Federal overreach in loan servicing enforcement will hurt consumers

rafapress/Rafael Henrique - stock.adobe.com

From the Financial Stability Oversight Council to the Federal Housing Finance Agency, Ginnie Mae and now the Consumer Financial Protection Bureau, discussions of the role of third-party loan servicers in our country's lending ecosystem have continued to grow in recent months. The CFPB has led much of the charge, and it is clearly on a mission to improve the baseline standards for servicers in all asset classes of consumer finance.

Protecting borrowers from poor servicing is a laudable goal, but the method of doing so matters. Unfortunately, in a little-noticed enforcement action against something called The National Collegiate Student Loan Trusts, or NCSLT, the CFPB enforcement actions targeted not just servicers but investors. The potential precedent could risk capital flight from consumer lending at a large scale. A much better approach would be for the CFPB to rightly see the securitization industry as its partners, and work with it to properly police bad servicing practices before they fester.

The CFPB's latest legal actions are a very big deal, but they haven't generated much reaction … yet. One reason is that some view these actions as an idiosyncratic student loan securitization issue from deals structured decades ago. But there is no certainty that the CFPB couldn't strike again, in any type of securitization. Trillions of dollars in consumer finance could be disrupted if investors are forced to pay for the mistakes of a bad servicer in other consumer asset classes going forward.

Retirees could be harmed, and the legal costs of lending will go up. Retirement funds keep asset-backed securities in their portfolios because they are solid, predictable investments. If securitization trusts are forced to pay damages or compensation for misbehavior by their third-party vendors, the result will be lower returns for these savers. Average consumers will also be the ones paying the price for the actions of a bad servicer in the form of substantial additional legal costs.

Judge sides with CFPB on challenge to small-business lending rule

The CFPB might have the misconception that securitization adds to the complexities of resolving bad servicing practices. This premise is untrue. In a case that helped instigate the complaint brought against NCSLT, a servicer was alleged to have intentionally given borrowers misleading information. The CFPB is right that this servicer attempted to shield itself from responsibility using an absurd excuse. But the reality of most securitizations is very different. When securitization deals are put together, a substantial amount of work goes into servicer selection. Once that choice is subject to due diligence, the servicer is charged with performing its duties in full compliance with the law. That responsibility rests with the servicers, not the investors or trustees.

In fact, the investors' interests are very much aligned with the stated aims of the CFPB. No one wins with bad loan servicers. Investors want borrower outcomes that are best for the long-term value of their asset, and that absolutely requires effectively working with consumers who need temporary assistance. Market participants and the CFPB should work together to proactively identify servicers that the CFPB has issues with so they can be excluded from playing a role in these important consumer finance markets. A cooperative and transparent dialogue between the CFPB and the industry would help root out bad actors before wrongdoing grows into a problem for everyone.

Consumers need to be able to speak to someone who can offer the help they need if they face unforeseen financial hardship. Poor servicing is a problem for the entire ecosystem of consumer finance. The CFPB has made it abundantly clear that loan servicing is an area of focus. That focus is commendable, so long as its investigations are undertaken and performed in a smart way. Suing securitization trusts and taking money from investors to punish servicers is not a wise approach.