The Plight of Financially Distressed Private Student Loan Borrowers

April 2009

TOO SMALL TO HELP

The Student Loan Borrower Assistance Project (SLBA) is a program of the National Consumer Law Center (NCLC).

7 Winthrop Square, 4th Floor Boston, MA 02110

(617) 542-8010 www.studentloanborrowerassistance.org

This report was funded in part by the Ford Foundation. We thankthem for their support but acknowledge that the findings and conclu-sions presented in this report are those of the author’s alone, and donot necessarily reflect the opinions of the Foundation. This report is arelease of the National Consumer Law Center’s Student Loan Bor-rower Assistance Project [www.studentloanborrowerassistance.org].The author thanks her colleagues at the National Consumer Law Cen-ter, Alys Cohen, Rick Jurgens, Tamar Malloy, and Elizabeth Renuart fortheir valuable comments and assistance.

ACKNOWLEDGMENTS

Too Small to Help: The Plight of FinanciallyDistressed Private Student Loan Borrowers

Written byDeanne LooninStaff AttorneyNational Consumer Law Center

Executive Summary v

Introduction 1

What are private student loans? 1

The Growth of Private Student Loans 3

Hitting the Wall 3

Market Distress 5

A Market Recovery? 6

Government Intervention 7

Too Small to Help 8

Our Study of Programs For Financially Distressed Borrowers 8

Key Findings 11

Recommendations to Improve Assistance for Private Loan Borrowers 12

Conclusion 18

Appendix 19

Notes 21

TABLE OF CONTENTS

The Boom and Bust of thePrivate Student Loan Industry

The private student loan industry generatedhuge profits for lenders and investors for manyyears. Over time, however, the defects in these ex-pensive, unsustainable products became clearand the loans began to fail. The industry hit awall, exposing the risks of making unsecured, ex-pensive loans to borrowers with little or no abil-ity to repay.

There are some signs of a market recovery andthe remaining lenders seem to have learned somelessons. Most have reduced their origination vol-ume and re-evaluated underwriting criteria. Theshape of the future depends to a large degree onhow the federal government responds. If the gov-ernment chooses to bail the lenders out by pur-chasing large portions of bad debt, the lenderswill suffer no consequences for their irresponsi-ble actions. They could return to irresponsiblelending. This is even more likely to occur if Con-gress fails to impose stricter regulations goingforward.

Too Small to Help

Regardless of how the future market plays out,there are countless borrowers stuck with loansthat they have no hope of repaying. Lenders andthe government have decided that, unlike thelenders that made these loans, the borrowers are“too small” to help. In reality, their numbers arelarge, but their political power is not.

This report focuses on these financially dis-tressed borrowers, examining how lenders aredealing with the increasing private student loandelinquencies and why. We then ask what elsethey could and should be doing to help borrow-ers get out from under debilitating debt loads.

Our Study of Programs For Financially DistressedBorrowers

Given their role in creating the crash, it is reason-able to expect lenders to do everything possibleto help borrowers with unaffordable loans. Dis-tressingly, this has not occurred. In our experi-ence representing borrowers through theStudent Loan Borrower Assistance Project(www.studentloanborrowerassistance.org), wehave found private lenders to be universally in-flexible in granting long-term repayment relieffor borrowers. Lenders that had no problem say-ing “yes” to risky loans are having no problemsaying “no” when these borrowers need help.

Survey Results

We sent a questionnaire to five for-profit lendersand one non-profit lender asking for informationabout their programs for financially distressedprivate loan borrowers. Although some no longermake private loans, all were heavily involved inthe business in recent years. The lenders surveyed

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EXECUTIVE SUMMARY

represent about 75% of the private student loanmarket with Sallie Mae by far the biggest player.We also surveyed one non-profit lender. Only Sallie Mae and the non-profit lender provided re-sponses to our questionnaire.

We also searched the Internet, finding onlyvery general information about options for trou-bled borrowers.

The lack of comprehensive information aboutpotential options is very troubling and detrimen-tal to borrowers seeking solutions. Even moretroubling is that in our experience representingborrowers these options have rarely been men-tioned when they have called for assistance.

Based on the survey results, our experiencesrepresenting borrowers, and other research, wefound that lenders appear to be offering someflexible repayment options for financially dis-tressed borrowers. Private lenders, however, donot offer income-based repayment. In addition,these lenders rarely cancel loans or offer reason-able settlements. For example, private lendersgenerally do not discharge student loan debtupon death of the original borrower or co-signer.Further, loan modifications are rarely offered.

The options are particularly limited for bor-rowers in default. Yet these are generally theborrowers most desperate for assistance. This isalso in sharp contrast to the federal programswhere borrowers in default have various ways toselect affordable repayment plans and get out ofdefault.

In the past, forbearance was the only optionoffered to these most distressed borrowers. How-ever, these policies have changed radically in re-cent months as most creditors have sharplyrestricted forbearance availability. The problemfor borrowers is not so much that forbearancesare less available, but that there is little or noother options to help them manage their debtsover the long-term.

Recommendations to ImproveAssistance for Private LoanBorrowers

1. Mandate Loss Mitigation ReliefA key barrier to improved assistance programs isthat lenders have not been required to provide re-dress for their irresponsible actions. This reportshows that voluntary efforts have been few andfar between.

Loss mitigation efforts should be encouragedacross the board, but they should be required ofany creditor that receives federal funds. Investorsshould support such policies, recognizing thatcollecting some money is better than spendingmore money on aggressive collection efforts andgetting little or nothing in return.

Lenders must also be required to provide in-formation to investors, regulators and the publiccomparing numbers of collection actions and re-coveries from such actions to the performance ofloan modifications.

Barriers to Loss Mitigation Programs

Restrictions in Securitization Agreements?Servicers may feel constrained in cases where theloans have been securitized. This has occurred inthe mortgage context where servicers often claimthat the pooling and servicing agreements do notlet them modify loans. In reality, most securitiza-tion documents give broad authority to servicersto service loans in accordance with customarystandards, often also stating that the servicersmust act in the best interests of investors. In anycase, we have not heard creditors or servicers usethis excuse in the student loan context.

To further test this issue, we thoroughly re-viewed a number of student loan pooling andservicing agreements. We did not find any ex-plicit barriers to modifications in any of thoseagreements.

vi TOO SMALL TO HELP

The Cost of ModificationsEven if servicers know they have discretion tomodify and restructure loans, they may choosenot to exercise it because of the additional ex-pense. Loan modifications can be labor intensive,although student loan modifications should beless complex than modifying mortgage loans.Unlike mortgage modifications, there is no un-derlying asset that requires valuation for studentloans.

Additional investigation is needed to assesswhether servicers are holding back on studentloan modifications because of cost. If so, thereare ways to address this problem, including addi-tional compensation for servicers. This has beensuggested in the mortgage context and is part ofthe Obama Administration’s new homeowner re-lief plan.

Accounting ProblemsIt is possible that lenders feel constrained by ac-counting and other regulations which generallyrequire consumers to repay settled debts withinthree to six months and lenders to recognize forgiven amounts as losses during this time period. However, we have not heard this concernexpressed directly in the student loan context. In addition, federal regulators can if necessaryact to allow creditors to make these settlementsand eliminate or reduce any tax liability for consumers.

2. Restore Bankruptcy RightsCreditors succeeded in persuading Congress in2005 to make private loans as difficult to dis-charge in bankruptcy as federal loans. Currentbankruptcy law treats students who face finan-cial distress in the same severe way as people whoare trying to discharge child support debts, al-imony, overdue taxes and criminal fines.

It is difficult to separate fact from fiction whentrying to understand the logic behind this policy,but one thing is clear—the restrictions cameabout without any empirical evidence that stu-dents were more likely to “abuse” the bankruptcy

system. It is long past time to restore these rightsto borrowers. Restoration of bankruptcy rightswill also provide a strong incentive to studentlenders to provide aggressive modifications out-side of bankruptcy in order to reduce losses.

3. Loan Cancellations for Fraud Victims

Not all borrowers will benefit from modifica-tions. Only those that are in serious financialtrouble, but still have some income to pay towardtheir loans, will qualify. Many of the most vulner-able borrowers will be left without relief. As onestep to providing relief for these borrowers werecommend that all borrowers that received pri-vate loans to attend unlicensed, unaccredited,schools that closed or are currently in bank-ruptcy receive full loan cancellations.

These consumers have been hit particularlyhard. They are stuck with debts they cannotrepay from worthless schools. In the current en-vironment, where creditors are rewarded withbail-outs for prior bad acts and where no onewants to take responsibility for the meltdown,taking action in this area is one small way to holdcreditors liable for the damage they have done.

4. Re-Regulate the IndustryAmong other reforms, re-regulation must include:

� Mandated Underwriting

� Limits on Interest Rates and Fees

� Remedies for Fraud Victims

� Improved Disclosures, and

� Private Remedies and Access to Justice

The lenders that created this mess can andshould be part of the solution. This report showsthat so far, they have not done much on a volun-tary basis to provide assistance. Yet without re-lief, student borrowers will never be able to helpfulfill our social and economic need for a produc-tive, educated work force.

TOO SMALL TO HELP vii

Introduction

Securitization fueled the explosive growth of theprivate student loan industry. During the boomyears, the focus was on quick profits. Over time,however, the defects in these expensive, unsus-tainable products became clear and the loansbegan to fail. The industry hit a wall, exposingthe risks of making unsecured, expensive loans toborrowers with little or no ability to repay.

Many lenders left the private student loanbusiness during this crisis period. The dust isnow starting to settle and the market is showingsome signs that it will rebound. The remaininglenders, at least for now, are adopting more re-sponsible practices. We do not yet know if thisera of increased lender responsibility will con-tinue but borrowers should hope that it does. Ul-timately, private student loans are useful only ifthey are affordable and can be repaid. The roadto equal access to higher education will never bepaved with predatory private loans.

Private student loans have been a benefit forsome students, particularly middle and higherincome students that need additional funding topay for more expensive colleges. There is no evi-dence, however, that these high cost productshave helped narrow the class or race gap inhigher education graduation rates. Despite ac-cess to credit (often very high rate credit), there isstill a pervasive gap in access to higher educationamong lower-income individuals and individualsof color. For example, low-income families areabout 32% less likely to send their children to col-lege than families with higher incomes. Further,students from low-income families attend public

four-year institutions at about half the rate ofequally qualified students from high-incomefamilies.1 President Obama highlighted this per-sistent problem in his 2010 budget proposal,calling for innovative programs to increase low-income student completion rates.2

Regardless of how the future market plays out,there are countless borrowers stuck with loansthat they have no hope of repaying. Some fin-ished school, some did not. Some went to fouryear colleges and universities, others to propri-etary schools. Lenders and the government havedecided that, unlike the lenders that made theseloans, the borrowers are “too small” to help. Inreality, their numbers are large, but their politicalpower is not. To the extent that their problemsare heard, it is generally through the voices of in-vestors angry at crashing stocks and decliningrevenues.

This report focuses on these financially dis-tressed borrowers. We examine how lenders aredealing with the increasing private student loandelinquencies and why. We then ask what elsethey could and should be doing to help borrow-ers get out from under debilitating debt loads.These policies are not just for borrowers, but fortaxpayers and investors as well. Providing reliefto borrowers can also make good business sense.

What are private student loans?

Private student loans are made by lenders to students and families outside of the federal student loan program. They are not subsidizedor insured by the federal government and may be

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The Plight of Financially Distressed Private Student Loan Borrowers

April 2009

provided by banks, non-profits, or other financialinstitutions.3

Private student loans are similar to federal stu-dent loans in a number of ways. Both can be usedto help finance educations and can be certifiedonly up to certain amounts. Until recently, bothprivate and federal loans were generally pro -cessed through school financial aid offices. How-ever, in recent years, many lenders bypassed theschools and marketed their private student loanproducts directly to consumers.

Despite these similarities, there are a numberof very important differences between federaland private loans, including:

� Underwriting. With the exception of PLUSloans for parents and graduate/professionalstudents, federal loan borrowers do not haveto meet creditworthiness standards. Privateloans, in contrast, are priced according tocredit worthiness standards.

� Pricing. All federal loans have interest ratecaps, in most cases with fixed rates set at 6.8%or lower for subsidized loans. In contrast,nearly all private loans have variable interestrates with no upper limits. Many of theseloans are very expensive, with interest rates upto 15% or higher.

� Loan Limits. There are loan limits for thevarious federal loan programs. The only ex-ception is PLUS loans for parents and gradu-ate/professional students. For private loans,there are no regulations setting a maximumdollar amount on how much a student canborrow. Generally, lenders allow students toborrow up to the cost of attendance minusother aid.

� Borrower Protections. Federal loans comewith a range of borrower protections that aremandated in the federal Higher EducationAct, including income-based repayment, deferment and cancellation rights. In contrast,private lenders are not required to offer anyparticular relief.

� Application Process. Private loan borrowersare not required to fill out the complicatedfederal application form, known as the“FAFSA.” Many companies tout the simplicityof the private loan application and approvalprocess.

� Regulation. Federal loans are regulatedthrough the Higher Education Act (HEA). Private loans, in contrast, are regulated (ornot) in much the same way as other types ofprivate credit, such as credit card installmentsor mortgage loans. Oversight largely fallswithin the jurisdiction of federal regulators.As in the mortgage market, federal enforce-ment actions to curb problems in the privatestudent loan market have been virtually nonexistent.

� Collection. Both federal and private lendersuse third party collection agencies to pursuedelinquent and defaulted borrowers. Privatestudent lenders have fewer collection powersthan federal collectors. This gap is closing,however, as private lenders have fought to obtain many of the same collection rights asthe government. They succeeded in persuad-ing Congress in 2005 to make private loans as difficult to discharge in bankruptcy as federal loans.

Although in theory private student loans mayhave some advantages over federal loans in termsof flexibility and less restrictive collection tacticsthe bottom line is that private loans are almostalways more expensive than federal governmentloans. This is especially true for borrowers withlower credit scores or limited credit histories. Un-like most government loans, there are no loan lim-its that will help prevent over-borrowing. Privateloans also do not have the same range of protec-tions for borrowers that government loans have.

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The Growth of Private Student Loans

By 2003, the total volume of private loans hadsurpassed the amounts awarded annually underthe Student Educational Opportunity grants andfederal work study. As of 2008, borrowing fromprivate sources equaled about 23% of total educa-tion loan volume.4 Private loans grew from $3billion in 1997-98 to $19.1 billion in 2007-08.5

The private loan market was profitable prima-rily because originators sold the loans with theintention of packaging them for investors.Lenders must sell a certain amount of loans inorder to generate sufficient pools of loans to sellto investors. As a result, creditors made and soldloans to borrowers, but with the specific goal ofselling them to investors. Loan products werethus developed for the repackaging rather than toprovide the most affordable and sustainableproducts for borrowers.

Asset-backed securities (ABS) backed by stu-dent loans grew from $3.1 billion in 1995 to$13.4 in 2001 to $77.5 in 2005.6 In 2007, Fitch reported that Sallie Mae, the largest private stu-dent lender by far, relied on ABS for approxi-mately 64.5% of its managed funding.7

The business has been extraordinarily prof-itable. For example, Sallie Mae’s return on equity,which was over 30% in 2006, was one of the high-est among American companies. 8 Their executivesreaped the rewards. From 1999 through 2004,former chairman and current vice-chairman andCEO Albert Lord took home over $200 million.9

Hitting the Wall

Warning SignsThe recent crash in the market should not havebeen so surprising. The writing was on the wallbut, as so commonly occurred during the bubbleeconomy, most chose not to read the warningsigns. Most ratings agencies continued to rateprivate student loan pools highly, even after signsof trouble began to emerge.

A few ratings agencies expressed some caution.The Fitch Ratings Company pointed out in 2007that the relatively healthy performance of privatestudent loans, including low charge-off rates, wasunsustainable over the long-term.10 Fitch citedthe floating interest rates and increasing pressureon borrowers to repay in a rising rate environ-ment as factors that could increase charge-offs.11

Fitch highlighted the importance of lender lossallowances, noting that Sallie Mae’s had fallenover time and needed to be bolstered to handlefuture charge-offs. Still, they hedged these warn-ings by stating that credit losses in the studentloan sector at that point compared favorably toother consumer lenders like American Expressand Capital One.

Not everyone was blinded by the dazzling profits.Bethany McLean of Fortune, who was instrumen-tal in uncovering the Enron scandal, questionedthe private student loan business model in a2005 article. She focused on the potential de-faults noting that “[t]hese are after all basicallyunsecured loans to people without jobs.”12

McLean warned of the lack of historical measure-ments by which to gauge default potential.

“These are after all basically unsecured loansto people without jobs.”

—Bethany McLean, Fortune, 2005

Some argue that lenders deliberately misledinvestors. For example, recent shareholder andfalse claims lawsuits focus on Sallie Mae’s allegedpractice of using the forbearance process to manipulate delinquency rates.13 Regardless of

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$77.5

Growth in Student Loan Asset-Backed Securities

intent, Sallie Mae and the other lenders clearlyunderestimated the potential for high delin-quency and default rates.

A savvy investor could have detected theselooming time bombs by carefully reading thepooling and servicing agreements (PSAs). Theseare the primary contractual documents underly-ing securitization transactions. The PSA broadlygoverns the formation of the trust, the servicingof the loans in the trust, and the duties of variousparties to the trust agreement.

A 2006 Sallie Mae PSA, for example, warnedinvestors that private loans are made to studentswho may have higher debt burdens than studentloan borrowers as a whole and that they have typ-ically already borrowed the maximum federal

loans. As a result, according to the informationin the PSA, these borrowers may be more likelythan other borrowers as a whole to default orhave higher rates of forbearances.14 In addition,the company disclosed that private loans are notsecured by any collateral and not insured by anyguaranty agency or any government agency.

An earlier PSA from Key Corp. cautioned in-vestors that the company had only been originat-ing unguaranteed student loans for a limitedtime and that an immaterial number of theseloans had entered repayment status as of the dateof the securitization sale. As a result, they admit-ted that they lacked meaningful prepayment, lossor delinquency data on the unguaranteed stu-dent loans.15 They even warned that default rates

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SECURITIZATION 101: COMMON TERMS

Lender. The originator of the loan.

Seller/Wholesale Lender. The party that sells theloans to the issuer. The seller can be the originallender, or an affiliate of the original lender. Alterna-tively, the original lender can sell the loans to awholesale lender who, in turn, becomes the seller ofthe loans to an issuer.

Issuer/Depositer. The seller transfers the notes toan issuer, also sometimes called a depositor. The is-suer issues securities that represent undivided inter-ests in the cash flows from a particular pool ofloans. The issuer then sells the securities and trans-fers legal title in the loans to a trust entity.

Servicer. The entity that collects monthly paymentsfrom borrowers and passes on the required cashflows to the trustee. The servicer retains a fee fromborrower payments and can usually also keep latecharges, bad check charges and other costs. In manysecuritization transactions, the seller retains theright to service the loan, so the seller and servicermay be the same entity.

Trustee. Usually a commercial bank, the trusteeacts on behalf of the trust and investors. It is essen-tially an administrative function, to represent thetrust, to monitor the effectiveness of the servicing, tomanage and oversee the payments to the bondhold-ers, and to administer any reserve accounts.

Custodian. The custodian may hold the notes andmortgages for safekeeping as an agent for the trust.

Underwriter. The investment firm or firms that pro-vide the initial capital to purchase the securitiesfrom the issuer and then, at a profit, sell them to itscustomers, institutional investors, and mutualfunds. The underwriter plays a key role in structuringthe entire transaction.

Rating Agency. The rating agency provides an eval-uation of the credit quality of the securities. AAAbonds are the highest quality with the smallest riskof default.

Insurer. In order to achieve an AAA rating, poolshave to be “credit enhanced.” Often these enhance-ments come in the form of insurance. The mostcommon forms of credit enhancement in studentloan pools are excess spread and over collateraliza-tion. Excess spread is the positive difference betweenthe interest collected from borrowers and interestowed to bondholders.

Pooling and Servicing Agreements(PSA). Theseare the primary contractual documents underlyingsecuritization transactions. The PSA broadly governsthe formation of the trust, the servicing of the loansin the trust, and the duties of various parties to thetrust agreement.

for student loans made to students attendingproprietary and vocational schools are signifi-cantly higher, except for a few selected, accreditedproprietary schools which grant degrees.16

Market Distress

The market ultimately tanked largely because toomany loans in the pools were no longer perform-ing. Lenders began reporting huge increases indelinquency and default rates. In October 2008,Sallie Mae reported a loss of $159 million in themost recent quarter, fueled by the acceleration ofdelinquent private loans.17 Fitch in 2009 statedthat from a net-charge off perspective, the rateshad been deteriorating for the main private stu-dent lenders since 2006.18 As of early 2009, thirty-nine lenders had stopped making private studentloans.19

In February 2009, Fitch announced that theperformance for U.S. private student loan ABS isunder increased pressure.20 The agency specu-lated that rising unemployment will continue tohave a worsening effect on private student loanperformance through 2009 and well into 2010.According to the February release, certain privatestudent loans trusts are exhibiting losses that are1.5 to 2 times greater than initial expectations.Trusts with higher concentrations of “direct toconsumer” loans are experiencing particularlygreat variability in performance. Lenders were ad-vertising direct to consumer loans as an easierway to get student loans and avoid the hassle ofinteracting with the school financial aid offices.

Sallie Mae and others have attributed much ofthe poor performance to their “non-traditional”loan portfolio. These loans are described as loansto borrowers that are expected to have a high de-fault rate due to numerous factors including hav-ing a lower tier credit rating or low programcompletion and graduation rates usually at“non-traditional schools.” Even where the bor-rower is expected to graduate, non-traditional

loans tend to go to borrowers with low expectedincomes relative to the cost of attendance.21 BothSallie Mae and Citi’s Student Loan Corporationhave identified lending to students attendingschools with lower graduation rates and lowerearning potential as the main source of credit de-terioration.22 Non-traditional loans at both for-profit and non-profit schools represented about14% of Sallie Mae’s private education loan port-folio, but accounted for 54% of charge-offs in thecompany’s portfolio in 2008. 23 Even Sallie Mae’sthen-CFO Jack Remondi admitted that this is “. .. [o]bviously, a business model that does notmake sense.”24

In discussing the company’s lending to “non-traditional” students, Sallie Mae CEO Al Lordsaid in a June 5, 2008 interview that “[i]t was ob-viously a mistake and I’m not going to step awayfrom responsibility because I was either chair-man or CEO when those loans were made. Wegot a little too confident in our own view thatcredit scores are of limited meaning for under-graduates. Maybe as early as 2004, we startedlending with less selectivity. The culture of thecompany has been a FFELP [federal guaranteedloan program] culture for 35 years. That meantyou made every loan to every student. I guesswith 35 years of experience of saying yes, we werejust not very good at saying no.”25

These belated admissions can be useful in pol-icy debates because they expose the inexcusablewishful thinking that masked as business plan-ning over the years. However, these mea culpas donot do much for troubled borrowers.

“I guess with 35 years of experience of sayingyes, we were just not very good at saying no.”

—AL Lord, Chairman, Sallie Mae (June 2008)

The reality is that many loans were so expen-sive that they were destined to fail. In a March2008 report, NCLC reviewed twenty-eight privateloans issued between 2001 and 2006, looking forwarning signs and potential problems. All of theloans in our survey had variable rates. The lowestinitial rate in our sample was around 5% and the

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highest close to 19%. The average initial disclosedannual percentage rate (APR) for the loans in oursurvey were 11.5%.26

The high fees made these loans even more ex-pensive. There are no limits on origination andother fees for private student loans. According tothe loan disclosure statements we reviewed, thelenders charged origination charges in all butabout 15% of the loans. For those with origina-tion fees, the range was from a low of 2.8% up toa high of 9.9% of the loan amount. The average inour survey was 4.5%.

A Market Recovery?

There are some signs that the market might beslowly recovering. In early 2009, the private stu-dent lending market fell as much as 25% as thesecurities market dried up.27 Fitch reported onlytwo private student loan deals in 2008, a $140million deal from My Rich Uncle and a $400 mil-lion deal from the Massachusetts Educational Fi-

nancing Authority.28 However, in January 2009,Sallie Mae secured $1.5 billion worth of financ-ing from Goldman Sachs for a batch of privatestudent loans. 29

It is unlikely that the securitization marketwill bounce back quickly or ever return to previ-ous levels. Fitch, for example, warned in February2009 that the weak job market, lack of home eq-uity financing, and negative student loan indus-try performance are all leading to diminishedinvestor interest in private student loan securiti-zations.30 Yet it is also unlikely that private stu-dent loans will disappear completely. Sallie Maerepresentatives said that the company expects tomake the same volume of private loans in 2009 asin 2008 and may fund even more if they are ableto access government TALF funding.31 Fitch pre-dicts that the private loan market will remainmost relevant for international graduate stu-dents with no access to federal loans and under-graduate borrowers whose parents cannot accessPLUS loans.32

The remaining lenders seem to have learnedsome lessons. Most have reduced their origina-

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THE HUMAN COST

Although it is hard to measure in dollar amounts,the human cost of unaffordable private loan debt isalarming. We hear from these borrowers every day.Those that attended inferior schools are particularly in-censed because they received nothing in return for theircrushing debt loads. Below are just a few examples.

Juanita, a social worker in Massachusetts rackedup over $100,000 in private student loan debt. Thestarting salary for a social worker in her area isaround $25,000. She has been working in a job sheloves for ten years, but earns less than $40,000 an-nually. She believes, with good reason that she willnever be able to pay off her student loan debt. Shewill not benefit from the new public service loan for-giveness program because it applies only to federalloans. Federal PLUS loans for graduate studentswere not available when she went to school. She isstuck, along with many other borrowers from all

economic classes who simply cannot afford to repaytheir private student loans.

Francine is a single mother raising a disableddaughter. While she was married, she went back toschool to try to finish her undergraduate degree. Thefamily moved a lot and she frequently transferredschools. Her husband had abused her for manyyears and she ultimately fled with her daughter. Shewas unable to finish college. She has a combinationof federal and private loans. The private loan debthas grown to over $75,000. Francine has been ableto set up flexible repayment and get deferments forthe federal loans, but her private lender refuses tooffer her any options to reduce the debt or pay-ments. She earns about $35,000 annually and sim-ply cannot afford to pay her private loans. Just likeJuanita, Francine says she would pay an affordableamount, but the lender refuses to work with her.

tion volume and re-evaluated underwriting crite-ria.33 Sallie Mae, the largest student lender, hastightened underwriting, terminated certain schoolrelationships and reduced volume.34 The com-pany has said that they plan to curtail less prof-itable student loan origination and acquisitionactivities that have less strategic value, includingoriginations of private loans for high default rateand lower-tier credit borrowers.35 In March 2009,the company announced that it will be replacingits existing private loan product with a shorter-term loan that requires borrowers to make pay-ments while they are in school.36

First Marblehead, a company that providesoutsourcing services for private education lending,reported in 2008 that it was designing new pro-grams with more selective underwriting criteria.37

The company also changed its servicing ap-proach and developed an early awareness pro-gram for high risk borrowers.

A thriving student loan market characterizedby responsible lending will likely provide benefitsto many borrowers, particularly middle andhigher income borrowers who have exhaustedfederal loan eligibility and need additional fundsto attend more expensive schools. However, a re-turn to the predatory market days would notsupport students’ or society’s interest in promot-ing equal access to higher education. There areother ways to achieve this important social andeconomic goal, including increased grant assis-tance, broad reductions in college tuitions, andincreased investment in public education.

The reality is that responsible lending, includ-ing careful underwriting based on ability torepay, means that many borrowers that were pre-viously able to get private loans are no longer beable to do so. These borrowers still have some op-tions. They should first exhaust federal grant andloan resources. In addition, the recent proposalsin the Obama administration budget aim to pro-vide targeted assistance through increased grantsand more affordable federal loans to the lowest-income students. The less creditworthy borrowerswho are now unable to get private loans were pre-

viously getting the highest priced loans. Manyhave found that the debt loads are insurmount-able. The fact that private loans are less availablewill help future students avoid these debt traps.However, it does not alleviate the need to findcost effective and efficient ways to help at-riskstudents go to college.

Government Intervention

The shape of the future depends to a large degreeon how the federal government responds. If thegovernment chooses to bail the lenders out bypurchasing large portions of bad debt, the lenderswill suffer no consequences for their irresponsibleactions. They could return to irresponsible lend-ing. This is even more likely to occur if Congressfails to impose stricter regulations going forward.

To date, the main government intervention isthe Term Asset-Backed Loan Facility (TALF). TheTALF program is intended to restore liquidity tothe asset-backed securities (ABS) markets forconsumer assets. The Federal Reserve of NewYork will make up to $200 billion of loans, whichwill be fully secured by eligible ABS. Eligible col-lateral will include cash ABS with a long-termcredit rating of AAA. Eligible ABS cannot be onreview or watch for downgrade. Further, lendersmust obtain the AAA grade without the benefitof third party guarantees. Eligible ABS must beissued after January 1, 2009 and all or substan-tially all of the underlying credit exposures of eli-gible student loan ABS must have had a firstdisbursement date on or after May 1, 2007.38

Fitch noted in early 2009 that government pro-grams like the TALF may temporarily increase in-vestment in private loan deals, but they will nottruly re-ignite interest to previous levels.39 Fitchbelieves that going forward, the ABS market willimprove only if lenders can convince investorsthat underwriting criteria is effective enough toidentity and exclude the riskier borrowers andschools that yielded significant deterioration.40

TOO SMALL TO HELP 7

Too Small to Help

Given their role in creating the crash, it is reason-able to expect lenders to do everything possibleto help borrowers with unaffordable loans. Dis-tressingly, this has not occurred. In our experi-ence representing borrowers through theStudent Loan Borrower Assistance Project, wehave found private lenders to be universally in-flexible in granting long-term repayment relieffor borrowers.41 Lenders that had no problemsaying “yes” to risky loans are having no problemsaying “no” when these borrowers need help.

The ABS market will improve only if lenderscan convince investors that underwritingcriteria is effective enough to identity andexclude the riskier borrowers and schoolsthat yielded significant deterioration.

—Fitch Ratings, Jan. 2009.

Our Study of Programs ForFinancially Distressed Borrowers

Survey ResultsTo test our experiences with borrowers, we sent aquestionnaire to five for-profit lenders and onenon-profit lender asking for information abouttheir programs for financially distressed privateloan borrowers. Although some no longer makeprivate loans, all were heavily involved in thebusiness in recent years. The lenders surveyedrepresent about 75% of the private student loanmarket with Sallie Mae by far the biggest player.The other for-profit lenders surveyed were Citi,Chase, Key Bank, and Wells Fargo.

Congress created Sallie Mae in 1972 to providea secondary market for student loans. Due tochanges in the federal student loan industry, in-cluding the creation of the government’s DirectLoan program in the 1990’s, Sallie Mae ulti-mately won Congressional approval to become afully private company.42 By 2004, Sallie Mae had

reached its goal of complete privatization andhas dominated the federal and private studentlending sectors. According to Student LendingAnalytics, a company that provides informationabout student loans, Sallie Mae accounted forabout 42.5% of private student loan originationsin 2007.43 Citibank was a distant second at 10.5%.

Non-profit lenders comprise a small percentageof the private student loan market. However, wedecided to survey one of these lenders for compari-son purposes. The non-profit lender selected wasVermont Student Assistance Corporation (VSAC).The questionnaire is attached at the Appendix.

Only Sallie Mae and VSAC provided responsesto our questionnaire, as summarized in the fol-lowing pages. One lender refused to answer,claiming that this information was “proprietary.”The others simply stated that they were decliningto respond. Citi did not respond at all.

VSAC provided more comprehensive informa-tion than the information provided by SallieMae, although Sallie Mae does deserve credit asthe only for-profit lender that responded. VSACis offering a number of flexible options as well asintensive counseling during the difficult eco-nomic times.

Additional Information About Private Loan Assistance OptionsGiven the low response rate to our survey, wesearched the Internet for additional information.For the most part, we uncovered only very gen-eral information about options for troubled bor-rowers. General student assistance web sitesdescribe numerous private loan terms, includingloan limits, rates, fees and term. However, they donot describe repayment, cancellation or defer-ment options.

Scattered and inconsistent information is avail-able on the Internet. Key Bank does not have muchinformation about private loans on their site,perhaps because they stopped making these loansin fall 2008. Chase states that flexible repaymentterms are available. We could not find further de-

8 TOO SMALL TO HELP

tail. The Chase site describes the deferment op-tions with some additional specificity. These areall related to deferment while in school.

Many of the lenders describe consolidationloan products. For some time, many lenders pro-moted consolidation as a solution if a borrowerexpressed concerns about potential debt loads.As in the mortgage market, lenders often prom-ised borrowers that they could always refinancelater and get a better deal. Just as in the housing

market, the refinancing bubble ended abruptlyand it is now very difficult to consolidate privateloans. It never should have been touted as a long-term repayment strategy, but now it is not evenreadily available.

With respect to repayment, Wells Fargo de-scribes benefits that can reduce interest rates.The repayment options in the “repayment plan”section mainly refer to federal loans. There is acategory for interest-only repayment that says

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SURVEY RESPONSES

Sallie Mae

Sallie Mae listed the following as options availableto private loan borrowers having trouble with loanrepayment:

� Forbearance. Offered only up to 3 months in tothe future, but can be used to resolve prior delin-quency as well. Requires the payment of a for-bearance fee of $50 per loan, cap of $150 peroccurrence. Typically capped at 24 cumulativemonths.

� Extended Repayment. Ability to extend the repay-ment terms, dependent on balance owed.

� Interest-only repayment plan. Typically, 2 or 4years of interest only payments and then full prin-cipal and interest for remaining terms.

� In school deferment. Borrowers can postponepayments if they return to school on at least ahalf-time basis.

If the borrower is not delinquent, these programs(with the exception of forbearance) are standard.

The company did not respond to the questionabout whether this information is available in writ-ing. They did not respond to a follow-up questionasking them whether they intentionally or inadver-tently failed to respond to this question.

In response to the question about how borrowerstypically find out about these programs, Sallie Maestated that borrowers can get this information ontheir website, or from a representative on the tele-phone. All options, they said, are available at theborrower’s request.

Sallie Mae stated that the options are availablewhen borrowers are delinquent, but additional doc-umentation may be required or the options may notbe automatically granted. We requested clarificationregarding whether there is a difference for borrowerswho are delinquent and those who are in default,but did not hear back. This is an important distinc-tion because only borrowers in default are subject tocollection lawsuits. Borrowers are in default on fed-eral loans if they fail to make payments for a rela-tively long period of time, usually nine months.There are no similar standardized criteria for privateloan defaults. Rather, default conditions for privatestudent loans are specified in the loan contracts. Inmost cases, borrowers will not have a long period toresolve problems if they miss payments on a privatestudent loan. Private loans may go into default assoon as one payment is missed. In addition, borrow-ers in default on federal loans have various ways toset up affordable repayment plans and get out ofdefault.

Sallie Mae stated that the options are the sameregardless of whether the loan is part of a securitiza-tion trust. They also responded that they servicetheir own loans.

Finally, we asked whether they have made anychanges to these options/programs to respond tothe economic crisis. They said that they are currentlyworking on a new option for delinquent customerswhich will allow borrowers to make lower paymentsby reducing their interest rate.

We requested additional information about thisnew option, including a time line for implementa-tion, but did not hear back.

only that many loan types allow for up to fouryears of interest-only payments and that borrow-ers should call to sign up. The site also describesforbearances for private loans, but only for in-school/residency programs and in-school sum-mer bridge students. Citi’s site says only thatstandard repayment is up to twenty years.

Sallie Mae’s site generally describes their vari-ous products. It notes when there is a grace period.

Sallie Mae also states that several repaymentplans are available for some products, includingstandard, graduated and extended. Others juststate that flexible repayment is available. For thecareer training loans, the site states that borrow-ers may take up to 15 years to repay the loan. Italso describes an interest-only repayment optionthat is available during school only. There is a $10deferred repayment option that allows deferments

10 TOO SMALL TO HELP

VERMONT STUDENT ASSISTANCE CORP.

In response to the questions about options for bor-rowers having trouble making payments, the non-profit lender Vermont Student Assistance Corp.described the following options for private loan bor-rowers experiencing trouble with repayment:

They said that they can offer a reduced paymentplan or forbearance on the private loan during peri-ods of financial difficulty. Other options for privateborrowers include:

� Extend loan term up to 30 years (with significantcounseling on the increased finance charge thatthe borrower will pay over longer terms)

� Reduced Payment Forbearance period, generallyoffered for 3 to 6 months, with a maximum of 12months (they emphasize this option in order tobuild a habit of repayment with the borrower):� Generally offered for 3 to 6 months� Maximum of 12 months� Currently no restriction on the number of

reduced payment forbearances per borrower� Borrower must be experiencing temporary

financial difficulty� Borrower must have a long-term plan to repay

the loan.

� Forbearance:� Generally offered for 1 to 6 months at a time� Maximum of 12 months at a time� Currently no restriction on the cumulative

number of forbearances per borrower� Borrower must be experiencing temporary

financial difficulty� Borrower must have a long-term plan to repay

the loan

Currently, there are no specific qualifying condi-tions for forbearances.

They said that extension of term is standardized,but that the other options are offered on a case-by-case basis, determined by the counselor, sometimesin consultation with a supervisor. The extension isdescribed in writing and available publicly on web-site and in loan materials.

When asked about how a borrower typically findsout about these options, VSAC responded thatavailability of temporary and permanent options tolower loan payments are discussed during loan origi-nation and during counseling calls or due diligencecalls (if borrower becomes delinquent in payments).Borrowers may also proactively contact the lender todiscuss options to reduce their monthly payment.

VSAC further responded that the programs areonly available if the borrower is current or delin-quent. If a borrower has defaulted on repayment,there are no options to extend term or reduce/suspend payments. They said that there is no differ-ence in servicing based on financing structure.

Finally, we asked whether the company has madeany changes to these options/programs to respondto the economic crisis. They responded that theyhave increased counseling during the origination pe-riod, including information about the benefits ofborrowing under the federal PLUS program insteadof using private loans. The company also requiresborrowers to take the maximum federal Staffordloan before even considering private loans and allprivate loans are certified by the school financial aidoffices. In addition, VSAC has increased calls to bor-rowers before loans become severely delinquent andmakes earlier and more intense calls to any borrowershowing previous financial difficulty.

VSAC services its own loans pre-default and usesan unaffiliated collection company for post-defaultservicing.

for up to 12 months, not to exceed the antici-pated graduation date on the application. It isnot clear from the site how available these op-tions are for borrowers in delinquency or default.

In a 2006 report, the Institute for Higher Edu-cation Policy noted that no private lenders intheir study offered income-based repayment.44

Lenders may be concerned about whether offer-ing flexible repayment would affect their abilityto sell their loan packages to investors. For exam-ple, industry observers such as Fitch Ratings havenoted that a mandated income-based repaymentpolicy could have a highly disruptive effect onthe flow of low-cost capital to the industry.45

Key Findings

Lack of InformationThe lack of comprehensive information aboutpotential options is very troubling and detrimen-tal to borrowers seeking solutions. The informa-tion on creditor web sites is sparse and mostlyrelates to federal loans. In response to our surveyrequest, Salle Mae at least provided general infor-mation, although it failed to respond to our ef-forts to clarify their responses. The other for-profitlenders refused to respond. Only the non-profitlender VSAC responded comprehensively.

Even more troubling is that in our experiencerepresenting borrowers, these options are rarelymentioned when they have called for assistance.In the private loan sector, it is unclear whetheranyone is actually being offered flexibility or re-structuring. This could be because most of ourclients are in default or late-stage delinquency,but lenders have not provided any explanation tous for this refusal to consider flexible solutions.

Lack of Assistance for Borrowers in Default

It appears that there are few, if any, choices forborrowers in default. Yet these are generally the bor-rowers most desperate for assistance. This is also in

sharp contrast to the federal programs where bor-rowers in default have various ways to select afford-able repayment plans and get out of default.

Borrowers are in default on federal loans ifthey fail to make payments for a relatively longperiod of time, usually nine months. There areno similar standardized criteria for private loandefaults. Rather, default conditions for privatestudent loans are specified in the loan contracts.In most cases, borrowers will not have a long pe-riod to resolve problems if they miss paymentson a private student loan. Private loans may gointo default as soon as one payment is missed.

In the past, forbearance was the only optionoffered to these most distressed borrowers, al-though many lenders charge fees for forbear-ances, generally up to $50 for each forbearance.These policies have changed radically in recentmonths as most creditors have sharply restrictedforbearance availability.

In a 2009 report, Fitch describes the preva-lence of lenient forbearance policies throughoutthe industry.46 The company noted that lendersbegan to impose more restrictive forbearance cri-teria starting in 2008, after realizing that the eco-nomic downturn would have a more prolongedimpact on a borrower’s ability to repay.47

Sallie Mae has described changes in their forbear-ance policies. Previously, according to allegationsin shareholder lawsuits, they heavily encouragedforbearance as a way of keeping delinquency rateslower.48 The company now says that they are ap-plying far more analysis to forbearance requeststo make sure that borrowers are both committedto repaying their debt and have the actual abilityto benefit from a forbearance.49

The more restrictive forbearance standardsmay be an appropriate response from an investorpoint of view because forbearance is intendedmainly to provide relief for borrowers with tem-porary financial difficulties. The problem for bor-rowers is not so much that forbearances are lessavailable, but that there is little or no other options to help them manage their debts over thelong-term.

TOO SMALL TO HELP 11

Cancellations and Settlements Are Rarely AvailableIn our experience representing borrowers in fi-nancial distress, lenders, including non-profitlenders, have not been willing to cancel loans oroffer reasonable settlements. The lenders havesaid they will cancel loans only in very rare cir-cumstances. For example, one lender told us thatthey will consider cancellations in circumstanceswhere a borrower has a very serious disability.However, it requires more than proof of a federaldisability cancellation. Private lenders generallydo not discharge student loan debt upon deathof the original borrower or co-signer. A numberof loans in our March 2008 study stated explic-itly that there would be no cancellation if theborrower or co-signer died or became disabled.

Further, loan modifications are rarely offered.The few lenders that responded to our survey didnot even describe loan restructuring as an op-tion. Our experience from representing borrow-ers is that lenders do not offer long-term interestor principal reductions or other restructuring.

Rather than focusing on working with borrow-ers, lenders have described efforts to ratchet upcollection. Sallie Mae, for example, has an-nounced steps to resolve higher risk accounts, in-cluding a more aggressive use of collectionefforts.50

Recommendations to ImproveAssistance for Private LoanBorrowers

1. Mandate Loss Mitigation Relief A key barrier to improved assistance programs isthat lenders have not been required to provide re-dress for their irresponsible actions. Lenders tendto blame the economy for the large numbers ofdistressed borrowers as if the economic crisis isunconnected to their irresponsible behavior.

The analysis above shows that voluntary ef-forts have been few and far between. Similartrends occurred in the mortgage industry wheremost creditors failed to act on their own to stemthe foreclosure tide.51

Loss mitigation efforts should be encouragedacross the board, but they should be required ofany creditor that receives federal funds throughTARP or TALF or other government programs.Among the primary student lenders, for example,as of early February 2009, Citi, Wells and KeyCorp. had all received significant federal TARPinfusions. These are general funds aimed atstrengthening the institutions and increasing liq-uidity. They are not specific to student loans.Other institutions are expected to receive loansthrough the TALF program.

There is ample precedent in the mortgage sec-tor tying loss mitigation and other consumerbenefits to receipt of federal funds. Citigroup, forexample, agreed in early 2009 to expedite mort-gage modifications as a condition of its secondreceipt of TARP funds.

Investors should support such policies, recog-nizing that collecting some money is better thanspending more money on aggressive collectionefforts and getting little or nothing in return. Inthe mortgage sector, researchers have shown thatthe returns from modifications are often greaterthan taking on the expense of foreclosure andseizing undervalued assets. For example, Profes-sor Alan White found the average loss for the21,000 first lien mortgages in his sample for No-vember 2008 liquidated that month was$145,000, representing an average loss of 55% ofthe amount due. Losses on second lien mort-gages were close to 100%. In comparison, for themodified loans with some amount of principal orinterest written off during that time period, theaverage loss rec ognized was $23,610.52 Given thisdata, White describes servicers’ decisions to fore-close as “mystifying.”

These types of modifications are likely to makeeven greater business sense in the student loancontext due to the unsecured nature of student

12 TOO SMALL TO HELP

loans. A student lender that sues and gets a judg-ment has no collateral to seize. Presumably,many of these borrowers will be “collectionproof.” Others, especially those that went tofraudulent trade schools, could potentially raiselegal claims against the creditors. We were unableto compare the numbers and evaluate how fundsseized through collections compare to paymentsreceived through modifications. In order to fullyunderstand this analysis, lenders must be re-quired to provide information to investors, regu-lators and the public comparing numbers ofcollection actions and recoveries from such ac-tions to the performance of loan modifications.The Obama administration’s homeownershipplan, for example, will require servicers to pro-vide data about loan modifications, borrowerand property characteristics, and income.53

Meaningful assistance should include loan re-structuring and flexible repayment. Servicersshould have the authority to modify loan terms,change interest rates, forbear or forgive principal,extend maturity dates, offer forbearances, repay-ment plans for arrearages, flexible repayment anddeferments. Congress and the Administrationshould also act to ensure that borrowers receiv-

ing relief through these programs do not face taxconsequences.

Many current lender efforts, such as enhancedcounseling and default prevention programs,may help in the future, but are insufficient to as-sist those already in trouble. As Professor KurtEggert notes in the mortgage context, “Early in-tervention and modeling software will not help a borrower who fundamentally cannot afford aloan.”54 Meaningful mitigation means develop-ing long-term solutions that work for both bor-rowers and investors. The modifications have tobe substantial enough so that the risk of re-default is low.

Barriers to Loss Mitigation ProgramsRestrictions in Securitization Agreements?It is short-sighted not to work with borrowersthat can afford to repay. We can only speculateabout the reasons why lenders are not doingmore, other than the fact that no one has re-quired them to do so.

One possibility is that servicers may feel con-strained in cases where the loans have been securi-

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LEARNING FROM THE OBAMA ADMINISTRATION’S MODIFICATION PLAN FOR HOMEOWNERS

The blue print for a student loan mandatory modifi-cation program can be found in the Obama admin-istration’s Home Affordable Modification Program.This program will provide relief to many home own-ers in default and those facing the risk of imminentdefault. The program:

� Supports affordable loan modifications based onmodest debt-to-income ratios with substantialdecreases in payments and interest rates;

� Stops foreclosures while loan modificationanalyses are occurring;

� Requires participating institutions to apply theprogram to their whole portfolio and to take

reasonable steps to secure additional authoritywhere needed;

� Incentivizes principal forgiveness as well asinterest rate reduction;

� Permits servicers to make and counselors torecommend more aggressive modifications when appropriate;

� Waives unpaid late fees for borrowers;

� Provides various incentive fees for servicers.

More detail can be found at http://www.financial-stability.gov.

tized. This has occurred in the mortgage contextwhere servicers often claim that the pooling andservicing agreements do not let them modifyloans. In reality, most securitization documentsgive broad authority to servicers to service loansin accordance with customary standards, oftenalso stating that the servicers must act in the bestinterests of investors.55 In any case, we have notheard creditors or servicers use this excuse in thestudent loan context. In fact, Sallie Mae and VSACstated that they service the loans the same whetherthey are securitized or not. In addition, SallieMae has stated that they securitized a lower per-centage of their non-traditional loans, the mosttroublesome loans.56

To further test this issue, we thoroughly re-viewed two recent Sallie Mae PSAs from 2006and 2007, a 2000 Key Bank PSA, and a 2006 Na-tional Collegiate Trust, administered by FirstMarblehead Data Services. We did not find anyexplicit barriers to modifications in any of thoseagreements. The Sallie Mae agreements specifiedthat servicers must use the same standard of careused to service other student loans owed by SallieMae, in compliance with applicable guaranteeagreements and other applicable state and fed-eral law. The Sallie Mae agreements admonish theservicer not to do anything to impair the rights ofthe investors. However, the agreements are ex-plicit that servicers can reschedule, revise, defer orotherwise compromise payments due on any stu-dent loan during applicable interest only, defer-ment, or forbearance periods or otherwise as longas the servicer uses the same standards it uses forsimilar student loans owned by Sallie Mae.

The “best interests of investors” clause is notnecessarily the barrier it might appear to be onfirst glance. As discussed above, although wecould not find data on this issue, it is logical toassume that it will be in the best interests of in-vestors in many cases to restructure loans andthereby ensure a continued stream of payments.For example, the FDIC’s loan modification pro-gram for Indymac and the administration’s newloan modification program focus on whetherloan modifications are more beneficial to in-

vestors than foreclosure. In the mortgage con-text, many loan modifications that are good forinvestors have not been made to date. In any case,the other PSAs we examined did not contain the“best investor clause,” requiring servicers only toperform the services and duties customary to theservicing of student loans with reasonable careand to do so in compliance with all applicablestandards and procedures. Now that the industrystandard for mortgage loans is evolving towardaggressive, standardized loan modifications, it isappropriate to figure out ways to do the same inother markets, including student loans.

The Cost of ModificationsEven if servicers know they have discretion tomodify and restructure loans, they may choosenot to exercise it because of the additional ex-pense. Loan modifications can be labor intensive,although student loan modifications should be lesscomplex than modifying mortgage loans. Unlikemortgage modifications, there is no underlyingasset that requires valuation for student loans.

In the typical student loan PSAs we reviewed,servicers received two fees, a primary fee and acarryover servicing fee. The Sallie Mae system, forexample, awards servicers a primary fee for anymonth equal to 1/12 of an amount not to exceed.70% of the outstanding principal amount of thetrust student loans. The fee is payable in arrearsout of amounts on deposit in the collection ac-count, the cash capitalization account and the re-serve account. The carryover fee is payable to theservicer on each distribution date out of availablefunds remaining after all payments owing on thenotes have been made. The fee is the sum of:

� The amount of specified increases in the costsincurred by the servicer;

� The amount of specified conversion, transferand removal fees;

� Any amounts descried above that remain un-paid from prior distribution dates; and

� Interest on any unpaid amounts.

14 TOO SMALL TO HELP

The payment of these funds does not appearto be dependent on servicer performance.

To some extent, it should be easier to automatemodifications for student loans. However, ser-vicers will still be required to thoroughly evaluatea borrower’s income and ability to pay so as tomaximize the return to investors while reducingthe likelihood that the borrower will defaultagain.57

Additional investigation is needed to assesswhether servicers are holding back on studentloan modifications because of cost. If so, thereare ways to address this problem, including addi-tional compensation for servicers. This has beensuggested in the mortgage context and is part ofthe Obama Administration’s new homeowner re-lief plan.58

Accounting ProblemsIt is possible that lenders feel constrained by accounting and other regulations which generallyrequire consumers to repay settled debts withinthree to six months and lenders to recognize for-given amounts as losses during this time period.However, we have not heard this concern expresseddirectly in the student loan context. In addition,federal regulators can if necessary act to allowcreditors to make these settlements and elimi-nate or reduce any tax liability for consumers.

2. Restore Bankruptcy RightsIt is nearly impossible at this point for studentloan borrowers to get any type of long-term relieffrom servicers and creditors. Most are also shutoff from bankruptcy.

Creditors succeeded in persuading Congressin 2005 to make private loans as difficult to dis-charge in bankruptcy as federal loans. Currentbankruptcy law treats students who face finan-cial distress the same severe way as people whoare trying to discharge child support debts, al-imony, overdue taxes and criminal fines.

Since 2005, nearly all student loan borrowersmust prove “undue hardship” in court in order

to discharge their loans. Courts have been veryrestrictive in applying this standard.59 The systemis strikingly arbitrary. Judges are granted extraor-dinary discretion to make these decisions, espe-cially since the code provides no definition of“undue hardship.” A study of 261 reported deci-sions affirmed the randomness in the applicationof the undue hardship test.60 The study foundfew statistically significant differences betweenthe debtors granted discharges and those thatwere not. The study also found that studentsseeking bankruptcy relief were in fact suffering fi-nancial distress. The authors conclude that judi-cial discretion has come to undermine theintegrity of the undue hardship system.61

Many courts, recognizing the inequity of thissystem, have begun to create an ad hoc middleground. Some allow partial relief by discharginga portion of the debt or by discharging some, butnot all, of the loans. Some courts have allowed arestructuring of the loan, for example by dis-charging collection fees and accrued interest andeven by delaying the student’s obligation to startmaking payments, during which time no furtherinterest accrues.62

Whether a borrower gets the benefit of a mid-dle ground approach depends entirely on whereshe happens to live and the judge she happens todraw. This is unfair, but the judges have a point.They are flying by the seat of their pants becausethey understand that the current all or nothingapproach does not work for everyone.

There might be ways to incorporate some ofthe ad hoc policies into the bankruptcy systemthrough partial discharges or by separately classi-fying student loans in Chapter 13 plans so thatborrowers can make a bigger dent in thesenondischargeable debts during the course of theplan. These middle ground approaches should be consid-ered, but not as a substitute for full bankruptcy rights forthe neediest borrowers. If, however, the undue hard-ship system is retained for these borrowers, thestandard should be refined to target those in themost distress and to ease the burden of proof.Congress should also restore the waiting periodas an alternative ground for discharge. A five year

TOO SMALL TO HELP 15

waiting period has the benefit of allowing a morestraightforward process so that borrowers whocannot access the system are not unfairly penal-ized and of weeding out those borrowers who canwork, but are choosing not to. If they truly haveassets and income, their loan holders can try tocollect during the waiting period. At a bare mini-mum, full bankruptcy rights must be restored forfinancially distressed private loan borrowers.

It is difficult to separate fact from fiction whentrying to understand the logic behind this policy,but one thing is clear—the restrictions cameabout without any empirical evidence that stu-dents were more likely to “abuse” the bankruptcysystem.63 It is long past time to restore theserights to borrowers. Restoration of bankruptcyrights will also provide a strong incentive to stu-dent lenders to provide aggressive modificationsoutside of bankruptcy in order to reduce losses.

3. Loan Cancellations for Fraud Victims

Not all borrowers will benefit from modifica-tions. Only those that are in serious financialtrouble, but still have some income to pay towardtheir loans will qualify. Many of the most vulner-able borrowers will be left without relief. As onestep to helping these borrowers, we recommendthat all borrowers that received private loans toattend unlicensed, unaccredited, schools thatclosed or are currently in bankruptcy, receive fullloan cancellations.

This issue has received little attention, but isone of the most egregious consequences of preda-tory student lending. For years, lenders fought toget into this largely unregulated world. Duringthis time, a particularly unholy alliance developedbetween unlicensed and unaccredited schoolsand mainstream banks and lenders.64 The credi-tors did not just provide high-interest privateloans to students to attend unscrupulous schools;they actually sought out the schools and part-nered with them, helping to lure students intoscam operations. They then turned around and,

like subprime mortgage providers, made big profitson these loans by securitizing them and shifting therisky debt onto unsuspecting investors.

Inferior schools continue to open and close ona regular basis. In March 2009, the for-profitConnecticut School of Broadcasting abruptlyshut its doors. Many students arrived for classesonly to find that the doors were locked. Thesestudents were paying about $12,000 for a 16week course.65 The school was owned by a divi-sion of Credit Suisse.

16 TOO SMALL TO HELP

NOWHERE TO TURN

Joe is a 25 year old student at Salem State Collegein Massachusetts. Without a glaring problem fromhis past, he would be much like many other stu-dents at the state college. He works part-time tohelp meet expenses, is articulate, ambitious andpersonable. He took out federal loans to help de-fray expenses at the public college. Unfortunately,about five years ago, he saw an advertisement for afor-profit culinary school. He visited the school andwas told about the amazing curriculum and strongjob placement program. The price tag of about$35,000, they said, would be easily repaid throughlucrative earnings after graduation. Joe was youngand impressionable and eager to work in the culi-nary field, so he signed up. He found out almostimmediately that the school’s statements wereempty promises. The teachers were inexperiencedand the materials and equipment inferior. He askedabout leaving and was told that he could not get arefund. He stayed and finished and was never givenjob placement assistance, despite his requests. Hehas since moved on and tried to put the experiencebehind him, but the loans will not go away. Hethinks he will be able to mange the federal loans,but his two private loans with current interest ratesof about 15% are unaffordable. He says he wantsto pay something and has asked for a break, butthe creditor offers only forbearances and in-schooldeferments. In response to Joe’s request for assis-tance, the creditor replied that Joe’s obligation wasnot negotiable. Joe is angry and frustrated and hasnowhere to turn. His future plans to build assetsand a family will be delayed as he tries to figure outa way to deal with this inescapable debt burden.

These consumers have been hit particularlyhard. They are stuck with debts they cannotrepay from worthless schools. Lenders thatpoured resources into ripping off students havespared no expense in trying to silence studentswho fight back by making it difficult for studentsto bring lawsuits in convenient forums, mandat-ing arbitration, and claiming that state laws donot apply to them. In the current environmentwhere creditors are rewarded with bail-outs forprior bad acts and where no one wants to take re-sponsibility for the meltdown, taking action inthis area is one small way to hold creditors liablefor the damage they have done.

4. Re-Regulate the IndustryAmong other reforms, re-regulation must in-clude:

Mandated UnderwritingIt is particularly challenging to develop responsi-ble underwriting in the student loan market. Asolution promoted by consumer advocates in themortgage area is to require lenders to originateloans only if the borrower has an ability to repay.Although more difficult in the student loan con-text where many borrowers are young and it ismore difficult to predict their future earningabilities, we urge that similar standards be im-posed. The general concept of lending only tothose that are likely to be able to repay remainscritical in the student loan market.

Limits on Interest Rates and FeesThe difficulty of predicting borrower ability torepay underscores the need to restrict the feesand rates that lenders can charge and regulatethe use of variable rate credit. This will help makethese loans more affordable so that the loans willbe less likely to fail.

Remedies for Fraud VictimsWe recommended above that past victims offraud receive complete loan cancellations. To

help prevent this problem from surfacing again,all lenders must be required to include the FTCHolder notice in their products going forward.Further, for those receiving government funds,the term should be implied in all contracts previ-ously made.

The holder rule (more accurately referred to asthe Federal Trade Commission Preservation ofClaims Rule), puts lenders on the hook whenthey have “referring relationships” with tradeschools that defraud students or shut down un-expectedly.66 When this occurs, the lender experi-ences heightened pressure to originate loans withupstanding schools so that they or subsequentloan purchasers will not shoulder the liabilityrisk later. Under the provision, students are enti-tled to recover any payments they have made andto have their remaining indebtedness canceled.

In NCLC’s March 2008 report, we found thatmost private student loan providers flaunt therule.67 Of the loans in our survey, we found that40 percent did not include the holder notice inthem at all. Nearly all the rest contained the no-tice but undermined it by including contradic-tory clauses—saying, for example, that studentswould be responsible for repaying the loans infull no matter how dissatisfied they were with theschools.

Improved DisclosuresCongress took an important initial step in 2008when it passed new disclosure requirements forprivate student loans.68 The Federal Reserve Boardreleased proposed regulations in March 2009.69

These proposals have some good features, in-cluding model disclosures that should help bor-rowers compare the cost of private student loanswith other types of credit. Among other con-cerns, however, the proposal includes prominentdisclosure of the interest rate and a less promi-nent disclosure of the APR. It is more accurate tolook at the APR to determine the trust cost of aloan because it shows the full cost includingmany of the lender’s fees. Other types of creditinclude an APR disclosure prominently at the top

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in a separate box. In addition, the Board does notrequire that lenders set a maximum rate cap.

Private Remedies and Access to JusticeVictims of abusive lending practices have very lit-tle recourse because the industry often uses itsmarket power to limit borrowers’ access to jus-tice. To be effective, consumer protection lawsmust: (1) give borrowers a private right of action,the right to pursue class actions, and as describedabove, the right to raise school-related claims anddefenses against lenders in cases where theschool and lender have a referral relationship orother close affiliation; (2) contain strong reme-dies and penalties for abusive acts; (3) provide ef-fective assignee liability so that borrowers canpursue legitimate claims even when the origina-tor has sold their loan; and (4) prohibit manda-tory arbitration clauses that weaken victims’legal rights and deny them access to seeking jus-tice in a court of law.

Conclusion

For many years, private student loans generatedsteady, if unspectacular, profits. The businessmodel was relatively conservative, providingloans mainly to graduate students and creditwor-thy borrowers. Armed with imperfect informa-tion and an all too tempting boom market,lenders adopted a new model in recent years. Un-fortunately, making large and often very expen-sive loans to lower credit tier borrowers wasdestined to fail. Now that it has failed, lenders arestarting to pick up the pieces and adopt more re-sponsible practices. Hopefully the governmentwill encourage this type of lending rather than areturn to the predatory days.

As this economic lesson has unfolded, manyborrowers have found that they have insur-mountable debt loads. Some will never be able torepay. These borrowers need a safety net, includ-ing bankruptcy discharge rights and cancellationrights for fraud victims, to give them some hopeof starting again. Without relief, these borrowerswill never be able to help fulfill our social andeconomic need for a productive, educated workforce.

Other borrowers can pay, but not at the levelscurrently required. The lenders that created thismess can and should be part of the solution. Wehave shown that so far, they have not done muchon a voluntary basis to provide assistance at leastthat they are willing to reveal. At a minimum,those lenders receiving government funds mustbe required to expand loss mitigation and otherassistance. Other incentives must be developed tobring the others along.

This report uncovers how an unsustainablebusiness model helped crash our economy. Theseunsustainable products were taken out by indi-viduals trying to improve their futures. “Unsus-tainable” in human terms means individuals whopursue their dreams of upward mobility, only tofind that these dreams are shattered due to unaf-fordable debt loads that they will never be able torepay. While it may be impossible to get all ofthese individuals back on track, it is clearly possi-ble to help some. The fact that lenders are hardlytrying is a national disgrace. We cannot trulybegin to reshape the future and improve access toeducation without redress for those left behind.

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Questions about Programs to AssistFinancially Distressed Private StudentLoan Borrowers

1. Please describe the options/programs youoffer, if any, to private loan borrowers whoare having trouble with loan repayment? Ifyou offer different programs for differentproducts, please describe the programs for at least 3 representative products. Please also specify if you do not have any such programs/options.

(If you offer these programs, please describeeach option in detail. e.g. if you offer forbear-ances, how long is the term; what are the quali-fying conditions; are there restrictions on thenumber of forbearances per borrower etc.)

2. Are the programs described in #1 above stan-dardized or are they determined on a case bycase basis?

3. If the answer to #2 above is that the pro-grams are standardized, are these programsdescribed in writing? If so, are these availablepublicly?

4. How does a borrower typically find outabout these options/programs?

5. Are there ways in which borrowers can auto-matically qualify for the programs describedin #1? If not, is eligibility at the discretion ofthe servicer (or another entity)?

6. Are there different options depending onwhether a borrower is delinquent rather thanin default?

7. Are the options different if a borrower’s loanis part of a securitization trust? If so, pleasedescribe.

8. Has your company made any changes tothese options/programs to respond to theeconomic crisis? If so, please describe.

9. If the answer to #8 above is “no,” please explain the main reasons why your companyhas not made changes and whether you areplanning to do so.

10. Please name the entities that typically serviceyour company’s loans. Are these servicers affiliated with your company?

Please send responses to Deanne Loonin, Na-tional Consumer Law Center, dloonin@nclc.org;617-542-8010.

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APPENDIX

National Consumer Law Center’s Student Loan Borrower Assistance Project

1 EPE Research Center, “College Access” (Sept. 10, 2004). 2 Office of Management and Budget, “A New Era of Respon-sibility: Renewing America’s Promise,” available at: http://www.gpoaccess.gov/usbudget/fy10/pdf/fy10-newera.pdf. 3 See generally National Consumer Law Center, “Paying thePrice: The High Cost of Private Student Loans and the Dan-gers for Student Borrowers” (March 2008), available at:http://www.studentloanborrowerassistance.org/uploads/File/Report_PrivateLoans.pdf.4 College Board, “Trends in Student Aid 2008” (2008), avail-able at: http://professionals.collegeboard.com/profdownload/trends-in-student-aid-2008.pdf.5 Fitch Ratings, “Private Education Loans: Time for a Re-Education” (Jan. 28, 2009).6 Fitch Ratings, “An Education in Student Lending” (Feb. 5,2007).7 Id. at 13.8 Bethany McLean, “The Surprising Profits of StudentLoans,” CNNMoney.com (April 16, 2007). 9 Id.10 FitchRatings, “An Education in Student Lending,” (Febru-ary 5, 2007). 11 Id. at 13.12 Bethany McLean, “When Sallie Met Wall Street,” Fortune(Dec. 26, 2005).13 See, e.g., In re: SLM Corporation Securities Litigation, Mas-ter File No. 08 Civ. 1029 (S.D.N.Y.) (Amended Class ActionComplaint filed 12/8/08). See also Paul Basken, “Suit Al-leges Fraud in ‘Resolving’ Troubled Student Loans,” TheChronicle of Higher Education (Oct. 23, 2008).14 Base Prospectus, The SLM Student Loan Trusts 20-22(Sept. 20, 2006).15 KeyCorp, Student Loan Trust 2000-A, June 15, 2000 at S-15.16 Id. at S-56-57.17 Paul Basken, “Sallie Mae Reports $159-Million Loss andMore Delinquencies by Borrowers,” The Chronicle of HigherEducation (Oct. 23, 2008).18 Fitch Ratings, “Private Education Loans: Time for a Re-Education” at 7 (Jan. 28, 2009). 19 Robert Tomsho, “Tuition Ammunition: A Happy Lessonon Lending,” The Wall Street Journal (Jan. 6, 2009).20 Fitch, “U.S. Private Student Loan ABS Exhibiting Reces-sion Strains” (Feb. 25, 2009), available at: http://www.reuters.com/article/pressRelease/idUS235916+25-Feb-2009+BW20090225.21 Fitch Ratings, “Private Education Loans: Time for a Re-Education” at 7 (Jan. 28, 2009). 22 Id.

23 Alejandro Lazo, “Sallie Mae Forecasts Surge in Defaults,”Washington Post (Jan. 23, 2009).24 SLM Corporation Q4 2007 earnings Call Transcript (Jan.23, 2008), available at: http://seekingalpha.com/article/61303-slm-corporation-q4-2007-earnings-call-transcript?page=8.25 Robert Tomsho, “SLM’s Headmaster on Lessons Learned,”The Wall Street Journal (June 5, 2008).26 National Consumer Law Center, “Paying the Price: TheHigh Cost of Private Student Loans and the Dangers forStudent Borrowers” (March 2008), available at: http://www.studentloanborrowerassistance.org/uploads/File/Report_PrivateLoans.pdf.27 Robert Tomsho, “Tuition Ammunition: A Happy Lesson onLending,” The Wall Street Journal (Jan. 6, 2009). For a general de-scription of the ABS market for student loans, see Fitch Rat-ings, “Private Education Loans: Time for a Re-Education” at4 (Jan. 28, 2009).28 Fitch Ratings, “Private Education Loans: Time for a Re-Education” at 4 (Jan. 28, 2009). My Rich Uncle stopped orig-inating loans in fall 2008 and filed for bankruptcyprotection in early 2009.29 Sallie Mae Press Release, “Sallie Mae Closes $1.5 Billion Fi-nancing” (Jan. 8, 2009).30 Fitch Ratings, “U.S. Private Loan ABS Exhibiting Reces-sion Strains” (Feb. 25, 2009).31 Student Lending Analytics, “Summary of December 16,2008 Sallie Mae Straight Talk Conference Call” (Dec. 17,2008).32 Fitch Ratings, “Private Education Loans: Time for a Re-Education” at 3 (Jan. 28, 2009). 33 Id. 34 Id. at 4. 35 SLM Corp. 10-K FY ending 12/31/07 at 9.36 Jane J. Kim, “Sallie Mae to Revamp Private Loans,” The WallStreet Journal (March 19, 2009).37 First Marblehead 10-K, FY ending June 30, 2008.38 Board of Governors of the Federal Reserve System, “JointPress Release: Launch of the Term Asset-Backed SecuritiesLoan Facility” (March 3, 2009), available at: http://www.federalreserve.gov/newsevents/press/monetary/20090303a.htm. See also Federal Reserve Board, “Term Asset-BackedSecurities Loan Facility Terms and Conditions” (March 19,2009), available at: http://www.newyorkfed.org/markets/talf_terms.html.39 Fitch Ratings, “Private Education Loans: Time for a Re-Education” (Jan. 28, 2009). 40 Id. at 5.

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Notes

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41 For more information about NCLC’s Student Loan Borrower Assistance Project, see http://www.studentloanborrowerassistance.org.42 See generally Erin Dillon, Education Sector, “Leading Lady:Sallie Mae and the Origins of Today’s Student Loan Contro-versy” (May 2007), available at: http://www.educationsector.org/usr_doc/SallieMae.pdf.43 Student Lending Analytics, “SLA Private Student LoanMarket Share Estimates (Update 4)” (Aug. 15, 2008), available at: http://studentlendinganalytics.typepad.com/student_lending_analytics/2008/08/private-student-loan-market-share-analysis.html. The percentage is an estimatedmarket share based on 2007 originations as compiled from10-Ks, 10-Qs, press releases, news articles and securitizationfilings. 44 Institute for Higher Education Policy, “The Future of Pri-vate Loans: Who is Borrowing, and Why?” at 6 (December2006).45 Keeny, “The Supply Side of Student Loans: How GlobalCapital Markets Fuel the Student Loan Industry” in Footingthe Tuition Bill 136, 252 (Frederick M. Hess ed., 2007).46 Fitch Ratings, “Private Education Loans: Time for a Re-Education” at 6 (Jan. 28, 2009). 47 Id.48 See, e.g., In re: SLM Corporation Securities Litigation, MasterFile No. 08 Civ. 1029 (S.D.N.Y.) (Amended Class ActionComplaint filed 12/8/08).49 Paul Basken, “Sallie Mae Reports $159-Million Loss andMore Delinquencies by Borrowers,” The Chronicle of HigherEducation, Oct. 23, 200850 Paul Basken, “Sallie Mae Reports $159-Million Loss andMore Delinquencies by Borrowers,” The Chronicle of HigherEducation (Oct. 23, 2008).51 Testimony of Alys Cohen, National Consumer Law Cen-ter, U.S. House of Representative, Committee on Oversightand Government Reform, Domestic Policy Subcommittee,“Is Treasury Using Bailout Funds to Increase ForeclosurePrevention as Congress Intended” (Nov. 14, 2008).52 Alan M. White, “Deleveraging the American Homeowner:The Failure of 2008 Voluntary Mortgage Contract Modifica-tions” 14-15 (Jan. 9, 2009) Connecticut Law Review, Forth-coming. Available at: http://ssrn.com/abstract=1325534.53 More details about the program can be found at http://www.financialstability.gov.54 Kurt Eggert, “Comment on Michael A. Stegman et al.’s‘Preventive Servicing Is Good for Business and AffordableHomeownership Policy’: What Prevents Loan Modifica-tions?,” 18 Housing Pol. Debate 279, 284 (2007).55 Testimony of Stephen S. Kudenholdt, U.S. House of Rep-resentative, Committee on Oversight and Government Re-form, Domestic Policy Subcommittee, “Is Treasury UsingBailout Funds to Increase Foreclosure Prevention as Con-gress Intended” (Nov. 14, 2008).

56 In a January 23, 2008 conference call, Sallie Mae’s CFO JackRemondi stated that because the company did not have a longhistory of making non-traditional loans, it did not feel that itcould put these loans into asset backed securities. SLM Corpo-ration Q4 2007 earnings Call Transcript (Jan. 23, 2008).57 See generally Kurt Eggert, “Comment on Michael A.Stegman et al.’s ‘Preventive Servicing Is Good for Businessand Affordable Homeownership Policy’: What Prevents LoanModifications?,” 18 Housing Pol. Debate 279, 285 (2007).58 The plan pays servicers for successful modifications. See“Remarks by the President on The Mortgage Crisis” (Febru-ary 18, 2009) available at: http://www.whitehouse.gov/the_press_office/Remarks-by-the-President-on-the-mortgage-crisis/. More details about the program can be found athttp://www.financialstability.gov/. See also National Con-sumer Law Center, “Summary of Industry and GovernmentSponsored Loss Mitigation Programs” available at:http://www.nclc.org/issues/financial_distress/content/loan_modification/Chart-LossMitigationPrograms.pdf.59 See generally National Consumer Law Center, “No WayOut: Student Loans, Financial Distress and the Need forPolicy Reform” (June 2006), available at: http://www.studentloanborrowerassistance.org/uploads/File/nowayout.pdf.60 Rafael I. Pardo and Michelle R. Lacey, “Undue Hardship inthe Bankruptcy Courts: An Empirical Assessment of theDischarge of Educational Debt,” 74 U. Cin. L. Rev. 405(Winter 2005).61 Id.62 See generally National Consumer Law Center, StudentLoan Law ch. 7 (3d ed. 2006 and Supp.).63 See generally National Consumer Law Center, “No WayOut: Student Loans, Financial Distress, and the Need forPolicy Reform” (June 2006), available at: http://www.studentloanborrowerassistance.org/uploads/File/nowayout.pdf.64 An example is ongoing litigation against Silver State Heli-copters. See “Pinnacle Law Group Files Class Action on Be-half of Students Against Keybank for Predatory LendingPractices in Connection with Failed Vocational School, SilverState Helicopters” (May 12, 2008), available at: http://www.pinnaclelawgroup.com/pdf/SSH-KeyBank_PressRelease.PDF.65 LeAnne Gendreau, “State Goes After Closed BroadcastSchool,” NBCConnecticut.com (March 5, 2009).66 16 C.F.R. §433.2.67 National Consumer Law Center, “Paying the Price: TheHigh Cost of Private Student Loans and the Dangers forStudent Borrowers” (March 2008), available at: http://www.studentloanborrowerassistance.org/uploads/File/Report_PrivateLoans.pdf.68 The Higher Education Opportunity Act, P.L. No. 110-315(2008),69 74 Fed. Reg. 12464 (March 24, 2009).