2012 Association of Credit Union Internal Auditors Conference
Student Loans: The Next Bubble?
June 20, 2012
Presented by Bob Glynn
McGladrey LLP
Objectives
By the end of this course, you will be able to
know:
The types of student loans today
What is driving the recent publicity around
student loans and how did we get here
How does bankruptcy affect student loans
Accounting and auditing considerations of
student loans
Reg Z - Compliance issues related to
student loans
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What is a Student Loan
Federal Loans
-
Direct loans
Federal Family Education Loans (FFEL)
Private Student Loans
2
FFEL Loans
FFEL Program
-
Government guaranteed loans
These were originated at credit unions or banks, yields
typically very small due to high compliance costs, but risk
of outright loss very minimal with government guarantees
Requirement for a compliance audit on an annual basis
depending on loan value
Eliminated in 2010. All Federal Loans are now Direct with
the Department of Education
“Taxpayers...paying banks a premium to act as middlemen—a
premium that costs the American people billions of dollars each
year....a premium we cannot afford.” - President Barack
Obama
3
Federal Direct Loans
Includes Stafford and Plus Loans
Individual loan maximums and interest rate
changes are fixed by Congress
Originated directly with the Department of
Education – guaranteed by the government
Loans are serviced by 4 different providers
Sallie Mae, Nelnet, Great Lakes
Educational Loan Services, or
Pennsylvania Higher Education
Assistance Society
4
Private Student Loans
Originated by financial institutions, these are
credit-based products used to bridge the gap
between Federal Direct loans and other
assistance and the cost of tuition
Terms and conditions are set by the financial
institution, but generally interest rates are
higher than Federal loans
Reg Z (2010) Requires very detailed
disclosures to be made to borrowers
throughout the loan application/approval
process
5
Federal vs. Private
These loans are typically not competing
products
Private lenders are compelled to educate
potential borrowers about Federal loans –
including cost and rate comparisons
Private loans are for those who do not qualify for
Federal or need additional funds
Key Differences
-
Private may have variable interest rates, limited
deferment options, or not require school certification
Key Similarity – All qualified education loans
(Federal and Private) – may not be discharged
in bankruptcy
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7
The $1,000,000,000,000 Bubble
Approximately $1 Trillion in total outstanding
student loan debt
Only 15% or, approximately $150 billion is in
private loan debt
-
In other words – 85% of this $1 Trillion is guaranteed
by the government and not private financial
institutions
Of the $112 billion in new student loans in 2011,
7% were originated through the private sector
Borrowers are unable to tap HELOCS due to
decreased home values
*Data from 2012 Sallie Mae Annual Report
8
Where Have We Seen This Before
It’s a story of an industry that may sound
familiar. The buyers think what they’re buying
will appreciate in value, making them rich in the
future. The product grows more and more
elaborate, and more and more expensive, but
the expense is offset by cheap credit provided
by sellers eager to encourage buyers to buy.
Buyers see that everyone else is taking on
mounds of debt, and so are more comfortable
when they do so themselves; besides, for a
generation, the value of what they’re buying has
gone up steadily. What could go wrong?
* Excerpted from Glenn Reynolds, financial blogger
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Tuition Increases vs. Home Prices vs. CPI
* source, www.businessinsider.com
10
Tuition Prices vs. Home Prices
Note that the housing bubble illustrated in...[this]
chart...shows home prices between 1978 and
2006 increased by 'only' a factor of 4.35, while
the cost of college has increased by much more
than twice that amount since 1978 in the bottom
chart. Over the last three decades, college
tuition and fees have gone up by a factor of
10.5, and they show no sign of slowing down.
For the last 12 months through July of 2011, the
CPI for college tuition and fees increased by
almost 6 percent, more than 4 times the 1.3
percent increase in consumer prices in general
over that period.
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What is driving this tuition price increase?
-
More access to higher education for those of
lesser means
Recession caused more individuals to go back to
school to bolster skills/resumes
Increased technology and better infrastructure
More program offerings
EASY ACCESS TO FUNDS, FOR WHICH THE
FINANCIAL INSTITUION MAKING THE LOAN
HAS LITTLE TO NO CREDIT RISK
•
Note the correlation between the change in bankruptcy
protection for student loans in 2005 with the steepness
of the tuition increase – probably not a coincidence
12
Back to That Bubble
The majority of these Private student loans are not with
credit unions
-
The top 10 originators make up almost 70% of the private
student loan market
Banks, especially the large banks such as Chase, Citi,
BOA, etc have large serviced portfolios of Private student
loans – Sallie Mae (SML Corp) is the largest originator of
Private student loans
Similar to the real estate loans, these loans can be
packaged and sold as bonds to investors looking for a
fairly low risk investment (loans are protected in
bankruptcy)
-
Per Fitch, little risk in pure SLABS backed by FFELs, whereas
increased defaults can be seen in Private SLABS originated
prior to the recession.
This should sound very familiar to those CU’s that had stakes
in Members United or indirectly with US Central
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Pin Meet Bubble
Senator Dick Durbin has proposed the Fairness for
Struggling Students Act
-
Would allow for Private student loans to be discharged in
bankruptcy – unknown if this would be retroactive or
prospective
No affect on Federal direct loans
Would apply same bankruptcy standards to Private student
loans, as other debt such as credit cards
Potential side effects (good and bad)
-
-
Could cause immediate devaluing of student loan backed
bonds
Potential decreases in college tuition as supplies of funds
dry up
Potential raises in borrowing cost to individuals to offset
credit risk potential
14
Other Current Events
Congress is debating the scheduled increase in interest rates
on Federal direct loans from 3.4% to 6.8% this summer
-
The Federal Reserve Bank of New York has estimated that
total delinquency across all student loans is 27%
Sallie Mae (the largest servicer of all types of student loans)
has reported the following as of March 31, 2012 specific to
their portfolio
-
-
Could cause a rash of defaults in these Federal loans
Increase is still cheaper than most Private loans
Total delinquencies in their $40 billion Private loan portfolio was
9%, but 90+ was 4.4%, which is down from 6.9% in 2009
In their $135 billion managed Federal loan portfolio, total
delinquencies are 16.9% with 90+ of 7.9%
For-Profit schools make up 10% of total Private loans,
but account for nearly half of all defaults (USA Today)
15
Accounting and Auditing Matters
16
Understand the Universe
Know your population of student loans
-
-
Runoff of FFEL program will last several years
and still require an annual compliance audit
depending on volume
Do you offer Private student loans? Do your loan
officers know if they do?
If they are offered, are they flagged and
categorized in a proper way in the loan
subledger to allow for monitoring
Are home equity loans, which are used for
educational purposes flagged
17
CU Impacts
Potential exposure to the Bubble
-
Micro Impacts
•
•
•
-
Any investments in SLABS
Do Member Investment CUSO’s currently have members in
these products
Exposure to portfolio Private student loans
- Possible file reviews to understand full credit risk if changes
to bankruptcy laws are put into place
◦ Co-signors?
◦ Possible additional judgmental factor in ALL
Macro Impacts
•
•
•
•
A collapse in this sector would likely upset banks more than
CU’s
Inability to discharge student loans, could cause increase in
credit card charge-offs for younger people
Collapses bring more regulation
Prolong the waiting for the economic recovery – young people
paying back loans versus spending
18
Regulation Z – Private Student Loan
Disclosures
19
Student Loan Compliance Disclosures
Key Definition
Private education loan means an extension of credit
that:
-
(i) Is not made, insured, or guaranteed under title IV of the
Higher Education Act of 1965 (20 U.S.C. 1070 et seq. );
(ii) Is extended to a consumer expressly, in whole or in
part, for postsecondary educational expenses, regardless
of whether the loan is provided by the educational
institution that the student attends;
(iii) Does not include open-end credit any loan that is
secured by real property or a dwelling; and
(iv) Does not include an extension of credit in which the
covered educational institution is the creditor if:
•
•
(A) The term of the extension of credit is 90 days or less; or
(B) an interest rate will not be applied to the credit balance and
the term of the extension of credit is one year or less, even if the
credit is payable in more than four installments.
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Student Loan Compliance Disclosures General/Timing
Form of Disclosures
-
Clear and conspicuous
Transaction Disclosures
-
Made in writing for the member to keep
May include an acknowledgement of receipt
Must include certain known terms – similar to other lending disclosures
•
‘Finance Charge’ or ‘Interest Rate’ must be the most conspicuous disclosures on the
form.
Timing of Disclosures
-
Provided with any application or solicitation
May be made orally over the phone if written disclosures are made within 3
business days
Required Disclosures – All of them must be provided and be in
compliance for the loan to qualify as a qualified private education loan
-
Application
Approval
Final
Note
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Student Loan Compliance Disclosures –
Content: Application
See Attachment 1 for example application disclosures
(1) Interest Rates.
-
-
-
(i) The interest rate or range of interest rates applicable to the loan
and actually offered by the creditor at the time of application or
solicitation. If the rate will depend, in part, on a later determination of
the consumer's creditworthiness or other factors, a statement that the
rate for which the consumer may qualify will depend on the
consumer's creditworthiness and other factors, if applicable.
(ii) Whether the interest rates applicable to the loan are fixed or
variable.
(iii) If the interest rate may increase after consummation of the
transaction, any limitations on the interest rate adjustments, or lack
thereof; a statement that the consumer's actual rate could be higher
or lower than the rates disclosed under paragraph (a)(1)(i) of this
section, if applicable; and, if the limitation is determined by applicable
law, that fact.
(iv) Whether the applicable interest rates typically will be higher if the
loan is not co-signed or guaranteed.
22
Student Loan Compliance Disclosures –
Content: Application (cont.)
2) Fees and default or late payment costs.
-
-
(i) An itemization of the fees or range of fees required to obtain the
private education loan.
(ii) Any fees, changes to the interest rate, and adjustments to
principal based on the consumer's defaults or late payments.
(3) Repayment terms.
-
(i) The term of the loan, which is the period during which regularly
scheduled payments of principal and interest will be due.
(ii) A description of any payment deferral options, or, if the consumer
does not have the option to defer payments, that fact.
(iii) For each payment deferral option applicable while the student is
enrolled at a covered educational institution:
•
•
•
(A) Whether interest will accrue during the deferral period; and
(B) If interest accrues, whether payment of interest may be deferred and added
to the principal balance.
(iv) A statement that if the consumer files for bankruptcy, the consumer may
still be required to pay back the loan.
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Student Loan Compliance Disclosures –
Content: Application (cont.)
(4) Cost estimates. An example of the total cost
of the loan calculated as the total of payments
over the term of the loan:
-
-
-
(i) Using the highest rate of interest disclosed under
paragraph (a)(1) of this section and including all
finance charges applicable to loans at that rate;
(ii) Using an amount financed of $10,000, or $5000 if
the creditor only offers loans of this type for less than
$10,000; and
(iii) Calculated for each payment option.
(5) Eligibility. Any age or school enrollment
eligibility requirements relating to the consumer
or co-signer.
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Student Loan Compliance Disclosures –
Content: Application (cont.)
(6) Alternatives to private education loans.
-
-
(i) A statement that the consumer may qualify for Federal student financial
assistance through a program under title IV of the Higher Education Act of
1965 (20 U.S.C. 1070 et seq .).
(ii) The interest rates available under each program under title IV of the Higher
Education Act of 1965 (20 U.S.C. 1070 et seq. ) and whether the rates are
fixed or variable.
(iii) A statement that the consumer may obtain additional information
concerning Federal student financial assistance from the institution of higher
education that the student attends, or at the Web site of the U.S. Department
of Education, including an appropriate Web site address.
(iv) A statement that a covered educational institution may have school-specific
education loan benefits and terms not detailed on the disclosure form.
(7) Rights of the consumer. A statement that if the loan is approved,
the terms of the loan will be available and will not change for 30 days
except as a result of adjustments to the interest rate and other
changes permitted by law.
(8) Self-certification information. A statement that, before the loan may
be consummated, the consumer must complete the self-certification
form and that the form may be obtained from the institution of higher
education that the student attends.
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Student Loan Compliance Disclosures –
Content : Final
(c) Final disclosures. After the consumer has accepted the loan in
accordance with §1026.48(c)(1), the creditor shall disclose to the
consumer the information required by §1026.18 and the following
information:
-
(1) Interest rate. Information required to be disclosed under §1026.47(b)(1).
(2) Fees and default or late payment costs. Information required to be
disclosed under §1026.47(b)(2).
(3) Repayment terms. Information required to be disclosed under
§1026.47(b)(3).
(4) Cancellation right. A statement that:
•
•
(i) The consumer has the right to cancel the loan, without penalty, at any time before
the cancellation period under §1026.48(d) expires, and
(ii) Loan proceeds will not be disbursed until after the cancellation period under
§1026.48(d) expires. The statement must include the specific date on which the
cancellation period expires and state that the consumer may cancel by that date.
The statement must also specify the method or methods by which the consumer
may cancel. If the creditor permits cancellation by mail, the statement must specify
that the consumer's mailed request will be deemed timely if placed in the mail not
later than the cancellation date specified on the disclosure. The disclosures required
by this paragraph (c)(4) must be made more conspicuous than any other disclosure
required under this section, except for the finance charge, the interest rate, and the
creditor's identity, which must be disclosed in accordance with the requirements of
§1026.46(c)(2)(iii).
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Potential Results of Failing to Comply
Qualified Private student loans may be
disqualified due to missing disclosures
-
Opens up the possibility of discharging these in
bankruptcy as regular unsecured loans
Reg Z also provides for criminal and civil
penalties for failure to comply
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Questions?
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