2012 Association of Credit Union Internal Auditors Conference

Presented by Bob Glynn McGladrey LLP

Student Loans: The Next Bubble?June 20, 2012

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Objectives

By the end of this course, you will be able to know:

The types of student loans today What is driving the recent publicity around

student loans and how did we get here How does bankruptcy affect student loans Accounting and auditing considerations of

student loans Reg Z - Compliance issues related to

student loans

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What is a Student Loan

Federal Loans- Direct loans

- Federal Family Education Loans (FFEL)

Private Student Loans

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FFEL Loans

FFEL Program- Government guaranteed loans

- These were originated at credit unions or banks, yields typically very small due to high compliance costs, but risk of outright loss very minimal with government guarantees

- Requirement for a compliance audit on an annual basis depending on loan value

- Eliminated in 2010. All Federal Loans are now Direct with the Department of Education

“Taxpayers...paying banks a premium to act as middlemen—a premium that costs the American people billions of dollars each year....a premium we cannot afford.” - President Barack Obama

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Federal Direct Loans

Includes Stafford and Plus Loans Individual loan maximums and interest rate

changes are fixed by Congress Originated directly with the Department of

Education – guaranteed by the government Loans are serviced by 4 different providers

Sallie Mae, Nelnet, Great Lakes Educational Loan Services, or Pennsylvania Higher Education Assistance Society

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Private Student Loans

Originated by financial institutions, these are credit-based products used to bridge the gap between Federal Direct loans and other assistance and the cost of tuition

Terms and conditions are set by the financial institution, but generally interest rates are higher than Federal loans

Reg Z (2010) Requires very detailed disclosures to be made to borrowers throughout the loan application/approval process

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Federal vs. Private

These loans are typically not competing products Private lenders are compelled to educate potential

borrowers about Federal loans – including cost and rate comparisons

Private loans are for those who do not qualify for Federal or need additional funds

Key Differences- Private may have variable interest rates, limited

deferment options, or not require school certification

Key Similarity – All qualified education loans (Federal and Private) – may not be discharged in bankruptcy

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The $1,000,000,000,000 Bubble

Approximately $1 Trillion in total outstanding student loan debt

Only 15% or, approximately $150 billion is in private loan debt- In other words – 85% of this $1 Trillion is guaranteed by

the government and not private financial institutions

Of the $112 billion in new student loans in 2011, 7% were originated through the private sector

Borrowers are unable to tap HELOCS due to decreased home values

*Data from 2012 Sallie Mae Annual Report

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Where Have We Seen This Before

It’s a story of an industry that may sound familiar. The buyers think what they’re buying will appreciate in value, making them rich in the future. The product grows more and more elaborate, and more and more expensive, but the expense is offset by cheap credit provided by sellers eager to encourage buyers to buy.

Buyers see that everyone else is taking on mounds of debt, and so are more comfortable when they do so themselves; besides, for a generation, the value of what they’re buying has gone up steadily. What could go wrong?

* Excerpted from Glenn Reynolds, financial blogger

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Tuition Increases vs. Home Prices vs. CPI

* source, www.businessinsider.com

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Tuition Prices vs. Home Prices

Note that the housing bubble illustrated in...[this] chart...shows home prices between 1978 and 2006 increased by 'only' a factor of 4.35, while the cost of college has increased by much more than twice that amount since 1978 in the bottom chart. Over the last three decades, college tuition and fees have gone up by a factor of 10.5, and they show no sign of slowing down. For the last 12 months through July of 2011, the CPI for college tuition and fees increased by almost 6 percent, more than 4 times the 1.3 percent increase in consumer prices in general over that period.

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What is driving this tuition price increase?

- More access to higher education for those of lesser means

- Recession caused more individuals to go back to school to bolster skills/resumes

- Increased technology and better infrastructure

- More program offerings

- EASY ACCESS TO FUNDS, FOR WHICH THE FINANCIAL INSTITUION MAKING THE LOAN HAS LITTLE TO NO CREDIT RISK• Note the correlation between the change in bankruptcy

protection for student loans in 2005 with the steepness of the tuition increase – probably not a coincidence

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Back to That Bubble

The majority of these Private student loans are not with credit unions- The top 10 originators make up almost 70% of the private student

loan market

Banks, especially the large banks such as Chase, Citi, BOA, etc have large serviced portfolios of Private student loans – Sallie Mae (SML Corp) is the largest originator of Private student loans

Similar to the real estate loans, these loans can be packaged and sold as bonds to investors looking for a fairly low risk investment (loans are protected in bankruptcy) - Per Fitch, little risk in pure SLABS backed by FFELs, whereas

increased defaults can be seen in Private SLABS originated prior to the recession.

- This should sound very familiar to those CU’s that had stakes in Members United or indirectly with US Central

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Pin Meet Bubble

Senator Dick Durbin has proposed the Fairness for Struggling Students Act- Would allow for Private student loans to be discharged in

bankruptcy – unknown if this would be retroactive or prospective

- No affect on Federal direct loans

- Would apply same bankruptcy standards to Private student loans, as other debt such as credit cards

Potential side effects (good and bad)- Could cause immediate devaluing of student loan backed

bonds

- Potential decreases in college tuition as supplies of funds dry up

- Potential raises in borrowing cost to individuals to offset credit risk potential

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Other Current Events

Congress is debating the scheduled increase in interest rates on Federal direct loans from 3.4% to 6.8% this summer- Could cause a rash of defaults in these Federal loans

- Increase is still cheaper than most Private loans

The Federal Reserve Bank of New York has estimated that total delinquency across all student loans is 27%

Sallie Mae (the largest servicer of all types of student loans) has reported the following as of March 31, 2012 specific to their portfolio- Total delinquencies in their $40 billion Private loan portfolio was

9%, but 90+ was 4.4%, which is down from 6.9% in 2009

- In their $135 billion managed Federal loan portfolio, total delinquencies are 16.9% with 90+ of 7.9%

For-Profit schools make up 10% of total Private loans, but account for nearly half of all defaults (USA Today)

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Accounting and Auditing Matters

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Understand the Universe

Know your population of student loans- Runoff of FFEL program will last several years

and still require an annual compliance audit depending on volume

- Do you offer Private student loans? Do your loan officers know if they do?

- If they are offered, are they flagged and categorized in a proper way in the loan subledger to allow for monitoring

- Are home equity loans, which are used for educational purposes flagged

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CU Impacts

Potential exposure to the Bubble- Micro Impacts

• Any investments in SLABS

• Do Member Investment CUSO’s currently have members in these products

• Exposure to portfolio Private student loans

- Possible file reviews to understand full credit risk if changes to bankruptcy laws are put into place

◦ Co-signors?

◦ Possible additional judgmental factor in ALL

- Macro Impacts• A collapse in this sector would likely upset banks more than CU’s

• Inability to discharge student loans, could cause increase in credit card charge-offs for younger people

• Collapses bring more regulation

• Prolong the waiting for the economic recovery – young people paying back loans versus spending

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Regulation Z – Private Student Loan Disclosures

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Student Loan Compliance Disclosures

Key Definition Private education loan means an extension of credit that:

- (i) Is not made, insured, or guaranteed under title IV of the Higher Education Act of 1965 (20 U.S.C. 1070 et seq. );

- (ii) Is extended to a consumer expressly, in whole or in part, for postsecondary educational expenses, regardless of whether the loan is provided by the educational institution that the student attends;

- (iii) Does not include open-end credit any loan that is secured by real property or a dwelling; and

- (iv) Does not include an extension of credit in which the covered educational institution is the creditor if:• (A) The term of the extension of credit is 90 days or less; or

• (B) an interest rate will not be applied to the credit balance and the term of the extension of credit is one year or less, even if the credit is payable in more than four installments.

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Student Loan Compliance Disclosures - General/Timing Form of Disclosures

- Clear and conspicuous

Transaction Disclosures- Made in writing for the member to keep

- May include an acknowledgement of receipt

- Must include certain known terms – similar to other lending disclosures • ‘Finance Charge’ or ‘Interest Rate’ must be the most conspicuous disclosures on the

form.

Timing of Disclosures- Provided with any application or solicitation

- May be made orally over the phone if written disclosures are made within 3 business days

Required Disclosures – All of them must be provided and be in compliance for the loan to qualify as a qualified private education loan- Application

- Approval

- Final

- Note

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Student Loan Compliance Disclosures – Content: Application

See Attachment 1 for example application disclosures (1) Interest Rates.

- (i) The interest rate or range of interest rates applicable to the loan and actually offered by the creditor at the time of application or solicitation. If the rate will depend, in part, on a later determination of the consumer's creditworthiness or other factors, a statement that the rate for which the consumer may qualify will depend on the consumer's creditworthiness and other factors, if applicable.

- (ii) Whether the interest rates applicable to the loan are fixed or variable.

- (iii) If the interest rate may increase after consummation of the transaction, any limitations on the interest rate adjustments, or lack thereof; a statement that the consumer's actual rate could be higher or lower than the rates disclosed under paragraph (a)(1)(i) of this section, if applicable; and, if the limitation is determined by applicable law, that fact.

- (iv) Whether the applicable interest rates typically will be higher if the loan is not co-signed or guaranteed.

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Student Loan Compliance Disclosures – Content: Application (cont.)

2) Fees and default or late payment costs. - (i) An itemization of the fees or range of fees required to obtain the

private education loan.

- (ii) Any fees, changes to the interest rate, and adjustments to principal based on the consumer's defaults or late payments.

(3) Repayment terms. - (i) The term of the loan, which is the period during which regularly

scheduled payments of principal and interest will be due.

- (ii) A description of any payment deferral options, or, if the consumer does not have the option to defer payments, that fact.

- (iii) For each payment deferral option applicable while the student is enrolled at a covered educational institution:• (A) Whether interest will accrue during the deferral period; and

• (B) If interest accrues, whether payment of interest may be deferred and added to the principal balance.

• (iv) A statement that if the consumer files for bankruptcy, the consumer may still be required to pay back the loan.

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Student Loan Compliance Disclosures – Content: Application (cont.)

(4) Cost estimates. An example of the total cost of the loan calculated as the total of payments over the term of the loan:- (i) Using the highest rate of interest disclosed under

paragraph (a)(1) of this section and including all finance charges applicable to loans at that rate;

- (ii) Using an amount financed of $10,000, or $5000 if the creditor only offers loans of this type for less than $10,000; and

- (iii) Calculated for each payment option.

(5) Eligibility. Any age or school enrollment eligibility requirements relating to the consumer or co-signer.

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Student Loan Compliance Disclosures – Content: Application (cont.) (6) Alternatives to private education loans.

- (i) A statement that the consumer may qualify for Federal student financial assistance through a program under title IV of the Higher Education Act of 1965 (20 U.S.C. 1070 et seq .).

- (ii) The interest rates available under each program under title IV of the Higher Education Act of 1965 (20 U.S.C. 1070 et seq. ) and whether the rates are fixed or variable.

- (iii) A statement that the consumer may obtain additional information concerning Federal student financial assistance from the institution of higher education that the student attends, or at the Web site of the U.S. Department of Education, including an appropriate Web site address.

- (iv) A statement that a covered educational institution may have school-specific education loan benefits and terms not detailed on the disclosure form.

(7) Rights of the consumer. A statement that if the loan is approved, the terms of the loan will be available and will not change for 30 days except as a result of adjustments to the interest rate and other changes permitted by law.

(8) Self-certification information. A statement that, before the loan may be consummated, the consumer must complete the self-certification form and that the form may be obtained from the institution of higher education that the student attends.

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Student Loan Compliance Disclosures – Content : Final (c) Final disclosures. After the consumer has accepted the loan in

accordance with §1026.48(c)(1), the creditor shall disclose to the consumer the information required by §1026.18 and the following information:- (1) Interest rate. Information required to be disclosed under §1026.47(b)(1).

- (2) Fees and default or late payment costs. Information required to be disclosed under §1026.47(b)(2).

- (3) Repayment terms. Information required to be disclosed under §1026.47(b)(3).

- (4) Cancellation right. A statement that: • (i) The consumer has the right to cancel the loan, without penalty, at any time before the

cancellation period under §1026.48(d) expires, and

• (ii) Loan proceeds will not be disbursed until after the cancellation period under §1026.48(d) expires. The statement must include the specific date on which the cancellation period expires and state that the consumer may cancel by that date. The statement must also specify the method or methods by which the consumer may cancel. If the creditor permits cancellation by mail, the statement must specify that the consumer's mailed request will be deemed timely if placed in the mail not later than the cancellation date specified on the disclosure. The disclosures required by this paragraph (c)(4) must be made more conspicuous than any other disclosure required under this section, except for the finance charge, the interest rate, and the creditor's identity, which must be disclosed in accordance with the requirements of §1026.46(c)(2)(iii).

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Potential Results of Failing to Comply

Qualified Private student loans may be disqualified due to missing disclosures - Opens up the possibility of discharging these in

bankruptcy as regular unsecured loans

Reg Z also provides for criminal and civil penalties for failure to comply

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Questions?

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