A r c h i v e d  I n f o r m a t i o n

   FOR RELEASE              Contact: Stephanie Babyak (202) 401-2311    September 12, 1995                   Jane Glickman (202) 401-1307

"The department and the administration are committed to full implementation of the federal direct loan program," Riley said. "Until this occurs, it is important that guaranty agencies be administered as cost-effectively as possible. The changes associated with the merger of these two agencies would provide incentives for work well-done and do away with a reserve fund concept that has out-lived its usefulness under the present system. This is a common-sense approach and good business practice."

The two guaranty agencies, Great Lakes Higher Education Corporation (Great Lakes) and Northstar Guarantee, Inc. (Northstar), are private, non-profit corporations designated by the Education Department to administer the Federal Family Education Loan Program (FFELP). Great Lakes serves Wisconsin, Puerto Rico, and the Virgin Islands; Northstar serves Minnesota. The combined Great Lakes-Northstar agency will continue guaranteeing loans in its designated states and will be considered for additional assignments as they become available.

According to an agreement in principle between the two agencies and the Education Department, Great Lakes and Northstar will implement new concepts to alter traditional arrangements with the department to address two major weaknesses in the structure of FFELP guaranty agency activities. The details for implementing these concepts will be worked out in the near future.

First, a total of nearly $2 billion in federal funds is held presently in reserve by guaranty agencies to pay off lenders and holders of student loans. However, the 1993 Student Loan Reform Act mandated that the Education Department assume responsibility for these reimbursements in the event that a guaranty agency becomes insolvent, thus eliminating the need for guaranty agency reserve funds.

The Great Lakes-Northstar merged agency will return to the department any reserves that are not necessary for the agency's working capital. The secretary is convinced that the plans for managing the merged agency's operations will protect both the federal fiscal interest and program participants. Accordingly, the department will not require the merged agency to maintain a specific ratio between its reserve fund and its outstanding guarantees.

A second initiative provides financial incentives to the merged agency for helping reduce defaults. Under current practice, FFELP guaranty agencies assist lenders in seeking payments on loans when borrowers fall behind in payments (preclaims), but receive no compensation if those initial efforts are successful. The agencies are paid a 1 percent fee if subsequent efforts (supplemental preclaims) are successful in preventing default. If the borrower defaults (defined as non- payment for 120 days), the guaranty agency pays off the lender and is reimbursed by the Education Department. The guaranty agency then becomes responsible for loan collection and retains 27 percent of any collections. Thus, guaranty agencies can generate much more revenue by collecting on defaults than by preventing them.

Under the new concept, Great Lakes-Northstar would pursue a new default reduction method designed to eliminate this anomaly and reduce default costs to taxpayers by remedying more late- payment situations before they become actual defaults. Under its authority to provide funds to pay guaranty agencies' administrative costs, the department would pay the agency an incentive fee for enhanced preclaims activities. It will then assign collections on defaulted loans to department contractors. If this new method is successful, the department will consider using it on a broader basis.