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EDMC ends loans during tough times for industry
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WASHINGTON -- The twin maelstroms of weak credit markets and controversy surrounding the for-profit education industry have forced dramatic shifts in private student lending at for-profit colleges in recent years.
In June, Pittsburgh-based Education Management Corp., one of the nation's largest for-profit college companies, will shut down its in-house lending program and is looking at selling off the loans it holds. The owner of the Art Institutes, Argosy University and other schools said it started the program in August 2008 because its students were having trouble getting loans and is closing it now because that's no longer a problem.
But investors and observers say the for-profit student lending market remains difficult because of students' high default rates and investors' wariness about being connected to an industry buffeted by scandal.
"Until the lenders become more comfortable and until the schools prove themselves more that they're improving their programs and the quality of their student body, I think it's kind of a wait-and-see game," said Dave Hartung, vice president of education lender First Marblehead.
Before the financial crisis, college students -- similar to homebuyers -- had access to loans even when the students weren't particularly creditworthy. For-profit colleges carry a riskier lender class than state and nonprofit private schools because they have more low-income and non-traditional students.
Such students are also much more likely to borrow.
A report by the Education Trust, an advocacy group for low-income and minority students, found that 95 percent of for-profit students took out federal loans and 42 percent had private loans at two-year schools in 2008. At private nonprofit two-year schools, 18 percent had private loans, while at public schools, just 5 percent had private loans.
In the past, many for-profit education companies struck deals with private lenders such as loan giant Sallie Mae to carry some of the risk in providing the subprime loans, which typically had interest rates far higher than federally backed loans.
Sallie Mae dissolved all those deals in 2008 and tightened its underwriting standards as the financial crisis hit, and its loans to for-profit institutions plummeted.
Many companies, including EDMC, responded by initiating or increasing programs in which they back the loans themselves. Education Management's program bought loans made by private lenders such as PNC.
According to a report by the National Consumer Law Center, such institutional loans exploded after 2008, and the loans often had predatory terms and astronomical interest rates.
In June 2010, EDMC held $85 million in loans but estimated that it would lose 41.2 percent of its investment to defaults, according to a filing with the Securities and Exchange Commission, based on past default rates from its schools and the credit ratings of the borrowers.
"The loans haven't been profitable, institutional loans, for the most part from the beginning," said Deanne Loonin, the author of the National Consumer Law Center study. "They weren't offering them for that reason. It was about entrance and exit from the market."
In fact, Ms. Loonin's report found the schools often didn't seek out delinquent student borrowers, figuring that the payments they would be able to retrieve weren't worth the expense. The real value for the loans was to help get more students in the door.
Schools can receive no more than 90 percent of their total funds from federal loans and grants, though there are a couple of exceptions including federal support for active-duty military and veterans. That remaining 10 percent at for-profits usually does not immediately come out of students' often-meager pockets -- it is borrowed elsewhere.
In EDMC's case, the money won't be borrowed from the school anymore.
"We always anticipated the phase-out of the Education Finance Loan program upon improvement in the capital markets (and) as additional financial aid options became available to students," EDMC spokeswoman Jacqueline Muller wrote in an e-mail. "We no longer believe the program is needed."
Ms. Muller added that applications for the program dropped, indicating that students were finding credit elsewhere.
But analysts said the subprime student loan market is still tight.
"There are some new third-party lenders out there -- credit unions are offering more student loans now," Ms. Loonin said. "But there still aren't many that are lending to higher risk populations. And that would be, we would say, well, that's mostly a good thing because those loans were unaffordable."
Sallie Mae's standards remain high for all borrowers. Mr. Hartung, of lender First Marblehead, said his company is now tiptoeing back into the private student loan market -- but for the most part not with for-profit schools.
In addition to the high default rates, Mr. Hartung said there is a question of perception at play. A series of lawsuits, news media reports and Congressional investigations have painted the for-profit industry in a negative light, exposing low graduation rates and high debt loads fueled by a highly pressurized sales culture. Even though the most egregious activity has been documented at only a handful of schools, Mr. Hartung said it has wider ramifications.
"There are bond investors ultimately taking that risk, and bond investors are asking what is the exposure to for-profit colleges in that portfolio," he said.
"Some don't want to do the research and see how that might be, some just read the paper. ... As a lender you have to be mindful of those things. Unless you're willing to take the time and educate the investors, and unless you have investors that are willing to learn and take that risk, they're probably going to shy away from it.
"Which is why folks like us, Sallie Mae and The Student Loan Corp. pulled away from that space. A lot of what we do is driven by our ability to sell bonds."
As Education Management sacks its institutional loan program, Ms. Muller said the company expects an increase in its in-school payment plans, in which students pay off their education in installments while they're in school and for up to three years after they leave.
Mark Kantrowitz, a financial aid and college planning author who lives in Cranberry, said more in-school payment plans help EDMC's bottom line by providing it with more immediate cash and helping the company keep ahead of a federally required change in institutional loan accounting due next year.
Under a temporary reprieve provided by the Higher Education Opportunity Act of 2008, schools are allowed to state the in-house loans they issue as income, counting toward their 10 percent of non-federal income. Starting in July 2012, that exception expires and they can only count the payments students make on those loans as income -- and those come in gradually in small amounts in the years after students graduate or leave.
"You can see how this leads schools, when they are making institutional loans, to have students make payments in the in-school period," said Mr. Kantrowitz, who publishes the student loan guide finaid.com.
As the credit markets come back, the market for private student loans remains in flux for for-profit students. Mr. Hartung said if new federal regulations -- which have been proposed by the Department of Education and have provoked an intense backlash from the industry and its allies in Congress -- increase the quality of the schools, bond investors could warm to for-profits and the credit could flow more freely.
Mr. Kantrowitz predicted the uncertainty will lead to experimentation.
"You have a lot of lenders that are trying to decide what are they going to do," he said. "And I think we're going to see a lot of innovation about creating rather novel twists on education loans."
First Published March 20, 2011 12:00 am
