"Inspecting a Student Loan Spigot"
January 18th, 2014
The New York Times
A few days after Christmas, ITT Educational Services, one of the nation’s largest operators of for-profit technical schools, reported some unwelcome news. The Consumer Financial Protection Bureau had warned the company that it might seek penalties and remedies against it for possible student loan violations.
ITT maintained that its practices were legal and said it would vigorously defend itself. Happily for the company, its shareholders seem unworried: last week, the stock hit a new 52-week high, closing at $45.27.
ITT is not the only for-profit educator under scrutiny, of course. But it is among the largest. At 149 institutes in 39 states (and online), ITT offers nursing, criminal justice, business, information technology and other programs to 61,000 students. Based in Carmel, Ind., the company generated $800 million in revenue in the first nine months of 2013, down 18 percent from the year-earlier period.
The consumer bureau, ITT’s filing said, wants to determine whether lenders and student loan servicers working with for-profit colleges “are engaging in unlawful acts or practices relating to the advertising, marketing, or origination of private student loans.”
That’s a pretty broad purview. Asked for more details last week, Rohit Chopra, student loan ombudsman at the consumer protection bureau, said he couldn’t comment on individual companies.
But with total student debt topping $1 trillion today, regulators are clearly on the alert for abusive practices. And with jobs scarce for recent graduates, these loads loom even larger.
Debt carried by students at for-profit colleges can be especially onerous when compared with what attendees make after graduation. Nicole Elam, an ITT spokeswoman, said the average annual salary reported by its 2012 graduates was $32,612. Their average debt burden was around $30,000, she said. By comparison, the average student loan balance nationwide and across all institutions was $24,803, Federal Reserve research shows.
Ms. Elam declined to comment further on the consumer bureau’s warning. But delving into ITT’s financial statements provides clues to what the regulator may be looking at. First, though, a tutorial in the student loan industry may be in order.
The United States government is by far the largest lender to students. In 2012, it provided 73 percent of the $236.7 billion in total student aid offered that year, up from 67 percent a decade earlier.
Private-sector loans, meanwhile, have plummeted in recent years — to $6.4 billion last year from $22.9 billion in 2008 — as investors retreated from the market.
Among for-profit institutions like ITT, student access to private loans is crucial. Under Department of Education rules, no more than 90 percent of tuition payments can come from federal funding. At least 10 percent must come from private sources like family savings or other lending institutions. Veterans’ tuition costs, however, can be fully paid by federal programs.
For-profit entities exceeding the federal funding limit for two years lose access to that money for their students. That could be a death sentence for the institutions. In 2012, some 80 percent of ITT’s revenue came from government aid programs.
This is typical among for-profit schools. Because these schools cost more than public universities or community colleges and recruit students of reduced means with little access to private funds, students at these institutions rely heavily on government programs.
As the private loan pool dried up, some schools had a tougher time meeting the 90-10 rule. In January 2010, ITT came up with a solution: the Peaks Private Student Loan Program, which increased the amount of private money available for its students.
The program was financed by an off-balance-sheet trust that raised over $300 million from investors, to whom it issued debt. This debt was guaranteed by ITT, but an unaffiliated lender used the cash to make loans to ITT students. Those loans were then put into the trust.
Because the lender was unaffiliated with ITT, the loans qualified as private money under the 90-10 rule. The company, therefore, ensured that its students could keep tapping into federal grants for the other 90 percent of their education costs.
The idea was creative and immensely helpful to ITT, as it kept revenue coming in. But the Peaks program, which ended in 2012, is becoming problematic now. Many of the loans in the trust are defaulting. In its most recent quarterly filing, ITT said it projected default rates in Peaks and a similar pool of loans to be as high as 59 percent.
Contrast this to the 14.7 percent default rate for students three years after starting repayment of federal loans, according to the Department of Education.
Signaling that the Peaks trust is teetering, ITT began making payments to it on behalf of students to help them avoid default. ITT said it had paid $7.65 million as of the quarter that ended in September.
As the guarantor of Peaks trust debt, ITT is on the hook for its loans. So far, the company has set aside reserves for possible losses of $40 million.
Bradley Safalow, founder and chief executive of PAA Research, an independent research firm in New York, reckons that based on ITT’s default projections, it could be forced to make additional payments for Peaks liabilities of over $100 million.
“There’s no question that 90-10 compliance was a major motivation for ITT to set up the Peaks trust,” he said, “and it was a huge source of cash generation for them.”
There’s another potential problem with the company making payments on behalf of borrowers: the possibility that those payments would imperil its compliance with the all-important 90-10 rule when the loans were made.
The magnitude of ITT’s projected default rates of up to 59 percent may also be of interest to regulators who are increasingly concerned that lenders weigh borrowers’ ability to repay such obligations. The company may argue that it did not originate the loans, and thus could not be considered responsible.
But, speaking generally and not specifically about ITT, Mr. Chopra of the consumer protection bureau said: “When a lender originates a loan that they expect to fail, that raises questions about their broader incentives. Our concern is normal market forces may not be working properly.”
ITT is fielding inquiries from another regulator as well. Last February and again last May, the company received subpoenas from the Securities and Exchange Commission asking for information about its Peaks program. It is cooperating.
For now, it seems, there are more questions surrounding ITT than answers.