Can banks allay concerns about emerging student loan product?

WASHINGTON — A novel partnership between a Virginia bank and a Boston-based community development financial institution is reigniting a debate about student financing products known as income-share agreements.

In April, consumer groups led by the Student Borrower Protection Center urged the Office of the Comptroller of the Currency to scrutinize the first-of-its-kind arrangement between Blue Ridge Bank of Martinsville, Va., and MentorWorks Education Capital. The bank funds financing packages developed by MentorWorks, a fintech firm, which students repay with a portion their income after entering the workforce.

Critics say banks could face reputational risks from working with a sector that is increasingly targeted for alleged consumer protection abuses, such as requiring expensive prepayment penalties, which some experts argue is illegal under the Truth in Lending Act. They worry that banks could lend false credibility to a product that has avoided regulatory scrutiny, similar to criticism of partnerships between banks and other nonbanks such as small-dollar lenders.

ISAs’ “underlying business model is incompatible with the most basic and straightforward consumer protection laws,” said Seth Frotman, executive director of the Student Borrower Protection Center.

But others say the concern about income-share agreements stems from the fact that they are a new and untested product that nevertheless offers students an innovative alternative to traditional financing.

Income-share agreements offer students tuition funds in exchange for a percentage of their post-graduation income, typically between 2-10% over a set period of time. The agreements are typically made between an educational institution and the student, with the fintech provider servicing the product in exchange for a fee.

Bloomberg News

Some argue that banks’ involvement in funding income-share agreements could help the product mature and improve compliance with consumer protection laws.

“There’s almost no financing area that having greater bank involvement makes it worse. I think that almost always makes it better,” said Jeffrey Naimon, a partner at Buckley who works in the firm’s student lending practice.

A relatively small sector of finance estimated to be worth about $200-250 million, the modern ISA industry has existed for roughly a decade in the U.S. The products offer students tuition funds in exchange for a percentage of their post-graduation income, typically between 2-10% over a set period of time. The agreements are typically made between an educational institution and the student, with the fintech provider servicing the product in exchange for a fee.

ISAs were once a darling in the fintech industry with a promise to disrupt higher education financing. But stakeholders say the industry hasn’t grown as quickly as some had hoped, in part due to regulatory uncertainty, consumer complaints and high-profile litigation.

“I think people are still very excited about the opportunity, and I think it’s kind of redefined the entire ecosystem of student finance,” said Daniel Pianko, managing director of the education-focused private equity firm Achieve Partners. “But to date, there hasn’t been the massive adoption that I think people have been hoping for.”

Consumer advocates highlighted the partnership between Blue Ridge and MentorWorks to raise alarm about banks stepping into an area that they say has evaded necessary regulatory requirements.

ISA providers have argued for years their product should not be considered a line of credit, but advocates say that distinction is an attempt to avoid compliance with credit-related consumer law.

“It is very clear to every serious person who doesn’t have a financial interest in this that these are loans, and they can and should abide by the laws on the books as they exist,” said Frotman, formerly assistant director and student loan ombudsman for the Consumer Financial Protection Bureau.

But as the ISA industry continues to develop, other analysts say that bank involvement in the sector could ultimately be a good thing for a product that proponents say can be a progressive alternative to student debt.

“It’s because of all the corporate infrastructure banks bring to the table, and they’re cautious institutions,” said Naimon. “They’ll have standards, and I think it’s helpful for many markets to have that kind of involvement.”

Some policymakers have attempted to establish a legal framework for ISAs, which they say offer a more attractive option than traditional student loans. In 2019, two Republican senators and two Democratic senators floated a bill to introduce more consumer protections for the product.

“There are students across the country who are already benefitting from ISAs and deserve the safeguards and certainty the ISA Student Protection Act would provide, including protections during periods of low earnings, dischargeability in bankruptcy, and oversight authority by the Consumer Financial Protection Bureau,” said Sen. Mark Warner, D-Va., one of the sponsors, in a press release announcing the bill.

Many ISAs include limits on what borrowers must repay and do not add interest. But Frotman’s group has pointed to other concerns. In March, the Student Borrower Protection Center released a study showing students at historically Black colleges and universities can owe more than students at predominantly white schools.

“Our student debt market is definitely broken, and it needs a massive overhaul,” said Federal Trade Commissioner Rohit Chopra at a 2020 conference, according to the New York Times. Chopra is currently awaiting Senate confirmation to be the next director of the CFPB. “I’m not sure that new products like income-share agreements will be an antidote, especially if they worsen disparities,” he said.

Consumer advocates have become increasingly critical of ISAs in just the past few months. Chief among their concerns is whether ISAs should legally be considered a form of credit, making them subject to state and federal consumer lending laws.

One of the nation’s leading ISA providers, Vemo Education, has been a focus of recent complaints. In June, the National Consumer Law Center filed an official complaint with the Federal Trade Commission against the firm for “deceptive marketing.” In July, 47 former students in California sued Vemo and a for-profit coding school that had offered ISAs in exchange for 20-25% of students’ pre-tax income.

“These are loans, and in many instances, these are private student loans,” Frotman said.

In a statement, a spokesperson for Vemo Education said the company could not comment on pending litigation but said the company “has long advocated for strong protections for student consumers and a legal framework to establish guardrails for institutions and providers.”

Some analysts say that the idea that ISAs as a whole are an unregulated wild west is misleading. Without being considered credit, ISAs are still subject to other forms of regulatory compliance.

“Every financial product has to be offered in a nondiscriminatory way, and state and federal unfair and deceptive acts and practices laws apply to everything,” Naimon said.

At the same time, many members of the industry agree that regulatory uncertainty is one of the defining characteristics of the ISA sector. “There clearly needs to be a more distinct regulatory framework for ISAs to truly grow into their own,” said Pianko. “They don’t fit neatly into the existing frameworks, which creates uncertainty.”

ISA proponents say that the financial instrument is fundamentally different from a loan and should not be regulated as such, in large part because payments revolve around trying to estimate a student’s future compensation.

“If you try to fit an ISA into a lending model it will fit poorly,” Naimon said. “Well, what are the payments going to be? How do you model the payments and the APR and all the rest of it if you don’t really have any idea how much money someone’s going to make?”

Proponents say that if an ISA is properly constructed, it could be viewed as a form of insurance, where if a student has a substantially lower income than they had anticipated after graduation, they won’t be further weighed down by inflexible loan payments, particularly private student loans.

“It’s a more progressive instrument simply because, as your income falls, you’re essentially paying less and less as a proportion of your income,” said Karthik Krishnan, president and CEO of MentorWorks, the CDFI working with Blue Ridge Bank to provide ISAs. “Whereas with a loan, your percentage of income actually shoots up, especially with accruals, as your income declines.”

According to Krishnan, one of the chief reasons his ISA provider decided to work with Blue Ridge Bank was the expertise a bank could bring about broader regulatory compliance.

“It’s really to subject ourselves to regulatory scrutiny — to commit and signal that we are a good player,” Krishnan said. “We’re not running away from regulation, we’re actually going back to it.”

Brett Taxin, executive vice president of Blue Ridge Bank, said via email that even as the ISA industry remains “in its infancy,” the banking sector is “positioned to help get the industry off the ground and grow safely in a controlled, regulatory environment that should provide additional protections for students.”

According to Taxin, MentorWorks and Blue Ridge Bank have developed an ISA program with disclosures “consistent with the spirit of” several federal consumer credit laws, including the Equal Credit Opportunity Act, Truth in Lending Act, and rules around unfair, deceptive, or abusive acts or practices.

But other analysts say that there is still significant risk for banks to experiment in a sector on questionable legal footing. For example, a potential declaration from the CFPB under the Biden administration that the agency considers ISAs to be a form of credit could open up banks working with ISA providers to enforcement action.

“There is a difference between the CFPB not yet bringing an enforcement action for an entity that runs around and touts itself as not a loan when it clearly is, and that actually being the state of the law,” Frotman said.

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