These modifications are among those being considered in response to public comments received on the September 20, 1996 Notice of Proposed Rulemaking (NPRM) methodology. The Department is interested in receiving feedback on these potential modifications. Please submit any written comments as described in the NPRM and other Federal Register Notices as discussed elsewhere on this Web site.
Equity ratio
Public comments have been received that the NPRM methodology does not account for the fixed assets of an institution. One measure that could potentially consider the impact of fixed assets is the Equity ratio. The Equity ratio is equal to Net Tangible Assets/Total Assets. This ratio could be used as an indirect measure of the institution's ability to borrow. Net Tangible Assets are divided by Total Assets to account for the size of the institution. The Department is seeking feedback on whether this ratio might distinguish between zero-debt schools that have no debt because they cannot obtain a loan and zero-debt schools that have no debt by choice. Using this ratio would bring the net tangible fixed assets into the methodology to incorporate this aspect of the institution's overall financial condition.
The Equity ratio might be used to replace the Viability ratio in the methodology. The methodology could conceivably consist of the Equity ratio, the Primary Reserve ratio and the Net Income ratio. The strength factors associated with various levels of the Equity ratio would have to be determined. Whether the Equity ratio would have the same weight as the Viability ratio had in the NPRM methodology, and the weights associated with all three ratios, would have to be considered. Whether the Equity ratio would be appropriate for all sectors, or just selected sectors, is under consideration. The Department is interested in receiving feedback on this.
Strength Factors, Weighting and the "Bright Line"
Public comments have been received on many different aspects of the strength factors, weighting and bright line contained in the NPRM methodology. The strength factors are the unweighted scores found in the NPRM tables associated with various levels of each financial ratio in the methodology. The unweighted score is weighted to assign the relative importance of each ratio in the overall measure of a school's financial condition. The Department is required to assure that schools fully participating in Title IV meet minimum standards for financial responsibility. Schools with composite scores above the "bright line" would be considered to have sufficient resources to pass the standards established by the regulations. Schools with composite scores below the bright line would be given the opportunity to demonstrate financial responsibility by an alternative described in current regulations or statute, or participate through provisional certification with other protections for the Federal interest.
Financial statements from 406 private non-profit schools filed under the new FASB accounting guidelines are being examined. KPMG, who has been contracted to assist the Department in developing the regulations, found that the expected increase in wealth reflected on the financial statements from the reclassification of endowment gains was not as widespread as previously expected before these statements were available for analysis. However, KPMG found that the effect of the FASB changes was not as significant for schools without significant amounts of endowment or other resources. Therefore, KPMG has made a preliminary suggestion that the strength factors for FASB statements be reduced so they correspond to the fund accounting strength factors published in the NPRM. Additional modifications to the strength factors are also under consideration.
KPMG and the Department have examined almost 600 financial statements from proprietary schools. All of the financial statements being examined have led to further consideration of the strength factors and weighting methodology, including the treatment of net income for proprietary schools. Various modifications to the strength factors and weights are under consideration.
In the NPRM methodology, a proprietary school with a Primary Reserve ratio of 0.10 received an unweighted strength factor of 2 while a proprietary school with a Primary Reserve ratio of 0.09 received an unweighted strength factor of 1. This anomaly has been called the "cliff effect" and was present for all sectors. Various alternatives are being considered to reduce or eliminate this anomaly, such as increasing the number of strength factor categories or converting the scoring process to a linear algorithm.
Additional issues under consideration
The appropriate methodology for the final regulation is being considered in light of the magnitude of the problem addressed by the proposed financial responsibility regulation. Other financial ratios have been analyzed using financial statements, including ratios measuring: cash income; contribution income; debt burden; debt leverage; age of plant; cumulative earnings; and, debt to assets. The advantages and disadvantages of each of these ratios are being considered. Trend analysis and secondary analysis are being considered. The issues relating to the treatment of owner compensation and taxes for the proprietary sector are being considered. The potential for manipulation of the methodology is being considered. Analysis of comments and financial statements is continuing. Analysis of financial statements for closed schools is being undertaken and the results of this analysis are too preliminary to determine what effect this analysis might have on the methodology. The regulatory treatment for public schools is being considered.
All comments received to date are continually analyzed and being considered by the Department and KPMG.
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