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Wall Street is fighting a CFPB deal over billions in defaulted student loans

Shahien Nasiripour, Bloomberg News on

Published in Business News

NEW YORK -- It seemed like the kind of case regulators had resolved countless times before: Debt collectors are accused of using flawed documentation and lawsuits to collect unpaid loans. A fine is levied, a promise to reform is made, and everyone moves on.

Not this time. A maelstrom of banks, insurers, debt collectors, and hedge funds enveloped the U.S. Consumer Financial Protection Bureau when it tried to settle allegations of shoddy collection practices on billions of dollars in student loans. A novel settlement proposal between the regulator and a private equity company meant to clear up the matter has Wall Street warning of expensive consequences for future student borrowers.

In the runup to the financial crisis, private student loans -- like mortgages -- were eagerly extended to people who were ill-prepared to repay them. The loans, like mortgages, were quickly bundled into securities to be sold at a premium. Then, in 2008, the bottom fell out.

Fast-forward a few years. Debt collectors working for National Collegiate Student Loan Trusts, a group of 15 investment vehicles and one of the nation's largest owners of private student debt, were accused of squeezing millions of dollars out of debtors using deceptive legal documents. A paper trail submitted to regulators stretched back years, and a resulting CFPB investigation focused on whether laws had been broken.

In September, the regulator and Florida-based Vantage Capital Group LLC, which controls the National Collegiate trusts, hammered out a settlement by agreeing to a third-party audit of the more than 800,000 loans that have been held by the 15 vehicles. The audit would enable Vantage to find out which loans it can really pursue and which loans it can't. While the audit proceeds, all payments to investors in securities based on those loans would be placed into escrow. The proposed deal also calls for $19 million in fines and restitution for thousands of borrowers sued by debt collectors.

The 15 vehicles that make up the National Collegiate trusts, along with the loan servicers, insurers, banks, hedge funds, and debt collectors with a stake in its operations, would be required to foot the bill for the audit and settlement -- under a deal they didn't approve. And if the audit reveals widespread wrongdoing, the price tag could climb sharply, according to court papers. Unsurprisingly, they cried foul.

Opponents to the deal also include Libremax Capital LLC, the hedge-fund business run by Greg Lippmann, a mortgage trader whose bets against the U.S. housing market were depicted in Michael Lewis's film "The Big Short;" hedge funds run by Waterfall Asset Management LLC; One William Street Capital Management LP; Angelo, Gordon & Co.; and another, Baldr Sherwood Fund Inc., with ties to French bank BNP Paribas SA and Montreal-based National Bank of Canada. The Structured Finance Industry Group, a Washington lobby, told its members recently that it's crafting an amicus brief to file on behalf of businesses seeking to block the accord.

All told, investors holding $1.4 billion in NCSLT notes asked U.S. District Judge Gregory Sleet in Wilmington, Del., to reject the accord, saying Vantage doesn't have the power to negotiate on their behalf. Loan insurer Ambac Financial Group Inc. and debt collector Transworld Systems Inc. said the deal mandates changes to how trusts operate that would violate decade-old contracts. The consequences would be far-reaching for the entire securitized loan market, Ambac warned.

The settlement "asserts control over millions of dollars of payments for an unknown period of time, and places seemingly complete discretion over such monies in the hands of a self-interested entity," Ambac said in court papers. "This complete disregard of the governing documentation threatens not only this transaction but also calls into question the fundamental assumptions that capital markets have long accepted in structuring analogous transactions."

For future students and their parents, this Byzantine fight over securitized loans may prove costly. The threat of a government agency setting aside securities contracts based on student loan payments could lead hedge funds to devalue their holdings, and cause them to demand higher interest rates on future loans to compensate for the risk of unilateral government action.

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