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.
Donald Uderitz, who owns Vantage, has stated that the settlement would help his company recover losses he blames on "systemic malfeasance, gross negligence and willful misconduct." Vantage lawyers have gone a step further, claiming in court last week that the trusts' contractors were responsible for triggering the federal investigation -- an allegation the CFPB denied. Uderitz has been trying to audit the trusts' loans for years. Transworld Chief Financial Officer David Zwick and CFPB spokesman David Mayorga both declined to comment. A spokesman for Ambac didn't return a request for comment.
At the time they were created, the trusts cumulatively held more than 874,000 student loans made to more than 812,000 people, according to securities filings. They were bundled into $16 billion of securities for sale to investors, backed by borrowers' monthly payments. Of the original $12 billion in loan principal bundled into the trusts, about 42 percent -- $5 billion, including interest -- was in default as of June 30, according to disclosures by the trusts' administrator.
This makes them the worst-performing student loan investment vehicles ever created by Wall Street, according to Jon Riber, a DBRS Inc. analyst who specializes in consumer debt that's been bundled into securities.
Initially, investors who bought the loan-backed notes had generous protection against the risk that borrowers would default en masse -- but the 2008 bankruptcy of the nonprofit that guaranteed their loans ended that arrangement. Collection efforts in the form of mass lawsuits filed by debt-collection law firms followed. Vantage gained control of the trusts in the ensuing years by purchasing more than 99 percent of the equity notes issued by the trusts, according to court filings.
Uderitz said he became alarmed by mounting losses and the trusts' inability to collect. Tens of thousands of collections lawsuits filed against debtors in state courts across the country yielded little in the way of recoveries. The CFPB alleged it found that in at least 2,500 cases, contractors working for the trusts sued borrowers even though the statute of limitations had expired or they didn't have the right paperwork. Under the proposed settlement, a third party would inspect the trusts' records to ensure that paperwork is in order and the trusts have a legal right to demand payment. In doing so, the bureau would give Vantage authority to temporarily halt payments to investors pending completion of the audit. Ambac has estimated the audit could cost as much as $80 million.
Should the judge approve the settlement, borrowers who had been forced to repay with wage garnishments or levies against their bank accounts would get a temporary reprieve. Debtors with loans the audit finds can't be collected would essentially be let off the hook.
The opponents posit three main reasons for being against the deal. First, they argue their substantial financial interests (which cumulatively total about $2 billion) weren't taken into account. Second, the roughly $19 million in immediate payments would come out of their pockets (and they'd be further harmed while the trusts halt collection on their loans pending the audit). Third, the settlement is part of a long-running effort by Vantage to enrich itself at everyone else's expense, various objectors to the deal alleged in court filings. (Michael Hanin, a lawyer for the hedge funds, declined to comment.)
Uderitz rejects these claims. As defaults have climbed and the trusts' assets have dwindled, Uderitz contends he's been trying to convince other investors and companies with an interest in the trusts that they could make more money if they included a Vantage affiliate called Odyssey Education Resources LLC as one of the trusts' debt collectors, according to records in other court cases. One way everyone could increase their earnings, Uderitz said in an interview, would be to allow Odyssey to purchase loans out of the trusts that are no longer collectible because the statute of limitations has passed. Odyssey would then try to persuade borrowers to pay up without threatening litigation. Uderitz said borrowers often would be able to pay substantially less than what's owed.
The objectors alleged that Uderitz would be buying the loans at a discount while reaping "lucrative" fees. Uderitz has said he's trying to maximize loan recoveries for all investors while staying on the right side of the law. Odyssey has proposed keeping 10 percent of the sale price of the loans it purchases out of the trusts as its compensation.
In court papers, the CFPB said that those opposing its settlement with Vantage appeared to be arguing they shouldn't be held liable for what the bureau calls unlawful collections -- even though they directly profited from it. The judge in the case could rule as early as next month.
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