Sallie Mae's student loan servicing changes could prove costly

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Sallie Mae, the nation’s largest private student lender, is curtailing its use of a collections practice that allows delinquent borrowers to delay making payments in the short term, which often costs them more money over the long run.

The Newark, Del.-based company announced last week that it plans to restrict its use of forbearance in an effort to prevent borrowers with private student loans from going long periods of time without making any payments. Those who have gone into forbearance at least once will have to wait six months before doing so again.

Sallie Mae also said that it plans to introduce a new program that will allow certain delinquent borrowers to make interest-only payments for up to six months.

The changes could be costly for Sallie Mae. The firm said that it expects the actions to accelerate loan defaults. It also said that defaults over the life of private student loans could increase by approximately 4% to 14%, though the company’s CEO emphasized that he thinks that range is high.

The changes were disclosed in a regulatory filing Wednesday and discussed the next day during the company’s third quarter earnings call.

CEO Raymond Quinlan did not offer a clear explanation of what prompted the changes, though he did say said that Sallie Mae takes feedback from both its regulators and its customers. “It’s always good to examine your practices,” he said.

Sallie Mae’s regulators include the Utah Department of Financial Institutions and the Federal Department Insurance Corp. The FDIC declined to comment, and the Utah agency had no immediate comment.

William Ryan, an analyst at Compass Point Research & Trading, said that he spoke about the changes with Sallie Mae officials, who seemed to suggest that regulators played a role.

“They said, ‘Look, from a regulatory perspective, everybody wants to make sure that losses are being recognized and not delayed,’ ” Ryan recounted.

Under the Current Expected Credit Losses accounting standard, which is expected to take effect for Sallie Mae on Jan. 1, banks will be required to forecast and reserve for lifetime credit losses upfront. Sallie said that it expects the changes it announced this week to increase the estimated impact of adopting the new accounting standard.

Forbearance allows student loan borrowers to avoid making payments for a specified period of time. But the term of the loan gets extended, and interest continues to accrue.

The frequent use of forbearance has been controversial in the realm of federal student loans, with industry critics alleging that borrowers get steered away from less expensive repayment plans.

In a 2017 lawsuit, the Consumer Financial Protection Bureau sued Navient Corp., which had been spun off from Sallie Mae three years earlier, over its forbearance practices.

The CFPB alleged that Navient added $4 billion in interest charges to the principal balances of borrowers who were enrolled in multiple, consecutive forbearances, and that a large portion of the charges could have been avoided if the company had followed the law. Navient has contested the allegations.

A borrower with $30,000 in federal student loans who spends a year in forbearance would pay an additional $2,247 in interest, according to a report last year by the U.S. Government Accountability Office.

The private student loan market looks quite different than the much larger federal market, in part because various government-backed payment plans for delinquent borrowers are not available.

“Borrowers generally struggle to access some affordable repayment option,” said Persis Yu, a staff attorney at the National Consumer Law Center, in reference to private education loans.

At Sallie Mae, approximately 2.6% of all private student loans were in forbearance as of Sept. 30, while 1.9% were classified as delinquent. Another 27.9% were in deferment or in a grace period, often because the borrower was still enrolled in school, and the rest of the portfolio was current.

Sallie Mae said that approximately half of the loans that it classifies as troubled debt restructurings involve a temporary forbearance of payments, while the other half involve a temporary interest rate reduction and a permanent extension of the loan term.

Sallie Mae also disclosed in a regulatory filing that it is planning to put greater focus on loan modifications as a way to partially offset the acceleration of defaults that it expects as a result of its reduced use of forbearance.
The company expects the changes to be fully implemented by the end of next year.

Quinlan noted that forbearance is a practice that Sallie Mae had designed specifically for the student loan industry, given the major life changes that college graduates typically experience in the initial years after graduation.

“But it’s always been a practice that people worry about because you don’t get a payment, and you’re not in particular contact with the customer,” he said. “We’d prefer to have more contact with our customers. We’d prefer to have a minimum payment.”

Quinlan also said that Sallie Mae will take steps designed to minimize the impact that the changes in its collection practices have on defaults.

Shares in Sallie Mae fell by more than 10% early Thursday, but they have since made up about half of that decline.

Analysts at Credit Suisse said that investors may be overrating the significance of the changes announced last week, in part because private student loans typically have co-signers.

“We note that these changes don’t impact Sallie’s relationship with the co-borrowers, whose performance could mitigate a significant portion of the higher defaults,” they wrote.

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Student loans Credit quality Delinquencies Consumer banking Law and regulation Sallie Mae Corp.