Tuesday, April 21, 2009

Best in Class, troubled funding

If I could tell this story well in fewer words and simpler terms, I would. Sadly, the details seem essential.

The collapse of the Best in Class loan program was a very bad thing. The basic story is discussed here and the failure of communication here, but the underlying finances also deserve attention.

Problem I: Cuts in federal fees
The widely circulated explanation is that the Student Loan People were forced into the cancellation by 2007 federal legislation that reduced some fees they received from the federal government.

That's part of the story, but not all of it.

Reading the Financial Statements: Kentucky Higher Education Assistance Authority/Kentucky Higher Education Student Loan Corporation: June 30, 2008, I'm convinced that the Student Loan People had two other major problems. (Click here to download the report.)

Problem II. Federal guarantees and ineligible loans
For several years, the Student Loan People received growing"special allowance" income on loans that were tied to tax-exempt bonds issued before October 1, 1993. Loans financed by those old bonds were entitled to a 9.5% guaranteed return. By transferring loans from one financing instrument to another, a number of lenders claimed that they could expand the total loan amounts eligible for the guarantee. For several years, the federal government paid what they asked. (Source: Money for Nothing, here)

In September 2006, the Department of Education's Inspector General concluded that another lender's claims like that were wrong and and the loans that had been transferred were ineligible for the guarantee. In January 2007, the Undersecretary of Education announced that the Department agreed and that “Other lenders also will not receive payments at the 9.5 percent floor rate until they can demonstrate that their loans come from eligible sources of funds.” (Source: Press release here)

The Financial Statements document continues the story this way:
On January 24, 2007, USDE sent a letter to the Authority/Corporation which set forth the same restatement and also imposed management assertion requirements for any 9.5% SAP billings after September 30, 2006, as well as guidance regarding the audit and certification requirements for those management assertions. A detailed list of management assertions to retain the 9.5 SAP was included in a separate DCL letter published by USDE on April 27, 2007. Due to the nature of the management assertions needed to bill for 9.5% SAP, the Authority/Corporation was unable to make such assertions and therefore lost all 9.5% SAP payments effective for all quarters ending on or after December 31, 2006.
That is, the Student Loan People asked for guarantee payments on a bunch of loans. When the Department asked for proof that the loans were eligible for the guarantee, the Student Loan People couldn't provide proof the Department would accept.

Cash flow from "special allowances" dropped from $42,483,265 in fiscal 2007 to $15,861,119 in fiscal 2008. I believe that's heavily a result of losing the 9.5% payments.

Problem III. The credit crisis
The credit crisis hit student lending long before it swept the headlines last fall. The Financial Statements take three pages to describe the impact, but a few snippets illustrate the danger:
  • "Beginning February 13, 2008, all of the Authority/Corporation’s [Auction
    Rate Securities] from that day forward were in failed auction mode, which triggered the maximum interest rate allowed under the related bond official statement."
  • "By May 2008, two-thirds of the Authority/Corporation’s [Variable Rate Demand Obligations] were placed with the liquidity provider, creating a need to refinance these debt obligations."
  • "In May 2008, that national bank informed the Authority that it was calling the $170 million line of credit, payable in three installments; $83.4 million upon closing of a planned refinancing bond issue, $16.6 million on September 30, 2008, and $47 million on December 31, 2008."
  • "On May 1, 2008, the Authority/Corporation temporarily suspended making FFELP loans to new borrowers due to a lack of funds available."
Later in May, President Bush signed a bill designed to free up loan funds. In the Financial Statement's explanation, I think the key phrases are the ones I've highlighted:
The participation program is operationally complex and results in negative cashflow for fiscal year 2008; as lenders are required to use operating reserves to pay all costs related to loans held in the participation trust.... The participation program is a profitable line of business, but the profits must remain in the closed trust until the loans are sold to another financing deal or the USDE and the trust is dissolved.
Reading that, I think the Student Loan People were compelled to tie up money that might, in better times, have helped the Best in Class borrowers. Best in Class was not canceled in the spring of 2007 when the 9.5% was lost, nor in the fall of 2007 when the federal fees changed. It was canceled later, when student loans faced nationwide danger and needed federal intervention to survive.

Bottom line
The mammoth fiscal crisis is the most important reason the Student Loan People could not do what student borrowers expected from the Best in Class program. The loss of the 9.5% guarantees and the reduced federal fees can vie for second place, but the federal fee issue is simply not the main reason Best in Class collapsed.

(Added source note: this Higher Education Watch post alerted me to the other sources I used to understand the ineligible loans. However, I do not agree with the weight they put on the loan problem. Having read their sources and the Financial Statements, I think that development is a smaller factor than the fiscal crisis, though still relevant to the total Best in Class story.)

13 comments:

  1. Thank you for bringing light to this situation. I appreciate it.

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  2. Thank you so much for doing your part in helping those with the power to actually do something about this aware of what is going on. There are many, many of us who are hoping and praying that something will be done to help us out.Thanks again.

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  3. Thank you so much for keeping everyone informed about this horrible situation. Please continue to post any information you find regarding how the Best in Class program was "not going away" and was "a sure thing." I feel we have been scammed and taken advantage of in so many ways.

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  4. What a fine analysis! Kentucky newspapers could take a lesson from this blogger, who has written more sense in two days than the Kentucky press has written in two years.

    What needs to be added, however, is not only that the loan forgiveness was largely built on the 9.5 funny-money, which KHEAA knew couldn't last, but Governor Fletcher raided KHEAA in a like amount to balance his own budgets. Anyone who reads the KHEAA financial reports will quickly discover this.

    Meanwhile, bravo to teachers, who have not bought into the spin that it is all Congress's fault. They have wisely resisted pressure from KHEAA to lobby Congress for more federal subsidies, even as KHEAA and Governor Beshear fail to fulfill Best in Class promises. Let KHEAA and the Governor fulfill their promises first, before having the audacity to pressure teachers to lobby for a few KHEAA jobs.

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  5. I think that the 9.5 funny money is difficult to understand but it sounds like that they knew that what they were doing wasn't right or they would have submitted the paperwork to the feds when they were asked. What year did Governor Fletcher raid the KHEAA/SLP funds to the tune of about 80 million and is the financial report available on line? I would love to read this for myself? What is the attorney general saying about the 80 million dollars and the broken promises?

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  6. To address the last commenter: The KHEAA/KHESLC financial reports are located as PDF downloads on their website. View the 2005 and 2006 audited financial reports. Also, they did submit proper paperwork to the feds and the Department actually said the claims were legal at one point. Don't forget that the Department of Education was tied up with the scandal also.

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  7. Anon@5:10

    The financial statements are at http://www.studentloanpeople.com/who_annual_reports.html. The 2008 audited statement, page 49, describes the "management assertions" KHEAA did not submit.

    Anon@11:45

    Can you share your source for saying "the Department actually said the claims were legal at one point"? I'll happy to update my post above with additional information.

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  8. I read the reports and saw the huge transfers of funds from SLC to the Kentucky Treasury. My questions are: Who benefitted politically or financially from these transfers? Why didn't SLC or KHEAA shout from the rooftops about the potential risk that this was putting on the thousands of their borrowers who had been promised loan forgiveness? Why did SLC and KHEAA never mention these transfers to the teachers when we called and asked what happened to the funding for BIC? Does the documented tranfer of money to the KY treasury make our current governor's position that KY has no responsibility in this mess sound outlandish?

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  9. Anon@10:55,

    Here's a possible answer, reasoning from the timeline.

    The process of asking for growing amounts in 9.5 special allowances runs from early 2003 to early 2007.

    The transfers came in the middle of that, between July 2004 and June 2006.

    If someone assumed the 9.5 money would keep growing more or less forever, a couple of one time transfers wouldn't have looked like a big threat. KHEAA could afford the transfers, Best in Class, and Best in Care, all at the same time, without reducing loans available to students.

    Today, it's clear that the transfers matter: if the $7.8 million and the $59 million had been left in a KHEAA bank account, that money would be available now to pay off the Best Loans. Then, I think folks assumed 9.5 would last, so the transfer money wouldn't be needed.

    So, we're up to four money problems rather than three: the transfers, the end of 9.5, the change in other federal fees, and the global fiscal crisis.

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  10. Susan,

    The document that implies KHEAA’s 9.5 claims were legal at one point is a 2005 program review which is referenced in the 2005 audited financials. Do a key word search for “program review”.

    I disagree that KHEAA believed the transfers would last. KHEAA and a few other lenders recycled loans so quickly because they knew the door was closing soon. Several national news outlets and two acts of Congress tried to address the “loophole” for years before Secretary Spellings actually stepped in. http://www.nytimes.com/2004/08/27/business/a-windfall-from-a-student-loan-program.html?pagewanted=1
    This 2004 NY Times article clearly explains the problem and a financial analyst even had this to say in the article. ''Everyone's rushing in before the door closes,'' said Matthew J. Snowling, an analyst with Friedman, Billings, Ramsey.” KHEAA has lobbyist in high places and they obviously knew about the risks of 9.5 monies running out. They should have told the state “NO”.

    Here is another Washington Post Column published in 2004 mentioning the problem and the Acts of Congress addressing it. http://www.anneapplebaum.com/2004/09/29/student-loan-swindle/

    Here is a NY Times article in 2004 discussing the first act of Congress trying to close the 9.5 “loophole”. http://www.nytimes.com/2004/10/01/national/01loan.html?_r=1

    Here is a PDF link explaining the Higher Education Reconciliation Act of 2005, the second effort Congress made to eliminate the problem. http://www.ogslp.org/news/archives/pdf/reconciliationupdate12-28-05.pdf

    KHEAA and Kentucky had to be extremely aware of the fact that the 9.5 payments were going to stop. Again, they should have left the money with KHEAA. Since they took the money, knowing that it would pose a serious risk to borrowers, they should admit it and begin to fix the problem.

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  11. To Whom It May Concern:

    Hello. My name is Michael. I decided four years ago to go back to college to get my masters in special education because colleges across the state recruited for online classes for special education degrees, there was a need for special education teachers, and I was under the impression that my loan would be paid back 20% each year for five years that I taught until my loan was paid off. From that point forward, the percentage of reduction has decreased to pretty much nothing. It looks like we are going to have to pay our own loan back since we were mislead by someone, but I don’t think anyone is really going to take the blame for it. I got my Special Education Degree, completed my KTIP, all of my evaluations have been really good, and I have taught for four years in Madison County. I lack one month and the first day of teaching the next school year to get my tenured and not have to be worried about being pink slipped because of budget cuts. I have loved and enjoyed my four years of teaching, but before I left school this past Friday, my principal pulled me to the side and told me that she was giving me my verbal pink slip because some person who worked at our school as a Guidance Counselor that has been working for KDE is coming back to our district. So, our Guidance Counselor has a Special Education Degree and she will be put in my spot, which puts me out of a job. I guess this is because of budget cuts, but I’m not for sure. I didn’t have, nor do I have now any way to pay off my loan. I am asking for your support to help people like me who have been put in this bad situation to help us pay off our student loans. I appreciate your time.

    Michael

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  12. Pub Ad ProfessorMay 7, 2009 at 10:51 AM

    What a great discussion. Some commenters and bloggers are really on top of this. Too bad the Kentucky press is asleep.

    Breaking news: the federal Department of Education's Inspector General has just released a new audit of the department's office of Federal Student Aid. The "program review" cited by KHEAA as approval for its 9.5 funny-money claims turns out to have been an after-the-fact "political" review that was not approved by the department's policy office nor by its office of general counsel. Did KHEAA know that? Did KHEAA or its trade association ask for the review, knowing they were being issued extra-legally by lender-connected personnel in the federal Department of Education?

    This reeks of corruption. Federal Education Secretary Spellings reversed the reviews, but no heads rolled.

    The honorable thing for Governor Beshear to do is to work with new federal Secretary of Education Duncan to fulfill Kentucky's commitment to its thousands of teachers, nurses, and lawyers who participated in the loan forgiveness programs. Each party should offer a mea culpa, then do the right thing and live up to their respective obligations.

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  13. I received a loan through the Student Loan People having been told I would not have to repay it. I went back to college to get my Rank I. I too was mislead. Not only am I repaying the loan but now have been audited by the IRS because some third party has paid part of the loan causing a debt cancellation that is viewed as income to me. The math is not adding up, $4000.00 is debt cancellation on a loan of $18,000.00, but I still owe over 14,000.00. Go figure!

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