CFPB’s Student Loan Ombudsman Report Reveals Private Student Loan Securitization Problems

The CFPB’s Student Loan Ombudsman has issued a report on consumer complaints about student loans.  Of particular interest is situation of private student loan borrowers, whose loans were securitized (bolding added by me for emphasis):

While securitization is often closely associated with the mortgage market, securitization activity in the student loan market has also been notable. While many issuers offered securities backed by government-guaranteed student loans, the share of student loan asset-backed securities whose underlying assets consisted of private student loans increased rapidly in the years prior to the financial crisis.

Lending practices in the private student loan market in the years preceding the financial crisis shared many characteristics with those of subprime mortgage lending.  A strong investor appetite for asset-backed securities created incentives for originators to increase volumes quickly, leading to significantly-reduced credit quality.  Many private student loan borrowers found that their loans were sold to new parties.  Unsurprisingly, many private student loan complaints mirror the problems heard from consumers in the mortgage market as economic conditions began to deteriorate.

In effect, a lender had an incentive to increase loan volumes that were ultimately sold to investors, with less incentive to assure the creditworthiness of those loans. This dynamic provided the means and the incentive for lenders and issuers of student loan asset-backed securities to originate and securitize greater and greater amounts of loans. In 2006, issuance of private student loan asset-backed securities topped $16 billion.

Although the market has reduced risky lending following the financial crisis (private student loan underwriting has tightened substantially since 2008), many student loan borrowers continue to struggle with high-rate, high-balance student loans made prior to the crash.

Not only did this securitization boom fuel many of the risky loans that continue to experience distress today, but securitization may also add significant complexity when seeking to launch loan modification programs.  In many cases, the same market structure that precipitated a boom in private student lending has left borrowers with few or no options in times of financial distress. This factor closely resembles loan modification challenges identified in the subprime mortgage market in the wake of the housing crisis.