Financial Responsibility Standards Requiring a Letter of Credit
Section 498(c) of the Higher Education Act (HEA) of 1965, as amended, requires institutions to submit financial statements to the Department of Education when applying to start participation, to determine compliance annually with the standards of financial responsibility, or to continue participation after a change in ownership, in the various Title IV programs. The regulations establish general standards of financial responsibility, and also provide for the Department to determine the financial responsibility of an institution each year by calculating composite financial scores. The regulations specify that certain amounts reported in the institution's financial statements are used as required elements to calculate the composite score.
The most common reason why an institution is required to remit a letter of credit (LOC) to the Department is because they have a failing financial responsibility composite score (generally a score of 1.4 or less on a scale of -1.0 to +3.0) and are not deemed financially responsible. In accordance with 34 CFR 668.175, an institution with a composite score of 1.4 or less may continue to participate in the Title IV programs under the Provisional certification alternative. Institutions participating under provisional certification are subject to heightened cash monitoring, and may be required to submit an irrevocable LOC of not less than 10 percent of the Title IV aid the institution received during its most recently completed fiscal year. Institutions that passed the score in the previous year may score from 1.0 to 1.4 for up to three consecutive years without providing a LOC, provided other reporting conditions are met. Institutions that score below a 1.0 are required to submit a LOC of not less than 10 percent of the Title IV aid the institution received during its most recently completed fiscal year.
A LOC may also be required by institutions that are cited for failure of other portions of the financial responsibility standards noted under 34 CFR Part 668 Subpart L. Such conditions may include the following:
- Failure to submit acceptable annual compliance and financial statement audits in a timely fashion. Institutions that are cited for such past performance violations under 34 CFR 668.174 are provisionally certified, subject to cash monitoring requirements, and must submit a LOC for a period of five years in an amount equal to no less than 10 percent of the Title IV aid the institution received during its most recently completed fiscal year.
- Failure to maintain sufficient cash reserves to return Title IV funds to the Department for students that withdrew from the institution in a timely fashion. As noted in CFR 668.173, an institution found in violation of the reserve standard is required to submit a LOC equal to 25% of the total amount of unearned Title IV funds the institution was required to return for its most recently completed fiscal year.
- The Department also requires prospective new owners of a participating institution that cannot provide the required two years of audited financial statements to submit a LOC of at least 10% to 25% of the amount of Title IV aid the Department determines the institution would receive in its first year of operations.
- Institutions that fail the composite score measure may elect to submit a LOC equal to 50 percent or more of their Title IV aid received to be considered financially responsible. As a result, the school may be free of cash monitoring and other participatory requirements during the tenure of the LOC if there are no other substantive problems related to its Title IV participation.
An irrevocable LOC is a financial instrument issued by a financial institution (most commonly a bank) on behalf of a school, which is generally secured by collateral (generally cash reserves), held by the bank. The bank will pay the LOC funds to the Department when the Department initiates collection for reasons that are listed in the LOC. The LOC mitigates the monetary risk from schools not in compliance with various regulatory standards, yet allows the school(s) to continue Title IV participation, while improving, or eliminating the issue(s) that required the LOC.
Institutions required to remit a LOC to the Department must provide one from a recognized U.S. financial institution and do so in the amount of and for the time period determined in the regulations and by the Department. Letter of credit requirements are applicable to private non-profit and proprietary institutions. These requirements generally do not apply to public institutions.
Funds from a letter of credit may be drawn in part or whole by the Department to reimburse the Department for student refunds, loan cancellation costs, and may be used with the institution’s agreement to cover the expense of teach-outs when an institution closes. LOC funds may also be used to pay institutional liabilities owed to the Department.
Additional information about Letter of Credit requirements is available in the FSA Handbook.
An Award Year covers the period of July 1 through June 30 and tracks the school year for which financial aid is used to fund a student’s education.
Tab 3 in the spreadsheet linked above provide descriptions of the data fields and common definitions for the reasons why an institution was required to remit a LOC to the Department.
Please note that this list shows the LOCs requested by the Department for Award Years 2013 and 2014, and does not indicate whether these institutions are currently required to provide a LOC to the Department. LOCs requested from institutions throughout Award Year 2015 will be posted by the summer of 2017.
NOTES: LOCs are generally for one year from the date of the condition causing the LOC, subject to annual renewals if the condition persists. LOCs required for late or unmade refunds are for at least a two year period. A past performance LOC is in effect for a five year period. LOCs are subject to renewal on, or before the expiration date, if a condition requiring an institution to provide the LOC has not been resolved by the school.
There are several reasons why an Institution Name may appear more than once within the requisite award year as being required to remit a LOC. In some cases, a LOC may have been requested more than once during the year for different reasons or time periods. In other cases, the institution may have submitted multiple LOCs within the same reporting period either for different reasons, or because the original LOC amount was increased (i.e. failed numeric test, and untimely refunds, or other risk factors were identified). Furthermore, a LOC provided to cover multiple institutions under common ownership may be listed separately for each institution.