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MagicDiligence (< 20)

Gainful Employment Rules Ignore Demographic Realities

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August 23, 2010 – Comments (6) | RELATED TICKERS: APOL , STRA , COCO

One of the biggest risks facing publicly traded for-profit educational institutions is the Department of Education's (DoE) proposed "gainful employment" rule. Under the proposed rule, schools where less than 35% of students are repaying the principal on federal education loans would essentially become ineligible. Schools with 35-45% would face restrictions on their ability to receive these loans. There are some additional income stipulations, where if debt is 8% or less of income, then the above restrictions can be waived.

Notably, the rule is set to only apply to for-profit institutions, not publicly funded 2 or 4-year schools.

The rationale for these rules is noble. The government wants to insure their investment in education is resulting in employment where the student is making enough incremental salary to show the value of the education received.

Private Sector Education Repayment Rates

Shortly after announcing the proposed rules, the DoE released a report that detailed the repayment rates at over 8,400 institutions, both for-profit and not (download it here). This release caused the share prices of many for-profit companies to tank, as several of them fell well below the 35% threshold. The consolidated repayment rates and weighted average federal debt per student at some of the larger companies were:

Corinthian Colleges (COCO) 24% ($6,794)
Strayer (STRA) 25% ($14,908)
Washington Post's Kaplan Division (WPO) 28% ($7,458)
ITT Education (ESI) 32% ($10,608)
DeVry (DV) 35% ($13,373)
Career Education (CECO) 36% ($10,775)
Apollo Group (APOL) 44% ($13,324)

Those are unquestionably some poor numbers, leading to an explosion of reactionary journalism and "analysis" that immediately concluded that the bear case on for-profit educators, of being "churn and burn" marketing institutions, must be true. In fact, a New York Times article had a quote from Debbie Frankle Cochrane, program director at the Institute for College Access and Success, that read “I think it’s notable that the for-profits are the only type of school where the majority of students are unable to repay their loans”.

With several of these companies a part of Magic Formula Investing, the issue is important to followers of the strategy (as well as investors at large). Is it really true that for-profit institutions are wholly unconcerned with educating their students? Is the problem just that the insatiable greed of capitalism is to blame for low repayment rates at private sector schools?

All Students Are Not The Same

For the purposes of this article, I'll put aside the objections raised by firms like Strayer that argue that consolidation loans, which are often structured as interest-only or graduated income repayment, are not considered in the repayment rates. That is fine, but if the methodology was the same for all schools, the net effect should be similar and bring down repayment rates for all schools.

More of interest to me was raised on Corinthian's conference call last Friday. Corinthian raised a very salient point: these companies, particularly the 2-year focused ones like COCO, ITT, DV, and CECO, service a generally low income, minimally educated demographic. In fact, up until this year a quarter of Corinthian's enrollment was "Ability To Benefit" students, a program set up by the government to allow students with no high school diploma or equivalent to attend higher education. It is of little surprise that ATB students graduated at low rates, defaulted on loans frequently, and were hard to place in jobs (Corinthian is dropping them for 2011). Most programs at these 2-year schools are vocational, and targeted at either older students or younger students that do not possess the desire, SAT test scores, or GPA to be accepted into public universities.

Could it be that the relatively low repayment rates at many of these institutions were due more to the demographic they served as opposed to the supposedly poor quality of education they delivered? I wanted to test the hypothesis.

Is There A Demographic Pattern?

One way to test the demographic theory on the DoE's data is to look at some 4-year public schools (the ones not ruined by capitalism). Data about average student incomes at public schools is obviously difficult to come by, but reputation is a good place to start. MagicDiligence operates from Baltimore, and I started there with a few inner-city and rural colleges that, by reputation, service low income demographics:

Coppin State University 23% ($11,958)
Morgan State University 23% ($14,765)
University of Maryland, Eastern Shore 31% ($12,433)

Hmmm... all 3 schools have similarly low debt repayment rates. We're off to a good start, but this is clearly not enough data. Let's stretch the example out some. Athletic conferences are built around schools with similar demographic populations, so let's look at the rest of the Mid-Eastern Athletic Conference (MEAC):

Bethune-Cookman 15% ($12,890)
South Carolina State 17% ($15,583)
Savannah State 20% ($12,511)
Delaware State 21% ($15,316)
North Carolina Central 22% ($20,367)
Norfolk State 24% ($13,325)
North Carolina A&T 27% ($12,036)
Howard 32% ($31,789)
Florida A&M 32% ($18,804)
Hampton 42% ($17,377)

Well, this is interesting! The entire conference of schools have repayment rates below 45%, and only Hampton even clears the DoE's 35% restricted threshold. 7 schools have lower repayment rates than Corinthian, the worst of the for-profits (1 is the same). And all are sticking the federal government with more than double the debt of the 2-year schools (challenging another myth that for-profits are way more expensive than public schools).

So, the MEAC should be shut down by the DoE and shorted by Steve Einsman. But is this an anomaly? What if we look at another conference of low income demographic public universities? Let's take the Southwest Athletic Conference (SWAC):

Mississippi Valley State 8% ($19,143)
Grambling State 12% ($17,111)
Jackson State University 12% ($20,433)
Alabama State 14% ($15,102)
Arkansas Pine Bluff 14% ($13,559)
Alcorn State 15% ($15,398)
Southern 18% ($19,621)
Prairie View A&M 20% ($20,833)
Alabama A&M 21% ($18,186)
Texas Southern 23% ($17,931)

That's even worse than the MEAC! The entire conference, 10 publicly funded schools, with repayment rates well below Corinthian's (drastically below ITT and DeVry), and with more than double the repayment obligations.

Clearly, Debbie Frankle Cochrane is dead wrong when she asserts that only for-profit schools have students that cannot repay their debt. But do we really believe that all of these schools are "churn and burn" institutions, uninterested in the outcomes for students? I think it is unlikely that is the case.

Summation

While I realize that this is by no means an exhaustive analysis, I think it is more then enough to show that demographics matter to repayment rates - and they matter a lot. The "best and brightest", with well-to-do families that pay a significant portion of their bills, should not be the standard for which a student who went to work out of high school to support their family is.

Furthermore, the "gainful employment" rule seems to do a very poor job at weeding out the bad apples in for-profit education - the ones that are not truly providing valuable instruction. In fact, for these low income students, the trade-based for-profit schools are a much better value than the 4-year publicly subsidized schools. They are providing jobs that allow higher repayment rates and leave students with much lower debt burdens, according to the DoE's own data!

A better plan would be to simply do what has been done - limit federal aid based on cohort default rates. This system has been fairly successful, penalizing a school when cohort defaults exceed 25% for three consecutive years (or 40% for one year). Even lowering these rates by a few percentage points would help the bad apples to shape up. If the DoE is really serious about pushing "gainful employment", for which no positive outcome studies exist, a better idea is to include consolidation loans that are current. It is unfair to penalize any school (private or public) for loans that are current, regardless of the repayment schedule.

I fear that, if passed, all this rule will succeed in is limiting educational opportunities for low income students looking to better their position in life. We need a better way to weed out what schools are providing value vs. those that are not.


Disclosure: Steve owns APOL, COCO, ESI

Like this article?  Read more at MagicDiligence.com.

6 Comments – Post Your Own

#1) On August 23, 2010 at 10:13 AM, Gemini846 (83.59) wrote:

90% of University undergrad programs do not provide a long term ROI. I've gone over this adnausem. Because there is no ROI there is no ability to repay.  I have a buddy that went to one of these schools and graduated with $60k in Sallie Mae loans that he can't consolidate due to market conditions and he makes about $15 an hour. No wonder he's 30 and lives at home with his mom. His student loan payments are about the same as my housing payment.

If you want to fix education loans, allow real Bankrupcy defaults. All of a sudden nobody would have money to attend colleges. Colleges would then have to provide a service to justify thier tuition again. The number of people with degrees would go down. People would clamor in the streets for education reform in secondary schools. Of course it would take 3-4 generations for this to happen and the US would go down the drain faster than Sub-Saharan Africa in the mean time.

I hate to champion anything from Europe, but at least they don't hide the fact that their schools are designed to churn out mindless employees. US schools are too, but they do it by faking people out into believing the education they are overpaying for will lead them to the promised land.

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#2) On August 23, 2010 at 11:22 AM, miteycasey (38.26) wrote:

I hate to champion anything from Europe, but at least they don't hide the fact that their schools are designed to churn out mindless employees. US schools are too, but they do it by faking people out into believing the education they are overpaying for will lead them to the promised land.

 

I totally agree with this. There is a reason American high schools don't teach personal finance as a required class.

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#3) On August 23, 2010 at 1:01 PM, MegaEurope (23.83) wrote:

I'm surprised at how strong APOL's repayment rates are compared to the others.  At this price they may be a decent investment.

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#4) On August 23, 2010 at 7:19 PM, Option1307 (29.96) wrote:

The fabulous Citron Research brought up these shady practices long ago, see here for their take on APOL (University of Phoenix).

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#5) On August 23, 2010 at 7:25 PM, Option1307 (29.96) wrote:

90% of University undergrad programs do not provide a long term ROI.

Definitely agree with this point. I know a ton of people who went to private universities for 40-50K per year and now have 200K in debt and have middle of the road jobs for 5-70K/yr. Oops! 

Admittedly it is hard to ask our young adults (18 yr. olds) to know what their profession is going to be before they enter college, but the said reality is that many of them should not be going to private schools that charge exuberant tuitions rates while they plan on becoming teachers/businessmen/etc.

They simply will have too much debt with little means of paying it off in a reasonably amount of time.

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#6) On August 28, 2010 at 1:08 AM, umps15 (54.91) wrote:

Thank you for this analysis. It appears that the for-profit schools are doing hell of a lot better than most universities at providing their students with economic mobility. It makes sense... if past students are doing well, they will endorse the school and more students will join the fold. These companies have a higher financial incentives than a regular public/private university to provide a good education to their students.

 This article provides more details ... it seems that there are more to the DOE proposal 

http://www.insidehighered.com/news/2010/07/26/regs 

 This would make the barrier to entry higher, weed out some of the competition and will be good for the industry overall. 

I'm thinking going long on apollo, devry, and itt now that there prices stop falling.

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