By Rick Hackett, former CFPB Assistant Director and F&I Sentinel Advisory Board Member
(Rick was responsible for auto and student lending at CFPB. Before joining the CFPB he represented student lenders and securitizers)
On March 19, 2024, the U.S. Courts of Appeals for the Third Circuit issued its opinion in National Collegiate Student Loan Trust, et. al. v. CFPB. The case may have significant implications for all of structured finance — including asset backed securities (ABS) used to fund the auto lending industry – as evidenced by the amicus briefs filed by multiple securities industry associations and the U.S. Chamber of Commerce. The case holds that the CFPB has jurisdiction over the trust in an ABS deal, because the trust “engage[s]” in a “consumer financial product or service,” which in this case involved acquiring and collecting student loans.
Does this decision matter to auto ABS issuers? Probably.
The extent of its impact depends on the differences between the fairly unique facts of NCSLT and typical auto ABS, and the similarities in the structure (and costs) of all ABS deals. Let’s begin with some background on why NCSLT is different and, perhaps, is a worst-case scenario.
Background on the National Collegiate Student Loan Trust Case
In the early 2000s, The First Marblehead Corporation (FMC) combined with TERI, the nation’s largest private student loan guarantor, to provide origination, guarantee, securitization and collections services for most of the U.S. banks in private student lending. Those loans, more than 800,000 in total, were originated on the FMC platform in white label arrangement (i.e., branded as the bank’s student loans), guaranteed by TERI, and purchased roughly every 90 days by a securitization trust. FMC caused the organization of the trusts and owned the residual equity (“residuals”) in the trust. FMC also oversaw the loan servicers, defaulted loan guaranty claims and the defaulted loan collections. The trusts were all versions of National Collegiate Student Loan Trust, and the trust administrator (who hired servicers and default managers) was an FMC affiliate. FMC went public and made significant profits from this structure, some in cash and some in future value of residuals.
In 2008, the ABS market froze, as part of the general financial meltdown. That shut down the forward flow of loans, because the banks involved would not make more NCSLT (FMC) loans without the ABS mechanism to sell them. TERI soon realized that, without the forward flow of new guaranty fees from new loans, it was cash flow insolvent, and it filed bankruptcy. FMC radically diminished its business and capabilities, the value of its equity in the trusts went to near zero, and the whole structure was unwound. FMC sold its residual equity in a fire sale and gave up administration of the trust assets (servicing and collection).
Because the loss of the TERI guaranty made the underlying student loans almost worthless, the NCT bonds became investment “junk,” and the new owner of the underlying residual equity was faced with the difficulty of collecting from students and parents directly, rather than from TERI. Logically, those collections would be aggressive and conducted at the lowest cost possible. The loans were orphan assets, and without the guaranty to back them up, they resulted in a large number of consumer collection suits, all bearing the strange name “NCSLT.” CFPB was certain to follow up and try to engage with this opaque entity, because there was no one else around to talk to. NCSLT rebuffed CFPB’s approaches, and the lawsuit ensued.
Differences Between NCSLT and Auto ABS
Unlike the NCSLT situation, most auto ABS involve loans that are serviced by the selling lender. The securitization is invisible to the consumer, except perhaps in the off-beat name of the lien holder on the car title. In many cases, the selling lender has a continuing customer relationship with the borrower, across multiple financial products. The selling lender has a reason to keep the consumer happy. Finally, and most importantly, the selling lender represents and warrants to the trust that the loan origination complied with all applicable laws, and has a repurchase obligation for breach of that warranty. As servicer, it makes similar representations about servicing activity. And the selling lender has a deep pocket to back up all of its representations as seller and servicer. What’s missing in NCSLT is both the seller’s customer relationships and the seller’s deep pockets — motivations to protect the trustee and the investors.
Also unlike NCSLT, large banks that originate and service auto loans, as well as larger finance companies, are already supervised by the CFPB. This takes the form of CFPB examination, a deep dive into all of their consumer-facing activities on a regular basis. Shoddy practices that might blow back on the trust should already have been uncovered.
While there are differences between NCSLT and the typical auto ABS situation, there is still reason for concern about the NCSLT decision.
Why the ABS Industry and Its Investors Should Worry
The amicus briefers in NCSLT surely knew that it was a perfect storm: orphaned assets, speculative investors, a broken plan for servicing and collection. Yet they briefed the case carefully and fully because of the principle: if the trust is subject to CFPB remedies for missteps in the ways the assets (the loans) were serviced, then trust assets may be liable for those CFPB remedies, which liability may go well beyond compensating the particular borrowers who were harmed. That loss will be born by bond holders, who in future deals will demand a risk premium, increasing the cost of borrowing to the next car buyer.
In addition, there’s the threat to the Delaware trust business model. Delaware banks who serve as trustees assume they are holder of “bare naked title” to the assets. Other parties, such as the loan servicer and a trust administrator, have sole responsibility for managing the assets and paying the bond holders. Now the CFPB is knocking on the door of the Delaware Trust Company. Presumably, the CFPB understands the “corporate veil” between the trustee and the trust, but that is not a certainty. Until that question is cleared up, fees to create a trust structure must escalate significantly.
NCSLT may have one other ramification for auto ABS that presents more risk to the securities industry than the student loan model involved in NCSLT. Unlike direct bank-originated student loans in NCSLT, most auto loans are originated indirectly by car dealers. That means the loans come with the “FTC Holder Notice.” That notice says that any holder of the asset is subject to all claims and defenses that the consumer could assert against the dealer. Such claims might range from defective merchandise to misleading sales practices to violation of (for example) the not-yet-effective FTC CARS rule. Lenders have long known about that exposure and have the ability to put back challenged loans to the dealer (or charge them to the dealer reserve). Proper ABS structures allow the trustee (administrator), to push back a similarly challenged loan to the selling bank, who can push it back to the dealer. But if the CFPB comes along and directly attacks the trust, alleging it is collecting defective assets, the repurchase arrangement may not work, and the injury to the trust assets may not be limited to particular loans affected by the particular dealer(s). All of this will need to be priced in and disclosed to bond holders.
In the end, ABS backed by loans sold and serviced by healthy, large financial institutions should not be materially affected by NCSLT. Their servicing obligations, plus seller’s reps and warranties and indemnities should cover the problem. But pricing for bonds arranged by sub prime finance companies that lack huge balance sheets should go up, if those deals can be arranged at all.
