Lenders Challenge Premise of CFPB's Student Loan Findings

WASHINGTON — To hear the Consumer Financial Protection Bureau tell it, the private student loan market is a mess, filled with angry borrowers many of whom claim to have been taken advantage of by banks and servicers.

That was the thrust of an agency study released Thursday which detailed a year's worth of consumer complaints.

But lenders and industry representatives are pushing back against the findings, arguing that the CFPB's view doesn't match what they see in the market. They argue that private student loans make up a small fraction of the overall $1 trillion student debt market — and an even smaller portion of the defaults, suggesting many complaints are about federal, not private, loans.

"The charge-off rates are at the lowest point in time in the private sector" and "new borrowers who are becoming delinquent are at a low rate," said Dan Feshbach, chief executive of MeasureOne in San Francisco, a private student loan data cooperative. "So how does a study like this get written with the private sector as the focal point?"

The CFPB is required by Congress to produce an annual report on private student loans and it does not have jurisdiction over federal loans, though a quick look at the individual stories in the complaint portal shows that consumers are complaining about both. This has angered some in the industry who will likely be affected by policy changes the CFPB is recommending to Congress and weighing under its own rulemaking powers.

"The private student loan market is a small but integral part of how some students meet their education financing needs," said Steve Zeisel, general counsel of the Consumer Bankers Association. "With a sustained and incredibly low default rate of less than 3%, private student loans far outperform federal loans, which have default rates over 14%."

To be sure, those figures have been challenged as coming from the industry itself. But a top CFPB official acknowledged this week that federal student loan borrowers face challenges too.

"We have raised concerns in the past about whether borrowers who have federal student loans are getting accurate information about their options to avoid default," said Rohit Chopra, the CFPB's student loan ombudsman during a call with reporters Wednesday. "While this report doesn't focus on that, I think some of the same misaligned incentive issues with servicing and securitization are issues in both the government-guaranteed program and the private loan market, as well. So, it's something that we are taking a very close look at to determine how to make the market work better."

One of the CFPB's key recommendations in the report is for Congress to revisit an amendment made to the bankruptcy code in 2005 that prevents most private student loan debt from being discharged.

The agency said that as a result, debt collection firms can increase recoveries on defaulted private student loans compared to other types of unsecured debt. But the CFPB also argues this incentivizes lenders and servicers to be less likely to work out loans through modifications or other remediation efforts.

"While regulators and policymakers have continued to urge the private student loan industry to work constructively with borrowers on loan modifications, the 2005 changes to the bankruptcy code may be undermining these efforts," Chopra said. "These changes may be leading to higher expected post-default collections, reducing the incentive for lenders and servicers to modify loans and help borrowers avoid default even though it may be in the best interest of all parties over the long run."

If lenders were required to forgive all student loan debt in bankruptcy, the industry argues they would then have to write down more loans, which leads to the product being viewed as a greater risk and raising prices.

"I have to assume there will be more write downs" if the bankruptcy code is changed, Feshbach said. And "higher write downs can lead lenders to pricing the loans in order to get a return and" have some protection from bankruptcy claims.

However, Chopra said that he "strongly" disagrees with that premise.

"The empirical analysis that was provided in the 2012 study showed just the opposite. When the 2005 changes to the Bankruptcy Code were made, we did not see prices go down," Chopra said. "In fact, there may be other factors that weigh more heavily in determining pricing and credit availability on this market."

Consumer advocates have also pushed heavily for changes to the bankruptcy code.

"It's an issue we've raised for quite some time and the CFPB's report coincides with recommendations for bankruptcy reform we made a year ago," said Joe Valenti, director of asset building for the Center for American Progress.

One reform the consumer group has suggested is a so-called "qualified student" loan similar to the CFPB's Qualified Mortgage rule in which lenders and schools would "earn" a discharge exception in bankruptcy court by meeting certain characteristics of the loan.

Other groups agree more action is needed.

"The problems the CFPB highlighted are not new and demonstrate why it is critical to restore bankruptcy rights for all student loan borrowers and to improve loan origination, servicing and loss mitigation for all future borrowers," said Persis Yu, an attorney for the National Consumer Law Center, in a statement. "This is a critical time for policymakers to create relief options for student borrowers who were harmed by irresponsible private student lenders."

Lawmakers have made numerous attempts to address debt issues in the student loan market. The most recent was Sen. Elizabeth Warren's proposal of a bill to help student borrowers refinance into lower rates. But analysts predict efforts will not move forward until next year at the earliest, if then.

"We do not expect Sen. Warren's student loan refinancing bill to return in this Congress given the considerably long to-do list facing lawmakers during the lame duck session but we do expect this legislation to be reintroduced in 2015," said Michael Tarkan and Isaac Boltansky, analysts at Compass Point Research & Trading in the latest research note on the topic Sept. 30. "While we believe there is a very low likelihood of higher education legislation becoming law in the next Congress, our sense is that a Republican Senate would likely produce less headline risk for the education services sector as a whole."