Getting to Know Guaranty Agencies: The Northwest Education Loan Association

Higher Ed Watch continues its series that takes a closer look at individual federal student loan guaranty agencies. The introductory post can be found here. The first post, on the Georgia Student Finance Commission can be found here. Today, the series continues with the Northwest Education Loan Agency.

The Northwest Education Loan Association (NELA) is a nonprofit guaranty agency based in Seattle, Washington that serves as the designated guaranty agency for both Washington and Idaho.

In operation since 1978, NELA was the 13th largest guarantor (out of 35) in the 2008 federal fiscal year, overseeing 176,773 loans worth $799.1 million. It was, however, the smallest guaranty agency to act as a designated guarantor for multiple states.

Unlike the Georgia Student Finance Commission (GSFC), which is basically a state agency, NELA is a private, nonprofit guarantor. It is, however, anything but independent. In late 2004, Sallie Mae, the country's largest student loan provider, essentially took over the guaranty agency's operations. This arrangement raises serious conflict of interest concerns, calling into question how a guarantor can carry out its federal oversight responsibilities over a lender that effectively controls it. As we have seen in similar cases, these types of close-knit relationships between lenders and guarantors can leave borrowers vulnerable to abuse.

Ties to Lenders

Student loan borrowers in Washington and Idaho may be forgiven if they are confused about NELA's relationship with Sallie Mae. On its website, NELA goes out of its way to stress that it is "not a subsidiary" of Sallie Mae. That is certainly true on its face. Federal law prohibits for-profit companies like Sallie Mae from owning nonprofit entities such as guaranty agencies. That restriction makes sense because the Higher Education Act puts guarantors in charge of overseeing loan providers -- making sure, for instance, that lenders do everything required to keep borrowers who are delinquent on their loans from defaulting.

But Sallie Mae found a clever way around that restriction. In December 2004 the lending giant acquired the Student Loan Finance Association (SLFA), a secondary market in the state of Washington, and its parent company, the Education Assistance Foundation. NELA had already outsourced all of its activities to SLFA's servicing arm. In this capacity, NELA maintained no employees, according to a 1999 report from the Financial Accounting Standards Board.

Sallie Mae's purchase of SLFA led to several changes in the way NELA was governed. First, it renamed SLFA's servicing arm NELA Services, though it maintained the outsourcing relationship that already existed. As part of this deal, the loan giant began marketing NELA's services as a guaranty agency (page 14). In fiscal year 2006, NELA paid Sallie Mae $30.5 million to handle guarantor services. It also paid $1.7 million to Sallie Mae's Student Assistance Corporation for default aversion assistance. NELA Services, meanwhile, outsourced its Seattle call center to Sallie Mae. By February of 2005, 74 of the 143 transferred employees at this counseling and default prevention center had been laid off.

In addition, NELA entered into an affiliate agreement with USA Funds (USAF), the nation's largest guarantor, which Sallie Mae also effectively oversees. While NELA maintained a separate legal identity, this arrangement basically made it a subsidiary of USAF. Today, five out of the seven members (page 5) of NELA's board are USAF executives, including its president and chief executive officer, vice president for customer relations, and general counsel. A sixth member, the president of the University of Portland, serves on both the NELA and USAF boards. NELA's financial statements are also filed by the same individual from the same address as USAF in Indianapolis. In 2006, NELA paid USAF over $240,000 for administrative fees.

NELA's relationship to Sallie Mae mimics the one that exists between the loan giant and USAF. In 2000, Sallie Mae purchased USAF's parent company, USA Group. While the loan company's purchase didn't include USA Funds, it did gain control of USA Group Guarantee Services, a for-profit subsidiary that provided administrative services to help the guarantor carry out its functions. In addition, USAF agreed to pay Sallie Mae $250 million annually to manage its guaranty agency's functions.

The Department of Education's Inspector General (IG) raised objections to this arrangement in 2002, arguing that it created a conflict of interest that could harm borrowers. With Sallie Mae effectively controlling the guarantor, the IG wrote, there was no independent agency ensuring that the loan giant was doing all it could to ensure borrowers didn't fall behind on their payments. In fact, the IG warned that by working hand-in-hand, the two entities actually had a perverse incentive to let borrowers fall behind so that USA Funds could collect the generous subsidies the government provided guarantors for keeping delinquent borrowers out of default.

The IG's warnings appear to have proved prescient. A former Sallie Mae employee has filed a false claims suit accusing the loan company of exploiting its ties with USA Funds "to systematically balloon student loan debts." According to the lawsuit, Sallie Mae employees working for USA Funds routinely placed delinquent borrowers into forbearance without getting their consent. Doing so allows borrowers to temporarily stop making payments on their loans, but interest continues to accrue, increasing the size of the borrowers' total debt load -- as well as the amount the guarantor can collect if the loans ultimately go into default.

While we have not heard specific complaints about NELA, it's clear that the similarity of its arrangement with Sallie Mae presents the same opportunities to undermine its ability to carry out a core function of guarantors -- providing independent and impartial oversight over the lenders with which it works -- that has allegedly occurred with USAF.

Non-Federal Activities

The ties between NELA, USAF, and Sallie Mae should raise the question as to why these companies have gone to such great lengths to keep the NELA name. One answer may be to build goodwill at the local level. As a diagram of the three agencies' connections outlines, some of NELA's strengths in the complex triangle are "familiar faces," being "regionally focused," and "extensive outreach efforts on campuses and the community." In other words, NELA provides a local face for a company that may otherwise be seen as a national behemoth.

NELA accomplishes its local goodwill through several activities, some of which are at least partially financed by USAF. For example, NELA sponsors the Take Aim Scholarship Program, which provides aid to students at community colleges in Oregon and Washington. USAF provided $231,000 for this initiative in the 2006 fiscal year, according to its tax filing.

In addition, NELA also operates Centers for Student Success in both Oregon and Washington. These facilities help provide information to the public about paying and planning for college. They also generate positive press such as this article.

On top of funding from USAF, NELA also partially pays for these initiatives through excess guaranty agency fees paid by the federal government. On its website, NELA notes that it has expanded its role beyond guaranteeing student loans "because technology has advanced and the guarantee process has become more automated, NELA has more resources available to promote access to higher education." While college access is an important goal, NELA presents no evidence documenting the effectiveness of the way it uses its excess government subsidies. Moreover, despite redirecting some of its excess subsidies to college completion activities, NELA still reported net income of $1.3 million in fiscal year 2006.

Performance Indicators

One area in which NELA is struggling is in preventing student loan defaults. In 2006 it had a cohort default rate of 8.9 percent, the seventh highest among the 36 agencies listed. This is substantially worse than the previous two years in which it had default rates of 7.1 and 7.2 percent, respectively. By contrast, the 2002 cohort -- the last round of data published before the Sallie Mae purchase of SLFA -- had a default rate of 5.2 percent. In other words, the cohort default rate for NELA has increased substantially since Sallie Mae and USAF took over its operations. This change is not attributable to the overall increase in cohort default rates, which has been much smaller.

Given that NELA contracts out its default aversion activities, the growth in its cohort default rate should certainly raise questions whether the Sallie Mae affiliate it has selected to handle these responsibilities was the best option.

Conclusion

Our first entry on the Georgia guaranty agency touched on how a state entity connected to both a lender and grant maker could distort its image, fail to properly carry out its oversight role, and gain political influence. But as NELA shows, a guaranty agency does not have to also serve as a lender to raise questions about independence and proper oversight. There is strong evidence that NELA's heavily intertwined relationships with Sallie Mae and USAF put it in a position that make it virtually impossible to carry out the oversight role expected of it by Congress and the U.S. Department of Education. Moreover, the growth in the agency's default rate since it outsourced default aversion activities to Sallie Mae and USAF raises significant questions about whether NELA is doing its best to serve students.

Check back soon for the next edition of Higher Ed Watch's Getting to Know Guaranty Agency series.

Editor's Note: The author attempted to contact NELA but the agency did not respond.