EXCLUSIVE: Questionable Federal Student Loan Practices in South Carolina

Something fishy appears to be going on in South Carolina.

Financial reporting documents that Higher Ed Watch obtained from the U.S. Department of Education suggest that the state student loan agency in South Carolina may be exploiting its ties to a closely affiliated guaranty agency to receive excessive taxpayer subsidies from the federal government. At issue is the guarantor's apparent abuse of an emergency program that the government has in place to ensure that all eligible students are able to obtain federal student loans.

The federal lender-of-last-resort program is administered by the designated guaranty agency in each state to provide government-backed loans to students whose applications have been denied by other lenders. Since the agency must give qualified borrowers a loan-of-last-resort, the federal government agrees to take on all the risk associated with the debt. This means that holders of these loans are reimbursed for 100 percent (page 8) of any losses sustained due to borrower default, as opposed to ordinary loans made through the Federal Family Education Loans program (FFEL) that are reimbursed at only a 97 percent rate.

As its name suggests, this program is supposed to be used only in rare cases. But the documents, which we obtained from the Department of Education through a Freedom of Information Act (FOIA) request, show that over at least the past six years, South Carolina's guaranty agency has provided loans to students through this program with unusual frequency. The rate at which the agency used this program to request reimbursement from the Department was at least 100 times greater than any of the other nine agencies whose documents we obtained -- a sampling that included the largest guarantors in the country. All told, South Carolina's lender-of-last-resort claims were three times greater than those for the other nine agencies combined. (See chart above or the spreadsheet at the bottom of this post for additional information on the guaranty agency claims.)

In an e-mail to Higher Ed Watch a spokesperson for the Department of Education said the Department "is aware of the situation and the Federal Student Aid office is conducting a program review." The spokesperson, however, declined to comment further until that process is completed.

The South Carolina Student Loan Corporation (SCSLC), the state student loan agency that made the lender of last resort loans on behalf of the guarantor, appears to have benefited from the frequent use of this program because it could shift the default risk on these high risk loans entirely to the government, and as a result collect more generous federal subsidies if the debt was not repaid. Increasing the number of lender-of-last-resort loans in a portfolio could make a securitized package containing those loans less risky, and thus more attractive, to potential investors -- reducing borrowing costs and thus increasing the profit spread earned on either federal or alternative student loans.

The South Carolina State Education Assistance Authority (SCSEAA), the state's designated guaranty agency, would also benefit from greater usage of the lender-of-last-resort program. The Department of Education excludes lender-of-last-resort loans (page 4) from its calculations of guaranty agencies' default rates. This matters because guarantors with high default rates must pay a larger fee (page 3) in order to receive reimbursement from the federal government for claim payments made to lenders.

Neither the SCSLC or the SCSEAA responded to calls for comment from Higher Ed Watch.

How Did We Find Out?

Through our FOIA request, we were given copies for 10 guaranty agencies of the monthly reimbursement request form, also known as Form 2000, that they must submit to the Department of Education each month. We also received copies of the loans-of-last-resort plans on file at the Department of Education for those same agencies. Unfortunately, we do not have a complete picture of what is going on in South Carolina because the Department of Education denied our request for a summary of loans-of-last-resort volume broken down by guaranty agency, on the grounds that the Federal Student Aid (FSA) office "does not have any existing reports or responsive documents." In a subsequent request this week, the Department agreed to provide this information at a later date.

An analysis of the monthly forms clearly demonstrates that since at least Jan. 2003, the South Carolina guaranty agency has filed reimbursement requests to the Department of Education for over $60.8 million in loan-of-last-resort default claims.[1] That figure represents 30.4 percent of all default reimbursement requests filed by the South Carolina guaranty agency from Jan. 2003 to Jan. 2009.

The documents we obtained also reveal that the South Carolina guaranty agency filed its loans-of-last-resort requests at both a more frequent rate and for a significantly greater dollar value than any of the other guaranty agencies we reviewed. At United Student Aid Funds (USAF), only $2.9 million, or 0.03 percent, of its default claims were for loans-of-last-resort during the same period of time. Meanwhile EdFund, the California guaranty agency, filed loans-of-last-resort claims worth only $12.0 million, or 0.31 percent, out of its total default requests of $3.9 billion.

In other words, the South Carolina guaranty agency has been filing loans-of-last-resort claims at rates 880 times higher than USAF, the country's largest guaranty agency, and 98 times higher than EdFund, which runs the second largest. Moreover, the agency's use of its emergency authority has increased over time. These claims represented 35.4 percent of its total default claims in 2008, an increase from 19.5 percent in 2003.

What We Think is Happening Here

What makes this all the more intriguing is that SCSLC for all intents and purposes runs the South Carolina guaranty agency -- a setup that makes it possible for the loan agency to exploit the lender-of-last-resort program for financial gain.

Though technically two distinct entities, the guaranty agency-the SCSEAA-and the nonprofit lender -- the SCLSC -- are largely inseparable. The SCLSC administers the operations of the SCSEAA (page 9), and receives compensation for carrying out this activity. The two share the same office complex in Columbia, S.C. and have a common website that is solely branded with the Corporation's logo. In fact, calls for comment on this story placed to both the lender and guaranty agency were transferred to the same individual.

According to the South Carolina guaranty agency's plan for lender-of-last-resort loans, a student becomes eligible for such a loan if their application is denied by a FFEL lender. Once that occurs, the loan-of-last-resort will be made by a loan company designated by the guaranty agency: in this case, SCSLC. This plan has been in place since at least 1994 and was reaffirmed by SCSLC in 2008.

Normally, the actual loans-of-last-resort process is of little importance because students' applications are usually approved by FFEL lenders-especially during the financial boom years covered by the documents we obtained. That is not the case, however, in South Carolina, where the sheer volume of default claims filed indicates that large numbers of students must have been denied FFEL loans.

As we said earlier, denying students' FFEL applications and shifting them into the loan-of-last-resort program appears to be a worthwhile endeavor for SCSLC because it allows the agency to reduce the risk in its portfolio, obtain higher federal reimbursement payments than it otherwise would receive, and make its assets more attractive to potential investors. It also helped its sister agency, the SCSEAA by excluding loans from the cohort default rate calculation, an accountability measure

To reiterate, what we believe is occurring is that borrowers are having their loan applications denied with unusual frequency by the SCLSC. Under SCLSC's lender-of-last-resort plan, a single denial makes them eligible for a lender-of-last-resort loan through the SCSEAA. That agency in turn, has conveniently contracted with its officemate, the SCSLC, to provide that loan. As a result, the borrower gets his or her loan, the SCSLC still gets the loan business but now has no risk of losing any money if borrowers default, and the SCSEAA guarantees a loan that cannot hurt its default rate calculations if the borrower fails to pay it back. It's a win-win-win for everyone involved. That is, except for taxpayers and the federal government, which are now on the hook for greater risk and subsidies.

The close ties between the loan agency and the guaranty agency also dramatically decreased the risk that the guarantor's excessive use of the loans-of-last-resort program would be discovered. Guaranty agencies are tasked with overseeing and auditing the activities lenders at the state level-but, as we've seen in other cases, when the two work hand-in-hand, abuses are more likely to occur.

A New Chapter in the Scandal-Prone History of FFEL

What appears to be occurring in South Carolina is yet another example in a long history of waste and abuse in the FFEL program. (See this report released yesterday by the Department's Inspector General for more on how oversight failures allowed these types of questionable practices to occur.) Whether it is charging for excessive subsidies, manipulating borrower balances, or paying off college and Department of Education officials, these repeated instances of improper and sometimes illegal activities again underscore the need for an overhaul of the federal student loan programs to better protect students and taxpayers.

In addition to the documents contained in this post, Higher Ed Watch has .zip files of the monthly forms for the 10 guaranty agencies mentioned. Here are links to .zip files for South Carolina, USA Funds, and EdFund. If you would like additional materials, such as lender-of-last-resort plans, please e-mail the author at miller [at] newamerica [dot] net

[1] When a federal student loan defaults, the guaranty agency handling the insurance on the loan is required to reimburse the lender for the vast majority of its loss. For loans-of-last-resort, this reimbursement covers 100 percent of default losses instead of the typical 97 percent. After paying a lender's default claim, the guaranty agency files a request with the Department of Education to be reimbursed for the majority of that payment.

These reimbursement requests are broken down by various categories on the monthly reimbursement form. One of those categories is for Exempt/Loans-of-last-resort. Example claims represent a very small subset of those claims and only are "filed in situations where the lender determines that the borrower or the student on whose behalf a parent has borrowed, without the lender or school's knowledge at the time the loan was made, provided false or erroneous information or took actions that caused the student or borrower to be ineligible for all or a portion of a loan. Also include claims where the student has been convicted of, or plead nolo contendere to, a crime involving fraud in obtaining title IV student aid."