State-Level Student Loan Servicer Licensing Requirements Are on the Rise
Over the last 18 months, state-level licensing requirements for student loan servicers have become more common. This is true especially in blue states with progressive legislatures, governors, and attorneys general.
These states are stepping into a field already dominated by the federal government, the largest lender, guarantor, and regulator of student loans. Several factors seem to drive the trend. One is the Trump administration's assumption of control over the Consumer Financial Protection Bureau and the Department of Education.
Another is increased media focus on how the nation's more than $1.5 trillion in student-loan debt affects borrowers and the economy. A third is a perception that student loan servicing warrants heightened regulatory scrutiny. That perception was fueled in part by unverified complaints and related reports issued during the Obama administration's control over the Consumer Financial Protection Bureau and the Department of Education.
Whatever the cause, state licensing regimes have proliferated. They came first in Connecticut, California, and Illinois, then Washington, D.C., and more recently in Washington, Colorado, and Rhode Island. Other states, such as New York, Maine, and New Jersey, have enacted licensing regimes this year that have not yet become effective. In many other states, similar legislation is pending.
Digging Deeper into the Requirements
The core of these licensing regimes is simple. Any company in the business of servicing student loans must register with and seek licensure from a state regulatory body. That category typically excludes banking organizations and post-secondary educational institutions. The regulatory body is often housed within the state's existing department of banking or financial services.
Obtaining a license typically requires three things. First, payment of nonrefundable licensing and investigation fees. Second, submission of a financial statement, detailed information about the loan portfolio being serviced, and the servicer's regulatory history, including its track record in other jurisdictions. Third, a commitment to abide by certain substantive standards of conduct, which may or may not be consistent with federal standards or those of other states.
Licenses typically must be renewed annually or bi-annually. Renewal is subject to additional fees and to ongoing reporting, disclosure, and record keeping requirements. Servicing student loans without a license in a regulated jurisdiction can carry serious consequences. These include financial penalties and civil enforcement proceedings.
Forecast: More States Likely to Develop Requirements
The nation's outstanding student loan balance, and the media attention that comes with it, is expected to keep growing. There is every reason to believe that more left-leaning states, and even some more moderate states, will seek to add similar licensing requirements soon. The national trend has been toward more detailed performance and reporting requirements for licensees.
California, for instance, enacted an initial licensing regime in 2016. It then amended the law in late 2018, almost immediately after it first became effective, adding substantially more rigorous obligations for licensees.
Bills to further refine the scheme are pending in the California legislature. One would create a private right of action against student loan servicers, and it seems likely to become law soon. Other states, like New York, have enacted an underlying licensure law with substantive and somewhat ambiguous requirements.
The details are to be finalized by the relevant regulator after an opportunity for notice and comment. New York's proposed rules are among the most onerous in the country. They incorporate concepts that New York regulators have unsuccessfully sought to impose through administrative processes.
Private student loans make up only about 8% of the total student loan debt. So it is clear that the states are seeking to control the servicing of federal student loans. Not surprisingly, the main obstacle to these regimes, and their expansion, is preemption. Preemption is a legal doctrine: federal law nullifies state law in three situations.
- Federal law expressly states that no state law shall apply.
- The federal government has fully occupied the relevant regulatory field.
- The state law conflicts, expressly or implicitly, with federal law.
For example, several federal courts have recognized that Section 1098g of the Higher Education Act expressly prohibits states from imposing additional disclosure requirements on federal loans. Another court recently held unconstitutional the part of the District of Columbia's licensing program that would have required federal contractors to obtain a license. As a result, some state legislation proactively exempts student loan servicers that administer only federal loans from licensing and reporting requirements.
Some regimes lack that exception. Others try to apply substantive servicing requirements to federal contractors without formally requiring a license. Both approaches are constitutionally suspect and sure to face more challenges.
Conclusion
Servicers are not the only ones affected. Lenders originating private student loans face a parallel set of state student loan lender licensing requirements, and several states apply both regimes to the same company.
In sum, state-level licensing requirements, especially for the servicing of private student loans, are likely to remain a fixture in at least some states for the foreseeable future. Unfortunately, the proponents of these laws seem less interested in uniform requirements. They seem more interested in raising servicing standards in discrete areas wherever possible.
That could push servicers to adopt the most restrictive standards across the board, for all loans in their portfolios, out of economic necessity. As a result, a working knowledge of the state-by-state procedural and substantive requirements will be mandatory for all student loan servicers with borrowers or cosigners in affected jurisdictions.
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