A “Key” Reason Not to Bail Out Private Student Loan Providers

Readers of this blog will know that we think it would be a major mistake for the U.S. Treasury and Congress to provide bailout funds for private student loan providers -- especially without giving the borrowers of these high-cost loans better consumer protections. To better understand why we think that way, consider the case of KeyBank -- which arguably has engaged in some of the most questionable private student loan practices of any company. Is it really in the best interest of the government and taxpayers to help companies whose lending practices have put students in such harm's way?

As we have reported previously, there has been in recent years a proliferation of unlicensed and unaccredited trade schools that do not participate in the federal student aid programs and therefore go largely unregulated. Their growth has been fueled by lenders that have "partnered" with these institutions to provide expensive private loans to the at-risk students these schools tend to attract. The lenders have then turned around and, like subprime mortgage providers, securitized the loans, shifting these high-risk loans onto unsuspecting investors.

One of the most aggressive players in this arena has been KeyBank. Over the last decade, KeyBank has formed exclusive arrangements with dozens of unlicensed trade schools -- particularly ones that focus on computer training and flight training. These unregulated schools have required their students to pay for the full cost of their training up front, with tens of thousands of dollars of private loans from KeyBank. Unfortunately, many of these schools, like the Nevada-based Silver State Helicopters (SSH), failed to deliver the education promised and then shut down without warning, leaving their students in the lurch -- heavily indebted with expensive private loans and no practical training.

In case after case, KeyBank has fought vigorously (and often successfully) to force students to pay back these high-cost loans, despite the fact that the schools closed before the low-income and working class students these institutions tend to attract could receive the training they were promised. In doing so, the corporation has denied borrowers basic protections that are in federal law to protect borrowers from being scammed by unscrupulous schools and loan providers. For example, the bank has routinely omitted from the promissory notes for its private loans a required notice that asserts the borrowers' right to have their loans canceled if a school with which it has "a referring relationship" closes down, is not licensed, or engages in fraud. [Higher Ed Watch will explore this issue in greater detail in a post tomorrow.]

Students who attended these unregulated fly-by-night trade schools are fighting back. At least two major lawsuits are moving forward against KeyBank, accusing the company of colluding with disreputable schools to defraud students. They say that KeyBank officials were well aware of problems at these schools but chose to ignore them in order to continue marketing loans to the institutions' students.

KeyBank officials deny any wrongdoing, saying that they cannot be held responsible for mismanagement at the schools with which they work.

Left in the Lurch at Silver State

In May, students in California who attended flight schools run by Silver State Helicopters, a Nevada-based chain that shut down suddenly on Super Bowl Sunday, filed a class action lawsuit against KeyBank and several other lenders, seeking to get their private loans discharged.

According to the lawsuit, KeyBank was Silver State's exclusive private student loan provider from 2002 to 2005, a time when the flight school chain grew by "an astounding 2,786 percent." The lawsuit states that the school directed prospective students to apply for private loans from KeyBank to cover the full cost of attendance -- nearly $70,000 per student -- that they were required to pay upfront before classes started. "The school targeted second career, limited income individuals who, but for the Defendant's loan, lacked the personal financial wherewithal to pay the tuition," the lawsuit states. The willingness of KeyBank to waive its credit requirements to provide these high-cost loans to mostly subprime borrowers served "as a fundamental catalyst for SSH's exponential growth," the document says.

Soon after the students enrolled, however, they realized that the school was ill-equipped to deliver the training that was promised. "SSH was unable to provide the equipment, instructors or maintenance necessary to enable the students to attain their pilot ratings,' the lawsuit says. KeyBank was made aware of these problems, the lawsuit states, but continued to help market the school. [In 2005, KeyBank severed its ties to Silver State, forcing the school to find other lending partners to make and service its loans. The flight school chain then forged an exclusive arrangement with Student Loan Xpress and Pennsylvania Higher Education Assistance Agency (PHEAA).]

The lawsuit argues that KeyBank's relationship with Silver State is not an isolated case. Instead it points to similar arrangements the bank has forged with other unaccredited trade schools that also shut down to assert that "KeyBank's involvement with SSH and its treatment of the SSH students is part of a pattern and practice of fraudulent conduct ." The lawsuit accuses the bank of violating the federal Racketeer Influenced and Organizations (RICO) Act by engaging "in a deliberate pattern and practice of aiding and abetting fraudulent vocational schools that aggressively induce students into obtaining loans with KeyBank."

KeyBank officials deny any wrongdoing, saying that they had little involvement with the schools except to provide financing to their students.

TAB Express International Students Fight Back

A second lawsuit -- filed by more than 50 former students from TAB Express International, a now-defunct flight school in northern Florida -- presents a remarkably similar case to that of the Silver State students.

In June 2005, TAB shut its doors without notice, after KeyBank ended its three-year relationship with the school. Prior to that, the lawsuit states, KeyBank and TAB had "a mutually advantageous relationship" in which the school required students to take out private loans from that lender to attend the institution, according to the lawsuit. "In fact," the lawsuit states, "TAB would not accept cash installments or other loans on behalf of students for their training, and insisted the students instead obtain a loan or loans from KeyBank exclusively."

Just as at Silver State, students wishing to attend TAB had to take out private loans from KeyBank covering the full cost of attendance -- sometimes as much as $100,000 -- before classes even started. The bank sent the money directly to the school. According to the lawsuit, students were told that their loans would be forgiven after they completed the training and worked for TAB's airline for a period of time.

But soon after enrolling, students became suspicious. "The students became aware of a lack of available instructors, simulators, and aircraft at the flight school as the school continued to increase the number of enrollees," the lawsuit states. Eventually, they realized that "TAB had no airline." The lawsuit says that the students repeatedly brought their concerns to KeyBank officials but were rebuffed, and the lender continued to help market the school to prospective students.

When the deal finally collapsed, the lawsuit says, KeyBank officials tried to convince the students to take advantage of a "train out option" that would have required them to take on more debt and to waive their right to pursue legal action. Most of the students were not persuaded. Now the case is scheduled to go to trial in a state circuit court in March.

Be Careful with Bailout Money

As a result of the credit crunch, KeyBank stopped making private student loans this summer. With Treasury Secretary Henry Paulson intent on bailing out the private loan industry, we fear that the government will rush to the aid of KeyBank, and others like it, without being aware of the provider's questionable past practices.

At the very least, the government should withhold any liquidity aid from KeyBank until it launches a thorough investigation of the serious allegations that have been made by students from dozens of unlicensed schools. We would hope that the bank would be required to discharge the private loans of students from Silver State and TAB International, as well as others who were victims of sham schools with which the lender partnered.

To be clear, we oppose a private loan bailout. But if one is to occur, the government needs to insure that it is not adding fuel to the fire, and encouraging private loan providers to continue harming students and borrowers. It's time to put an end to these types of predatory lending practices, not encourage them.