SecondMarket attended the 2012 EFC Annual Membership Meeting in Arizona last week. Here is a summary of the event:
As the Education Finance Council celebrated its 20th anniversary, attendance was quite strong with approximately 150 participants.
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Federal Direct Loan Servicing – Implementation Challenges for NFP Servicers
Moderator:
Ron Gambill, Chairman & CEO, EdSouth
Panelists:
Raymond Bayer, Jr., Executive Director & CEO, Missouri Higher Education Loan Authority David A. Feitz, Executive Director, Utah Higher Education Assistance Authority Elena Lubimtsev, Senior Vice President, Government Relations Officer, Edfinancial Services
In this session, the three panelists discussed the challenges which each of their respective organizations faced in becoming a not-for-profit servicer for direct loans. Ray Bayer spoke first, walking the attendees through the various obstacles for MOHELA, both prior to and after the account conversion. Bayer discussed the importance of a ‘welcome packet’, in order to explain to the borrowers that their accounts were in the process of being transferred to a new servicer, one of which they had likely never heard. Operationally, setting up the IPAC (Interagency Payment and Collection) process with the Department of Education was difficult for MOHELA, and the funds transfer still continue to take over 60 days in certain instances. His company has also set up an internal escalation team in order to deal with continued requests for information from the Department. Post-conversion, the largest hurdle MOHELA faced was the sheer volume of calls received from the borrowers (1,000s per day). They have also had to hire many more Spanish-speaking operators, to address the new demographic.
Elena Lubimtsev spoke on behalf of Edfinancial Services, which is based out of Tennessee. She talked in depth about how her organization worked in teams to meet the various MOU deadlines to become a servicer. Edfinancial will be converting approximately 300,000 accounts in March, which will clearly be a big test for them. Lubimtsev discussed the importance of breaking the long process into small pieces (she organized 22 different focus/implementation teams) with weekly meetings for proper coordination. She also noted the big role that outside consultants played to get everything set up, which she had not expected.
Dave Feitz concluded the panel with a discussion on his situation at Utah. They’ve been allocated a total of 104,500 accounts (slightly more than the 100,000 limit) with a total principal balance of $2 billion. The borrowers come from every state in the nation plus the territories (only 9 accounts are from Utah), so they changed the name of their servicing operation to CornerStone to move away from a very regional name. As they are also a servicer for FFELP loans, they have worked to create an integrated information network system which can seamlessly handle both loan types. He described the background check process which each CornerStone employee underwent in order to get federal approval as being “very invasive” and thorough.
There are currently 31 not-for-profit direct loan servicers, which the panelists all agreed is a good sign. They are all working to establish a non-profit brand in loan servicing, just as they were able to on the origination side under FFELP.
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Overcoming Hurdles and Obstacles in Setting Up a Supplemental Loan Program
Speakers:
Charles P. Kelley, Executive Director, Rhode Island Student Loan Authority Steven W. McCullough, President & CEO, Iowa Student Loan Liquidity Corporation Lauris Rall, Partner, S&R Denton Mark Weadick, Managing Director, Student Loan Capital Strategies
Mark Weadick opened the panel with a quick overview of the private student loan market. He estimated that there are approximately $870 billion in total loans outstanding, about $110 billion of them being private. The securitizations being completed today are mostly single-A rated transactions (very few AAA ratings are given out by S&P currently), and the tax-exempt fixed rate bond market is open for business. He said that today’s private loan originations are about $8 billion, and that lenders are requiring school-certifications for all loans. He described the private student loan securitization market as still being challenged, and that sponsor brand remains critical to market share.
Charlie Kelley talked about the various obstacles associated with the marketing of private loans. He first stated that federal regulations make it difficult for lenders to market their private loan product. He finds himself constantly fighting the perception that federal loans will always be better than private loans. For his state of Rhode Island, he finds that direct mail is the most effective in reaching out to potential new borrowers, but the mailing list will always be incomplete. He admits that the federally mandated disclosures are a challenge, but still believes that his RIFEL program is better than the federal direct PLUS loan.
Lauris Rall then went through a list of all of the legal issues that private loans originators need to consider as they design and implement their program. Rall mentioned that the establishment of the Consumer Financial Protection Bureau has made it even more complicated for private loan lenders. Issues which the originators need to keep in mind include: consumer disclosures (both federal and state), marketing regulations, credit-based pricing, tax issues, Truth in Lending rules, tax implications and financing vehicle limitations, etc.
Steve McCullough began his discussion by talking about how, as a non-profit, they are compelled to make loans that for-profit originators will not. That is one definitive way of how a non-profit can service the needs of a borrower that is not met by the other for-profit counterparts. Additional challenges include the influence which the ratings agency has over the design of the loan program (to create loans which are able to be financed in the term securitization market), as well as questions surrounding the borrower’s ability-to-pay for loans with a cosigner. Iowa has implemented what they term the “Student Loan Game Plan” for both the student and the cosigner, which include mandatory financial literacy tutorials, warnings to students of the dangers of high debt levels and potential salary levels for their respective degrees, etc. Iowa believes that this will lead to lowering excess borrowings on the part of the student, thereby increasing the ability of the lender to collect.
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Credit Risk Management for Supplemental Loan Programs
Speakers:
Stephen Dessner, President, Unifund Thomas Graf, Executive Director, Massachusetts Educational Financing Authority Michial Thompson, Managing Director, First Marblehead Corporation
This panel focused on the student loan data analytics, risk management and portfolio trends necessary to managing a successful private loan program. Tom Graf kicked off the discussion by talking about how the significant disruption in the securitization market hurt the ability of lenders such as MEFA to finance loans (originations experienced a huge drop-off from the 2007~2008 academic year to that of 2008~2009). As Graf sees it, his competitive advantage is the ability to formulate a comprehensive approach to financing education (prepare/finance/repay). All of MEFA’s originations are certified by schools, and annual professional development seminars give the students some of the skillsets needed to become more fiscally responsible. Graf stated that another competitive advantage is the quality of schools within his state of Massachusetts; the cohort default rate for 2009 was 4.7%, compared to 7.17% nationally. They also have 30 years’ worth of historical performance data on which they could rely to get financing.
Michial Thompson of First Marblehead went into an in-depth talk on the analytics behind successful portfolio management strategies. He believes that the keys to formulating such strategies center around: having a strong credit policy, managing your own student loan collection efforts, data & analytics, as well as getting accustomed to the various idiosyncrasies of the student loan sector such as deferments and cosigners. In the last few years, much better data and analytics tools have allowed holders to gauge their respective portfolios in a more meaningful way. However, he believes that many lenders still rely too heavily on FICO scores of cosigners. In his experience, cosigner FICO is not a very good indicator of loan performance.
Dessner represented Unifund, a company that purchases underperforming consumer loans, including student loans. Unifund has purchased $6 billion of debt over the past 3 years, and is looking to buy pools of defaulted student loans. As part of their overall strategy, Unifund seeks to collect data points which may seem extraneous as separate pieces but tell a story as a whole (i.e. data on people who have purchased riding lawn mowers and aluminum siding to deduce the people whom are likely to be homeowners. Being a homeowner can lead to certain assumptions about income and net worth adequacy.) Dessner also spoke about the use of predictive analytics to help monitor student loan performance.
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Implementation of the Dodd-Frank Act – What You Need to Know
Moderator:
Vince Sampson, President, Education Financing Council
Panelists:
Cindy Tjoe, Director, KPMG Blake K. Wade, Partner, Ballard Spahr
In this session the panelists discussed the effects of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and its role on the student loan finance market. Blake Wade started the discussion by focusing on a few of the many rules and topics which directly impact the student loan market. The focal points for his discussion were Risk Retention/”skin in the game”, the underwriting “Fair Dealing Interpretive Notice”, reporting requirements on repurchase obligations, rating agency reports, proposed Volcker Rules and Financial Advisor Rules.
The Risk Retention or “skin in the game” requires underwriters to purchase at least 5% of the assets they securitize, which is intended to align the interest of the underwriter with the investors. A key takeaway was the emphasis on the roles of the underwriter and financial advisors, as another important focus was the role of financial advisor and underwriter through the “Fair Dealing Interpretive Notice” which requires a clear distinction between the financial advisor and the underwriter. The underwriter must make it clear that they are acting as principal not as fiduciary, and disclose any third-party payment. Blake also mentioned that the SEC has stated that more information will be disclosed on EMMA on a go forward basis.
Cindy Tjoe continued by rehashing many of the items discussed by Blake and mentioned that the majority of the rules have not been finalized and that there is still a lot going on and a lot left to do before Dodd-Frank is finalized.
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Capital Markets Update – The New Normal
Speakers:
Christopher G. Cronk, Managing Director, Bank of America Merrill Lynch Jeff Jackson, Managing Director, Ramirez & Co., Inc. Bart Steenbergen, Managing Director, BMO Capital Markets Jeffrey J. Wagner, Managing Director, RBC Capital Markets
Jeff Jackson commenced the capital markets discussion by speaking about the macroeconomic environment, touching briefly on the Greece restructuring and his belief that they will likely default again in the future. China is currently spending about 50% of its GDP on infrastructure development, while the U.S. is at 12.4% (just ahead of Cuba). Bart Steenbergen also remarked that while the overall economy is still not in great shape, things are getting better. But the tough financial environment is continuing to affect people’s views on private credit.
Chris Cronk cited $125 billion of total asset-backed securities issuance in 2011 vs. $104 billion in 2010. He said that the spreads for high quality ABS has been resilient, and that there have been $17.5 billion of student loan ABS issued since January 2011 in 27 different transactions. And there is significant market segmentation: there’s Sallie Mae, then Nelnet, and then everyone else.
Cronk also walked through the various issues investment banks are facing when structuring transactions. He talked about the difference between wide window pass-through securities versus the traditional sequential pay-down bonds. Also, today’s investors are seeking tight structures with small servicing and admin strips, and digging deeper into the quality of loan servicing and the bankruptcy remoteness. He also mentioned that he expects the primary source of 2012 FFELP securitizations to be from both the Straight-A conduit and the continuing refinancing of auction-rate trusts.
Jeff Wagner talked about how even Sallie Mae no longer seeks to get AAA from S&P in doing their transactions. Their most recent deal is expected to receive AAA/Aaa from Moody’s and Fitch, respectively. Investors are getting more comfortable with buying S&P AA+ bonds, given that it seems to be the highest level that S&P is handing out currently. As collateral that is sitting in the Straight-A conduit is now shorter in maturity (5 years and in), it should be possible to get it financed in the term market. Steenbergen then talked about how while some investors have a strict AAA restriction when it comes to investments, they will naturally have to amend such criterion to play in new issues. The EdSouth transaction will likely price at about 30 to 35 basis point premium to Sallie Mae.
They continued by discussing the ARS restructuring and cited that $6.7 billion has been refinanced since January 2011 (90% restructured using LIBOR FRNs, 6% fixed rate and 4% using VRDNs). The remaining ARS “overhang” is an estimated $33 billion. Restructuring has slowed down considerably but as downgrades cause max rate formula multipliers to increase, we could see an increase in activity, but that the low hanging fruit is already done. The restructuring done last year was also largely aided by broker dealers holding large amounts of paper willing to sell at a significant discount. They also mentioned that competing with the volume of Straight-A deals will also make things more difficult.
There is also a push to get ARS issuers to switch the key rates for the max rate formulas from 3 month CP to 1 month LIBOR where the trust allows. Jeff argued that it makes more sense to go with LIBOR as you are able to eliminate basis risk and better plan where the rates will fall on a go forward basis.
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Washington Update
Speaker:
Vince Sampson, President, Education Finance Council
In this panel, Vince Sampson talked about what’s going in Washington and how these events impact nonprofit and state agency student loan providers. He touched on key legislative issues and executive branch initiatives including the current activities of the Department of Education. Vince discussed how Congress has been essentially gridlocked (only 326 bills passed the House last year compared to 970 in 2010) and therefore a lot of the action has shifted to the executive branch. There is a big debate as to how to “protect the middle class” with the right believing that eliminating big government and the left believing we should eliminate big business. There was also a big focus on the effect of Direct Loan Program and the sheer size of borrowing that the Fed will have to undertake (approx.. $176 billion in 2012 and another $147 billion in 2013 is expected).
Next on the agenda, he discussed how the focus in Washington has shifted from college “Completion” to “Affordability”. There are several college affordability proposals in the FY 2013 Budget from the current administration and he expects them to be a topic of discussion in the upcoming election. He also mentioned that the economy will be the most important issue in the upcoming election and that unemployment will be a large factor. Vince touched on some of the initiatives of the Consumer Financial Protection Bureau such as the private student loan complaint line and the attempt to understand the student loan market more fully. In closing he mentioned the likely 50/50 partisan split will make things even more difficult going forward and we should expect more gridlock.
