CFPB Impact on Nonbank Student Loan Servicers

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1 Cognizant Insights CFPB Impact on Nonbank Student Loan Servicers With CFPB all set to bring the large nonbank student loan servicers under its regulatory umbrella, players who take a proactive and comprehensive approach towards CFPB compliance will be more successful in managing impact of CFPB changes on a sustainable basis. Executive Summary Student loan market debt in the US stands at $1.2 trillion, second only to home loan debt. In Q3 2012, the default rate for student loans crossed the default rate for credit cards, raising concerns about their wider economic impact. This spiraling debt and rising defaults combined with customer complaints about poor customer service, poor loss mitigation efforts, unnecessary charges and lack of transparency made Consumer Financial Protection Bureau (CFPB) intervene and take proactive steps to improve loan performance rates, prevent dubious practices, enhance customer experience and ensure transparency. To assess the situation and make informed decisions, CFPB started collecting information on customer complaints from March Based on the analysis of these complaints, CFPB noticed that loan servicing dominated the list of complaints, which included poor customer service, poor request resolution and lack of transparency and loss mitigation options. Subsequently, CFPB issued a directive that allows it to monitor large nonbank servicers (with one-million-plus borrower accounts) effective March 1, CFPB has not proposed any new consumer financial laws; but it will ensure that the nonbank servicers comply with existing consumer financial laws. Most bank servicers have already gone through several cycles of regulatory changes such as Making Home Affordable, Consent Order (top five banks), CFPB rules, etc. and have already managed the impact of regulations on their processes, workforce and systems. For most large nonbank student loan servicers, who would be facing such stringent regulations for the first time, there are some big challenges ahead. This white paper provides a brief background on student loan industry and CFPB, lists the major reasons for CFPB to step in, and touches upon existing consumer financial laws that affect the student loan industry. It presents a high-mid level analysis of the current process deficiencies and suggests solutions to overcome them by improving supporting processes, people, and systems. cognizant insights february 2014

2 Growing Numbers and Players in the Industry Size and Scale $ 1.2 trillion debt as of Q % of $1.2 trillion is federal loans. Roughly 40 M borrowers with average debt of $ 25K. Key Players Key stakeholders are Department of Education, Borrowers, Servicers, Educational Institutions and Private Lenders. Non-bank servicers have 85% loans Sallie Mae Great Lakes etc. Figure 1 Student Loan Industry Background In its efforts to promote higher education in an equitable fashion, the US government has been helping students secure loans for post-secondary, undergraduate and postgraduate courses. Bolstered by the government support, student loan debt shot up to $1.2 trillion by Q3 2013, second only to mortgage debt in the US. Of this, federal loan balance takes lion s share of $1.035 trillion and private loan balance is around $165 billion. Student loan servicing is handled by two types of institutions banks and nonbanks. Nonbank servicers account for almost 85% of the debt and dominate the student loan servicing market (see Figure 1). Sallie Mae, American Education Services, Great Lakes and Nelnet are some of the largest student loan servicers in the U.S. Student loan industry has been well regulated for several years. Regulations such as the National Defense Education Act of 1958 were formed to provide dedicated higher education funding for defense personnel, and Higher Education Act in 1965 that broadened the scope to strengthen educational resources of institutions and provided financial assistance to all students have reformed the way the industry functioned. The recent CFPB act in 2013, which aims to monitor and improve servicing practices of large nonbank student loan servicers, is an important addition (see Figure 2). CFPB Expands to Student Loans CFPB has not proposed any new consumer financial laws; but it will ensure that the nonbank servicers comply with existing consumer financial laws. In response to the financial and housing crisis of 2007, the government passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of The Dodd-Frank Act comprised 16 titles, in which Consumer Financial Protection Bureau (CFPB) is part of Title X. Student Loan Industry Regulations Snapshot 1958: National Defense Education Act Provide assistance to defense personnel. Funding Increased from $183 million in 1959 to $222 million in : Department of Education Organization Act Policy formulation, administration for federal assistance to education. Collect data on U.S. Schools and enforce regulations budget - $19.4 billion 2010: Health Care and Education Reconciliation Act Ends the practice of federally subsidized private loans cutting federal deficit by $87 billion over 10 years Includes Student Aid and Fiscal Responsibility Act. Figure : Higher Education Act Strengthen educational resources of institutions and provide financial assistance for students. 2008: Higher Education Opportunity Act Changes in student loan discharges for disabled. Higher Education Act amended, effective July : Dodd Frank Act CFPB brings nonbank student loan servicers under its supervision effective Mar Aims to rectify servicing practices based on concerns raised by student borrowers. cognizant insights 2

3 CFPB is a consumer protection organization and its main responsibility is to monitor, supervise and regulate institutions dealing with consumer financial products. This includes mortgages, student loans, personal loans, and payday loans. The main reasons for CFPB s intervention in student loan servicing industry are: Rising student loan debt that touched $ 1.2 trillion in In Q3 2012, default rate of student loans crossed the default rate of credit cards and could further affect the US economy (see Figure 3). Customer complaints about poor customer service, unnecessary fees and lack of transparency. To address the aforementioned issues, the CFPB brought the industry under its purview and started analyzing the consumer complaints. Data collected by CFPB suggested that majority of the borrower issues were about servicing, and 96% of complaints about loan repayment and default management. CFPB s deeper analysis clubbed all complaints into eight major pain areas (Refer Figure 4, next page). Key Timelines Dodd-Frank Act (and hence CFPB) came into effect from July 21, After a year, the Bureau obtained enforcement authority and began most activities on July 21, As the complaints against unfair practices of student loan servicers grew, CFPB began accepting complaints from student and parent borrowers from March Based on its findings, CFPB came up with proposed rules on March 28, 2013, which were available for public comments until May 28, Based on the comments received, CFPB finalized the rules between September and December These rules for largest nonbank student loan servicers would become effective from March 1, 2014 (see Figure 5 for timeline summary, next page). Rule for Coverage of Players As the complaints against unfair practices of student loan servicers grew, CFPB began accepting complaints from student and parent borrowers from March CFPB already oversees the largest banks and their servicing operations. In its proposed rule for nonbank servicers, CFPB states that it would monitor nonbank servicers with more than 1 million accounts as of December (see Figure 6, page 5). It would supervise the banks. For the next two years irrespective of the number of borrower accounts. There is also provision for a nonbank servicer to dispute the number of borrower accounts. The current rule would affect the top seven nonbank servicers who have about 49 million borrower accounts collectively, and account for 71-94% activity in the nonbank servicer market. Delinquencies by Loan Type Percent :Q1 03:Q3 04:Q1 04:Q3 05:Q1 05:Q3 06:Q1 06:Q3 07:Q1 07:Q3 08:Q1 08:Q3 09:Q1 09:Q3 10:Q1 10:Q3 11:Q1 11:Q3 12:Q1 12:Q3 Credit Cards Student Loans Auto Loans Mortgages Home Equity Loans Source: Federal Reserve Bank of New York Consumer Credit Panel and Equifax Figure 3 cognizant insights 3

4 Customer Complaints to CFPB on Student Loans Loan Restructuring Loan Prepayment Repayment Processing Denial of active-duty service member protection Inaccurate, inconsistent and incomplete information Missed Communication Loan transfer between servicers Issues faced by Co-Signor Limited loss mitigation options provided to borrower by the servicers. Borrowers not informed about deferment and forbearance options, which can help reduce defaults. Borrowers face excessive prepayment charge. Lenders make it difficult for borrowers to close high-interest loans bydistributing the payment across loans. Issues related to partial payments causing maximum late charge to the borrower. Servicers have not implemented SCRA rules,so protection/benefits for service members are not provided. Borrowers provided inaccurate/inconsistent information on service requests and loss mitigation processing. Has led to late charges. Missed communication (oral, written and electronic) due to lack of centralized correspondence management solution. Inefficient processing of servicing transfers leads to missing documents/data,lack of information and hence poor customer service and payments being sent incorrectly. Co-signors not given loan information access. Parents/ student borrowers have issues in accessing basic account information. Figure 4 As per the final rule, effective March 1, 2014, student loan servicers, banks or nonbanks, must comply with federal consumer financial laws and the broader consumer protection laws given below (see Figure 7, next page). CFPB Impact on Student Loans Recent rules imposed by CFPB indicate a paradigm shift for the student loan servicing industry. The rules would bring greater accountability, improve customer service, reduce defaults and eliminate unfair practices. It is important to note that CFPB has not proposed any amendments to existing consumer financial laws or introduced new laws, but only extends coverage to largest nonbank student loan servicers. Most of the monitoring and compliance requirements will be similar to, and an extension of those applicable to, Mortgage Servicing and Credit Card lines of business. Nonetheless, having been cushioned by the lack of regulation in student loan sector so far, nonbank servicers face a new Most of the monitoring and compliance requirements will be similar to, and an extension of those applicable to, Mortgage Servicing and Credit Card lines of business. CFPB Rules for Student Loan Industry Timeline July 2010 DFA and CFPB formed Mar 2012 CFPB starts receiving complaints from borrowers Sep to Dec 2013 Finalizes rules July 2011 CFPB obtains enforcement authority Mar to May 2013 Proposes rules and seeks comments Mar 2014 Rules become effective Figure 5 cognizant insights 4

5 CFPB Proposed and Final Rule for Student Loan Servicer Coverage >= 3 Million borrower accounts (Top 5) >= 1 Million borrower accounts (Top 7) >= 200 K Borrower accounts (Top 15-18) > 0 Borrower accounts (All) Proposed Rule Proposed rule considered various options to determine who would be supervised by CFPB Final Rule considers only Servicers with more than 1 Million borrower accounts would be supervised >= 3 Million borrower accounts (Top 5) >= 1 Million borrower accounts (Top 7) Not under CFPB Final Rule Figure 6 challenge. They need to make significant changes to their processes and systems and train their associates to set up a sustainable compliance modules. Student Loan Industry Regulations Based on our analysis, we believe servicers should focus on four key are to analyze their processes and prepare for the impending CFPB monitoring: Customer Service, Payment Processing, Loss Mitigation and Correspondence Manager. Equal Credit Opportunity Act (ECOA) Makes it unlawful to discriminate on the basis of race, color religion, national origin, sex,marital status or age. Truth In Lending Act (TILA ) Part of Regulation Z Imposes requirements for private education loan providers to provide disclosure of terms and interest rate. Imposes advertisement of terms, crediting of payment & treatment of balances requirements. Gramm Leach-Bliley Act (GLBA) Requires financial institutions to provide each consumer with a privacy notice at the time of establishing a relationship and annually thereafter. Fair Credit Reporting Act (FCRA) Part of Regulation V Require entities to have reasonable policies and procedures to ensure the accuracy and integrity of information they furnish to consumer reporting agencies. Institutions have to investigate/reinvestigate disputes reported directly or by consumer reporting agencies. Fair Debt Collection Practices Act (FDCPA) Governs the activities of debt collectors. Intends to eliminate abusive practices and provide avenues for disputing and obtaining validation of debt information. Electronics Fund Transfer Act (EFTA) Part of Regulation E Imposes requirements on loan servicers if recurring electronic payments are received from borrowers. Financial institution are required to promptly investigate the errors and resolve within stipulated time. Figure 7 cognizant insights 5

6 Impact Analysis Figure 8, illustrates typical process challenges, corresponding process improvements and technology changes for each of four focus areas to help set the stage for sustainable compliance. Process Challenges Proposed Process Improvements Proposed Technology Changes Customer Service Payments Processing Loss Mitigation Correspondence Management Figure 8 Inadequate tracking of borrower communications and regular service requests leading to poor customer service and request processing delays. Inadequate tracking and lack of well-defined processes and Service-level Agreement (SLA) for borrower complaints and other critical requests such as Mods. Lack of transparency due to inaccessibility to loan data and associated documents for various stakeholders. Applying the payments to minimize borrower charges and expenses. Lack of transparency in prepayment terms and processing. Vendors process payments inaccurately. Servicers do not provide adequate information on loss mitigation options. Lack of well-defined loss mitigation processing and fulfillment. Borrower approved for loss mitigation but still charged late fees. Service Members Civil Relief Act (SCRA) benefits not provided to borrowers. Lack of income-driven repayment options causing further distress to borrowers with low income and high loan balance. Borrowers not sent regular statements/receipts. Borrowers not provided with critical notices such as rate changes, statements, fees notices, servicing norm disclosures, etc. Borrowers not informed adequately about servicing transfers. Customer Service not able to resolve issues and communicate effectively as customer correspondence is distributed. Establish process for unified tracking of borrower communications, service requests and complaints. Establish sound processes and SLAs for critical requests such as Mods. Build escalation matrix and processes to provide oversight on issues that involve legal and compliance issues. Employee training and change management. Providing access to information to various stakeholders. Well-defined policies for applying payments. Clear and consistent prepayment terms and processing. Immediate payment credit to borrower. Employee training and change management. Statements to reflect payment processing. Better controls on processes executed by vendors. Define processes and policies for various loss mitigation options. Train employees to offer and process loss mitigation options. Explore Single Point of Contact (SPOC) concept for loss mitigation. Define communication processes and templates for loss mitigation. Provide incentives for loss mitigation. Define escalation matrix. Train staff to check eligibility of borrowers for Federal debt-relief programs such as Public Service Loan Forgiveness Program and Pay as You Earn Program and determine repayment terms Define processes and SLAs for all borrower correspondence interest rate changes, billing statements, account statements, etc. Define loan transfer processes and correspondence for the same. Ensure transfer of all documents and correspondence. Centralized service request management and tracking. Process controls and SLAs built into systems with workflow and alerts. Centralized borrower correspondence and imaging. System decision based escalations and tracking to legal & compliance. Customer-facing portal for various stakeholders with role-based access. Metrics and reports around complaints management and issue resolution. System-based controls for payment application. System-based statements/ communications for payments application and processing. System to track and manage prepayment and partial payment scenarios. System-based controls for vendor process management. Automation/ insourcing of processes outsourced to vendors Build policy driven loss mitigation hierarchy in system. Capture borrower communication and conversation in system. Build reminders and escalations based on policy in the system. Proactively communicate with borrowers to educate them about loss mitigation options. Implement SCRA rules in system. Enhance system to automate income-driven loan repayment options. System-based unified management of inbound and outbound communications. Manage and control correspondence templates. System triggered reminders, notices and statements. cognizant insights 6

7 Looking Ahead CFPB s decision to supervise large nonbank student loan servicers aims to reduce defaults, improve customer service, and curtail unfair practices. Under new guidelines, CFPB would constantly monitor the participants, review their data, process and procedures. CFPB has not proposed any new consumer financial laws or amendments to existing laws but will ensure compliance and penalize entities for non-compliance. Changes in CFPB regulations are always a possibility. Servicers need to gear up for several changes on people, process and technology fronts to be able to cope with the CFPB monitoring. Process-related changes would impact customer service, collections, loan restructuring, complaints management and proactive communication/solicitation for compliance management. Servicers need to redesign processes in these areas to capture deeper data and automate decisions. They need to build new processes to support unified customer communication, requests and complaints management. Servicers should also install compliance-related escalation/authorization/approval matrix along with SLAs for all processes, with special emphasis on customer complaints and loan restructuring. Training associates across business processes on new policy and procedures and automated systems can help them follow new processes and capture critical data points to handle compliance through automated decisioning, audit trail and data depth. Typically, the student loan systems are a mix of off-the-shelf products and custom-build systems. Most of these are inflexible and disparate legacy systems. Given the inflection point and risk of non-compliance, now would be a good time for servicers to decide if new systems will be a better fit for future flexibility and compliance. Servicers need to gear up for several changes on people, process and technology fronts to be able to cope with the CFPB monitoring. CFPB s decision to monitor large student loans servicers will have substantial impact on the nonbank servicers and will test their resilience. The upgrade process, which could take several months, will strengthen the servicers with supportable systems to meet future compliance needs. Based on the research on CFPB compliance for various players, we believe that players who take a proactive and comprehensive approach towards CFPB compliance by leveraging their internal resources will be more successful in managing impact of CFPB changes on a sustainable basis. References Supervision and Examination Manual - Version 2.0 CFPB Student Servicing Rule CFPB Quarterly Report, Nov 2013 Federal Reserve Bank of New York Type of Student Loans American Student Association Rachel Witkowski Student Loan Market Headed for Crisis Nov. 18, American Banker Mid-Year Snapshot of Private Student Loan Complaints July 2013 CFPB cognizant insights 7

8 About the Authors Sivaraj Lakshmanan is a Senior. Consultant with Cognizant Business Consulting. He has over 10 years of experience working with leading banks in project management, product management, and business process optimization. He can be reached at Sivaraj.Lakshmanan@cognizant.com. Saurabh Parakh is a Consultant with Cognizant Business Consulting. He has over seven years of experience working with leading banks in product management and business process optimization across geographies. He can be reached at Saurabh.Parakh@cognizant.com. Ashish Shreni is a Principal Consultant with Cognizant Business Consulting and has worked for over 14 years in the banking and insurance space on projects spanning business and IT strategy, business process optimization and complex project execution. His core focus area is consumer finance. He can be reached at Ashish.Shreni@cognizant.com. About Cognizant s Consumer Finance Practice Cognizant s Consumer Finance Practice employs over 70 subject matter experts and analysts and 5000-plus associates, and has successfully delivered over 500 large and complex engagements across originations, secondary markets, servicing, and loss mitigation in the U.S. and UK, and Europe which include several CFPB related projects. We offer Consulting, IT, BPO and IT infrastructure services across all functional areas. About Cognizant Cognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process outsourcing services, dedicated to helping the world s leading companies build stronger businesses. Headquartered in Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep industry and business process expertise, and a global, collaborative workforce that embodies the future of work. With over 50 delivery centers worldwide and approximately 166,400 employees as of September 30, 2013, Cognizant is a member of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the top performing and fastest growing companies in the world. Visit us online at or follow us on Twitter: Cognizant. World Headquarters 500 Frank W. Burr Blvd. Teaneck, NJ USA Phone: Fax: Toll Free: inquiry@cognizant.com European Headquarters 1 Kingdom Street Paddington Central London W2 6BD Phone: +44 (0) Fax: +44 (0) infouk@cognizant.com India Operations Headquarters #5/535, Old Mahabalipuram Road Okkiyam Pettai, Thoraipakkam Chennai, India Phone: +91 (0) Fax: +91 (0) inquiryindia@cognizant.com Copyright 2014, Cognizant. All rights reserved. No part of this document may be reproduced, stored in a retrieval system, transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the express written permission from Cognizant. The information contained herein is subject to change without notice. All other trademarks mentioned herein are the property of their respective owners.