Posts Tagged ‘CCA’

Over the summer, negative stories about the for-profit education industry were not hard to find. A government study showing misleading sales tactics, congressional hearings that painted a negative image of the industry, and stricter industry regulations proposed by the Department of Education all fed into the anti-for-profit education story being pushed by short sellers.

Throughout the summer, the industry was rather quiet–rarely defending itself. We believe most companies and various industry groups were in a holding pattern, waiting for the DoE’s official proposal on gainful employment before firing back and defending themselves fully. As the public comment period came to an end in September, the industry finally started its counterattack. After taking their time to digest the gainful employment proposal, education companies, industry groups, and other interested parties sent a barrage of comments to the DoE, explaining their concerns with the proposal. Given the vast number of public comments–estimated to be over 100,000 in number–the DoE recently delayed the publishing of its final gainful employment regulation until early next year (Nov. 1 was the original deadline). It will also hold various meetings and public hearings in the near future to further discuss the issue.

While the delay could be construed as an increase in the likelihood that the DoE will once again soften the regulation, we caution investors that it could be nothing more than the DoE needing extra time to sift through the large number of public comments. We continue to believe this policy is not the best way to address the issues surrounding education. However, given the DoE’s hard-line stance toward regulating for-profit schools, we question the DoE’s willingness to make further concessions, even if they are in the best interest of the public. That said, a change to the proposal is not out of the question.

In our opinion, the current proposal fails to look at traditional, not-for-profit schools, which undermines the issue that student debt loads and a tough employment market are problems that affect all students and not just for-profit ones. Additionally, the rules create many unintended consequences, potentially harming quality schools as opposed to just impacting the bad actors, which is the intent of the regulation. Also, the regulation seems abruptly put together as it uses different data than what will actually be used when the regulation is implemented. This means that the DoE’s current impact analysis could be significantly different than the actual results.

After reading through various comments from the companies as well as industry groups, we believe they have made a good case for why the regulation, as proposed, is bad policy. The Association of Private Sector Colleges and Universities, or APSCU (formerly the Career College Association), even argued that the DoE doesn’t have the legal authority to institute the rules in the proposed regulation. The APSCU argues that Congress already addressed student debt levels and institutional default rates in the Higher Education Act and it has not given the DoE authority to override or augment the current requirements. The APSCU also points out that the regulation violates due process because it does not allow institutions access to the data used in its calculations. We have heard other industry insiders question the legality of the regulation. While it would be in everyone’s interest to resolve this issue without a legal fight, if the regulation goes through as proposed, we would not be surprised to see legal challenges.

Congress could preempt any legal challenges by passing new laws. However, we don’t think there is the political support to make that happen. The Republican Party is cautious of over-regulation, and they could potentially gain additional congressional seats in the upcoming elections. Additionally, many Democrats oppose the regulation as they fear it could limit educational access for minorities and lower-income students.

So what does all of this mean for investors? We believe the majority of any regulatory impact is already factored into most of the education companies’ stock prices, creating investment opportunities within the space. In our opinion, many stock prices reflect an overestimation of the impact and also imply a near 100% probability that the regulation goes through as currently proposed. One prominent short seller openly admitted that he would not be short this industry without the regulation. Given the political and legal headwinds facing the regulation as well as pricing that already reflects a dire scenario, we question why anyone would still be short many of these stocks.

One example of where the market appears to be overestimating regulatory impact is Apollo’s (APOL) stock price. The company’s $50 stock price implies an almost 50% hit to its earnings. The company even recently traded as low as $39 before the industry started to fully defend itself. This approximate 50% earnings drop was first promulgated by a short seller before the most recent gainful employment proposal was issued. However, when an updated proposal was issued, it created two additional ways to remain eligible for financial aid access. Additionally, Apollo scored relatively well (a 44% repayment rate versus a 45% threshold for full eligibility) on one of the DoE’s preliminary tests. Despite the fact that the likelihood of a sever earnings impact has decreased significantly, it appears the market is still factoring in a 100% probability of a massive hit to earnings. Also keep in mind that the 50% hit to earnings was an estimate that we believed was overly bearish even under the initial, more stringent regulatory proposal.

Instead of a 50% hit to earnings, we believe a more likely scenario for the higher-quality education names is a slight dip in their enrollment followed by decreased growth opportunities. A recent study from an independent, nonpartisan think tank that favors the regulation, Education Sector, supports our opinion. Education Sector concluded that only 6% of programs at the 14 publicly traded education companies would be ineligible and 21% would fall into the restricted category. Restricted programs would face enrollment caps, limiting growth but not necessarily causing an enrollment decline. The remaining programs would fall in one of two categories: fully eligible, or requiring a debt warning. Programs in either of these categories should see no material impact on their growth prospects. We even believe that providing incoming students with aggregate debt levels is a good thing for all programs, not-for-profit and for-profit alike.

To put this impact into perspective, let us compare the potential impact from this analysis to our original growth estimates before any regulation. Our original growth estimate for the industry was 10% compounded annually over the next few years. Assuming Education Sector’s estimates hold, our new growth estimate drops to 1.3%. This scenario of limited to almost no growth is a far cry from the massive earnings losses that are baked into many education companies’ stock prices.

Here is how the math works. If we assumed a 100 student population index, our estimate for the following year with 10% growth would be 110 students. However, given 6% of programs would be ineligible, that index would decrease to 94 students. An additional 21 students would be in programs that could not grow. But the remaining 73 students would be in programs that can continue to grow at our original 10% estimate. Growing these 73 students by 10%, and adding back the 21 students that are still in restricted programs, results in 101.3 student index.

We are cautious to give too much weight to the exactness of the impact analysis that studies like Education Sector’s provide. As is the case with the DoE’s impact analysis, the use of estimations and substitute data sources (like using the Bureau of Labor and Statistics versus the Social Security Administration to estimate student earnings) make any calculation just an approximation. However, we believe it gives a good ballpark figure as it relates to the potential impact.

A common theme in Education Sector’s study echoes what we have been saying. Higher-quality education companies will likely see a more limited impact than others in the industry. In fact, this study suggests that Apollo, Strayer (STRA), Grand Canyon (LOPE), DeVry (DV), Capella (CPLA), and Bridgepoint (BPI) will have no programs that fall into the ineligible category. So while the exercise above gives an indication of the industry impact, these schools should experience a milder decline in growth. This study even indicates that Apollo will only see 10% of its programs in the restricted category. Therefore, a 50% decrease in earnings potential is a vast overestimation, in our opinion.

Finally, it is important to remember that this impact analysis is by no means 100% accurate. One of the key flaws in this proposal is that it lacks the detail and data needed to fully analyze the impact. Additionally, the downside industry scenario described above is only likely if the regulation goes through as proposed, which is still a big if. Given the market’s overreaction and the excessive fear surrounding increased regulation, not to mention the potential for a favorable change in the proposal, we believe there are numerous investment opportunities in the industry. However, we would advise investors to stick with the higher-quality names as the eventual impact should be less detrimental to their operations compared with the rest of the industry.

Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.


The Liberal Paradox

Suppose that a conservative Republican Administration, in the middle of high unemployment and an economic slowdown, proposed new regulations that would most hurt lower income people and minority groups and the for-profit colleges and universities that serve them? Can you imagine the cries of outrage from liberal critics, condemning “hard-hearted” Republicans targeting the most vulnerable young people in our society?

Yet that is exactly what the Department of Education’s proposed “gainful employment” regulations would likely do. They are almost exclusively aimed at “for profit” private colleges, which are predominantly comprised of lower income and minority students. Let’s be careful about characterizing, as some liberals have done, those schools catering to such vulnerable at-risk students with “open admission” policies as “bad actors” whereas the more selective elitist Harvards and Stanfords with less student loan defaults are deemed “good actors.”

This has the uncomfortable look and feel of disparate class and racial treatment – which should make liberals very uncomfortable.

So how to explain the paradox that, in fact, these proposed regulations are being proposed by a progressive Democratic Administration and its strongest proponents are liberal members of congress?

There appear to be three explanations – each one less meritorious than the other.

The first is a simple misunderstanding of the facts. For example, liberals supporting these proposed regulations rightly complain about marketing and other abuses. But the fact is, such abuses occur at non-profits and public institutions as well as at for-profits and, in any event, the gainful employment regulation doesn’t even address the issue of these abuses (although liberal commentators and editorial writers continue to conflate the two issues).

Moreover, those liberals who cite the excess “cost” of student loan defaults among the lower income and minority students ignore two inconvenient, indisputable facts: first, billions of dollars of taxpayer subsidies that go to non-profits and public colleges are not available to for-profits; and for-profits cost taxpayers substantially less per-student each year than non-profits and public colleges, when the approximately $1 billion of taxes/year paid by for-profits are taken into account.

Second, this is a classic example of overly broad regulations confirming the law of unintended consequences.

How overly broad? According to the Department of Education’s own data released last month, its proposed “gainful employment” regulations are so poorly crafted that if applied to non-profits too (which they currently are not), Harvard Medical School, D.C.’s famous minority school, Howard University, and 93 of 100 Historic Black Colleges in the U.S. would all fail the so called loan repayment test. But, supporters of the regulation say, failing just one-of-two tests won’t result in loss of student federal loan eligibility. However, just recently, Iowa Democratic Senator Tom Harkin, one of the strongest proponents of this proposed regulation, suggested that failure of the loan repayment test alone should be enough to bar student loans to those who need them the most.

This is why numerous members of the Congressional Black Caucus have strongly weighed in against these proposed regulations and more and more representatives from minority and blue collar communities are waking up and opposing the proposed regulation.

The third explanation appears a classic example of ideology trumping facts: the instinctive negative reaction of many liberals to the word “profit” when associated with providing education. This seems uncomfortably similar to opposition by most liberals to private “charter” schools within urban public school districts, opposition that seemed increasingly paradoxical as more and more inner city parents supported having the choice of charter schools for their children.

The fact is, it is precisely the profit motive that causes for-profits to offer more flexible, consumer-responsive schedules and courses, such as night classes, online courses, and new curricula that are directly responsive to recent changes in the job market.

Clearly Secretary Duncan needs to put an amber light on the “Gainful Employment Regulation” as it is presently written. As Harry C. Alford, President and CEO of the National Black Chamber of Commerce wrote recently, “student debt is a national problem, one that must be addressed, but imposing regulations on schools that are effectively educating students is unnecessary.”

If any regulation is necessary, then Mr. Duncan owes it to the most vulnerable students who will be disproportionately hurt by the current version to use a scalpel, not a hatchet, and to address the issue of excessive student debt at all higher education institutions – not just at for-profits, but at non-profits and public universities as well.

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Lanny J. Davis, a Washington D.C. attorney and former Special Counsel to President Bill Clinton in 1996-98, serves as a paid “Special Advisor” to the Coalition for Educational Success, a group composed of several companies that own and operate for-profit higher educational colleges in the U.S.

1. The proposed regulation will limit access to higher education for hundreds of thousands of non-traditional students (primarily working adults and lower income students) at a time when job creation, often requiring skills training or retraining, is a paramount national public policy goal.

  • Student demand for professional and career education is at historically high levels partly because of the transformation of the U.S. economy from a production-based to a skilled services-based economy and partly because of the high unemployment rate.
  • At this time, only proprietary (i.e., for-profit) colleges and universities have the resources to increase capacity to meet the demand. Alternative educational paths for students seeking such training do not exist because those institutions, e.g., community colleges, are facing substantial funding shortfalls.President Obama has set a goal of regaining the nation’s number one rank internationally for the highest proportion of college graduates by 2020. Even critics concede that we cannot reach this goal without a robust proprietary sector of higher education. The Gainful Employment metric is directly at odds with this national policy goal.

2. The regulation will eliminate high quality programs that offer graduates a lifetime of improved earnings because the initial post-graduation earnings in those careers are low.

  • According to data released by the Department of Education (“ED”), if the same metric were applied to traditional medical schools, most would fail. An analysis of the data provided show that institutions in the private not-for-profit and public sector that serve populations similar to those attending private sector colleges and universities (i.e. non-traditional, minority, and lower socioeconomic populations) have similar repayment rates. Yet, ED is targeting just one sector.

3. The regulation falls most harshly on low income and minority students.

  • Schools in our sector serve proportionately more low income and minority students who are under-represented in postsecondary education than the traditional sector. This regulation implicitly discriminates against African American and Hispanic students by eliminating program choice and access.

4. The proposed rule, which pegs the calculation of the debt-to-income ratio on earnings in the first three years post graduation, is heavily biased against longer term (baccalaureate and above) and costlier (e.g., health care) programs, because students in those programs have to borrow more in the aggregate but their earnings differential from those with lesser degrees do not emerge until after the first three years after graduation.

  • Economists have shown that it takes seven years or more after graduation, not three years, for those with higher degrees to begin to experience the real financial advantage of additional education in the marketplace.
  • The explanation given by ED for using the first three years of earnings is that the gap in earnings in the first three years is about the same as the gap in later years. This measure of the gap in earnings does not measure the gap in earnings between those with a high school degree and those with some postsecondary education, but rather only the level of earnings. In ED’s explanation it is admitted that the level of earnings increases significantly even over the first ten years after school. Whether the gap, measured this way, stays the same is not relevant to the proposed rule.

5. Although the proposed regulation is lengthy and complex, it is still basically the same concept ED previously proposed that created such strong opposition when it surfaced in January 2010—programs must show a debt to income ratio of 8% or less to continue. In this version of the regulation, ED simply recognized the need for adding a more nuanced measure of income, namely discretionary income.

  • Most independent research by authorities such as Dr. Sandy Baum and Mr. Mark Kantrowitz has shown that an 8% metric, borrowed from other types of consumer debt metrics, is wrong for higher education.
  • While the addition of the discretionary income to the debt-to-income metric results in fewer programs being impacted, the vast majority that do not meet the flawed 8% metric would still fail and a majority of programs that do not meet the 8-12% metric would remain in the restricted category.

6. The regulation creates a complex taxpayer funded regulatory regime within ED without a sufficient basis of research to assess its national impact.

  • ED does not have the current infrastructure to monitor and enforce this complex regulation and significant resources will have to be expended to implement this new regime.
  • ED selectively cites research findings and interprets experts on financial aid issues to support and promote its flawed proposal.

7. ED’s Gainful Employment metric exceeds statutory authority by going well beyond the definition of the term “gainful employment.”

  • It provides new authority for ED to pre-approve all new programs.
  • It uses a narrowly defined repayment rate to measure acceptable levels of debt for the first time rather than the congressionally sanctioned and well-tested cohort default rate.
  • It does not permit students using congressionally supported debt management programs such as deferments or forbearances, or who choose lower-wage jobs in social service fields and rely on the Income Based Repayment Plan, to be counted in the repayment calculation, although those are fully legitimate means of repayment for any graduate.

8. Although ED offers the repayment rate test as an alternative qualification test for programs that fail the debt to income ratio metric, by ED’s own analysis that alternative test will benefit only a tiny fraction of programs and arbitrarily hurt smaller programs and small schools.
9. The repayment rate test may often be the only test available to smaller programs and, as a result, small programs, often at smaller schools, would suffer random and severe consequences.

  • Small programs are more likely to be unable to meet the debt ratio metric due to small student numbers, and will have to rely on the repayment test according to ED.
  • As a result, repayment problems by just a few students could eliminate the entire program. The repayment test results for small programs would be random and impacted by economic volatility at much higher rates than larger programs, for no quality reason.

10. The proposed regulation does not balance risks and interests in pursuit of a common policy goal, but instead appears to advance an agenda unrelated to student debt.

  • Institutions bear all the risks of repayment without taking into account student populations served.
  • Institutions will know whether a program fails only after it fails because only ED will have access to the repayment information and income data (using social security reported earnings) used to calculate the metric.
  • The retroactive application of the regulation violates a basic principle of legal fairness and points to the agenda of ED to eliminate, not reform, programs.
  • Institutions will have no way to monitor compliance and make adjustments until after a program has failed the metrics.
  • If a single program is out of compliance with the metric, the entire institution can be placed on provisional certification, limiting the institution’s ability to add new programs and increase enrollments. The Department has stated that when reviewing an institution’s application for recertification of its program participation agreement – the school’s agreement with ED for participating in the title IV Federal student aid programs – they will take into consideration the fact that an institution is provisionally certified due to being out of compliance with one of the gainful employment measures for one program. Thus, the institution’s participation in the title IV programs can be terminated due to one program not meeting the gainful employment provision.
  • By excluding students utilizing deferments, forbearances, and in some cases IBR from the repayment calculation, institutions will have to choose between assisting students in selecting the best method of managing their student loan repayments or risking running afoul of the metric.
  • Institutions will lose their right to due process because without access to the income data (out of privacy concerns for the students) they will not be able to defend themselves against action by ED.
  • The requirement that institutions on restricted status obtain testimonials from an employer unaffiliated with an institution that the program aligns with expected job skills is weighted against institutions. While many private sector institutions have well-established relationships with employers, they may not be permitted to speak on behalf of the school and the students they have hired. An unaffiliated employer has no reason to take the time and effort needed to support a program.

11. The proposal is social engineering at its worst.

  • ED is telling lower income students who rely on title IV Federal aid to assist them in achieving their postsecondary dreams where they can go to school, what they can study, and what careers they can enter. A student who can afford to pay out of pocket can make his/her own choices.
  • ED states institutions could comply with the metric by lowering their tuition. Not only is this a back-door way to control tuition pricing, it is a false premise. Students will still be able to take out the same amount of federal loans even if a school lowers tuition because institutions are not permitted to limit loan eligibility even when that eligibility far exceeds institutional charges. Also, institutions would run afoul of the 90-10 rule if they lowered their tuition to the degree ED infers in the proposed regulation.
  • By placing an entire institution on provisional certification if a single program is out of compliance with the proposed gainful employment metric, the regulation stunts one of the great advantages of private sector education for our economy: the rapid development of new programs closely tied to changing workforce needs.

12. CCA supports substantially increased, and yet easy to understand, consumer disclosures to prospective students that gives detailed information on the costs of the educational program, the likely occupations in which the student may work after graduation, the overall loan burden the student is likely to have at graduation (including the predicted monthly repayments), and the range of earnings in those occupations, as determined by the U.S. Department of Labor.

  • Increased consumer information, not a complex and convoluted set of metrics, is the direction ED should take to address concerns that prospective students do not fully appreciate the risks and rewards of entering an educational program.