Sallie Mae

The Asset Building News Week is a weekly Friday feature on The Ladder, the Asset Building Program blog, designed to help readers keep up with news and developments in the asset building field. This week's topics include poverty, consumer protection, and banking services.

The Asset Building News Week is a weekly Friday feature on The Ladder, the Asset Building Program blog, designed to help readers keep up with news and developments in the asset building field. This week's topics include college financing, housing policy, consumer protection, and asset limits.

Did Sallie Mae officials engage in an elaborate scheme to hide the rapidly deteriorating state of the company’s private student loan portfolio from Wall Street at a time when they were trying to complete a buy-out deal that would have brought them great riches? Were they systematically pushing subprime private loan borrowers at for-profit colleges into forbearance to mask the amount of risk they were taking on by making such high-cost loans to this vulnerable group of borrowers?

Unfortunately, we’ll probably never know the answers to these questions, which are at the center of a class action lawsuit that a group of investors have brought against the company (click here for part 1 of the suit and here for part 2). That’s because a federal district court judge in Manhattan – William H. Pauley of the Federal District Court in Southern New York – has preliminarily approved a $35 million settlement agreement between the parties that would not require Sallie Mae to admit to any wrongdoing. A final ruling on the settlement is expected in August.

While the shareholders will make out well from this deal, the real victims of Sallie Mae’s apparent scheme – the low-income and working-class students who never should have been steered to these risky loans in the first place – will not even get the satisfaction of seeing this case get its day in court. Sallie Mae will essentially get off scot-free ($35 million is hardly even a wrist slap for a company that holds nearly $140 billion of federally guaranteed student loans), many of these borrowers will be stuck with this debt hanging over them for the rest of their lives.

At a time when there is so much concern about a potential student debt bubble, the allegations made in this lawsuit should be getting more attention. With that in mind, I am re-posting a piece I wrote for Higher Ed Watch in October 2010 that lays out the investors’ case and shows why it is so regrettable that the questions posed at the top of this post may never be answered.

The Asset Building News Week is a weekly Friday feature on the The Ladder, the Asset Building Program blog, designed to help readers keep up with news and developments in the asset building field. This week's topics include savings products and financial behavior, the Consumer Financial Protection Bureau, income inequality, and housing. 

When the new Consumer Financial Protection Bureau starts its work on private student loans in earnest, it will have to confront a question that has vexed policymakers and student aid experts in recent years: Why do so many students take on this debt without exhausting their eligibility for federal loans first?

According to the most recent data available from the Department of Education, the majority of undergraduates who borrowed private loans in the academic year 2007-08 did so even though they hadn’t taken out all of the federal loan debt for which they were qualified. Nearly one quarter of these private loan borrowers did not take out any federal loans at all.

This is a major public policy problem because private loans are far more risky than federal loans and almost always much more expensive. Unlike federal loans, which carry a fixed rate, private loans generally have uncapped interest rates that vary month to month based on market conditions. While federal loans offer the same terms to all borrowers, private loan providers tend to charge higher rates to those with the greatest need.

Federal loans also offer much greater consumer protections than private loans. Borrowers in the federal programs who become unemployed or suffer economic hardship, for instance, have a legal right to have their loans deferred for several years. Private loan borrowers who run into trouble don't have that option. And unlike federal loans, private loans are not automatically discharged if a borrower dies, is permanently disabled, or attends a school that unexpectedly shuts down before that student completes his or her studies.

How much does it really cost a student loan company to collect on a defaulted private student loan? That question is at the center of a class action lawsuit that a federal judge in California has allowed to proceed against Sallie Mae, the country’s largest private student loan provider.

The case was filed by four borrowers who have defaulted on private loans they took out from the student loan giant between 2002 and 2004 to attend Career Education Corporation’s California Culinary Academy in San Francisco. Before sending these borrowers’ loans to a collection agency, Sallie Mae added a collection fee of 25 percent to their loan balances in a process known as capitalization. As a result, the total amount each of the plaintiffs owed ballooned -- growing, in one case, from approximately $48,000 to $60,000 and, in another, from about $73,000 to $103,000.

While Sallie Mae’s actions in this case were not necessarily unusual, the lawsuit argues that the company violated the terms and conditions of the loans. At issue is the following clause that Sallie Mae includes in its private student loan promissory notes regarding potential collection charges:

 “[Borrower] agree[s] to pay [holder] reasonable amounts permitted by law, including attorneys’ fees and court costs which [holder] incurs in enforcing the terms of this Note, if [borrower is] in default.” [Emphasis added]

The lawsuit contends that the 25 percent fee is "not reasonable" and has no relation to the true costs that Sallie Mae incurs when a borrower goes into default. Instead, the borrowers' lawyers argue that this is an arbitrary fee that is "designed to substantially exceed the collection costs actually incurred."

While “it would not be impracticable or extremely difficult to fix the actual costs of collection," the lawsuit says, Sallie Mae has not made “a good faith attempt” to do so. “The amount of the Collection penalties does not represent the result of a reasonable endeavor by Defendant to estimate a fair compensation for any loss that may be sustained."

By Deanne Loonin

Before the credit crash in 2008, many for-profit colleges partnered with third party lenders, such as Sallie Mae, to provide private student loans to their students. When these loans started to fail at devastating rates, nearly all of these lenders exited the subprime student loan business and terminated their partnerships with these schools. 

The sudden and unexpected exodus of lenders from this market left proprietary school executives facing a dilemma. The report that we at the National Consumer Law Center’s released earlier this week, “Piling It On: The Growth of Proprietary School Loans and the Consequences for Students” highlights how many for-profit schools responded to this “funding shortfall” by creating their own student loan products. Nearly all of the large companies -- with the notable exception of the industry’s largest player, the Apollo Group, which owns the University of Phoenix -- have increased institutional lending in some way. 

Industry and Wall Street insiders often describe the growth of institutional lending at these schools as inevitable. This misses the mark because the schools deliberately chose to make the loans. They made a purposeful decision that may have benefited the companies and their investors but was not in the best interests of their students.

Do colleges with high student loan default rates have any responsibility for their former students’ loan repayment problems?

While for-profit college lobbyists and leaders would like us to believe that the answer is “no,” Sallie Mae, the student loan company with the most experience lending to students at these schools in recent years, has a much different story to tell.

As we’ve previously reported, a little less than a decade ago, the student loan giant began forging sweetheart deals with some of the country’s largest chains of for-profit colleges, such as Career Education Corporation, Corinthian Colleges, and ITT Educational Services, among others. Under these arrangements, Sallie Mae agreed to provide high-interest private loans to low-income and working class students at these institutions. The company apparently viewed these loans as “loss leaders,” meaning that it was willing to make these risky loans in exchange for becoming the exclusive provider of federal loans to the hundreds of thousands of students these huge chains collectively serve.

It didn’t take long for these loans to start going bad. For a while, the company, which had put itself up for sale, appears to have tried to hide the rapid deterioration of its “non-traditional” private loan portfolio from investors and potential buyers by pushing as many delinquent borrowers from these schools into forbearance as they could. But after an investor group led by the private equity firm J.C Flowers & Co. dropped its bid to buy the company, Sallie Mae came clean.

In a conference call with investors on January 23, 2008, executives at Sallie Mae announced that the company had sustained more than $1 billion in losses on these loans, and, as a result, would no longer make private loans to financially needy students attending these institutions. Al Lord, the company’s chief executive officer, laid the blame for the losses squarely on the shoulders of the schools with which they had been working:

Earlier this week, we wrote about a class action shareholder lawsuit that accuses Sallie Mae executives of having engaged in an elaborate scheme to hide the rapidly deteriorating state of the company's private student loan portfolio at a time when they were trying to complete a buy-out deal that would have brought them great riches.

At Higher Ed Watch, we find these allegations compelling. It was, after all, only a week after Sallie Mae's deal with J.C. Flowers & Co. collapsed that the company began to come clean about the huge amount of losses it was about to incur on the extremely risky private loans it had made to sub-prime borrowers at some of the largest chains of for-profit college companies in the country.

Unsurprisingly, Sallie Mae's lawyers tell a different story. Far from being conspirators, the student loan giant's leaders, they say, were "unsuspecting victims" of the financial turmoil that overtook the country during that period of time. "Although not recognized at the time, the second half of 2007 marked the start of what became the largest credit crisis since the Great Depression, described by former Federal Reserve Chairman, Alan Greenspan (who did not predict it), as a "once-in-a-century credit tsunami," the company's counsel wrote in their unsuccessful motion to get the case dismissed. "During this period SLM Corporation experienced unprecedented defaults by its student borrowers and its stock price declined substantially, on virtually the same downward trajectory as other consumer credit providers."

They concluded the motion by saying, "In sum, plaintiffs offer no contemporaneous, reliable evidence sufficient to support any inference other than that defendants were unsuspecting victims of a consumer credit tsunami that cause unprecedented numbers of its student borrowers to default."

This explanation could be convincing -- but only if you ignore the numerous statements that Sallie Mae officials have made since that time acknowledging the part they played in creating the mess in which they find themselves. At Higher Ed Watch, we thought we'd provide the following chronology to remind our readers of what Sallie Mae executives had to say as the true condition of  the company's private loan portfolio became known:

On December 12, 2007, Sallie Mae announced that the extremely lucrative buy-out deal that it had reached earlier in the year with an investor group led by the private equity firm J.C. Flowers & Co. had gone up in smoke. A week later, Sallie Mae executives began to acknowledge the rapidly deteriorating state of the company's private loan portfolio, particularly among those high-risk loans it had made to sub-prime borrowers at some of the largest chains of for-profit colleges in the country.

Was the timing a coincidence? Or had the student loan giant's leaders engaged in a deliberate scheme to mask the company’s true financial condition to make sure the deal -- which promised to bring great riches to its board members, including chairman Al Lord, who was set to rake in $225 million -- was consummated?

Those questions are at the center of a class action shareholder lawsuit (click here for part 1 of the complaint and here for part 2) that a federal judge in Manhattan has allowed to proceed against Sallie Mae [SLM]. Late last month, William Pauley of the Federal District Court in Southern New York rejected a motion by Sallie Mae to dismiss the lawsuit, saying that the investors suing the company had provided sufficient evidence of possible wrongdoing to allow the litigation to move forward.

The case dates back to the fall of 2006 when Sallie Mae put itself up for sale. In the immediate years preceding, the loan company had forged sweetheart deals with some of the largest chains of for-profit colleges in the country, including Career Education Corporation, Corinthian Colleges, and ITT Educational Services, as Higher Ed Watch has previously reported. Under these arrangements, Sallie Mae agreed to provide funds for private student loans, with interest rates and fees totaling more than 20 percent per year, to low-income and working class students at these schools who normally wouldn’t qualify for them because of their poor credit records. Sallie Mae apparently viewed these loans as “loss leaders,” meaning that the company was willing to make these loans, many of which were likely to go into default, in exchange for becoming the exclusive provider of federal loans to the hundreds of thousands of students these huge chains collectively serve.

As they started to shop the company around, Sallie Mae executives, the lawsuit says, decided to double down on this risky strategy. "Defendents sought to increase short-term profits in an effort to negotiate a sale to the Flowers group (or another buyer) at an attractive premium and convince investors that an acquisition on favorable terms was likely,” the complaint states. “The scheme consisted of writing billions of dollars in private loans to high-risk borrowers, recording increased income from these loans (as a result of increased loan volume and higher rates of interest SLM was entitled to receive on the loans" as compared to federal loans), and "underreporting expected losses.” From June 2006 to December 2007, Sallie Mae’s private loan portfolio “more than doubled,” from $7 billion to $15.8 billion.

To make the strategy work, Sallie Mae officials needed to find a way to mask the amount of risk the company was taking on. Their aim was to keep delinquency and default rates on these high-cost loans artificially low while the buy-out deal was pending, the lawsuit says. Otherwise, they would have had to significantly raise the amount of money they held in reserve to cover possible losses on these loans -- which would have “reduced reported income and earnings” and ultimately the company’s value. 

According to the lawsuit, Sallie Mae officials found an easy solution: pretend that the problems with the portfolio didn't exist by pushing delinquent borrowers into forbearance. By manipulating the company's forbearance, they could ensure that delinquent borrowers would not default on their loans until after the buy-out deal was completed and ownership had changed hands.