Why I Have Never Been More Worried About Student Loan Defaults

The light bulb went off as I was reviewing the first set of performance metrics for the four new DL servicers.  The default metrics looked quite good with the only blemish being a 0.01% default rate figure for the prop. school category serviced by Great Lakes.  Of course, it's hard to default when almost all of your borrowers are still in school.  Sallie Mae executives have noted that default figures are not likely to factor into the allocation methodology for several years until the portfolio ages and students enter repayment. 

That led me to think about who is making sure that borrowers in repayment are not defaulting, which led me to the exercise below.  So, who's keeping an eye on the bulk of the $621.1 billion in federal loan debt?  [Hint:  Many companies that don't have a long-term future in the business and therefore may be distracted as they figure out their exit strategies or how to maximize their cash flows.] 

• ACS currently services about $140 billion in loans for the Direct Loan program
  
  • Will be replaced as originator of new Direct Loans by the four new servicers selected by the Department of Education to take over this fall
  • ACS is undergoing internal changes also, having been acquired recently by Xerox
  • Uncertainty over who will be servicing portfolio of Direct Loans that ACS currently services

• FFELP servicers (such as Citibank, Wells Fargo) excluding the big four (Sallie Mae, Great Lakes, Nelnet and AES/PHEAA) account for over $100 billion in federal loans serviced. 
  
  • If FFELP is eliminated these servicers will have no new loans coming in and will be in run-off mode harvesting these businesses for cash
  • Expect a wave of consolidation; Sallie Mae has indicated an interest in rolling up the sub-scale players

• The largest servicer selected by the Department of Education, Sallie Mae, has made it clear that the DL contract terms will make it difficult for them to collect on delinquent loans.
  • Sallie Mae executives at a recent investor conference:  "Their [Dept. of Education] way of managing better performance is to pay less when account becomes delinquent.  We would argue that you gotta incent people to make contact.  In one category we get paid as little as $.90/month for a highly delinquent account.  You can't make contact for $.90/month.  It's just very hard."  Note:  A Sallie Mae subsidiary has a contract as a private collection agencies to collect on defaulted loans, so they will get another "bite at the apple" if they don't contact the delinquent account. 

• Sallie Mae also noted in an investor meeting yesterday that they are mulling their options for their FFELP portfolio, including an outright sale or spin-off.  Note the comments about cutting servicing costs: 
  
  • Executives had this to say about their FFELP portfolio:  "[FFELP] portfolio will amortize very slowly.  Our object is to maximize value; we will cut servicing costs that are related to it..."

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So, what about current borrowers?  They will be experiencing their own form of "split servicer" roulette as the Dept. determines which servicer to assign them to.  Unfortunately, it is not as simple as that.  Ironic that on the same day that NASFAA News linked to the ED announcement about performance ratings for the DL servicers (which had below-average ratings coming from the borrowers), they described the complex repayment situation facing new borrowers today unless they consolidate their loans:   

"The Ensuring Continued Access to Student Loans Act (ECASLA) successfully prevented any disruption in student loan access, but now it is making it more difficult for some borrowers to keep track of their loans. This is because a student with pre-ECASLA and post-ECASLA loans has to repay each loan separately, even if both loans have the same loan servicer.

If this same student's school switches to the Direct Loan program and the student is disbursed a Direct Loan, this student will have to make three separate payments. Even if all three loans are serviced by the same loan servicer, the student will have to make three separate payments unless he or she consolidates the loans.

NASFAA has been working with the Department of Education to find a solution to this issue, but the Department has indicated that a solution is unlikely because pre-ECASLA loans, post-ECASLA loans (Put Loans), and Direct Loans are all made under separate loan programs."

You can guess what happens when students can't track their loans...it starts with a D.

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But, at least income-based repayment can help many struggling borrowers manage their payments, right?  I haven't seen new numbers from ED for quite some time, but with servicers looking to cut costs, what is the incentive (especially for short-timers) to take the extra time to explain IBR and collect the necessary information from the borrower when a forbearance is so much easier.  How about offering a bounty to servicers, akin to the payment made to servicers to modify mortgages, to get as many struggling borrowers signed up as quickly as possible?  I know, I know, why should we have to pay servicers to do the right thing?   Well, we can argue that point and let these abysmal take rates on IBR persist or try to find a solution that helps more borrowers. 

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Notice that I have gotten this far in the post and I haven't even talked about the abysmal employment situation for recent grads.  Is anyone else concerned? 

Comments

[Craigie]

There seems to be a confusion about the difference between "originator," "servicer," and "holder." Origination is not impacted by the "four new servicers." That is completely-separate functionality. "Run-off" mode may describe loan holders but does not describe loan servicers. Their business model is to receive loan servicing fees from the loan holder. That would not change if new originations of FFELs were to end. It would be like any other business out there which receives payments from existing clients but is not growing. What would be "harvested"? They don't own the loans, they service them. It is true that some entities are performing multiple functions. That was a business decision they made in the past which may or may not turn out well for them. The "$100 billion" is not clear, nor why Sallie Mae, Great Lakes, Nelnet and AES/PHEAA would be considered the "big four." A very small handful of servicers, including those four, are servicing almost 100% of the FFEL portfolios which are not at the guarantor or at DoEd. There are hardly any remaining "sub-scale players" out there, unless FFEL servicers like Great Lakes, ACS, Citi, Wells Fargo/Wachovia are considered "sub-scale."
Why would someone want to pay a servicer a higher fee the deeper the borrower fell into delinquency? That would be the old FFEL incentives which in many cases seemed to encourage defaults. It sounds like it is not necessarily an issue of cost but rather an apparently-difficult paradigm shift for those who are accustomed to doing things one way. In the 1990s FFELP loan holders told Treasury that servicing costs were about 32bp for in-school & deferment and about 95bp for repayment (Stafford/PLUS) and 47bp for repayment (consolidation). The current contract pricing is publicly available on DoEd's web and is generally double or triple those rate levels. Moreover, there is nothing nearly as low as $0.90 except for extreme late-stage delinquency.

[Tim Ranzetta]

Craigie,
Thanks for your comments. The main point of my post was that there are many moving pieces here at a time when the economic environment is straining borrowers. Put another way, the deck chairs are being rearranged for the post-FFELP world at the same time that default rates are spiking due to the economy. The opportunity for service levels to borrowers to be impacted are quite high given the uncertainty swirling.

I would argue that a servicer that has no new volume coming in the door is not investing in the business anymore and will focus on maximizing cash flow even more than they might have previously (one need only look at SLM's comments that they "cut servicing costs." If that means reducing call center time per call then so be it.

On the issue of servicer fees at various stages of delinquencies, I am not suggesting that they should be paid more. I just find it curious that a servicer who signed the contract with the Dept. now seems to want to recut the deal. And if they are serious that they can't service at those prices, well students will suffer.

Finally, your data about rates being double or triple, what assumptions are you making about average loan size per borrower. If average loan held per borrower is about $10,000 and in-school repayment rate is $1.05 per month, that would appear to be a rate of about .12%. Even if I am off by factor of two, that still only gets me to 0.24%. Loans in repayment are $2.11 so double that number so I have trouble getting to 2X the 1990 figures.

[Eddie Meboy]

Great article and it really points out the perfect storm in default rates that are on the horizon. Servicers were given a take it or leave it deal from ED and to think that they will do anything more then is required is farcical. Add to that the constant movement of accounts between originating lender, Ed servicer and new direct loans, in an economy that is struggling and an extra year for borrowers to default and you have set the table for an enormous rise in default rates. In the case of SLMA the fox is watching the hen house. As a servicer they make next to nothing or maybe even loose money but as a collector on defaults… well that has been their bread and butter for a long time. It is important that institutions step in and assist their current and prior students during this period. The Department while concerned about default rates seems oblivious to the problems that their “solutions” have created. When asked about assisting students with split servicing their answer has been that “it’s the student’s responsibility to know where their loans are.” Well they know where they took them from they just have no idea where ED PUT them. Servicer’s deficiencies have already been documented, so the institution is left as the sole source to actually assist the student. They have a skin in the game as well; the more students that default the higher their institutional cohort default rate will climb. Add to that the new formula for calculating rates that gives borrowers an additional year to default and the importance of institutional involvement becomes clearer. For students that borrow for college keeping track of their lender will be akin to herding cats, as they get there eye on the locations of some loans others will move. I wish them luck.

[Paul Combe]

Tim, you raise a good point that lies at the heart of this whole issue - “What is the incentive (for servicers). . . to take the extra time to explain IBR and collect the necessary information from the borrower when a forbearance is so much easier.” Answer: There is none. The goal of student loan servicers is to collect payment in the most efficient and cost-effective manner possible. It is NOT about taking additional time and resources to make sure borrowers understand their options. Even with realigned incentives, like the “bounty” you suggest, servicers will always have a vested interest in the repayment solution that the borrower chooses. Some of those solutions benefit the borrower, while some may benefit the servicer/holder more in the long-run (more interest paid, loan kept in portfolio a longer time, etc.). And as you point out, the picture gets even murkier if the servicer has financial ties to private collectors and gets a “second bite at the apple.” That’s why I’ve always argued that borrowers need third-party, independent advocates (see borrowersrights.org) to provide neutral counseling, in addition to regular servicing. And the counseling must be proactive, before payment problems occur. If we are focused on contacting borrowers only after they are severely delinquent, we have already failed them.

[C. Cryn Johannsen]

I am enormously concerned, and that's why I continue to advocate for the indentured educated class. Have you seen my latest interview? It's a great clip that provides information about TICAS.org, my advocacy work, and so forth - http://www.youtube.com/watch?v=ArC6UHatvzY&feature=player_embedded#

[C. Cryn Johannsen]

Tim - my response to your outstanding piece above. http://alleducationmatters.blogspot.com/2010/03/quick-post-please-join-support-group.html

[Jeremy]

Craigie,

I was looking for the pricing information in the RFP. The only thing I could find was in the Redacted / Signed RPF Responses the following table under B.13.N:

Borrowers in In-school $ 1.050
Borrowers in Grace or Current Repayment
Status 1 3,000,000 $ 2.110
3,000,001 UP $ 1.900

Borrowers in Deferment or Forbearance
1 1,600,000 $ 2.070
1,600,001 UP $ 1.730

Borrowers 31-90 Days Delinquent $ 1.620
Borrowers 91-150 Days Delinquent $ 1.500
Borrowers 151-270 Days Delinquent $ 1.370
Borrowers 270+ Days Delinquent $ 0.500

I don't see any $.90 number specifically, but it seems like this lines up with what Sallie Mae is saying.

See: https://www.fbo.gov/spg/ED/FSA/CA/FSA-TitleIV-09/listing.html
Look for "Title IV Redacted Contract Awards"

[Mark Russell]

I am a newcomer to this blog, so you may have already covered this topic... Why is the cost of private education rising so rapidly? I have to assume that educational labor costs (professors, admin support, etc.) are rising in line with the increase in inflation, so what's causing the other costs to rise well above the increase in inflation?