Recent judicial decisions and a proposed settlement between the Consumer Financial Protection Bureau (CFPB) and the National Collegiate Master Student Loan Trusts (NCSLT) highlight risks to the cost of consumer credit products including student loans, mortgages, and auto loans.

Background

The NCSLT trusts originally held more than $12 billion of student loans that served as collateral for a type of bond called a securitization. Securitizations are bonds backed by a pool of loans held in a trust for the benefit of the bondholders, and through which loan repayments flow to pay the principal and interest due on the bonds. When borrowers repay their loans, principal and interest are returned to the bondholders. When borrowers default, losses are shared among the bondholders according to the terms of the bonds. The trust in a securitization, such as the NCSLT trust, is a legal structure established for the sole purpose of holding the loans as collateral and distributing the flow of funds between the underlying collateral and the bonds. The trust contracts with a loan servicer to manage the loan portfolio (e.g., to collect payments and manage delinquencies).

Student loans are not the only types of loans that are securitized – for example, 70% or more of all residential mortgages originated in the U.S. are typically securitized in a given year. Auto loans, credit cards, equipment leases, vendor finance and other consumer and commercial assets are also securitized – it is a multi-trillion-dollar cog in engine that powers the American consumer and the economy. In contrast to Europe and other regions where finance is predominantly bank-based, the U.S. depends heavily (>70% per SIFMA data) on capital markets such as stocks and bonds, including securitizations, and this is especially true in the area of consumer finance. In fact, Europe has seen the value in our system and is trying to increase its share of capital markets-based funding, including securitizations. However, here in the U.S., the CFPB’s actions are threatening to reduce the ability of capital markets to fund consumer credit needs, as we will discuss below.

Long-term passive investors, such as mutual funds, pension funds, insurance companies, and endowments commonly buy securitization bonds. These investors’ clients include tens of millions of consumers saving for retirement. The important point here is that the long-term investors who own the bonds are passive – they do not direct the management or servicing of the loans that collateralize the bonds, instead they earn returns as specified in the contracts that create the bond, and assume that these contracts will be executed as written.

The Problem

In 2017, the CFPB sued a number of NCSLT securitization trusts in Delaware claiming that some of the practices of the debt collectors servicing the student loans in these trusts were not legal, and entered into an enforcement action resulting in a proposed a settlement that would require both the servicers and the trusts to pay fines for the alleged indiscretions. The passive investors in these trusts were not included in these negotiations but would be subject to losses from the fines.

In court filings, the CFPB claimed that the trusts themselves, not just the servicers and trustees, were subject to direct CFPB jurisdiction. SIFMA strongly disagreed with this position and filed an amicus brief on behalf of its members, which include many securitization investors along with other securitization market participants. Other industry organizations filed similar briefs. Ultimately, the court held that the trusts were subject to CFPB jurisdiction, which is disappointing. That decision is being appealed.

As a logical consequence of this decision, in 2024 the CFPB continued its actions and filed another enforcement related to NCSLT, this time in Pennsylvania. The proposed settlement would again require both the debt collectors and the trusts to pay fines for the alleged indiscretions. Similar to the 2017 case, the passive investors in these trusts were not included in these negotiations, and the CFPB has gone so far as to assert in court that they have no standing to contest the proposed settlement, despite the fact that they would help pay for it!

The CFPB’s settlement proposal would use the assets of the trusts to pay for the alleged violations of others. In other words, instead of the debt collectors paying for their alleged misconduct, the passive investors in the trusts – including long-term investors such as pension plans, retirement plans, and millions of retail investors that own mutual funds – would be forced to pay for alleged bad acts of third parties that they had nothing to do with. This would involve rewriting the terms of the trusts’ contracts long after the bonds had been sold, and in the process, penalizing investors who are not accused of any wrongdoing.

Why does this matter?

While this may sound like an unfortunate deal for only those investors invested in these trusts, it has much broader implications for both securitization investors and for future student loan borrowers, not to mention consumers who benefit from other kinds of loans and financial products.

If the CFPB can use the assets of a student loan trust in this manner, in theory no securitized consumer asset market – credit cards, cars, mortgages, etc. – is safe. The question then becomes why would anyone – especially fiduciaries and stewards of American’s retirement savings – invest in securitizations at the same price they do today? The answer is that they likely would not.

Ratings agencies, which assign risk ratings to securities such as securitizations, and are an important factor in many investors’ decision to invest, have responded negatively to the CFPB’s overreach:

Fitch said in 2024 that the actions “could increase the risk of unforeseen monetary losses for these NCSLT issuers as well as other U.S. structured finance transactions backed by consumer assets” and “could significantly affect transaction performance and introduce increased rating volatility in U.S. structured finance transactions backed by consumer assets.”

In 2018, Moody’s lowered (downgraded) the ratings on a number of NCSLT bonds and said that the “primary rationale for the downgrades is the potential negative impact to cash flow from penalties which may be imposed by the CFPB and from performance deterioration in the underlying pool if the propose proposed consent order is implemented. An adverse impact on cash flow could lead to insufficient credit enhancement to support the affected tranches at specified rating levels.”

This does not bode well for securitization markets, their investors, or consumers, should the CFPB continue to expand the scope of these actions.

The Bottom Line

All consumers benefit from the vast supply of capital available in securitization markets, because this capital funds the broad availability of credit which leads to lower borrowing costs. However, these CFPB actions that attempt to penalize passive securitization investors present an entirely new and unexpected risk to securitization markets.

Ultimately, the only recourse investors have to mitigate this risk is to assign a lower value to securitization bonds (or not buy them in the first place), and that will mean consumers may find their future loans, leases, and other financial products to be more expensive, less available, or both.

Policymakers and regulators should consider the true costs of their actions, and consider these unintended consequences before allowing this CFPB overreach to continue.

Author

Chris Killian is Managing Director, Securitization and Corporate Credit at SIFMA.

Related Resources

• Amicus Brief

  CFPB v. National Collegiate Master Student Loan Trust

• Resource Page

  Securitization and Housing Finance