CFPB Deal Could Mean Relief From Wall Street's Worst Student Loans

(Bloomberg) -- Hundreds of thousands of Americans in debt from the worst batch of student loans Wall Street ever bundled could see their balances cut under a tentative agreement the feds have struck with a little-known firm that effectively owns more than $8 billion in securitized student debt.

The tentative deal, which has not yet been finalized, would resolve a years-long investigation by the Consumer Financial Protection Bureau into consumer lawyers’ allegations that debt collectors for the 15 trusts that hold that debt have flooded courts with sloppy lawsuits against tens of thousands of borrowers accused of having defaulted.

Those trusts, the National Collegiate Student Loan Trusts, are collectively one of the nation’s largest owners of private student debt. Their preliminary settlement with the CFPB was reached by their ultimate owner, VCG Securities LLC, a Florida-based investment firm led by Donald Uderitz. If finalized, it would require the payment of “large sums” in restitution to borrowers and civil penalties to the U.S. government, according to a summary of the proposal filed in a separate court case.

The specific terms of the draft settlement weren’t clear Friday. David Mayorga, a CFPB spokesman, declined to comment. Uderitz said he couldn’t comment on the settlement because he was bound by confidentiality. Past settlements have required loan companies to correct business practices the CFPB considers improper.

The trusts, created more than a decade ago, cumulatively have held well over 874,000 loans made to more than 812,000 people who borrowed money from banks mostly to pay for their higher education, according to filings with the U.S. Securities and Exchange Commission and monthly reports to investors. Those banks sold the loans to a middleman who created the trusts, and the trusts then sold notes promising certain returns to investors ranging from the hedge-fund manager Waterfall Asset Management LLC to the Bill & Melinda Gates Foundation. Monthly payments to investors are backed by borrowers’ monthly payments on their student loans.

The loans, made by banks such as JPMorgan Chase & Co. and Bank of America Corp., largely went to borrowers with good credit scores, and more than 80 percent of them were co-signed by someone else, like a parent, securities filings show. But many of them came due in the aftermath of the 2007-09 financial crisis, and borrowers ended up defaulting at record rates.

Of the original $12 billion in loan principal bundled into the trusts, about 42 percent—$5 billion, including interest—were in default as of June 30, the trusts’ administrator’s disclosures to investors show.

Initially, investors who bought the loan-backed securities had generous protection against the risk that borrowers would default en masse—but the 2008 bankruptcy of the nonprofit that had guaranteed their loans ended that arrangement. Collection efforts in the form of mass lawsuits filed by debt-collection law firms ensued.

Consumer lawyers say borrowers generally don’t show up in court, leading to default judgments against them that could eventually lead to wage garnishment. But the lawsuits haven’t led to big recoveries for investors. And in recent years, a number of judges around the U.S. have dismissed the trusts’ lawsuits against borrowers or else ruled against their debt collectors, citing sloppy paperwork.

Of the more than $4.1 billion of defaulted loans that insurance didn’t cover, investors have recovered $538 million—or 13 cents out of every $1 in default. The rest remains unpaid.

All 10 of the worst-performing student-loan investment vehicles ever created, when measured by defaults on the underlying loans relative to amounts borrowed, are among the 15 National Collegiate Student Loan Trusts, said Jon Riber, a DBRS Inc. analyst who specializes in consumer debt that’s been bundled into securities.

Last month, Ambac Financial Group Inc., which has nearly $1 billion of exposure to the securities through insurance it sold investors, cited a potential CFPB enforcement action as one reason it could be forced to set aside an extra $200 million to cover losses.

Sean Silva, an outside spokesman for Ambac, didn’t respond to messages seeking comment. Neither did Tristan Fleming, general counsel of Goal Structured Solutions Inc., the parent company of the trusts’ administrator; representatives for Transworld Systems Inc., the debt collector that hires law firms to pursue borrowers in court; nor Nathan Hench or Keith New, spokesmen for the Pennsylvania Higher Education Assistance Agency, which handles the accounts of borrowers who are making steady payments. Dana Ripley, a spokesman for U.S. Bancorp, which ultimately oversees debt collection on behalf of the trusts, declined to comment.

Uderitz, the Florida investor whose firm VCG ultimately owns the National Collegiate trusts, for years has been trying to assert management of them in order to juice recoveries, legal filings show. As part of that effort, he partnered with Boston Portfolio Advisors Inc., a Fort Lauderdale, Fla.-based firm, to form a student loan company called Odyssey Education Resources LLC in order to collect from borrowers they say have defaulted, in some cases by reducing their balances.

He reckons that his newer company can do a better job than the trusts’ existing loan contractors. For instance, in a contested audit it conducted two years ago with VCG, Boston Portfolio said PHEAA, which deals with borrowers making payments, was missing loan-ownership documents critical to suing defaulted borrowers; PHEAA has said it wasn’t responsible for any missing documents.

Uderitz hasn’t yet gained the confidence of fellow investors or the various companies that manage the trusts. On Friday, Fitch Ratings Inc. said it assumed many of the trusts won’t be able to collect anything at all from troubled debtors, “in light of recent lawsuit uncertainty between the trusts and defaulted borrowers.”

To contact the author of this story: Shahien Nasiripour in New York at snasiripour1@bloomberg.net.

To contact the editor responsible for this story: Samantha Schulz at sschulz17@bloomberg.net.