With a full plate of health, safety and security priorities on the table and the challenge served up by a deeply divided Congress, the prospects are dim for substantial student loan forgiveness in the early stage of the Biden/Harris Administration. Still, we anticipate the White House will try to find meaningful ways to reform a space that has become a progressive lightning rod. Any significant relief can reshape the future of student lending and securitization.
A Modest Proposal for Loan Forgiveness
As we‘ve reported, the first wave of student loan COVID-19 relief came in the form of temporary repayment suspensions and extensions for federal student loans and a moratorium on collections. In an Executive Order on day one of his presidency, President Biden asked the Education Department to continue these protections. The Education Department has paused student loan payments and interest accrual for federal student loans through September 30, 2021.
Throughout the pandemic, many progressive Democrats have pressed to see further action on student loans, including substantial loan forgiveness via executive order. But, keeping with his reserved tone on the campaign trail, President Biden has suggested loan forgiveness at the $50,000 level is not something he would pursue and that, in any event, he does not have the power to implement it by executive order. An executive order could result in litigation under the view it is a taking under the Constitution or a violation of the Anti-Deficiency Act. He has asked the Department of Justice to look into whether he could use executive action to cancel student debt.
Overall, Biden’s moves have shown a preference for legislative action. He has been supportive of the HEROES Act House bill, which called for $10,000 in loan forgiveness for “economically distressed” borrowers which would include the government paying off private loans. This may not be on the fast-track for Senate business, but the Senate did insert into the recent stimulus bill, dubbed the American Rescue Plan, a provision to make student loan forgiveness tax-free for five years—adding just a little more momentum and pressure on the Biden administration.
Impact on Student Loan ABS
Loan forgiveness could be a boon to student loan ABS by providing prepayments and liquidity immediately upon forgiveness. Whether the loans are federal or private, the lender would be paid and prepayment rates will go up but at least distressed borrowers will be less likely to default.
The impact on investors varies depending on the price paid for the bond. SCI has reported one source as saying, “if I owned the bonds at a discount, the prepayment would be positive, but if you purchase at a premium you get an unexpected prepayment and you lose the premium.”
The greatest area of uncertainty for ABS investors may be bankruptcy reform. While it may not be as flashy as loan forgiveness, this is an area that President Biden has shown support for and has motivation to change. One could argue it is a much more progressive idea as it would provide targeted relief to those who need it most, versus loan forgiveness, which would broadly benefit high earners as well as those struggling from lack of employment opportunities or unfinished degrees.
For federal student loans, given they are backed by a federal guarantee, the only impact might be a reduction of excess spread. But according to Fitch for private student loans, if more borrowers are able to discharge their loans in bankruptcy this could lead to less charged-off loans sales and collections post-charge-off which these investors benefit from now.
Whether or not there is federal bankruptcy reform, as we’ve reported, there have been some flickers of change with respect to the ways courts have found undue hardship and granted student borrowers discharge.
The Second Circuit’s three-part Brunner test assesses whether a debtor can show undue hardship to discharge a student loan. How circuits have interpreted Brunner has varied—some making it an impossible test to ever pass. Other circuits have applied a more forgiving totality of the circumstances approach. These different tests and approaches yield differing results depending on which circuit a debtor lives in. Therefore, a petition for a writ of certiorari has been filed in McCoy v. United States with the Supreme Court to see if the circuit split can be resolved. If the case is taken up, there is a chance that the assumption that student loans can almost never be discharged may be upended. This could seriously disrupt the realm for investors who expect this to be a rare occurrence.
CFPB and the Return of Enforcement
Student loan lenders, servicers, debt collectors, and other market players should get ready for more regulation and scrutiny in this new administration with nominee Rohit Chopra at the helm of the CFPB. Chopra is, after all, the former student-loan ombudsman at that agency who made a name for himself during the Obama administration pushing for greater protections for borrowers. As an FTC Commissioner, he has called for reforms around student debt, debt collection, and lending practices. He’s been critical of the way in which the Department of Education (DOE) oversees student loans. We expect to see him act on these previous grievances with stronger regulatory action and enforcement. We may even see an expansion of CFPB authority to include private student loans and a possible new federal bureau created exclusively for the oversight of student loans.
Greater enforcement may also be the result of greater harmony between federal agencies under the new administration. The relationship between the CFPB and DOE under the previous administration was contentious. The two existing Memoranda of Understanding between the DOE and CFPB for information sharing and enforcement cooperation were ended by the DOE in 2017, with the reestablishment of only minimal sharing of data after that.
During this time, servicers were instructed by the DOE not to cooperate with the CFPB. The servicers could only turn over materials to the CFPB examiners with the DOE’s permission. This effectively cut off the CFPB from being able to conduct examinations of servicers and they allowed this situation to drag on for years, giving the DOE all the power.
With a new head of the Department of Education, Dr. Miguel A. Cardona, coordinated action between the agencies is likely to return. Dr. Cardona has himself said student loan borrowers will be a priority for his agency.
In a time of great social and economic change brought about by the pandemic, student loan reform and enforcement may not be the highest priority for the new administration or Congress. However, its impact on lower income and disadvantaged segments of the population will continue to make it a focal point for progressive policy proposals, which could gain traction sooner if we come out of the pandemic in the coming months. In the meantime, if there is little activity at the federal level, look for more bankruptcy courts to potentially side with debtors in seeking relief from their student debt. Such relief on a case-by-case would be a slow road to change that is not likely to quell the calls for reform, though it will immediately affect the outlook for the risks and costs of private lending.
Nicole Serratore, an attorney in the Insolvency, Creditors’ Rights and Financial Products Practice Group of Davis & Gilbert, contributed to this post.