Private Student Loan Origination in Hindsight: What the Litigation Paper Trail (in PDF) and SEC Filings Can Tell Us About the National Collegiate Student Loan Trust Debacle

134 Pages Posted: 10 May 2018 Last revised: 21 Jun 2018

Date Written: April 24, 2018

Abstract

In 2007 the First Marblehead Corporation launched the last quartet of bankruptcy-remote student loan securitization trusts (bringing the total to 15) through its subsidiary, the National Collegiate Funding LLC.

A large proportion of the private student loans were originated through direct advertising and marketing to consumers (DTC), rather than through school financial aid offices (school-channel). The loans were combined into pools and sold to statutory trusts set up as investment vehicles, which purchased the loans with the proceeds of bonds sold to institutional investors. The students’ installment payments on their loans would then be used to repay interest and principal to the bondholders and generate residuals for the trust certificate holders. Up-front, however, the FMC paid itself more than 88 million from the surplus proceeds of each securitization transaction, the equivalent of about 8% of the loan balance. Its capital contribution to the trust through National Collegiate Funding, LLC, one of the two original trust certificate holders, was a merely nominal $1.00 per trust.

Ten years down the road, and half way through the nominal 20-year amortization period, many of the loans originated in 2007 had gone into default, but were not necessarily beyond the statute of limitations thanks to the grant of forbearances that had deferred default. As the number of loans not generating cash flows increased, collection turned into litigation.

This paper sheds light on how these loans came into being, drawing on SEC filings and a systematic review of a sample of NCSLT collection cases filed in 2017 in Texas. It concludes that these private student loans were high-cost loans originated under false pretenses because borrowers were not provided with timely, adequate, and accurate disclosures about the future cost of the loans:

- The Interest Rate was understated because it was shown as a Margin percentage to be added to LIBOR on the loan application, rather than as the sum of LIBOR Margin (APR).

- The Origination Fee was shown as a percentage on the application, but the actual fee in dollar terms was a higher percentage relative to the approved and disbursed loan amount, and the fee was immediately added to principal with the result that the borrower owed considerably more than he or she received in proceeds from day one.

- The cost of the loans was further driven up by capitalizing not only of the Origination Fee, but the interest accrued during the in-school deferral period and thereafter.

While the same model of loan origination had been used in early iterations, the 2007 iterations were characterized by both higher Margin rates and higher Origination Fee percentages, which made most of the loans much more costly relative to earlier vintages.

The high-cost nature of these loans, however, was critical to their marketability to investors because the high interest rate margin promised high yields. And it was also critical to maximizing the upfront fee taken by the First Marblehead Corporation as arranger, which was funded from the proceeds the Trusts received from the issuance of the bonds.

Keywords: Private Student Loans, SLABS, Securitization Trusts, TILA, Truth-in-Lending-Act, Collection Lawsuits, Student Loan Defaults, Student Debt, Educational Loans, Consumer Loans, Interest Rates, Finance Charges, Usury

JEL Classification: K41, K12, K22

Suggested Citation

Hirczy de Mino, Wolfgang, Private Student Loan Origination in Hindsight: What the Litigation Paper Trail (in PDF) and SEC Filings Can Tell Us About the National Collegiate Student Loan Trust Debacle (April 24, 2018). Available at SSRN: https://ssrn.com/abstract=3168268 or http://dx.doi.org/10.2139/ssrn.3168268

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