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“Hello, my name is Steven Eisman.”
“Hi Steve, we loved the Big Short. Thanks for your email — yes, let’s grab a coffee and discuss why you’re shorting the for-profit college industry.”* (*FT Alphaville translation.)
So goes the WSJ’s splash on hedge fund warnings about a fast growing, federally subsidised industry, that happens to be aggressively targeted at low income people. Oh, and there are weak regulations and high default rates, too.
Sound familiar?
According to the Education Trust, for-profit colleges enroll 12 per cent of all US college students, and have grown over ten times as fast as public and non-profit private colleges in the last decade — albeit from a low base.
And as the WSJ’s graphic shows, they’re less likely to graduate and more likely to default on their debts (click to expand):
The charts on the left show default rates after 15 years — this slide from the Education Trust shows how quickly default can occur in the for-profit sector (click to expand):
Unsurprising, you may argue given the demographics of for-profit college students. To an extent, yes, though there is evidence to suggest that even controlling for background and income, results are poorer in this sector.
In any case, these two and three year default rates matter because under the Higher Education Act, an institution could lose its eligibility to participate in some or all of the federal student financial aid programs if defaults by its former students on their federal student loans equal or exceed 25 per cent per year for three consecutive years, or 40 per cent in a single year.
But fear not would-be applicant, since Sallie Mae cut back on loans to high-risk borrowers the colleges themselves have stepped in to offer sub-prime loans. And this is when it gets really interesting.
One example is Corinthian College’s Genesis Lending Program, which is described in its 2010 SEC filing:
In the face of this change in policy, we created a new student lending program with a different origination and servicing provider, Genesis, who specializes in subprime credit. This new Genesis loan program has characteristics similar to our previous "discount loan" programs. Under this Genesis loan program, we pay a discount to the origination and servicing provider. As with our previous discount loan program, we record the discount as a reduction to revenue, as the collectability of these amounts is not reasonably assured.
So what? Well, according to the earnings call transcript available on seeking alpha, the discount rates on this $150m worth of lending is a whopping 56 – 58 per cent. According to Corinthian, this equates to anticipating a default rate of 56-58 per cent, of its own students who go into this programme.
Wow. The defence here is that these are the highest risk students with the worst credit scores, and, hey, it’s their money. But having colleges run loan programmes where they assume over half will default doesn’t seem to us like a healthy marker of an educational system.
And with figures like that on top of high default rates for the federally subsidised loans, it’s clear why the likes of Eisman are shorting the industry.
As John Kemp wrote in an email this morning, we shouldn’t confuse this with public interest action. But even if you’re the most forceful advocate of personal responsibility it’s worth asking whether the current system of subsidies and seemingly lax regulation is best serving US taxpayers, and of course the students themselves.
The next big short? One to watch…
Related links: A ‘Short’ Plays Washington – WSJ For-profit colleges’ increased lending prompts concerns – AP (2009) Marine Can't Recall His Lessons at For-Profit College – Bloomberg
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