CU Campus Resources Third Annual Client Forum March 19-20, The Private Student Loan Landscape

Transcription

1 CU Campus Resources Third Annual Client Forum March 19-20, 2015 The Private Student Loan Landscape Arthur J. Rotatori, Esq. (216)

2 Overview CFPB Concerns NCUA Supervisory Letter Fair Lending Use of CDRs Servicing and Payment Processing Lending Practices PEL Modifications and TDR Latest Developments CFPB Recommendations

3 Issues of Concern to the CFPB Private student loan complaints submitted by consumers to the CFPB from October 1, 2013 through September 30, 2014 totaled 5,300, an increase of approximately 38 percent compared to that of the previous year. The largest subset of private student loan complaints relate to the lack of repayment options and flexibility in times of distress.

4 Issues Concerning the CFPB The CFPB feels that many borrowers are still struggling to repay the loans they borrowed during the period. Many consumers who borrowed private student loans during the subprime boom graduated from college into an extremely challenging labor market. While federal student loans offer options to avoid default through several loan modification and alternative repayment programs, lenders and servicers of private student loans generally do not.

5 Issues Concerning the CFPB According to the CFPB, many complaints indicate that borrowers sought to negotiate a modified repayment plan during a period of financial distress, but lenders and servicers provided no options, leading the borrower to default. These complaints closely mirror problems found in the mortgage servicing market, as large numbers of homeowners sought to avoid foreclosure.

6 Issues Concerning the CFPB Regulators and policymakers have encouraged lenders to constructively engage with borrowers to find workout solutions. Despite commitments by a number of major market participants to expand alternative repayment options, the CFPB says that consumers continue to encounter limited or no flexibility when seeking help from their lender or servicer.

7 Issues Concerning the CFPB The CFPB wants policymakers and market participants to consider whether changes to the treatment of private student loans in bankruptcy proceedings are reducing incentives for lenders and servicers to help borrowers avoid default.

8 NCUA Supervisory Letter Private Student Loans December 2013 Acknowledged increasing CU activity in PELS Identified 7 risk areas Credit, compliance, interest rate, strategic transaction, liquidity, reputational

9 NCUA Supervisory Letter Private Student Loans December 2013 Credit risk is based on unknown ability to repay; long periods of little performance data Credit risk can be mitigated by underwriting/collection requirements; portfolio analysis

10 NCUA Supervisory Letter Private Student Loans December 2013 Compliance risk based loan: TILA, EFTA, ECOA, FDCPA, UDAAP, GLBA Disclosure and loan maturity requirements driven by closedend/open-end credit distinction Closed-end: Regulation Z Subpart F; for FCU s, 15 year terms/from origination; for state-chartered CU s, state law limits Open-end: Regulation Z Subpart B; for FCU s, no maturity limit; for state-chartered CU s, state law limits Consolidation loans have additional disclosure requirements for potential loss of borrower benefits

11 NCUA Supervisory Letter Private Student Loans December 2013 Transaction Risk Income Recognition and Nonaccrual GAAP permits interest accrual during deferment period In repayment period, placed on nonaccrual at 90 days past due; charged off.

12 NCUA Supervisory Letter Private Student Loans December 2013 Use of Third Parties CU is ultimately responsible for vendor compliance CU must evaluate vendor s financial capacity to meet contract terms CU must ensure vendor legal and regulatory compliance CU must include in vendor contract reporting requirements for monitoring

13 Fair Lending/PEL Origination ECOA & Regulation B: Regulation B prohibits discrimination on a prohibited basis. Prohibited basis means race, color, religion, national origin, sex, marital status, or age. Discrimination can be either as a result of disparate treatment or disparate impact. Disparate treatment is the treatment of applicants differently based on one of the prohibited factors.

14 Disparate Impact Discrimination that occurs when a lender applies a practice uniformly to all applicants, but the practice has a discriminatory effect on a prohibited basis that is not justified by a business necessity. Found in Regulation B, not in ECOA. Derived from employment law. Comment 2 to Regulation B states that the Congressional intent was to include in effects tests for ECOA.

15 Disparate Impact and the CFPB Disparate Impact is still the law, even though we thought that might change CFPB Bulletin : Guidance to indirect auto lenders stating that they are responsible for unlawful, discriminatory pricing; dealer participation arrangements create a significant risk of fair lending violations No Supreme Court Decision: Mt. Holly case settled; HUD case settled; Texas Housing case was argued before the U.S. Supreme Court on January 21.

16 Disparate Impact Ally Consent Order: Pattern or practice of discrimination on the basis of race and national origin based on the dealer mark-up of the interest rate; Ally did not admit allegations, said it did not believe that there is measurable discrimination by dealers, no court decision; Ally agreed to pay a civil penalty, compensation, monitor dealer participation and take appropriate corrective action if the monitoring reveals discriminatory effects of the dealer participation

17 Disparate Impact Auto finance is the source of the current controversy Dealer offers the consumer s application to several sales finance companies Dealer has discretion to increase (or decrease) the buy rate Dealer participates in any interest in excess of the buy rate Dealer sometimes negotiates the rate with the consumer No transparency to the consumer

18 Disparate Impact The assignee is the person being held responsible for the discrimination; the assignee is the only party subject to CFPB

19 Disparate Impact Auto finance industry response has been to consider alternative dealer compensation methods: Flat or fixed compensation based on amount financed or per deal Tightly-limited scenarios for dealer discretion; meeting competition option Monitoring of dealer discretion scenarios

20 Disparate Impact The auto finance enforcement actions show the CFPB s willingness to enforce fair lending when: the covered person does not directly or personally interact with the consumer; and The covered person does not directly determine the interest rate The CFPB s methodology used in these enforcement actions is highly controversial and could be used in other settings

21 Disparate Impact The CFPB s methodology is based on the use of proxies for race and ethnicity The CFPB published its methodology in October 2014 in a highly technical statistical analysis

22 Implications for Education Finance Implications for education finance: No pricing discretion similar to that exercised by auto dealers FAO role in product access? CFPB s prior concern about the use of CDR as loan qualification or loan pricing factor Lack of direct interaction with consumer is not a bar to testing for or alleging disparate impact Same statistical methods used by CFPB with respect to auto finance would apply to any type of loan portfolio

23 The Use of CDRs in PEL Underwriting CFPB 8/29/2012 report noted that most lenders use CDRs to either determine school eligibility or to set loan pricing Most lenders using CDRs use it to determine school eligibility at usually between 8-12% CFPB also noted that racial and ethnic minority borrowers are disproportionately concentrated in schools with higher CDRs.

24 CFPB s View of CDRs CDRs weren t designed for use in PEL underwriting Potential disparate impact concern at least at a threshold level CFPB December 2012 Fair Lending Report also noted that the use of CDRs at very low levels is a fair lending concern: reduced credit access increased costs

25 CFPB s View of CDRs CFPB PEL Examination Manual looks at the use of CDRs, business justification for that use and whether there is any analysis to support its business justification

26 NCUA and CDRs NCUA Supervisory Letter No (December 2013) addressed a number of issues concerning PELs NCUA identified credit risk as a risk factor in offering PELs NCUA said CDRs were a useful analytical too for risk assessment and monitoring

27 Use of CDRs A Summary Possible Fair Lending issue Possible regulatory conflict Possible business justification Possible change to the law

28 PEL Servicing Since the CFPB began accepting private student loan complaints, the complaints surrounding student loan servicing have mirrored the problems heard from consumers in the mortgage market in the wake of the financial crisis CFPB Student Loan Ombudsman Report

29 High Priority Private Education Loan Issues Loan modification Obstacles to modify loan Payment processing Borrower experience Applicable policies Servicer interaction

30 Payment Processing Manner in which payments are processed Treatment of additional payments Pay ahead Reduce principal Explanation of policy Billing statements Online portal 2015 McGlinchey Stafford

31 Payment Processing Billing group and multiple loan issues Excess payments Benefit to borrower Borrower instructions Underpayments Benefit to borrower

32 Payment Processing Since publication of 2013 annual report, some servicers notified the CFPB that they have changed their payment allocation policies and now allocate payments from borrowers in excess of the scheduled payment amount toward the loan with the highest interest rate Other industry participants noted that they plan to upgrade borrower-facing systems to allow borrowers to easily specify how they wish to allocate a payment across various loans

33 Payment Processing CFPB said in its 2014 Report that it continues to receive complaints that some servicers remain unwilling to update their servicing platforms to honor standing payment instructions without requiring the borrower to instruct them each month to request an accurate payment allocation.

34 Payment Processing FDIC Order to Sallie Mae and Navient The FDIC determined that Sallie Mae and Navient violated federal law prohibiting unfair and deceptive practices in regards to student loan borrowers through the following actions: Inadequately disclosing its payment allocation methodologies to borrowers while allocating borrowers underpayments across multiple loans in a manner that maximizes late fees; and Misrepresenting and inadequately disclosing in its billing statements how borrowers could avoid late fees. The FDIC ordered Sallie Mae and Navient to cease all unfair and deceptive practices in its payment processing practices, make restitution of approximately $30 million to victims, and pay civil money penalties.

35 Auto-Defaults and Co-Signer Release In April 2014, the CFPB published a report detailing complaints related to auto-default provisions included in many private student loan contracts. These provisions provide lenders with the ability to immediately place borrowers into default and demand the entire amount due upon the death or bankruptcy filing of a co-signer.

36 Auto-Defaults and Co-Signer Release The report noted that industry participants were exercising this option even if the primary borrower was successfully repaying the loan. Borrower complaints identified at least seven large depository institutions and specialty student loan market participants, including four of the top ten bank holding companies by assets, acting as the marketer, lender, loan originator, loan servicer, or the current loan holder. When borrowers submitted a complaint with the CFPB, industry participants noted that the terms of the loan permitted such action. However, the business justification for these auto-defaults upon death or bankruptcy of a co-signer often seemed questionable.

37 Auto-Defaults and Co-Signer Release Although many lenders offer a borrower the opportunity to release his or her co-signer, information or applications to release co-signers are often not easily accessible through lenders and servicers websites. To help borrowers in obtaining a co-signer release, the Bureau published sample letters that consumers may use to request a cosigner release or more information on a co-signer release policy.

38 Auto-Defaults and Co-Signer Release Since the publication of the Bureau s report, certain market participants alerted the Bureau that they intend to suspend triggering autodefaults until an account is carefully reviewed. In addition, others informed the Bureau that they intend to make co-signer release policies more transparent.

39 Mistreatment of Military Families In October 2012, the CFPB published an addendum to its annual report that focused on the unique issues faced by military families in the student loan market. The report noted a number of challengers related to military-related benefits and highlighted complaints related to inappropriate handling of Servicemembers Civil Relief Act (SCRA) rate reduction requests.

40 Mistreatment of Military Families Many servicers quickly sought to identify the root cause of these errors, to enhance training, and to upgrade IT systems, in order to ensure that these potential violations would stop. Since the publication of the report, the number of SCRA-related complaints has fallen substantially.

41 Department of Justice Settlement with Sallie Mae and Navient The Department of Justice launched an investigation, which determined that Sallie Mae s and Navient s conduct was intentional, willful, and taken in disregard for the rights of servicemembers. The FDIC, which jointly participated in the action against Sallie Mae and Navient, determined that the companies were:

42 Department of Justice Settlement with Sallie Mae and Navient Unfairly conditioning receipt of benefits under the SCRA upon requirements not found in the law; Improperly advising servicemembers that they must be deployed to receive benefits under the SCRA; and Failing to provide complete SCRA relief to servicemembers after having been put on notice of these borrowers active duty status. The order provides for $60 million in relief to approximately 60,000 servicemembers to address these violations

43 Lending Practices by For- Profit Colleges A substantial portion of student loan complaints received by the CFPB come from borrowers who were previously enrolled in for-profit colleges. Many lenders pulled back from the proprietary sector due to the perceived risk of making loans to students in these schools and programs. When bank-funded, private student loans became unavailable to students at for-profit schools, some proprietary programs began lending directly to their students in response.

44 Lending Practices by For- Profit Colleges In February 2014, the CFPB announced a public enforcement action against ITT Educational Services, accusing the for-profit college of predatory lending. As ITT students were increasingly no longer able to obtain private student loans from banks and other private lenders, the school began to facilitate lending to its students through other means. In the complaint, the CFPB alleges that ITT exploited consumers and pressured them into predatory loans.

45 Lending Practices by For- Profit Colleges In September 2014, the CFPB announced a lawsuit against another for-profit chain, Corinthian Colleges, for a predatory private student lending scheme, alleging that the chain of colleges allowed employees to routinely deceive and illegally harass private student loan borrowers. The CFPB obtained forgiveness of these loans by the acquirer of Corinthian.

46 Servicer Relationship Owner and servicer roles Sub-servicers Ownership transfers User experience Account interruption Fees Policies

47 PEL Modifications & TDR

48 Background Perception that PEL borrowers are very distressed and would materially benefit from loan modification programs Such programs should be similar to Government Loan Modifications Graduated repayment IBR Consolidation Loans Loan Rehabilitation

49 Safety & Soundness Concerns Uniform Retail Classification and Agreement Management Policy Closed-End loans should be charged off at 120 days Prudent use of extensions, deferral, renewals, etc. is acceptable when based on renewed willingness and ability to repay No special consideration for PELs

50 Uniform Classification Policy Published by FDIC, OCC, FRB only NCUA not a party; NCUA has Appendix C to Part 741; NCUA Rules and Regulations Non-depository lenders are not subject to any regulatory policy

51 Supplemental Regulatory Guidance 2010 OCC Student Lending Guidance NCUA Supervisory Letter 3-13 OCC; FDIC Testimony, June 2013 Banking Agency Joint Release 7/25/13

52 Message of Supplementary Guidance Lenders are not prohibited by safety and soundness concerns from offering PEL modifications The traditional features of PELs are permitted modifications In-school deferment Grace periods and post-graduate extending grace periods (12 months) Short-term (1-3 month) forbearances Loan Modifications (interest rate; payment reductions)

53 Possible Additional Modifications Graduated Repayment Plans IBR At origination As restructuring A plan similar to Federal plans would be permitted Consolidation Loans But Loan Rehabilitation Programs similar to federal program would not be consistent with Uniform Classification Policy

54 So What s the Problem? Limited need for workouts/modifications Practical Considerations Accounting Considerations

55 Limited Need for Workouts According to Industry Sources Only 5-7% of Education Loans are PELs Only 4% of PELs are delinquent

56 CFPB View of Distressed Borrowers The most common issue reported by borrowers is the inability to negotiate alternative repayment options with lenders and servicers when facing distress. The lack of availability of transparent loan modification options and complicated enrollment procedures persist as pain points in the market.

57 CFPB View of Distressed Borrowers In May 2013, the CFPB published a report that analyzed public comments on ways to spur greater loan modification activity. Since that time, policymakers and regulators have urged market participants to work constructively and proactively with borrowers to identify appropriate loan workout arrangements.

58 CFPB View of Distressed Borrowers In January 2014, CFPB Director Richard Cordray, Education Secretary Arne Duncan, along with senior officials from the Department of the Treasury and federal financial regulatory agencies, convened a meeting of the largest lenders and servicers of private student loans to identify opportunities to accelerate the rollout of alternative repayment plans. Several participants noted that they were exploring new ways to assist borrowers.

59 Borrower Expectations Based on Federal Loan Options Prior to 2010, students could borrow both federal and private student loans from the same lender. Many borrowers submitting complaints with the CFPB note that they have been able to enroll in loan modification programs to prevent default on their federal student loan.

60 Borrower Expectations Based on Federal Loan Options In addition, prior to entering repayment, federal student loan borrowers generally participate in exit counseling facilitated by their institution of higher education. Federal student loan borrowers also receive information on periodic billing statements which provide information and instructions on how to lower student loan payments and enroll in different repayment options.

61 Practical Considerations More than 25% of outstanding PELs are in securitization trusts Limited ability for servicers to modify such loans But remember mortgage modifications! PELs are generally serviced on systems originally designed to service federal loans; limited flexibility

62 Distorted Incentives Due to Changes in the Bankruptcy Code In 2005, the Bankruptcy Code was amended so that all loans made for a qualified education expense became exempt from discharge in bankruptcy absent undue hardship to the debtor.

63 Distorted Incentives Due to Changes in the Bankruptcy Code Industry participants from many of the nation s largest financial institutions have noted that rolling out new loan modification programs in challenging, particularly when dealing with a third-party servicer. In certain cases, these institutions have simply determined that it is in their financial interest to only permit the borrower to use some short-term forbearance options rather than solutions that are renewable or longer-term. This is because recoveries on defaulted private student loans are relatively high compared to other unsecured consumer debt obligations, due in part to the 2005 changes to the Bankruptcy Code.

64 Distorted Incentives Due to Changes in the Bankruptcy Code The expected present value of payments in a modified payment plan, less any one-time costs with modifying the loan, may be less than the expected present value of a borrower self-curing or through recovery by third-party debt collectors and litigation.

65 Accounting Considerations A loan modified in a way that the regulatory agencies permit may still have to be treated as a troubled debt restructuring (TDR) A workout loan may not always be a TDR loan

66 TDR Debtor experiences financial difficulties Creditor grants a concession that it otherwise would not have made

67 TDR TDR triggers enhanced accounting/reporting requirements Loan is placed in non-accrual status Loan requires ongoing monitoring

68 PEL Implications of TDR Lenders have outsourced loan servicing Third-party servicers may service for different types of lenders FFELP loan servicing systems were not designed to handle TDR

69 Is a Modification Really a TDR? To be a TDR, the modification has to be a concession that the lender would not otherwise have made What would the lender otherwise have done?

70 Note Provisions Some PEL notes are silent about forbearances, deferments, other modifications Some PEL notes provide for deferment upon specified events; forbearance upon request; lender discretion Some PEL notes provide for forbearance only upon request; lender s sole discretion

71 Note Provisions Tension between promising modifications in advance; flexibility Lenders/servicers may have deferment/forbearance policies that guide discretion Is following the policy a concession? What do the accountants say?

72 Latest Developments January 29, 2015 CFPB sent a letter to major PEL lenders asking for information on available loan modification options Voluntary response without any borrower or lender information Interagency Guidance on Graduated Repayment Loans Issued by NCUA, OCC, FRB, FDIC, CFPB and State Liaison Committee Not a regulation, but guidance that will be implemented by examination

73 Graduated Repayment Guidance Loans with graduated repayment terms at origination were not included in modification discussions; but are the subject of the guidance Guidance is based on safety and soundness prudential supervision, but primarily concerns consumer protection

74 Six Principles for Originating Graduated Repayment Loans The guidance does not have a clear definition of a graduated repayment term PEL. The guidance doesn t incorporate by reference the TILA definition of a PEL, so, for example, it is not clear if the guidance applies to a line of credit, which, being open-end credit, is technically not a PEL, due to being open-end credit. It is also unclear whether a stepped-repayment PEL, with only one payment change, such as from interest-only payments to fully amortizing payments, is a graduated repayment loan. A loan with only one step in the repayment amount doesn t seem to be a graduated repayment loan, but that isn t clear.

75 Six Principles for Originating Graduated Repayment Loans The ensure orderly repayment principle says that the loans should have defined repayment periods and promote orderly repayment over the life of the loan. Also says that the loan terms should be calibrated according to reasonable industry and market standards based on the amount of debt outstanding. The repayment terms should avoid negative amortization or balloon payments.

76 Six Principles for Originating Graduated Repayment Loans The second principle is that the graduated repayment terms should avoid payment shock by having payment increases begin early in the repayment period and phase in principal amortization. The third principle is that the payments should be aligned with the borrower s income, based on reasonable assumptions about the borrower s and cosigner s ability to repay at the highest payment level. The guidance suggests that the graduated payment amounts should be calculated on a basis specific to a particular loan with a particular borrower and cosigner.

77 Six Principles for Originating Graduated Repayment Loans The fourth principle is that the lender should provide the borrower with clear disclosures that are in compliance with applicable law, such as TILA. The fifth principle is that the loans must comply with all applicable federal and state consumer laws and reporting standards. It is difficult to understand what this means beyond normal compliance review, other than potential UDAAP exposure.

78 Six Principles for Originating Graduated Repayment Loans The final principle states that lenders offering graduated repayment terms should develop processes for contacting borrowers before the start of the repayment period and before each payment reset date. This is as a new disclosure requirement without any guidance as to how far in advance of a payment reset date such notices should be provided or what those notices should say.

79 CFPB Recommendations Determine whether changes to the Bankruptcy Code might motivate lenders to constructively work with borrowers to modify loan terms. One potential option for exploration is to determine whether the special bankruptcy protection afforded to lenders may be limited to those lenders that offer certain loan modification options. For example, without pursuing a bankruptcy filing, federal student loan borrowers can seek income-driven repayment plans that are similar to a Chapter 13 repayment plan.

80 CFPB Recommendations If loan holders could only retain their special bankruptcy protection if they offer meaningful loan modification options, then these loan holders would have a stronger, short-term, economic incentive to offer borrowers a greater array of options to avoid default. Determine whether lenders and servicers provide adequate and timely disclosures to borrowers about repayment options, particularly in times of financial hardship.

81 CFPB Recommendations Further analysis might reveal whether supplemental counseling, disclosures shortly before entering repayment, or inclusion of information in routine communications, such as periodic billing statements or late notices, may enhance borrower awareness of all repayment options, particularly in times of distress In the mortgage market, servicers must contact delinquent borrowers about the delinquency and the possible availability of loss mitigation options. Servicers must also consider and respond to a borrower s application for a loan modification if it arrives before a certain period of time before a scheduled foreclosure sale

82 CFPB Recommendations If private student lenders and servicers are unable to overcome the challenges they face to offer and effectively communicate repayment options to borrowers in distress, the Bureau may wish to study the effectiveness of the current disclosure framework implemented five years ago and determine whether additional disclosures and servicer obligations are warranted. 82

83 CFPB Recommendations Loan modifications that involve principal forgiveness can require the lender or servicer to report the amount of forgiveness as taxable income to the borrower. Industry participants are concerned that borrowers may encounter additional distress if the forgiveness leads to a large one-time tax bill or significant burden on unemployed consumer.

84 CFPB Recommendations In 2007, Congress passed the Mortgage Forgiveness Debt Relief Act, which generally allows homeowners to exclude income from discharge of debt on their principal residence Without this temporary tax exemption, many industry participants have noted that providing principal reductions may actually lead to financial distress for student loan borrowers due to a heavy tax levy

85 Questions?