Guaranteed Student Loan Programs - Financial Statements, March 31, 2002 and 2001 (index)

Notes to Financial Statements

March 31, 2002 and 2001

(1) Organization and Operation

New York State Higher Education Services Corporation (HESC) is an agency of New York State (NYS) created in 1974 under Chapter 942 of the Laws of 1974 and is primarily responsible for the administration of New York State's student financial aid programs, including the Federal Family Education Loan Program (FFELP) and State loan guarantee programs.

FFELP was established by Congress and is administered by the U.S. Department of Education through HESC and other guarantee agencies. As a guarantee agency, HESC makes loans available through lending institutions to students attending colleges, universities, postsecondary educational and vocational schools. FFELP allows HESC to guarantee repayment of principal and accrued interest to lenders for eligible student loans. HESC has the responsibility of processing loans submitted for guarantee, issuing loan guarantees, providing collection assistance to lenders for delinquent loans, paying lender claims for loans in default and collection activities on loans after purchase by HESC. In addition, the Guaranteed Student Loan Programs (GSL) include the residual activity of the State guaranteed loan program in which no new loans have been guaranteed since 1984.

The accompanying financial statements reflect HESC’s Guaranteed Student Loan (GSL) program activities only and are prepared on the accrual basis of accounting. The Higher Education Amendments of 1998 (1998 Amendments) were enacted on October 6, 1998 and changed the manner in which FFELP is administered. Under the Amendments, HESC established a Federal Student Loan Reserve Fund (Federal Fund) and an Operating Fund as required to account for FFELP activity. The Federal Fund assets, and earnings on those assets are restricted in use and are considered property of the U.S. Department of Education and are recorded as a HESC liability. The Operating Fund is considered property of HESC and its assets and earnings may be used generally for all guarantee agency and other student financial aid related activities. The balances as of March 31, 2002 and 2001 reflect FFELP results under the new regulations. Certain amounts have been reclassified from the prior year to conform with the current year presentation.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and in the disclosure of contingencies at the date of the financial statements and the reporting of revenue and expenses during the reporting period. Actual results could differ from those estimates.

HESC also administers the Tuition Assistance Program, State Scholarship Programs, Federal Gear Up Program and Robert L. Byrd Federal Scholarship Program under which students apply for payments to attend particular educational institutions based on family income and/or academic achievement. These programs are not included in the accompanying financial statements.

The Guaranteed Student Loan Programs’ of HESC are discretely presented as a component unit in the State of New York’s financial statements.

(2) Guaranteed Loans Outstanding and Respective Unpaid Balances

As of March 31, 2002 and 2001, HESC was the guarantor of loans outstanding with original principal amounts of approximately $15,421,000,000 and $14,397,000,000, respectively, made to students by participating lending institutions. The majority of that amount is guaranteed by the U.S. Department of Education, with an amount representing less than 1% guaranteed by the State of New York. At March 31, 2002 and 2001 the unpaid balances were approximately $13,347,000,000 and $12,148,000,000, respectively.

HESC’s management anticipates that a certain portion of the loans outstanding as of March 31, 2002 and 2001, will go into default status requiring HESC to purchase loans from lenders. Because the majority of these loans are Federally guaranteed, they will be reimbursed by the U.S. Department of Education and the Federal Fund.

(3) Cash, Cash Equivalents, and Investments

Cash and Cash Equivalents

Cash equivalents are short-term investments with remaining maturities of twelve months or less when purchased and are generally short-term United States Treasury Bills and collateralized repurchase agreements. Cash equivalents are recorded at cost plus accrued interest, which approximates the fair value at March 31, 2002 and 2001. The carrying value of treasury bills are adjusted for amortization of purchase discounts and premiums. Federal Fund amounts and reserve recall amounts are restricted in use and are property of the U.S. Department of Education. HESC actively manages the investments of its cash balances to minimize its uninvested funds. Excess cash balances are generally invested in short-term repurchase agreements until such time that HESC anticipates the funds will be necessary for operational needs. Cash balances in the administrative account of the Operating Fund are invested in the New York State Comptroller’s short term investment pool.

Included in Operating Fund bank balances are $4,737,173 for 2002 and $3,473,439 for 2001, which were deposited by lenders, to be forwarded to schools generally within three business days, under an electronic funds transfer program (EFT). The offsetting liability is shown as amounts due to lenders, which are held by HESC for future disbursement.

HESC’s cash and cash equivalents at March 31 were as follows:

HESC requires collateral consisting of federal government obligations or agency instruments guaranteed by the federal government pursuant to investments in repurchase agreements and delivery to its Trustee (agent) of all securities purchased and collateral for repurchase agreements, regardless of the seller institution.

As of March 31 the cost and fair value of cash equivalents are as follows:

Long term Investments

HESC invests cash not required for short term operating needs in long term United States Treasury Notes. In accordance with GASB Statement No. 31, Accounting and Reporting for Certain Investment Pools, all investments with a maturity of more than one year are recorded on the balance sheet at fair value and all investment income, including changes in the fair value of investments, are reported as investment income. Long term investments are property of the Federal Fund and are carried at fair value. Any realized or unrealized gains or losses recognized are an increase or decrease in the Federal Fund liability (see note 11). HESC’s investments are categorized to give an indication of the level of custodial risk assumed by HESC at year end. All of HESC’s investments are included in category “A”, the lowest risk, as defined by the Government Accounting Standards Board to include investments that are “insured or registered or securities held by HESC or its agent in HESC’s name”. Disclosure relating to risk and type of investments as described are indicative of activity and financial positions held during the year.

At March 31, 2002 and 2001 the cost and fair value of long term investments were as follows:

The long term investment which matured in 2002 was reinvested in short term instruments due to low interest rates and market volatility. It is now reported in cash and cash equivalents of the Federal Fund.

(4) Administrative Fees

The 1998 Amendments established three fees paid to HESC for administering the loan program on behalf of the Federal Government based on performance as a guarantee agency.

A Default Aversion Fee is recognized for default aversion activities on delinquent loans at the time the lenders request aversion assistance between the 60th and 120th days of a borrowers delinquency. A fee of 1% of principal and interest on the loan may be charged to the Federal Fund at the time the guarantee agency receives a request from a lender for preclaim assistance. However, the fee must be refunded by HESC in the event the loan is later paid as a default claim. Accordingly, HESC has calculated an estimate of default aversion fee refunds which is presented as an Operating Fund liability. HESC transfers the net default aversion fee from the Federal Fund to the Operating Fund on a monthly basis.

Loan Processing and Issuance Fee is paid based on the original principal amount of new loans guaranteed and disbursed during the period at a rate of 0.65% through fiscal year 2003 and 0.40% thereafter. This fee is paid to HESC on a quarterly basis.

Account Maintenance Fee is calculated on the original principal amount of loans outstanding at a rate of 0.10% after fiscal year 2000, and 0.12% for prior years. The fee is paid directly by the Department of Education or as an authorized transfer from the Federal Fund on a quarterly basis.

For the years ended March 31, 2002 and 2001, the administrative fees receivable from U.S. Department of Education consisted of the following:

Gross default aversion fee income for the years ended March 31, 2002 and 2001 was $9,314,682 and $10,016,911, respectively. HESC records an estimated reserve for default aversion fee refunds which is netted against default aversion fee income. In 2002, HESC estimated that 22.5% of all default aversion fee income, recorded since the fee was established in 1998, will have to be refunded to the Federal Fund in the future. In 2002, HESC increased the estimated reserve for future default aversion fee refunds to account for this liability by $6,378,167. The estimate is based on current and historical data which reflected a higher rate of default consistent with economic conditions and an increase in default loan purchases.

(5) Collections Receivable from or Payable to U.S. Department of Education

HESC is required by Federal statutes to pursue collections on loans upon default claim payment. Collections on defaulted loans and related complements are recorded at the time such collections are received. Collections due to Department of Education increase the Federal Fund liability and are not recognized as revenue in the Operating Fund. All collection receipts are initially deposited in the Operating Fund. The Operating Fund retains 24% of borrower payments and 18.5% of consolidation and rehabilitation payments. As required by the 1998 Amendments, effective July 1, 2000, HESC adopted the 48 hour rule for depositing collections, changing when funds are transferred from the Operating Fund to the Federal Fund. A daily transfer is now made based on an estimate of the Secretary’s equitable share of daily collections. A final settlement for the actual amount of collections due to the Federal Fund is made at month end. In fiscal year 2002, the Operating Fund underestimated the collection transfer amount, resulting in a payable of $632,914, from the Operating Fund to the Federal Fund. In fiscal year 2001, the Operating Fund overestimated the collection transfer amount resulting in a receivable of $1,761,796 from the Federal Fund to the Operating Fund. In both years, the appropriate interest earnings were transferred with the funds settlement at the end of the month.

(6) Due from Other Sources

In 2002, HESC used Operating Fund revenues in the amount of $74,014 to fund part of the Federal Gear Up program expenses, which were subsequently reimbursed to the Operating Fund after year end. In 2001, HESC used Operating Fund revenues in the amount of $470,716 to initially fund part of the Federal Gear Up program expenses, subsequent to year end this amount was reimbursed by the Federal grant. Gear Up is a Federally funded program initiated to increase middle school students interest in higher education.

HESC recorded a net receivable at March 31, 2001 from New York State of $1,391,938, as a result of State and Federal Programs operation income and expenses being allocated at the end of each quarter. In the State fiscal year ended March 2001, HESC was required to consolidate its data centers with other State agencies. As a result, computer equipment owned by HESC and the Federal Fund was transferred to the NYS Office for Technology. Payment for the assets purchased with Federal loan program funds was based upon fair market value assessed by a third party resulting in a net receivable of $1,782,439.

In 2001 HESC also received additional revenue from New York State in excess of expenditures for the State loan program and has a liability to the State for $862,494.

(7) Fixed Assets and Transfer to New York State

The majority of HESC’s Federal Fund and Operating Fund equipment consists of computer equipment, while a small part of these assets are office equipment. A significant portion of HESC’s computer equipment was transferred to NYS Office for Technology (OFT) in 2001 due to a State mandate aimed at consolidating State computer operations. The majority of the assets transferred to OFT were the property of the Federal Fund. To complete the transition in 2001, the HESC Operating Fund reimbursed the Federal Fund at a value appraised by a third party and then transferred the assets to OFT, leaving a receivable from New York State to the Operating Fund.

Fixed assets are recorded at cost. Depreciation for Federal Fund assets is based on an estimated 5 year useful life, using the straight line method. In fiscal year 2001, HESC Operating Fund changed from straight line to accelerated depreciation for all equipment, however, the estimated useful life of 5 years remained. Appropriate adjustments to the depreciation expense and net asset values were made. This change did not result in a significant impact on operations.

(8) Federal Reserve Recall

The 1997 Budget Reconciliation Act (Act) requires the return of a total of $1 billion nationwide in Federal reserves from all FFELP guarantee agencies. HESC share of this nationwide return has been determined to be $47,377,098. Act provisions require HESC to transfer 20% of its share, or $9,475,420, each fiscal year from 1998 to 2002 from the Federal Student Loan Fund to a separate and distinct Federal Student Loan Reserve Fund, held in a restricted account with the U.S. Department of Education as owner. To date HESC has made all of the required deposits totaling $47,377,098 which will be remitted to the U.S. Treasury on September 3, 2002. The deposits and interest earned are held as cash and cash equivalents in the Federal Fund. Federal regulations allow HESC to use interest earned on deposits to fund Default Management Initiative activities. HESC has used a portion of the interest for this purpose resulting in a net interest balance of $3,811,748 as of March 31, 2002. In July 2002, the Department of Education notified HESC that the interest earned on the 1997 reserve recall funds may be transferred to the Operating Fund on or after September 1, 2002. This money will still be earmarked for use in Default Management Initiative activities only.

The 1998 Amendments to the Higher Education Act contain a provision for an additional recall of federal reserve funds held by guarantee agencies totaling $250 million nationwide. On July 11, 2002, HESC was notified by the U.S. Department of Education that HESC’s share of this recall would be $18,222,100. HESC is required to transfer to the U.S. Treasury $6,195,514 by September 3, 2002, the remaining two payments of $6,013,293 are to be paid in 2006 and 2007.

(9) Purchase of Defaulted Federal Loans

Purchases of defaulted loans are recorded as Federal Fund activity net of amounts repurchased by lenders. The reinsurance calculation, results in a net reduction to the Federal Fund liability due to the reduced reinsurance rates of 98% and 95% as a result of various amendments to the Higher Education Act.

(10) Insurance Premiums

As a result of the 1998 Federal regulation implementation, HESC no longer earns insurance premiums for administrative expenses. The fees became Federal Fund revenue, subject to the Federal Fund’s restricted use. During Federal fiscal year 1999, HESC discontinued charging the fee because the Federal Fund had sufficient balances to cover anticipated future default loan purchases. If the Federal Fund balance is significantly reduced in the future, insurance premiums may be reinstated.

(11) Payable to the U.S. Department of Education

Under the Higher Education Amendments of 1998 all liquid and nonliquid assets related to the FFELP guarantee functions were transferred to the Federal Fund effective October 1, 1998. The Federal Fund is administered by HESC on behalf of the U.S. Department of Education (ED) and is the property of the Federal government. The net assets in the Federal Fund are shown in the financial statements as a liability to the ED. The amount payable to ED for the 1997 Budget Reconciliation Act of $1 billion federal recall and the federal advance are not included in the following:

(12) Federal Advances

HESC has received, in prior years, non-interest bearing advances from the ED total $10,300,348, for the purpose of helping to strengthen FFELP through the infusion of additional working capital. Under the terms of the agreement, HESC will be required to repay these advances at such time as the amount of federally guaranteed loans outstanding (note 2) is reduced to less than $454,950,000. The federal advanced funds are shown as a liability.

(13) Pension Benefits

Substantially all employees of HESC are members of the New York State and Local Employees’ Retirement System (System), a cost-sharing, multiple employer public employee retirement system. The State Comptroller is sole trustee and administrative head of the System. The System issues a publicly available financial report that includes financial statements and required supplementary information which may be obtained by writing to New York State and Local Employees’ Retirement System, 110 State Street, Albany, New York 12236.

The System provides retirement benefits as well as death and disability benefits. All benefits vest after five years of accredited service as changed by Chapter 389 of the laws of 1998. Retirement benefits are established by the New York State Retirement and Social Security Law. Retirement benefits and contributory requirements depend upon the point in time at which an employee last joined the system. Most members of the System who joined before July 27, 1976 are enrolled in a noncontributory plan; HESC contributes the entire amount determined to be payable to the system for these employees. Personnel who joined the System after July 27, 1976 are required by law to contribute 3% of their gross salary; HESC contributes the balance payable to the System for these employees. After October 1, 2000, employees with 10 years of service are not required to contribute to their plan.

HESC paid to the New York State Comptroller’s Office $858,478 for 2002 and $987,223 for 2001, and $946,084 for 2000 to cover 100% of the required employer contributions for retirement benefits each year, respectively. These payments made represent 3.11%, 3.56%, and 3.72%, of covered payroll for each of the years, respectively.

(14) Postretirement Benefits

In addition to the pension benefits described in note 13, the State provides health insurance coverage and survivor benefits for retired employees and their survivors. Substantially all of the State’s employees may become eligible for these benefits if they reach normal retirement age while working for the State. Health care benefits are provided through an insurance company whose premiums are based on the benefits paid during the year. HESC recognizes the cost of providing health insurance by recording its share of insurance premiums as an expenditure determined through the State’s fringe benefit rate. Additionally, the survivor’s benefit program provides for a death benefit to be paid by the State to a retiree’s designated beneficiary.

(15) Employees’ Vacation Pay Benefits

Under the terms of HESC’s personnel policies and its union agreements, vacation pay benefits may be paid upon termination up to a combined maximum of 30 days. HESC recognizes employee’s vacation pay benefits when earned. HESC has determined that the liability for employees’ vacation pay benefits is $2,643,164 and $2,592,882 as of March 31, 2002 and 2001, respectively, and is recorded in accounts payable and accrued expenses.

(16) Deferred Compensation

New York State offers its employees, including HESC employees, a deferred compensation plan created in accordance with Internal Revenue Code Section 457. The plan, available to all employees, permits them to defer a portion of their salary until future years. The deferred compensation is not available to employees until termination, retirement, death, or unforeseeable emergency. All amounts of compensation deferred under the plan are placed in trust for participants and their beneficiaries.

(17) Leases

HESC leases office space and storage space under noncancelable operating leases and month to month agreements. Total rental expense, which includes utilities for one of two major leases, for the years ended March 31, 2002 and 2001, approximated $2,422,809 and $2,166,475, respectively. The future minimum lease payments for the noncancelable operating leases are as follows:

(18) Contingencies

HESC is subject to ED oversight and audit that at times may result in program issues and potential liabilities to ED. The issues relate to possible violations of rules and regulations established by ED to administer the federal loan program. Management diligently attempts to interpret ED’s rules and regulations, and believes that their implementation of policies and procedures properly adheres to those rules and regulations and any resulting liabilities would not be material.

During the normal course of business HESC is involved in various legal proceedings and investigations, pertaining to matters relating to Corporation operations and activities. While these proceedings and investigations may lead to a possible liability, in the opinion of HESC management, after considering all relevant facts, these possible liabilities will not in the aggregate have a material adverse effect on the financial position of HESC.

(19) Subsequent Events

In May 2002, New York State through the approval of the State’s 2002-2003 budget appropriated $39,404,000 million of HESC’s Operating Fund balance to be used for other financial aid related activities during the 2002-2003 State fiscal year. The effect on the fund balance would be to reduce it to $33,278,589 if applied at March 31, 2002.

In July 2002, the National Council of Higher Education Loan Programs (NCHELP) and the U.S. Department of Education tentatively agreed to a settlement regarding the interest income associated with the implementation of the 48 hour rule for depositing collections. As a result of this tentative agreement, the HESC Operating Fund may in the future be able to reclaim approximately $1,000,000 already paid to the Federal Fund.