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Cohort Default Rates Provide Insights into Outstanding FFEL Loans

October 23, 2013

Updated 10/24/2013 6 PM: This post was updated to include a better description of the Asset Backed Commercial Paper conduit program.

Hidden amidst the shutdown furor was the annual release by the U.S. Department of Education of new student loan default rates. The data measure how many borrowers who entered repayment in a single year defaulted on their federal student loans within two or three years. This year, the data show that 10 percent of borrowers default within two years of entering repayment and 14.7 percent do so within three years. As has historically been true, for-profit and community colleges had the highest default rates, well above those at public or private non-profit 4-year schools.

The overall trend here is not pretty. This is the sixth consecutive year in which two-year default rates increased, and they are now at the highest they’ve been since 1995. But with the growth in borrowing, this means there are significantly more people entering repayment and defaulting. More than 1.1 million more borrowers entered repayment in fiscal year 2011 compared to two years prior, and 10 percent defaulted, as compared to 8.8 percent in fiscal year 2009—an increase of more than 230,000 defaulters. Over those two years, enrollment in postsecondary education also increased, by more than 590,000 students, while the number of borrowers who entered repayment skyrocketed by 1.8 million students. See the chart below for more specific default rate figures.


Source: U.S. Department of Education

But beyond the school-based cohort default rates, the Department of Education also released some other interesting default rates: those for guaranty agencies and lenders under the Federal Family Education Loan (FFEL) Program.

FFEL is the now-defunct program replaced by the Direct Loan Program. Vestiges of the program remain, however, in the form of more than $400 billion in outstanding loans issued before the change. Under FFEL, government-backed loans were issued through a set of lenders, and 35 private non-profit organizations called guaranty agencies performed various administrative tasks, including providing federal default insurance to the lenders.

Default rates for lenders don’t carry much weight – there are no sanctions associated with high default rates. Each lender has a calculated two-year and three-year default rate, both for loans they originated and for loans they currently hold. Current lender two-year default rates range from 0 percent for over 500 lenders, including many who don’t hold any loans anymore, to a shocking 89 percent for Citibank, which still holds about 2,000 loans. Among the largest FFEL loan-holders (the 28 companies that hold 10,000 or more loans), rates average about 7 percent. Sallie Mae, the largest FFEL lender, has a default rate of 4.1 percent on the nearly 27,000 loans totaling almost $20 million it still holds from this cohort.

And the Department holds one set of loans with a very high default rate. During the financial crisis, in order to help FFEL lenders continue to make new loans, the Department of Education set up a financing vehicle called the Asset Backed Commercial Paper conduit program. The Department purchased some of the participants' FFEL loans, including all loans that were more than 210 days delinquent, as required by the contract. Those loans, now held by the Department but purchased through the conduit, carry a two-year default rate of 51.7 percent and a three-year rate of 56.6 percent. The requirement that the Department purchase those delinquent loans explains the abnormally high default rate.

The guaranty agency default rates provide another way of judging the results in the FFEL program. When a FFEL borrower defaults, the lender can file a claim to a guaranty agency to recover most of the outstanding loan balance. Then the guaranty agency—a true middleman—uses federal money to reimburse the lender, and the Department of Education reimburses those costs (this is known as “reinsurance”). But guaranty agencies with high default rates can’t receive the full amount of reinsurance reimbursement. If guaranty agency rates are below 5 percent, they get a 95 percent reimbursement; for rates between 5 percent and 9 percent, 85 percent; and for default rates that are 9 percent or higher, 75 percent.

As it turns out, at least when it comes to two-year cohort default rates, five of the reported guaranty agency default rates exceeded 9 percent for the 2011 cohort – Student Loan Guarantee Foundation of Arkansas, Texas Guaranteed Student Loan Corporation, Higher Education Assistance Authority (Alabama and Kentucky), Florida Department of Education, and Oklahoma College Access Program. Still, in every one of those states except Oklahoma, the statewide student two-year and three-year cohort default rates are even higher than the guaranty agency two-year default rate.

And although some guaranty agencies are private non-profit organizations, while others are state-based and may receive some state resources, there doesn’t seem to be much difference in their performances. The non-profits’ average default rate is 6.2 percent – effectively identical to the 6.3 percent default rate among state-based guaranty agencies.

Two-year cohort default rates don’t set a particularly high bar, as it stands, either for guaranty agencies and lenders or for students. Guaranty agencies are not held accountable for their borrowers’ defaults. Schools are – for rates at or above 25 percent three years in a row, or higher than 40 percent in one year, schools lose eligibility for Title IV federal financial aid – but not as much as they once were. The last time rates reached about 10 percent, in 1995, more than 200 schools were sanctioned by the Department of Education. Since then, the number of schools subject to sanctions has dropped precipitously – to just 8 colleges for the 2011 cohort. The 2010 cohort – the most recently available class of students – illustrates the limitations of the default rate. Consider that schools’ two-year default rates jumped from 9.1 percent to 14.7 percent when a third year was included in the window. And default rates in a cohort (unsurprisingly) continue to grow every year – even outside the 2-year or 3-year window.

Thanks to a change enacted in the 2008 Higher Education Act reauthorization, cohort default rates will get moderately stronger next year as the Department finally transitions to relying on three-year rates to determine whether a disconcertingly large share of a school’s students are unable to pay their loans. This year, over 130 schools would be in danger of facing sanctions if their default rates did not change in the third year of calculations (to date, only two official three-year default rates have been calculated). The hope is that a longer window would be harder for schools to game by utilizing temporary measures such as deferment or forbearance to avoid default up to the edge of the two-year window.

Default rates are by no means a perfect measure of a school’s value to students, but they are part of a scaffolding of restrictions on colleges – a sort of baseline quality metric to help students avoid low-value schools and to avert wasted taxpayer dollars. The numbers released by the Department offer valuable insights into students’ struggles.

How to Waste Millions of Dollars on Something Students Hate More than Sallie Mae

September 26, 2013

Sallie Mae might be the most unpopular entity in education (just look at social media if you think otherwise). As a recent post by Rohit Chopra at the Consumer Financial Protection Bureau notes, the Delaware-based loan giant had the worst overall performance record among the four companies that won competitive contracts to service new federal student loans. In response, Sallie Mae’s contract to service federal loans says the company will get fewer loans to work with next year (meaning they get paid less) and other servicers get more.

Meanwhile, the U.S. Department of Education is required to give a completely different group of servicers a free pass, even if their results may be substantially worse than the four competitively chosen companies. And it pays them more per borrower than Sallie Mae, too. But this is no accident. It’s an intentionally wasteful policy vigorously sought after by several members of Congress.


Not-for-profit but politically connected

These companies are known as nonprofit loan servicers. Many of them used to be loan companies back when students could borrow through either the bank-based federal loan program or the government run Direct Loan Program. But after Congress ended the bank-based option in 2010, saving taxpayers $68 billion in the process, all new loans were supposed to be made by the government and serviced by companies that won a competitive contracting process.

Enter Congress. Several members demanded that a role be maintained for their local loan companies, which were nonprofit and often quasi-state agencies. As a concession, legislators agreed to guarantee these nonprofit loan companies would each receive a minimum of 100,000 borrower accounts to service instead of the four competitive winners. It was a straight politics play to keep directing federal subsidies to home companies based upon political connections and cloaked in claims of local expertise. There were no demands for results or accountability. It was a kickback calculated in students to provide the same services already contracted for elsewhere.


Paying more, often for the same product

In addition to getting a guaranteed allocation regardless of results, these agencies also received a special allocation in the bill that gave them this earmark—about $1.2 billion more over 10 years to service a fraction of the loan volume that the bigger companies are overseeing. As the table below shows, this includes paying the nonprofit servicers about 22 percent more than the large ones for borrowers that are in their grace period of current repayment status. For the 100,000 accounts, that’s as much as an extra half a million dollars a year for servicing borrowers who are just doing what they should be.

Not only are taxpayers paying more for these nonprofit servicers, but in many cases those dollars are buying the same platform as the cheaper companies that won competitive contracts. Looking at the publicly posted contracts of 11 nonprofit servicers shows that in nearly half the cases the government is simply paying more money for a product they are already getting from the competitively determined contractors. Five of the 11 servicers indicated an initial plan to subcontract with Nelnet or the Pennsylvania Higher Education Assistance Authority (PHEAA) to use their platforms, but getting paid at a price that is between 10 and 32 percent higher than what those two companies are receiving per borrower.

Since those initial plans, consolidation among nonprofit servicers means that over 70 percent (five of the remaining seven) are getting more money to use other companies’ platforms. The Department announced in July that the platform run by Campus Partners and EdManage, which are owned by the South Carolina Student Loan company would be shutting down. In addition to EdManage, three other providers—COSTEP in Texas, EDGEucation in North Carolina, and KSA in Kentucky—had planned to use this platform. As a result, the loans of the Texas, North Carolina, and South Carolina servicers are being transferred to MOHELA and the loans serviced by KSA are being moved to Aspire. But these companies are already using PHEAA’s servicing platform, just increasing the extent to which nonprofit servicers are relying on a product the government is already getting for less. That does not sound like the local expertise many of these companies cited in trying to justified their continued existence to Congress during negotiations on the 2010 bill.


What about results?

Judging how well these servicers are actually doing is not an easy task. The 100,000 accounts each got were randomly assigned, but they all came from the company that used to service all of the government-held student loans back when there were two competing federal loan programs. Because of this competition, the loans held by this company had some characteristics that could make it different from the broader loan population. First, it was from schools that had been in the government-based system for longer, which means the quality of loans would be affected by the types of schools the bank-based program was able to recruit to participate versus those with riskier loans it may not have wanted to serve as much. Second, these were likely not new borrowers, so they may have already been in repayment or even defaulted. Third, the sample could include some of the bank-based loans that were sold to the government during the credit crunch, which are generally among the worst debts in the program. Comparing the nonprofit servicers to the competitively determined ones is also not easy because only two of the five different metrics each is measured upon are in common—measures of borrower and federal personnel customer satisfaction. None of the information on actual outcomes is consistent across the two groups.


Students don’t seem happy...

Comparing nonprofit and competitive servicers on the metrics they do have in common suggests that the extra money spent on the former is buying little more than unhappier students. This is measured by a survey of borrowers done under the framework of the American Customer Satisfaction Index, which can be uniformly applied across a range of sectors and types of industries. The table below shows the average scores on the borrower satisfaction measure over the last two quarters of the 2012-2013 year for all servicers that had received marks for at least three quarters. Presenting the data in this way ensures servicers are not judged based upon only their first score, which tends to be a bit lower, and have the results partially smoothed out. For reference, the national average is about 76 and a “good” score would be in the 80s.

As the table shows, the competitively determined contractors scored as high as or higher than every single one of the seven nonprofit servicers with data. The five additional servicers that lacked enough data would also have come up well short, with most having scores in the mid to high 60s. And the two most liked serivcers—Great Lakes and Nelnet—scored approximately 10 points higher than the worst nonprofit, an offshoot of the South Carolina Student Loan Corporation. Even Sallie Mae, the bane of students everywhere (or at least on Twitter) bested every nonprofit with data for this period.


...Federal personnel think things are only OK

Below is the same table, but for the federal personnel scores. The results are a bit more tightly clustered, with Utah-based CornerStone even exceeding three of the competitive winners. But the bottom group, especially the Oklahoma result, is not pretty.

Now it is possible that maybe some of the scores are affected by the quality of a given servicer’s sample—defaulted borrowers may look more negatively upon their servicer than someone in active repayment. But regardless of the scores, the saddest thing across the two tables is that no one appears to be providing above average customer service.


Outcomes vary, but unclear why

Since there’s no way of knowing whether the borrower populations across each servicer are equivalent, it’s hard to tell whether variations are the result of differences in quality or the underlying borrowers. It could be that only 72 percent of loans in repayment or delinquent status overseen by the Kentucky Higher Education Student Loan Corporation’s servicing arm were current or in grace status at the end of the fourth quarter of 2012-13 because it received a disproportionate number of defaulted loans, while Aspire’s 93 percent mark on the same metric could be a result of having more borrowers at flagship public four-year schools. There simply aren’t enough data to know for sure. Because of those caveats, the table below simply shows the results on the three outcome metrics for all servicers in the fourth quarter of 2012-13 for all entities that had servicing results for at least two quarters.

Sequestration Silver Lining

The number of nonprofit servicers in the program—and thus the size of the giveaway—would likely be even larger were it not for sequestration. Funding limitations stemming from that process have prevented the Department from giving any additional volume to nonprofit servicers (see slide 10 for more). But it’s unclear if more companies will come on board if funding conditions improve.


What are we paying for?

The continuation of nonprofit servicers in the student loan program was a much debated concession made in the heat of negotiations over not just ending the bank-based system but reforming health care as well. It was politically expedient and of dubious policy merits. But with three years of hindsight we now have a clearer picture of just what this set of exemptions bought taxpayers and students. For a 10-year investment of more than $1 billion we are getting servicing that is less liked by students than even Sallie Mae, on platforms that in most cases were already available for less money. The data are less clear on how these entities actually perform in terms of loan results, but given the first two conditions, they would certainly have to be substantially better than what the bigger servicers are doing to even remotely justify this continued giveaway.

Asset Building News Week, July 23 - 27

July 27, 2012
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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.

Asset Building News Week, July 16 - 20

July 20, 2012
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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.

An Unsettling Settlement in Class Action Lawsuit Challenging Sallie Mae's Subprime Lending Practices

June 19, 2012

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.

Asset Building News Week, Feb 20-24

February 24, 2012
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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. 

The $64 Million Dollar Question on Private Student Loans

July 20, 2011

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.

Sallie Mae Faces Another Class Action Lawsuit Over its Private Loan Practices

March 1, 2011

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."

Guest Post: The Growth of Proprietary School Loans and the Consequences for Students

February 3, 2011

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.

Sallie Mae Puts the Lie to Career College Spin on Default Rates

December 21, 2010

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:

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