SLM Corp., better known as Sallie Mae, is by far the biggest maker of private student loans. But it hasn’t always been a bank.
Until 2010, the company primarily originated private student loans in partnership with banks, referring borrowers to third-party institutions and then purchasing the loans shortly after disbursement.
It’s a kind of arrangement that allows nonbank lenders to skirt state caps on the interest rates they can charge. Federal law allows banks to “export” the interest rate cap in their home state to other states with lower limits. Piggybacking on a bank’s charter allows nonbank lenders to do the same thing.
The strategy made sense when Sallie Mae was first privatized and its primary business was still servicing federally guaranteed student loans. The same strategy has long been used by numerous independent mortgage originators and payday lenders, and more recently by marketplace lenders, which make unsecured loans over the internet.
So a recent federal court decision affirming the right of a servicer to collect on private student loans originated on Sallie Mae’s behalf isn’t just good news for investors in student loan-backed securities; it’s also good news for marketplace lending platforms and other online lenders that partner with banks to make loans.
In Jamie Beechum v. Navient Solutions, the plaintiffs, California residents, argued that the interest rates on loans they obtained in 2003 and 2004 from Stillwater National Bank and Trust Co. in Oklahoma exceeded California’s 10% general usury cap. In 2015, they filed a putative class-action lawsuit against Navient Solutions, the servicer of the loans (and other parties including a securitization trust), alleging that a predecessor company to Sallie Mae was the “actual lender” of their loans and therefore California usury laws applied.
No "Predominant Economic Interest" Test
But in September, the U.S. District Court for the Central District of California granted the defendants motion to dismiss the case. The court based its decision solely on the California usury law exemption for national banks. It declined to review the substance of the loan transactions, as urged by the plaintiffs.
The Beecham decision goes in the opposite direction of two other recent cases. In January, the U.S. District Court for the Eastern District of Pennsylvania denied a motion to dismiss a true-lender suit, Commonwealth of Pennsylvania v. Think Finance. The court cited the alleged “level of control” over the relevant loan transactions by the defendant lender.
And in the high-profile Madden v. Midland Funding lawsuit, the 2nd U.S. Circuit Court of Appeals found federal preemption of state usury laws available to banks no longer applied once the loan was sold to a non-bank and the originating bank no longer retained an interest in the loan.
“The Beecham decision provides further evidence that when courts do not apply the ‘predominate economic interest’ test that has been used in some true lender cases in recent years, loan owners are more likely to be protected,” Moody’s stated in its report.
The decision is also notable, according to the law firm Pepper Hamilton, because the court analyzed possible public policy impliations of its decision. Unlike other federal and state courts that have recently decided true lender cases, it “explicitly acknowledged that making it difficult for banks to assign or sell their commercial property to the secondary market impedes, versus promotes, good public policy,” the firm stated in a Sept. 22 client alert.
The authors said that the court’s public policy analysis helps to bolster the effect of the decision because it does not rely strictly on legal technicalities of a single state law usury exemption.
Good News for Student Loan Bondholders
An adverse ruling could have hurt private student loan securitizations. Student loans that SLM originated under the partner-bank-origination model, which it used primarily through 2009, have served as collateral in 38 transactions completed by Sallie Mae or Navient (which it spun off two years ago) since 2002, according to Moody’s Investors Service.
For the 12 public deals issued through 2007, the California concentration at closing ranged from 7% to 17%, the rating agency said in a report published last week. (Because the Beechum case does not explicitly cover loans made to residents of other states, the decision is less applicable to those loans.)
More recent deals are likely to contain lower concentrations of loans originated in partnership with banks, as Sallie Mae now primarily originates through its own bank. Moreover, interest rates on loans originated since the financial crisis are less likely to exceed state caps, simply because Sallie Mae and other private lenders have tightened their underwriting criteria.
Of course, the Beechum decision can be appealed, and courts deciding on similar cases could reach different conclusions. “For example, other courts might choose to take different approaches to interpreting their states' usury laws as a result of a lack of similar legal precedents, or if the language in those laws differs from California's law,” Moody’s stated in its report. However, “even if the Beechum ruling is overturned or not followed by other courts, legal victories of this type can serve to dissuade additional litigation.”