DMEAST# The CFPB Is Coming! The CFPB Is Coming! NCHER Knowledge Symposium November 7, 2012 Copyright 2012 by Ballard Spahr LLP John L. Culhane, Jr., Partner Consumer Financial Services Group Christopher J. Willis, Partner Consumer Financial Services Group The CFPB Is Coming! THE CFPB IS HERE! NCHER Knowledge Symposium November 7, 2012

What if... A Regulatory Agency Fable John L. Culhane, Jr., Partner Consumer Financial Services Group Christopher J. Willis, Partner Consumer Financial Services Group

3 What If... A Regulatory Agency Fable A discussion between an employer and a new Federal agency regulating employment Starting time Sick Pay Dress Code Probationary Period And now...

The CFPB Report on Private Student Loans and Its Implications for Examinations and Enforcement Actions John L. Culhane, Jr., Partner Consumer Financial Services Group

5 Introduction – The CFPB’s Unstated Goals Show that borrowers (students and their families) need the CFPB’s help. Demonstrate the dysfunctional nature of the marketplace. Stake out the agenda for consumer financial protection (examination and enforcement implications). Shine the spotlight on fair lending issues (examination and enforcement implications).

6 The Borrowers Students who are younger, African American, or dependents and families who are less educated or less wealthy rely more on private student loans. Students at for profit schools rely more on private student loans and students in certificate programs rely more on private student loans that students getting bachelors degrees. Many borrowers do not take full advantage of federal loans and (unsaid) many borrowers should be going to less expensive schools to minimize the amounts of their loans. Many recent graduates are having difficulty making their loan payments, in fact, a significant percentage are unemployed and a minority have payments that are greater than 25% of their income.

7 The Marketplace Bank lenders are not properly handling over borrowing, interest rate risk, or “economic” (bad economy) risk and are too susceptible to secondary market forces. Schools need to act as quasi-fiduciaries, providers of information, and monitors of prudent lending (but only under the watchful eyes of the CFPB and other regulators). Servicers and collectors need to improve customer satisfaction and reduce consumer harm. The secondary market should not be contributing to imprudent lending by creating incentives to increase approval rates.

8 Consumer Protection – Information Gaps Timing – The CFPB wants students and their families to get all pertinent information before picking a school and before making any decisions about debt. Additional data – The CFPB wants students and their families to get more and better information about post- graduation outcomes, including employment and wages, and the CFPB wants lenders to use this information instead of cohort default rates. Disclosure parity – The CFPB wants to end the exemption for open-end credit. Loan servicing – The CFPB wants a publicly accessible data base that includes all pertinent information about a borrower’s federal and private loans.

9 Consumer Protection – Over Borrowing Federal aid – The CFPB apparently wants schools to determine whether a student has exhausted his or her eligibility for federal student aid. It’s unclear whether schools are to communicate that information to lenders and, if so, whether lenders are to refrain from making private student loans if federal aid is still available. School certification – The CFPB wants schools to certify that the loan amount does not exceed the borrower’s need. Other recommendations – Note that some other recommendations, such as information about post- graduation outcomes, would also help address over borrowing.

10 Consumer Protection – A Bad Economy Fixed rates – Although criticizing the interest rate risk in private student loans, the CFPB stopped short of seeking to require lenders to offer a fixed-rate product or to regulate rates by imposing additional disclosure requirements on “high cost” loans. But there has been some additional jawboning here. Flexible repayment programs – The CFPB want to see private loans provide the same debt management or loss mitigation options as federal loans. Bankruptcy relief – The CFPB wants Congress to provide bankruptcy relief. Options mentioned include discharge after a period of time in repayment or filing after a set period of time with a discharge after a period of time in a wage earner plan.

11 The Criteria Under the Microscope – Cohort Default Rates African American and Hispanic students are more likely to attend schools with higher CDRs. African American and Hispanic students are almost twice as likely to attend schools with CDRs above 8% (and above 12%). Hispanic students are over seven times as likely to attend four- year private schools with CDRs above 8% (19 times for CDRs above 12%). African American students are almost four times as likely to attend four-year public schools with CDRs above 8% and are over three times as likely to attend four-year private schools with CDRs above 8% (3.5 times for CDRs above 12%).

12 The Criteria Under the Microscope – Cohort Default Rate CFPB states that the CDR was not specifically intended to be used for eligibility, underwriting and pricing decisions. CFPB concludes that consideration of CDR may reduce credit access and increase prices for minority borrowers. CFPB cautions that the use of CDR may require lenders to provide evidence of a legitimate business need. CFPB is clearly skeptical and has already signaled that it believes there are less discriminatory alternatives. CFPB sees the same concerns with school graduation rate (and by implication, major by school and all other school-specific criteria).

13 Fair Lending – Imputing Demographic Characteristics CFPB notes that a robust analysis would require access to applicant demographics (or the ability to impute them). In other circumstances, demographic characteristics are imputed based on address and name (first name and surname). Imputing characteristics is more difficult here because of both temporary addresses and (although not stated) school location. CFPB concludes that imputation may be difficult  but suggests it may be possible by using other data in addition to geographic data – in exams, it asks for age, citizenship or residency status, marital status (if available), and school major plus all variables used by the institution, in any internal reviews, to classify loan applicants by gender, race, and ethnicity.

14 Opinions and Recommendations Comments of CFPB representatives make clear that this will be a significant issue for the industry. A wave of enforcement and litigation appears to be on the horizon for lenders that use CDR or any other school-specific criteria. Lenders should consider conducting fair lending assessments (and overall compliance assessments) in advance of CFPB examinations or civil investigative demands. In the long term, lenders should consider abandoning the use of school-specific criteria, particularly since HMDA-like data collection and reporting requirements likewise appear to be on the horizon.

15 Conclusion Concerns for Lenders – CFPB will be looking to see how bank lenders are addressing over borrowing, interest rate risk, “economic” (bad economy) risk, fair lending issues, and the susceptibility to secondary market forces. Concerns for Servicers and Collectors – CFPB will be looking to see how servicers and collectors address “economic” (bad economy) risk and the efforts they are taking to improve customer satisfaction and reduce consumer harm.

John L. Culhane, Jr., Partner Consumer Financial Services Group The First Annual Report of the CFPB Student Loan Ombudsman

17 The Ombudsman’s Report – An Overview Released just six days after the CFPB’s Consumer Response Team released its Snapshot of Complaints Snapshot provided a one-page summary of the approximately 2900 private student loan complaints Report contains a twenty-page discussion which addresses the complaints in more detail Report also includes the Ombudsman’s observations regarding the complaints as well as his recommendations for legislative and regulatory initiatives

18 The Ombudsman’s Report – Servicing Issues Report broadly characterizes all complaints as servicing related First category – complaints where responsible borrowers are “stymied” by servicing policies Second category – complaints where borrowers are “surprised” by servicing procedures Third category – complaints where struggling borrowers are “frustrated” by collection practices Fourth category – complaints where military borrowers are reportedly disadvantaged by non-compliant programs

19 The Ombudsman’s Report – General Observations Complaints are not necessarily indicative of the prevalence of the practices Complaints vary greatly in weight and potential import Complaints are generally proportionate to market share But “the breadth of potential servicing errors and the inability to easily modify a loan bear an uncomfortable resemblance to experiences faced by homeowners in the mortgage market”

20 The Ombudsman’s Report – Specific Comments Comments are directed to all market participants Lenders are encouraged to develop creative loan modification programs for struggling borrowers Investors and entrepreneurs are encouraged to develop innovative loan refinance programs for suitably employed college graduates Colleges and universities are encouraged to develop appropriate financial planning programs for their existing students as well as for their alumni

21 The Ombudsman’s Report – Government Action Ombudsman recommends legislative and regulatory action Ombudsman recommends that Congress “identify opportunities to spur the availability of loan modification and refinance options” Ombudsman recommends that Treasury, the Department of Education, and the CFPB work together to improve the income-based repayment program for federal student loans Ombudsman also recommends that the agencies draw on the lessons learned in mortgage servicing to improve the quality of student loan servicing

John L. Culhane, Jr., Partner Consumer Financial Services Group The Next Front? Student Loan Servicing and the Cost to our Men and Women in Uniform

23 The Next Front – Servicemember Student Debt Specifically intended to expand on the Ombudsman’s Report by highlighting issues faced by servicemembers Focuses on repayment issues with private and federal student loans and identifies two major problems First, many servicemembers are not taking advantage of the most favorable repayment plans available, and may thus be incurring significant additional debt Second, many servicemembers are not receiving the protections and benefits to which they are entitled, particularly in the case of SCRA protections

24 The Next Front – Actions Being Taken The CFPB has issued a “Guide for Servicemembers with Student Loans” The CFPB has added an FAQ section directed at military student loan borrowers to the “Ask CFPB” section of its website The CFPB will be working with the DOD to be sure that JAG personnel and others are able to counsel servicemembers about all of the various benefits and protections available for federal and private loans The CFPB is likely to focus on this in any examinations

Update on CFPB Examinations and Enforcement Activity Christopher J. Willis, Partner Consumer Financial Services Group

Enforcement: What’s Happened and What’s Coming Next CID Activity So Far Practical observations about CIDs The CFPB’s First Consent Orders The Bureau's first ruling on a petition to set aside or modify a CID Preview of administrative enforcement procedures Preview of regional enforcement office activity

CID Activity So Far The CFPB does not announce CIDs, but targets have occasionally announced them in securities filings. CFPB has also stated it will publish orders on motions to set aside or modify CIDs unless there is "good cause" for confidentiality We are aware of CIDs in the following industry sectors:  Credit card payment protection / add-on products  Private student lending  Subprime auto finance  Debt collectors/buyers -Captive reinsurance of PMI  Payday lending Are there really 100 or more CIDs out there?

Practical Observations on CIDs Breadth of requests Descriptions of the “nature of the conduct constituting the alleged violation” Reluctance to extend deadline to file Petition to Set Aside or Modify All decisions on compromises/modifications made by the Deputy Director Petitions decided by the Director, with judicial review unspecified in terms of availability and standard of review The CFPB’s e-discovery experts

The CFPB’s First Consent Orders Large amount of monetary relief involved Tie-in with credit card complaint data released several weeks before first settlement Underlying alleged violation is a familiar one – subject of prior AG actions and private class actions Information was said to have arisen “through our supervision process,” highlighting the connection between supervision and enforcement Promise of future enforcement actions: “We expect announcements about other institutions as our ongoing work continues to unfold.” (Richard Cordray)

First Decision on a Petition to Set Aside Bureau published its first decision recently on a petition to modify or set aside a CID Clear that Bureau does not accept relevance (in terms of time period or subject matter) to be a proper objection Also clear that Bureau does not require much specificity of itself in defining the purpose of a CID Heavy emphasis on proving claims or undue burden with evidence, rather than simply making objections Also strong emphasis on meaningful participation in "meet and confer" process Portrays CFPB enforcement staff as reasonable and open to compromise Possible judicial review?

Preview of Things to Come Administrative enforcement procedures Speed of proceeding Lack of discovery Hearsay admissible No limitation on remedies available Regional enforcement offices Four offices: Northeast, Southeast, Midwest, and West Purpose of regional enforcement presence

32 Supervision Update Observations on the Supervisory Process Service Providers Update on the Privilege Issue

33 Observations on Supervisory Process Who are the CFPB examiners? Process being followed Enforcement lawyers in attendance Differences between CFPB exams and exams of federal and state prudential regulators How to prepare for first CFPB exam

34 Service Providers OCC/FRB/OTS Consent Agreements, April 2011 National Mortgage Servicing Settlement, March 2012 CFPB Bulletin , April 12, Applies to both banks and non-banks within CFPB supervision and enforcement authority. -Supervision and enforcement authority extends to service providers. -Initial and ongoing due diligence reviews of service providers. -Contract provides for compliance, with consequences for non- compliance.

35 Update on the Privilege Issue Still not resolved in the underlying statutes – 12 U.S.C. §§ 1828(x) and 1821(t) still not applicable to the CFPB Partial legislative fix passed the House (HR 4014), but stalled in the Senate Now new Senate legislation introduced (S.3394) that combines identical provisions of HR 4014 with ATM fee placard issue Reports that AFSA has proposed legislation that would go further than HR 4014 in protecting privilege in situations where CFPB shares info with state banking regulators Legislative uncertainty did not delay the CFPB in finalizing its privilege waiver rule – announced final rule on June 28, 2012

36 If you have any questions about anything we covered today, please contact: Questions / Resources – Ballard Spahr Visit our blog, the CFPB Monitor, at Subscribe to our e-alerts at (click “subscribe”). John L. Culhane, Jr., Partner Consumer Financial Services Group Christopher J. Willis, Partner Consumer Financial Services Group