Sunday, July 23, 2017

Untrustworthy National Collegiate Trusts or untrustworthy NYT Reporting ?

Shoddy loan sharking or just shoddy reporting?


On July 17, 2017 New York Times broke the next big story on the sub-prime horizon: “As Paperwork Goes Missing, Private Student Loan Debts May Be Wiped Away." 

International News Too - Voila, Free of Debt 

The article cited a few cases in which National Collegiate Student Loan Trusts had sued students-borrowers and had suffered setbacks on appeal. Also see Consumerist story headlined “$5 Billion In Private Student Loans Could Be Wiped Away Because Of Shoddy Record Keeping" and Business Insiders' equally hypy intimation that $5 billion in student loans may be dismissed because the lender lost the paperwork

The referenced appellate court opinions tell a more granulated story. Not as complex as the hard-to-comprehend securitization transactions involving private (i.e. non-federal) student loans themselves, but well worth reading as an antidote to the hype emanating from New York about billions of oustanding student loans and bonds secured by them dissipating into a mirage on the horizon. 

In NTL COLLEGIATE STNDT LN TRUST 2005-1 v. ISAAC OWUSU, 2016 Ohio 259 (2016), an Ohio court of appeals reversed a summary judgment for the Trust because the Trust had not included specific documentation to directly link the pool of debts assigned to NCSLT from  the program lender, Charter One, to the debt Owusu's incurred. 

The appellate opinion does not provide support for the proposition that “the debt was wiped out” and the reviewing court expressly stated that its resolution of Owusu’s appeal and its opinion should not be taken as any indication of the ultimate merits of this case, given that NCSLT may supplement the trial court record upon remand to trial court. NCSLT attempted to add to the record while the appeal was pending, a request that the appellate court denied because the rules of procedure required it to review the summary judgment granted by the court below on the basis of only those documents that were before the trial court at the time the trial court ruled in NCSLT’s favor. NCSLT was not precluded from producing better evidence later on, on remand to the lower court.

In NATIONAL COLLEGIATE STUDENT LOAN TRUST 2003-1 et al v. ADAM BEVERY et al, 2014 Ohio 4346, a different Ohio court of appeals agreed to set aside default judgments entered against lawyerless defendants and to remand both cases to the Huron County Court of Common Pleas for further proceedings. As in the Owusu case, the Court of Appeals did not wipe out the alleged debt, but merely vacated judgments in favor of the Trust (and the trial court’s denial of their motions for relief from judgment), and sent the cases back to the court below for retrial. Unsurprisingly, the defendants had competent attorney representation on appeal, and properly presented their case. The reversal was not a final adjudication on the merits, and did not resolve the matter for good. 

The few appellate cases referenced by the New York Times in its July 17, 2017 article titled “As Paperwork Goes Missing, Private Student Loan Debts May Be Wiped Away“ and other media outlets that followed its lead, do not warrant the conclusion that merely because some lawyers for NCSLT in some cases did not adduce sufficient documentation to prove their case, or did not satisfy the relevant rules of evidence when held to their burden of proof, all such cases are doomed; much less that none of the underlying loan notes are enforceable, thus rendering worthless the entire pool of loans nominally valued in billions.

Indeed, a generalization based on such a tiny and unrepresentative sample of cases that reached the court of appeals, is a logical fallacy, and is therefore properly characterized as hyperbole.

More signs of international propagation: Italy 
The New York Times story nevertheless snowballed, and has apparently already spooked the financial markets, and given rise to even more misconceptions.

On July 18, 2017 - the day after - Business Insider seconded the New York Times with the headline proclaiming that “$5 billion in student loans may be dismissed because the lender lost the paperwork.” 

This headline exemplifies a logical fallacy likewise, because the premise of a dismissal due to missing “paperwork” presupposes that a lawsuit is filed in the first instance that gives a court subject-matter jurisdiction over the defaulted loans, and triggers the applicable burdens of proof, though that burden of proof is very low in the context of default judgments (at least in Texas). 

The various NCSLT Trusts may have been busy filing thousands of collections cases through TSI’s network of attorneys throughout the country, but that is a tiny percentage of all collateralized private student loans under the National Collegiate Trust umbrella. Nor are all loans in default in the first instance so as to provide a legal basis for a collection suit to even be contemplated as a collection tool and as a means to upgrade portfolio performance. 

Finally, NCSLT could simply stop filing lawsuits and rely on other collection methods, and thereby deprive courts of cases, a few of which might be resolved against it. Until the Trust, or the financial gurus behind it, get sued for some sort of grand wrongdoing connected with origination and securitization, the Trust - or whoever is at the helm - is also in control of the litigation machine, and could simply pull the plug, which is unlikely to happen for reasons that will be discussed below.

Hailing from Delaware: National Collegiate Student Loan Master Student Trust
and Progeny of more than a Dozen  

Delaware Department of State: Roster of NCSLT Trusts
Who is currently at the helm of the Trusts is not that clear because the Trusts' governing documents themselves are ambiguous (or at least arguably so, for high-octane lawyers) as to the respective roles of Owners, Owner Trustee, Administrator, Indenture Trustee, and Servicers, and because some of the original players performing these respective roles have been substituted or have otherwise changed. PHEAA, the original loan servicer, is currently embroiled in litigation with the Trusts over who is in charge, and who has the power to set policy on such matters as forbearance agreements and handling of defaulted loans.

Another current issue is the push to unload bad loans onto the secondary market (for bad debt) to realize a cash infusion and eliminate the service costs for loans gone bad payable to PHEAA or other servicers. PHEAA's opponents, speaking for the Trusts, want to audit PHEAA, clip its wings, or replace it altogether with a new servicer, a move PHEAA has been vigorously resisting.

But filing collection lawsuits appears to be part of the business model, and appears to be a key component of the efforts to shore up the shoddy quality of the unsecured loans made to folks with marginal credit at high interest rates, not to mention hefty origination fees added up-front to the applied-for loan amounts, which increased the principal balance ab initio, without any interest yet having accrued. The borrowers never saw the origination fee (which went to the marketers and originators of the loans), except on their Truth in Lending Disclosures. While not labeled interest outright on the loan application, the Origination Fee would, in effect, substantially raise the cost of the loan. And they would eventually have to pay it all back.

Ten years down the road, the loans have entered the repayment period, whether students graduated or not, and whether they got the well-paying jobs they were aspiring to or stayed mired in misery, and borrowers are officially defaulting after their loans have been kept nominally alive for months, if not years, through the grant of hardship deferrals and forbearance agreements, "earning" interest, and then "late charges" only on paper, or rather, on the electronic equivalent thereof, PHEAA's accounting system. Once assigned to litigation, TSI would keep adding interest to the "charge off" balance, based on LIBOR, and would present that additional amount, plus filing fees, to the courts as part of the total damages sought by the particular Trust claiming to own the defaulted account and named as Plaintiff. 

Why there is little reason for NCSLT to stop suing students on defaulted loans 

The majority of student loan collection cases currently prosecuted by NCSLT’s lawyers result in default judgments because Defendants do not hire competent counsel to object to NCSLT’s loan documentation, which is often defective or insufficient because it is prepared by mass-litigation subcontractor in Georgia, Transworld System, Inc. The proof standards for default judgments are minimal. In Texas, failure to answer a lawsuit means that the allegations in the pleadings are admitted, and only damages have to be proven, and such damages are easily proven by affidavit. Which is where TSI comes in. TSI mass-produces such affidavits for default judgments and for summary judgments, or - if the case is contested - for filing prior to trial and use as business records affidavit in lieu of a live witness at trial.

TSI's official designation is "Subservicer" of U.S. Bank National Association, the "Special Servicer" or backup-servicer. U.S. Bank National Association is actually the Indenture Trustee and the only bank that is still involved with the student loans bundled years earlier into Trust assets. The myriad of banks and other lenders that originated the loans are no longer in the picture, and the actual loan servicing is done by AES, which is a trade name for PHEAA, a governmental entity ("Pennsylvania Higher Education Assistance Agency") that services private student loans as a side line.

TSI gets the defaulted accounts. It is highly efficient in churning out affidavits, with copies of documents and loan history reports attached, to support motions for judgment. There is no economic rationale for high quality standards to be imposed upon the production of affidavits and documentary exhibits because it is known by all parties with a stake in the matter, based on a long track record of such litigation whose efficiency can by monitored with simple statistical analysis tools, that the vast majority of Defendants will not contest the lawsuit filed against them. Even if they do, the same documents will suffice in most cases, as long as the Defendants are not legally savvy, and do not or cannot afford to hire a lawyer to make proper objections and hold the Trust's lawyers to their burden of proof in court.

In short, it makes no business sense to produce high-quality work product for the Trusts' lawyers to take to court. These are not tort cases with difficult issues of establishing causal connection between tort and injury, and proving and quantifying personal injury damages. These are run-of-the-mill cases based on a few pieces of look-alike forms and print-outs from an account management system. Even the loan origination document are all identical for particular program lenders, excepts for borrower names, amounts, dates, and such. And interest rates, of course, but those are already in the accounting system and the loan history is generated from the servicer's computer system to which TSI operatives are given access. TSI then calculates additional interest based on the LIBOR rate that has accrued since the account was assigned to them. This additional interest includes interest accruing while the case has been pending in court.

The proposition that litigation costs will put a dent in the Trusts' ability to collect on student loans, and lead to losses, is also a fallacy. 

First, it is common industry practice for collection law firms and solo collection attorneys to be retained based on a contingency fee agreement, which means that they will receive a percentage of the recovery, rather than billing the client by the mushrooming hour. Within that framework, the law firm has every incentive to keep the expenditure of attorney hours low, and the amount of recoveries at the maximum, at the lowest cost. In other professions, the collection law firm’s cut would be called a commission. In still other lines of work, it would be called a bounty. 

Second, the recovery of a lump sum representing the sum of the accelerated principal balance and accrued interest (some of it already capitalized, i.e. added to principal) is always much larger than the sum of missed installment payments for any particular student loan. Each default judgment on which NCSLT is able to collect (whether through wage garnishment, in some states, or writ of garnishment served on a bank at which the judgment debtor has money on deposit, in states such as Texas that do not allow express wage garnishment) will thus improve the cash-flow for the portfolio as a whole because lump sum recovery by judgment will compensate for a multiple of similar defaulted loans on which no installment payments are being made. 

Each successful lawsuit against a student debtor is accordingly a win-win proposition for the Trust and, ultimately, its bondholders because each successful lawsuit will bring in revenue against a bases-line of zilch. By definition, the loans assigned to TSI and passed on to the lawyers for collection are in default. They have not been bringing in any return because no installment payments were being made. 

Like all other creditors and assignees of original creditors, the Trust always seeks judgment for the accelerated loan balance (though it may waive additional interest calculated by TSI and added to the “chargeoff” balance). This allows the Trust to improve the quality of the defaulted notes in toto by precipitously increasing the yield on defaulted student loans that would otherwise – by definition - occasion no yield at all. 

Even allowing for the bounty percentage shared with the collection law firm and even allowing for the fact that many default judgments will be un-collectible, each collected judgment is a windfall because it brings in more money immediately than would be realized if the loan were performing in accordance with the amortization schedule spanning a time period of twenty years, only a portion or half of which has elapsed so far. 

Student loans were collateralized from 2004 through 2007 (typically only a few months after origination), as reflected in the array of suffixes ranging from National Collegiate Student Loan Trust 2004-3 through National Collegiate Student Loan Trust 2007-4 - more than a dozen. None of them would yet have matured by their own terms as of 2017, but many are past the date the deferrals and past multiple hardship or other forbearance extensions, and that's where the part of the business model involving the court systems kicks in.

Why settling for a lot less than amount sued for makes sense for NCSLT 

For the same reasons - the imperative of cash now, rather than later -- it makes perfect sense for the Trusts – or their authorized representative - to settle pending lawsuits and already-granted judgments for 50% or less of their face value when the Defendant contests the claim or hires a lawyer to put up a fight. 

Settlement for a reduced lump sum amounts results in immediate cash-flow because the payment is tendered voluntarily by the debtor at once, and may not otherwise be collectible through coercive means such as execution on nonexempt assets. Many debtors do not have sufficient nonexempt assets, which is why they went into default in the first place. 

In order to obtain a release of a judgment for a substantially discounted amount, however, a debtor may be willing to liquidate assets that would otherwise not be reachable by the judgment-creditor, or might borrow money from family and friends to get the student loan millstone off his neck.

Like TSI, the "sub-servicer" hired to provide litigation support for defaulted student loans that are assigned for litigation, the collection law firms filing the lawsuit against borrowers in the Trust’s name use automated processes and rely on computer-based document production systems to produce pleadings, motions, draft judgments and other litigation documents. Like TSI, they do so very efficiently and at very low cost. There is often no actual court appearance by a lawyer for the Trust because motions for default judgment with attached business records affidavit are merely submitted to the court for processing and a judge’s signature. 

Actual attorney involvement in NCSLT collection suits minimal. The economies of scale and the lawsuit-mill efficiencies serve the bottom line of the collection firm (by keeping labor costs down) as well as the client (through recovery of lump sums either through settlement or collection of judgments). The contingency nature of the retainer contract gives the law firm an incentive to maximize collections in dollar terms, rather than billing for unnecessary legal work at higher hourly rates to improve its own revenue stream.  

It is only in highly contested cases that evidentiary matters, "shoddy paperwork", and missing links in the chain of title even become an issue, and that is also where the labor cost for legal work performed on behalf of the Trust goes up. Those are the cases that have a chance of ending up on appeal and result in published appellate opinions. About a handful of them so far, around the country. A tiny number. These are outlier cases by definition and are unrepresentative of the thousands of cases that predictably result in default or summary judgments in the courts below.

The proposition that the Trust’s collection litigation entails high costs that will choke off the revenue stream for the Trusts and the bondholders is likewise a myth that is easily debunked. 

When NCSLT files a lawsuit, it must pay filing fees, and those costs are added to the loan balance by TSI. But the filing fees are small ($250-$300 in Texas) and they approximate the value of a single installment payment of the average defaulted NCSLT student loan (The monthly installment amount is shown on the Loan Disclosure statement when the loan is disbursed - as an estimate, based on a 20-year repayment period - and on a computer printout from AES, the Trust's loan servicer, that is typically included as proof of account history with the Trusts' court-filed affidavits and attachments). 

While it is true that these filing fees represent out-of-pocket expenses for each lawsuit up front, NCSLT will receive judgment for reimbursement of these out-of-pocket expenses when default or summary judgment is entered in its favor. 

The only filing fees that NCSLT will not collect are those expended on cases that are not resolved in its favor, or result in judgments that are uncollectible because the judgment defendants are destitute or otherwise judgment-proof because they do not possess nonexempt assets. 

Because both the Trust's successful lawsuits and the pending lawsuits and judgments it settles result in lump sum recoveries ranging in the thousands of dollars or tens of thousands of dollars, the expenses incurred for filing unsuccessful ones are easily absorbed. They represent but a small cost of doing business. That business being the conversion of nonperforming private student loans - usually made to high-risk borrowers at high interest rates, compared to federal loans, i.e. unsecured and sub-prime - into performing ones (on the portfolio-wide basis) by taking defaulting former students and their co-signers to court.

The collegiate debtors' day of reckoning has already arrived. The day of reckoning for the wizards behind the Collegiate Trust money-making machine may still be far out on the horizon.

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