executed master promissory note (or all electronic records evidencing the same) evidencing each eligible loan that the lender wishes to sell to the Department and any and all other documents and computerized records relating to that eligible loan.

For the purpose of the Short-term Purchase Program, an otherwise eligible FFELP loan must have been first disbursed on or after May 1, 2007 for a loan period that includes July 1, 2007 or begins on or after that date. At the time of purchase by the Department, the loan must be free and clear of any encumbrance, lien or security interest or any other prior commitment. At the time of purchase by the Department, the loan cannot be in a default status, be 210 or more days delinquent, or have had a lender claim filed for it. In addition, if the lender wishes to sell a loan from a particular borrower, all loans from that particular borrower must be offered for sale.

Under the Short-term Purchase Program, the Department will purchase loans with borrower benefits; however, the benefits are limited to those that can be implemented by the Department's servicer for these loans. The Department will accept loans that provide Eligible Borrower benefits as summarized in Exhibit F to the Master Loan Sale Agreement—2007-2008, dated November 24, 2008, attached as Appendix A to this notice. A listing of those specific borrower benefits will be posted to the Department's Web site at http://www.federalstudentaid.ed.gov/​ffelp. The Department will not purchase loans if a cash rebate was promised to the borrower.

The Department will purchase loans for 97 percent of the total of the outstanding principal balance plus accrued but unpaid interest as of the purchase date. In order to ensure that the loans offered for sale represent a fair share of the loans in a lender's 2007-2008 portfolio, the average outstanding balance of all of the loans included in a lender's weekly offer must be at least $3,000. Upon purchase, the loans become Federal assets and will be serviced by the Department's contracted servicer as FFELP loans. Any lender that wishes to participate in the Short-term Purchase Program will be required to commit to originate or acquire loans, and continue participation in the FFEL program, as set forth in the Master Loan Sale Agreement (Appendix A). Additional terms and conditions for the Short-term Purchase Program are contained in the Master Loan Sale Agreement—2007-2008, dated November 24, 2008 (Appendix A).

Outline of Methodology and Factors in Determining Prices

In accordance with Pub. L. No. 110-227, Pub. L. 110-315, and Pub. L. 110-350, the goal in structuring the Short-term Purchase Program is to maximize student loan availability while ensuring loan purchases result in no net cost to the Federal Government. More specifically, this Short-term Purchase Program will offer temporary liquidity to FFELP lenders to encourage their continued participation in the program and ensure that students and parents have access to FFELP Stafford and PLUS loans for the 2008-2009 and 2009-2010 academic years, including second and subsequent disbursements of loans which have already had a first disbursement. This section of the notice responds in particular to the statutory requirement for an outline of the methodology and factors considered in evaluating the price at which loans may be purchased, and describes how the use of such methodology and consideration of such factors will ensure no net cost to the Federal Government results from the loan purchases under the Short-term Purchase Program.

Price: As noted elsewhere in this notice, the Short-term Purchase Program is intended as a temporary, transitional measure to help lenders address immediate liquidity shortages until one or more conforming Asset-Backed Commercial Paper (ABCP) conduits for purchasing FFELP loans become operational.

To determine the price FFELP loans would be purchased at, the Secretary of Education and the Secretary of Treasury took into account several factors. These factors included the price that would ensure this program resulted in no net cost to the Federal Government; the increased liquidity that the rate would offer distressed lenders; borrower benefits; and other factors. Based on this analysis, the Secretaries determined that 97 percent of outstanding principal and accrued interest was an appropriate price for this program.

Borrower Benefits: The Department will purchase loans with certain borrower benefits; however, the Department will only purchase loans with benefits that can be implemented by Federal Student Aid's current servicing processes. Further, the 97 percent price considers borrower benefits for both administrative expediency, cost neutrality, and to ensure that student's or parent's expected borrower benefits on purchased loans are not compromised.

Analysis of Cost Neutrality

The cost-neutrality analysis used credit subsidy cost estimation procedures established under the Federal Credit Reform Act of 1990 (Pub. L. No. 101-508) and OMB Circular A-11. These procedures entail performing various analyses to project cash flows to and from the Government, excluding administrative costs. For changes to outstanding FFEL guaranteed loans, the analysis reflects the modification cost, or the difference between the estimate of the net present value of the remaining cash flows underlying the most recent President's Budget for such loan guarantees, and the estimate of the net present value of these cash flows after the purchase program, reflecting only the effects of the modification. For new loans, cash flows are discounted to the point of disbursement, using the Credit Subsidy Calculator 2 (“OMB calculator”), developed by the Office of Management and Budget to estimate credit subsidy costs for all Federal credit programs, as the discounting tool.^[1] Costs for new loans can be expressed as subsidy rates that reflect the Federal costs associated with a loan; these costs are expressed as a percentage of the credit extended by the loan. For example, a subsidy rate of 10.0 percent indicates a Federal cost of $10 on a $100 loan.

The metric to determine cost neutrality was that costs under the new program should not exceed costs expected under the FFEL program had the loan purchase authority in Pub. L. No. 110-227 not been extended in this manner. All costs were based on estimates in the 2009 President's Budget for the FFEL program, and estimated administrative costs.

Student loan cost estimates were developed to assess the Federal cost incurred for loans financed for students in five categories for each loan type: Those attending proprietary schools, two-year schools, freshmen/sophomores at four-year schools, juniors/seniors at four-year schools, and students in graduate programs. Risk categories have separate assumptions based on historical patterns—for example, the likelihood of default or the likelihood of exercising statutory deferments or discharge benefits—of borrowers in each category. The analysis also considered risk factors particular to the Short-term Purchase Program, such as the likelihood that lenders would sell only their least profitable loans.

This discussion outlines the analysis of the Short-term Purchase Program with respect to the following critical aspects affecting the Federal cost:

○ Administrative costs

○ Borrower behavior

○ Lender behavior

○ Risk factors

Administrative Costs. Federal administrative costs are normally not included in subsidy cost calculations. To capture the full cost of the Short-term Purchase Program, however, section 459A of the HEA requires that the determination of cost neutrality reflect total costs, including Federal administrative costs subject to annual appropriation, and these costs were included in this analysis. Administrative cash flows primarily involve servicing costs associated with loans purchased by the Department. These costs can extend for up to 40 years, as servicing must continue until the last loan is paid in full. Under the base scenario where $6.5 billion in small loans were purchased, servicing costs would be $261 million on a present value basis. Estimates were developed using the price structure of the Department's servicing contract for put loans, with adjustments for start-up costs, inflation, and other costs.

Borrower Behavior. Since the base FFEL program serves as the foundation of the Short-term Purchase Program, and the characteristics of the base program are unchanged, there is no reason to believe that the Short-term Purchase Program will affect borrower behavior. Thus, this cost analysis uses borrower behavior assumptions used to prepare the FY 2009 President's Budget to gauge the effect on program costs of borrower-based activities such as loan repayment, use of statutory benefits such as deferments and loan discharges, and default rates and timing. These assumptions are based on a wide range of data sources, including the National Student Loan Data System, the Department's operational and financial systems, and a group of surveys conducted by the National Center for Education Statistics such as the 2004 National Postsecondary Student Aid Survey, the 1994 National Education Longitudinal Study, and the 1996 Beginning Postsecondary Student Survey.

Lender Behavior. A key factor in assessing whether the Short-term Purchase Program would operate in a cost-neutral manner was lender behavior: Specifically, how lenders would participate in the program, including how many and what type of loans would they eventually choose to sell to the Department. The Department considered alternative scenarios of lender behavior to determine whether the Short-term Purchase Program could be considered cost-neutral under each. Because the Short-term Purchase Program would allow lenders to sell loans with contingent borrower benefits—such as interest rate reductions for a specified number of on-time payments—all alternatives include an adjustment to reflect the impact of these potential reductions on future loan repayments. Consistent with stress tests applied by rating agencies in the private securitization market, this adjustment reduces the net cash flow to the Government by reducing the principal of sold loans by 0.5 percent a year.

In both scenarios, the Department assumed a “worst-case” in which lenders sold $6.5 billion of their smallest, least profitable loans. Because long-term loan servicing costs are generally charged on an account basis independent of loan size, small loans tend to be less profitable than larger loans. Under this scenario, it was determined that costs for the Short-term Purchase Program were less expensive to the Government than baseline subsidy costs for FFELP loans. (Please see Table 1 for a summary of the analysis.)

Risk Factors. Analyzing whether the Short-term Purchase Program would operate in a cost-neutral manner requires that projected costs account for the presence of various risk factors that must be assumed since the Short-term Purchase Program will not operate entirely like the base FFELP, or without operational risk. As such, the Secretaries' and Director's estimates included adjustments for four risk factors: That some of the loans purchased by the Department would be those where the Department would otherwise reject a reinsurance claim under the FFELP (“claim rejects”); that unforeseen problems undermine the Department's ability to effectively oversee and administer the Short-term Purchase Program (“operational risk”); that costs related to servicing purchased loans do not fully reflect possible future requirements (“general administrative risk”); and, that the composition of loans ultimately sold to the Department may result in higher Federal costs than the composition assumed in this analysis (“portfolio composition risk”).

To ensure cost estimates reflect a conservative assessment of possible Federal costs, the Secretaries and Director added cost adjustments to incorporate each risk factor. The adjustments were based on an assessment of private-sector behavior and program data as follows:

Claim Rejects. This risk factor takes into account the costs associated with the purchase of loans that would not typically qualify for the federal default guarantee in the FFELP due to improper origination or servicing. The 12 basis point increase in cost is based on a historical rejected claim rate of 1 percent of volume, and assumes that these loans would have higher loss rates than the average portfolio. This cost assessment is double that which was assessed in the analysis of the original Purchase Program. This doubling is appropriate given that the 45-day period allotted to the Department, under the Terms and Conditions of the original Purchase Program, to conduct due diligence on loans to be purchased is much shorter under the Short-term Purchase Program. This increased cost assessment is intended to take this into account.

Operational Risk. In the Short-term Purchase Program, operational risk might result from servicing errors, technology failures, and the risk of fraud. While the Department has made every effort to mitigate operational risk, the emergency nature and accelerated implementation timeframe for the Short-term Purchase Program make operational risk more of a concern than in established Department programs.

For the low risk scenario, the analysis assumes a 20 basis point increase in program cost to reflect this risk. The analysis of the original Purchase Program only included a 10 basis point assessment. However, given the accelerated implementation timeframe, as compared to the original Purchase Program, the doubling of this assessment is appropriate in this case.

For the high risk scenario, the analysis assumes an additional 60 basis point increase for operational risk, for a total of 80 basis points, consistent with the assessment in the high risk scenario of the original Purchase Program. In this scenario, the worst-case was estimated using survey data from bank regulators implementing an overhaul of bank regulations. The largest United States banking organizations will be subject to a new system of capital requirements that includes an explicit charge for operational risk. Under those regulations, banks will be required to develop models generating a probability distribution of losses for operational risk, and hold capital equal to the 99.9th percentile of that estimated probability distribution. Banks were surveyed to measure the anticipated impact of the regulations. Using the best available models of operational risk, the banks reported that operational risk would account for roughly 10 percent of their required capital. As banks currently finance on average about eight percent of their assets with capital, worst-case scenario operational risk losses can thus be estimated at about one percent of total assets. Also, while we do not believe that this program has, or necessarily will, face such a level of operational risk, we developed the high scenario to ensure that the program is cost-neutral, even under extreme and unlikely circumstances.

General Administrative Risk. The analysis of cost neutrality examined the Department's current loan servicing contract, and assumptions of borrower status over the life of the loan after purchase by the Department. The analysis assumed minimal start-up costs as the Short-term Purchase Program builds on the current loan purchase program infrastructure. In December 2008, the Department plans to extend its current loan servicing contract for one year. This will involve the renegotiation of payment rates for certain activities which may affect long-term servicing costs for the loans purchased under the Short-term Purchase Program. Given the future uncertainty surrounding several factors, including the assumptions outlined above and the status of loans ultimately purchased by the Department, it is possible that unforeseen additional costs may be incurred. Accordingly, a General Administrative Risk Factor of 100 basis points was added to the analysis.

Portfolio Composition Risk. The cost to the Government of the Short-term Purchase Program depends on numerous factors, including loan size, default/prepayment risk, borrower benefits, and other characteristics of the purchased loans. The cost-neutrality analysis accounts for some of these factors, as outlined in this notice, but may not incorporate all of the dimensions of lender behavior and the loans ultimately purchased by the Department. Given this uncertainty, savings may deviate to some degree from the savings estimated in the model. To ensure that the potential risk and the potential costs are adequately reflected, a Portfolio Composition Risk Factor of 100 basis points was added to the analysis. The Department considered a base scenario under which lenders sold $6.5 billion in loans, the maximum amount allowable under the Short-term Purchase Program. This scenario also assumed lenders would sell their smallest, least profitable loans to the Department and included cost assessments for claim rejects and operational risk. This scenario would result in an average loan balance of approximately $3,000. Under this scenario, the Short-term Purchase Program is cost-neutral.

The Department also considered a high operational risk scenario in which the cost assessment for operation risk was raised from 20 basis points to 80 basis points. Even with this increased assessment, the Short-term Purchase Program remains cost-neutral. The Terms and Conditions for the Short-term Purchase Program seek to reduce the likelihood of lenders exclusively selling low-balance loans. For example, a floor would be established under which batches of loans sold to the Department must have a minimum average balance of $3,000. This would likely ensure that the base scenario considered by the Department would reasonably reflect the cost exposure to the Federal Government should lenders choose to sell their lowest balance loans. In addition, lenders would be required to sell all 2007-08 Stafford loans held for a specific borrower. These provisions make it less likely that lenders will choose to sell only poorly-performing loans to the Department.

Conclusion. After taking into account alternative market and lender behavior scenarios, the Administration determines that the Short-term Purchase Program is in the best interest of the United States and will result in no net cost to the Government.

Applicable Program Regulations: 34 CFR part 682.

Electronic Access to This Document. You may view this document, as well as all other Department of Education documents published in the Federal Register, in text or Adobe Portable Document Format (PDF) on the Internet at the following site: http://www.ed.gov/​news/​fedregister/​index.html.

To use PDF you must have Adobe Acrobat Reader, which is available free at this site. If you have questions about using PDF, call the U.S. Government Printing Office (GPO), toll free, at 1-888-293-6498; or in the Washington, DC area at [phone]. You may also view this document in PDF at the following site: http://www.ifap.ed.gov. You may obtain a copy of the Master Loan Sale Agreement and direction regarding submission of the Master Loan Sale Agreement and offers to sell loans at http://federalstudentaid.ed.gov/​ffelp.

Note:

The official version of this document is the document published in the Federal Register. Free Internet access to the official edition of the Federal Register and the Code of Federal Regulations is available on GPO Access at: http://www.gpoaccess.gov/​nara/​index.html.

(Catalog of Federal Domestic Assistance Number 84.032 Federal Family Education Loan Program)

Program Authority: 20 U.S.C. 1087i-1.

Dated: November 26, 2008.

Margaret Spellings,

Secretary of Education.

Karthik Ramanathan,

Acting Assistant Secretary of the Treasury.

Jim Nussle,

Director, Office of Management and Budget.

Footnotes

1.  The OMB calculator takes projected future cash flows from the Department's student loan cost estimation model and produces discounted subsidy rates reflecting the net present value of all future Federal costs associated with loans made in a given fiscal year. Values are calculated using a “basket of zeros” methodology under which each cash flow is discounted using the interest rate of a zero-coupon Treasury bond with the same maturity as that cash flow. To ensure comparability across various Federal credit programs, this methodology is incorporated into the calculator and used government-wide to develop estimates of the Federal costs of credit programs.