Beginning to Make Sense of the New Borrower Defense Regulations

By: Michael T. Wherry, CPA

After committing two years ago to making significant changes to the borrower defense to repayment regulations, the Department of Education (ED) released finalized office rules on Sept. 20, clarifying existing pieces and overhauling many other facets. While these changes affect the nature of claims, procedural steps and items related to those areas in a legal sense, a number of the new regulations affect accounting and regulatory issues— notably, the rules regarding financial responsibility.

The finalized regulations will be effective for federal student loans first disbursed on or after July 1, 2020. While the rules relating to the composite score calculation can be adopted early, we see no reason to do so. In the meantime, institutions should work with their counsel and consulting partners to develop a complete understanding of how the rules impact them. For starters, take a look at this brief overview of the items applicable to the financial responsibility standards.

Triggering events

The triggering events were established in the 2016 regulations, as ED believes more contemporaneous information is necessary to prevent precipitous closures since audited financial statements are only provided annually. ED still believes having the triggering events is important, and according to the department, the new regulations will provide fair, clear and verifiable financial triggers for recalculating an institution's financial responsibility composite score or prompting financial protection. We believe this is a positive change from the 2016 regulations, as uncertain or undefined events will no longer be reported, and institutions will be solely reporting events with quantifiable outcomes.

ED defines mandatory and discretionary triggers. If two discretionary triggers occur for an institution, those events become mandatory events, unless a triggering event is resolved before any subsequent event(s) occur. If an event causes the composite score to drop below 1.0, the institution is deemed not to be financially responsible. If the ratio is above 1.0 and below 1.5, no change occurs. ED will recompute the ratio by using an institution’s most recently submitted annual audited financial statements and the quantifiable amount from the triggering event(s). As a reminder, a triggering event needs to be reported to ED ( within 10 days.

ED defines triggers as:


  • Liabilities are incurred by an institution, including but not limited to those arising from a settlement, final judgement or final determination from an administrative or judicial action or proceeding initiated by a federal or state entity. This includes borrower defense claims. It’s also important to note that ED’s definition of “settlements” is undefined, so it’s uncertain if it includes tuition waivers, FDL voluntary refunds or informal settlements with a student.
  • Withdrawal of an owner’s equity from the institution may also be a mandatory event, unless the withdrawal is a transfer to an entity included in the affiliated entity group upon whose basis the institution’s composite score ratio was calculated. This means institutions will need to closely monitor all changes in equity, related party receivables and guaranteed wage payments for partnerships to determine reportable events if the composite score ratio is below a 1.5. Timely and accurate internal monthly financial statements are a must, and institutions should stay in frequent contact with their auditors.
  • For publicly traded institutions, the Securities and Exchange Commission (SEC) issues an order suspending or revoking the registration of the institution’s securities or suspends trading of the institution’s securities on any national securities exchange, the national securities exchange notifies the institution that it is not in compliance with the exchange’s listing requirements and the institution’s securities are delisted, or the SEC is not in timely receipt of a required report and did not issue an extension to file the report.


  • The institution’s accrediting agency issues an order, such as a show-cause order or similar action, that could result in the loss of institutional accreditation.
  • The institution fails to meet the 90/10 requirement for one year. (This failure needs to be reported within 45 days from year-end).
  • The institution has high annual dropout rates as calculated by the secretary. (To date this metric is undefined by statute).
  • The institution’s two most recent official cohort default rates are 30% or greater, unless it files a challenge that results in lowering either rate.
  • The institution violates a provision or requirement in a security or loan agreement with a creditor. Regardless of whether they are waived or remedied, ED believes all violations are potentially significant and must be reported.
  • The institution’s state licensing or authorizing agency notifies the institution that it has violated a requirement and it intends to withdraw or terminate the institution’s licensure or authorization if the institution does not take the steps necessary to come into compliance.

Financial ratios

ED made a significant change regarding the treatment of leases, stemming from the Financial Accounting Board’s (FASB) accounting standards update (ASU 2016-02, Leases) that requires most operating leases to be recognized as assets and liabilities on a company’s balance sheet. While this update may be delayed by the FASB up to a year for private entities (for years beginning after December 15, 2020), in an effort to establish one composite score ratio, ED is grandfathering in leases entered into prior to December 15, 2018 and applying the update to any leases entered into on or after the same date. All operating leases prior to December 15, 2018 will continue to be excluded from inclusion in the composite score ratio. All new leases or lease changes after December 15, 2018 will be included in the composite score ratio as the Right-to-Use asset will be Property, Plant and Equipment (PP&E) and the Lease Liability will be long-term debt. As such, institutions should be considering the impact to the composite score ratio as new leases are structured. M&A is clarifying with ED officials that leases entered into or amended after December 15, 2018 are only included in the composite score ratio once ASU 2016-02 is effective.

In the 2018 proposed regulations, ED expressed concern over the manipulation of the composite score ratio using long-term debt.  As such, ED now requires that long-term debt must be used specifically for the acquisition of PP&E to be treated favorably in the primary reserve ratio in the composite score calculation. ED believes reverting back to the original intent of adding debt obtained for long-term purposes solely related to PP&E to the numerator of the primary reserve ratio is the proper approach, claiming it results in a more accurate portrayal of an institution’s financial health. However, ED acknowledged some type of phase-in is necessary. As a result, all long-term debt memorialized on the audited financial statements submitted to and accepted by ED prior to June 30, 2020 will be treated as qualified long-term debt. Any subsequent long-term debt must be specifically tied to PP&E and documented as such in the audited financial statements to be treated as qualified debt.

Next steps

The finalized borrower defense regulations are significant, as they are making major changes, or modifying and clarifying existing rules. With less than a year before they become effective, institutions have time to adjust their practices to be ready for them, but preparation should begin now.

M&A has sent questions regarding the lease and long-term debt regulations to ED officials and will keep the broader community advised as answers and clarifications are received. We are here to guide you in understanding and implementing these new regulations and all others. Please contact us with any questions or concerns.

The revamped Borrower Defense to Repayment Regulations are now official.

Featuring significant changes, a full understanding of the new rules before they become effective will be vital for institutions.

McClintock & Associates’ own Mike Wherry, CPA/Director, recently was part of a CSPEN presentation to provide an initial summary of these regulations and how they will affect institutions. The presentation gives an overview of the regulations, including "CliffsNotes" summaries of the borrower defense final rule, financial responsibility final rule and other key revisions.

Just fill out the brief form below for a free download of the presentation.