WASHINGTON The Consumer Financial Protection Bureau's push to encourage private lenders to refinance student loan debt is raising questions about whether the agency is focusing on the right target.
A report issued by the agency last week focused solely on private lenders, who represent anywhere between 7% and 15% of student loan originations, while the rest are backed by the federal government. That has left many in the industry arguing that the solution to systemic problems in the student loan market, which echo those of the mortgage market before the financial crisis, lies with the government, not bankers.
"The bigger picture is that private student loans are very much a small part of the market and [private lenders'] loans perform significantly better," said Pace Bradshaw, vice president of congressional affairs at the Consumer Bankers Association.
Many observers argue that the Department of Education should be working on a fix to problems in the student loan market, noting that government loans have default rates that are three times the percentage of private student loans. The Education Department's most recent default report last year showed that the three-year cohort default rate was 13.4% for fiscal year 2009 a rate that would put most banks under an enforcement action. (Private lenders had a roughly 5% default rate.)
Moreover, several private student lenders say they already offer aggressive refinancing plans.
"More than 90% of our customers are making on-time payments, and for our customers experiencing difficulty, we offer customized assistance, including modifications on more than $1 billion in private education loans," said Sallie Mae, the largest student lender, in an emailed response to American Banker. "We are committed to collaborating with the CFPB and helping our private education loan customers succeed."
One reason federal student loans have higher default rates is due to looser underwriting standards designed to make it easier for those with little to no income to secure a loan.
Still, while the Education Department and some lenders have programs to consolidate debt or reduce monthly payments, there is no sweeping plan from the government that helps borrowers refinance their payments if they encounter trouble after the graduate.
"Federal loan consolidation isn't truly a refinance, it's simply a combination of multiple loans into the weighted average interest rate," said Rohit Chopra, the CFPB's student loan ombudsman, in a conference call with reporters last week. "So there is really very limited activity in the refinance space."
Chopra added that he routinely hears from consumers holding six or more student loans that are both federal and private.
"It's difficult to determine whether those loans are federal or private," he said. It's difficult in determining "from a credit report and it's also difficult for the consumer to easily tell in one view what the rates on all their loans are."
As a result of the relative opaqueness of the student loan market, the secondary market has mostly stayed away from securitizing student loans. That makes it even tougher for the private market to take a lead role in refinancing student loans.
Many industry advocates say it's up to Congress to create a stronger refinancing program for federal loans or hold universities to a higher standard when offering federal loans.
"There is a disconnect where lawmakers could reform federal loan programs and make it more accountable," said Rob Lavet , general counsel for Social Finance Inc., one of the few nonbank student refinance lenders.
He suggested a policy in which schools would have to buyback a portion of the student loans if the portfolio hits a certain default threshold. This would also prevent lawmakers from having to create a public fund from taxpayer dollars in order to modify government-backed loans for struggling borrowers.
"Right now, schools are only kicked out of the federal loan program if they have horrific default rates but there's no risk-sharing," Lavet said. "You really wonder about the policy of that."
CFPB officials have hinted that if private student lenders don't take action on their own, the government could attempt to encourage or force refinancings.
"In terms of other authorities, there are certainly other ways that this could be done from a purely private market solution," Chopra said. "But what the comments suggested is that in order to expedite some of that activity, there may be a role for public participation."
Lawmakers are also concerned about the issue. Sen. Elizabeth Warren, D-Mass., introduced a bill last week that would temporarily lower the rate of certain federal loans set to increase July 1.
But that still does not address a disconnect occurring between the Department of Education and the servicers it has contracted to handle federal loans, including approving struggling borrowers into relief programs.
The Education Department declined to comment for this article.
Instead, it provided statistics showing that its federally-held portfolio had a 72% approval rating for 1.3 million applicants who requested an income-based repayment option as of Jan. 31. Their rating was significantly higher than the 58% approval by servicers for the Department for non-federal loans. However, the non-federal loans had a lower number of rejected applicants and far more applicants pending than federal loans with the Department of Education.
The Education Department has also repeatedly said that it offers consolidation of federal loans as well as payment options for certain loans based on income or "pay as you earn" plans for more recently originated loans. But most of these plans are limited to certain types of borrowers (excluding parents) and can incur extended taxes on the backend, unlike a typical refinanced mortgage.
It does not address some borrower's struggles in getting approved for payment reduction programs through the servicers of federal loans, especially if they wanted to consolidate a group of federal and private loans. Servicers are limited in reworking federal loans since they cannot change the actual terms of the loan.
"Our guys often take the heat because people see a servicer's name in a story, not realizing they work for the federal government," Bradshaw said.
Many lenders have left the student loan business since Congress redirected all of the federal loan programs directly to the Department of Education in 2010 to separate private lenders from taxpayer dollars. Because of this, many observers said it will again take another act of Congress to cap rising default rates of federal loans and restructure the market. The Senate Banking Committee was scheduled to discuss the private student loan market Thursday but has since postponed the hearing.
"There's starting to be much more attention from all parties, including universities and Congress" on the student loan market, Bradshaw said. "Congress will be going through higher education over the next two years starting this year and we expect some enactment next year."