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June 05, 2020  

Investors Dodge CFPB Cashflow Seizure

(SEE CORRECTION BELOW) A federal judge has blocked, at least temporarily, an effort by the Consumer Financial Protection Bureau to hold investors in 15 student-loan securitizations from First Marblehead financially accountable for the actions of a servicer.

At issue are some 840,000 private loans totaling at least $15 billion that First Marblehead securitized from 2003 to 2007 via its National Collegiate Student Loan Trust. Many of the loans soured after the credit crisis, leading to collection practices that prompted the CFPB to sue the issuing vehicle in September 2017.

As part of that process, the agency had proposed a so-called consent order under which investment firm Vantage Capital Group, which holds the residual interests in the deals, would use incoming loan installments to pay fines and borrower restitution. Replacement servicer Transworld Systems also agreed to settle as part of the arrangement. But a May 31 decision by U.S. District Court Judge Maryellen Noreika in Wilmington, Del., denied a request from the CFPB to implement the order.

Noreika’s reasons were sealed in a separate memorandum. Representatives of the National Collegiate trust and the CFPB had until June 3 to submit proposed redacted versions of the opinion. It’s unclear if they took such action.

The saga has been years in the making. First Marblehead, which obtained its loans from banks, stopped issuing asset-backed bonds in 2007. In November 2011, it sold the residual interests in its outstanding deals to Vantage.

Meanwhile, missing paperwork complicated efforts to collect on troubled accounts. As early as November 2012, an unnamed former servicer sued borrowers who weren’t keeping up on their payments even though it allegedly lacked the documents necessary to prove that the issuing trust owned their loans. In many of those complaints, the servicing personnel allegedly filed affidavits falsely claiming personal knowledge of the debts.

In November 2014, Transworld took over as subservicer and special servicer.

Judges eventually dismissed dozens of the lawsuits in actions that effectively wiped out the borrowers’ debts. The collection practices also attracted the attention of the CFPB, then headed by Richard Cordray.

The agency’s complaint marked the first time a securitization trust, which has no employees and relies on service providers to interact with borrowers, was named as a party in a lawsuit. Its proposed consent order, in turn, included requirements that the trust audit all of the affected loans, pay at least $21.6 million of penalties and restitution, and stop suing borrowers for invalid or unverified debt.

Transworld signed off while agreeing to pay only $2.5 million of restitution. But the arrangement also would have created a board of defendants headed by Vantage, which would have the authority to take any actions necessary to comply — including directing the servicer to remit all incoming loan payments to an escrow account.

That meant capital that normally would be used to pay interest and principal to bondholders instead would fund the trust’s penalties and restitution. It also raised objections from a number of operations whose feedback presumably contributed to Noreika’s denial.

Indeed, multiple transaction parties that weren’t named in the CFPB’s lawsuit filed motions to intervene, including Pennsylvania Higher Education Assistance Authority, as primary servicer; U.S. National Bank, as indenture trustee; GSS Data Services, as administrator; Wilmington Trust, as owner trustee; bond insurer Ambac; and holders of the securities.

The Structured Finance Association also weighed in with an amicus brief. In May 2019, after Kathy Kraninger took over as CFPB director, the trade group followed up with a letter stating that the proposed consent order contained injunctive provisions that “would abrogate and rewrite the trusts’ governing contracts, which the parties previously agreed to, and penalize the underlying investors, (including pension funds and retirement plans), who aren’t accused of any wrongdoing.”

An attorney representing bondholders Angelo Gordon & Co., Libremax Capital, One William Street Capital and Waterfall Asset Management has a more blunt characterization that accuses Vantage of attempting to enrich itself at his clients’ expense. Said Michael Hanin, who leads the Kasowitz Benson team with Uri Itkin: “The proposed consent judgment represented an unprecedented gambit by NCSLT’s residual equity holders to invert the securitization waterfall and trample the rights of investors and other deal parties.”

As part of the discovery process, the investors and Ambac obtained access to communications between Vantage and McCarter & English, the law firm it hired to represent the trust. While such communications typically would be protected by attorney-client privilege, investors successfully argued that they were entitled to see them under a fiduciary exemption. McCarter & English has since resigned as counsel for the trust.

What happens next? The CFPB’s lawsuit against National Collegiate Student Loan Trust remains outstanding. But it first will have to overcome a motion for dismissal from Transworld, which argues that the agency lacks the proper jurisdiction.

From 1994 to 2007, First Marblehead completed 25 student-loan securitizations totaling $15.6 billion, according to Asset-Backed Alert’s ABS Database. The bulk of the offerings took place via the National Collegiate trust in the years leading up to the market crash.

CORRECTION (6/8/20): This article has been revised. The original misidentified the firm that owns the residual interests in First Marblehead’s student-loan securities. Those positions are held by Vantage Capital Group.