The Wall Street Journal-20080204-Some Colleges Are Jeopardized By Tight Credit- For-Profit Schools Seek New Student Lenders As Sallie Mae Retreats
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Some Colleges Are Jeopardized By Tight Credit; For-Profit Schools Seek New Student Lenders As Sallie Mae Retreats
Full Text (1161 words)Pop quiz: Can for-profit colleges overcome the double whammy of tighter lending standards for student loans and an economic downturn?
The answer: Probably not.
It is looking less likely that outfits such as ITT Educational Services Inc., Career Education Corp. and Corinthian Colleges Inc. will be able to withstand the impact of a credit crunch and a possible recession. Even bullish analysts have trimmed earnings expectations to reflect these dangers.
Shares of these companies took a big hit two weeks ago after Sallie Mae, or SLM Corp., told them it was pulling back from lending to some of their students. Private lending accounts for 10% to more than 30% of revenue at these schools; at Corinthian, Sallie Mae's move could affect loans that are equal to about 10% of 2007 revenue.
Sallie Mae's retrenchment, resulting from a renewed focus on credit quality, could force prospective students to scramble for loans and pay more when they get them. The move "came as a surprise and suggests that tightening in the student-loan market will have more of an impact on some companies than previously expected," Merrill Lynch said in a recent report.
For-profit education companies cater to a wide variety of students and offer an array of programs, from diploma courses that prepare for skilled, blue-collar trades to graduate degrees. Much of the funding for tuition comes from federal loans and grants.
The difference between this aid, which can account for more than two-thirds of tuition, and the total cost of the courses, which can range into the tens of thousands of dollars, typically comes from private student loans. Sallie Mae has been the biggest provider of such lending, but it is becoming more selective amid mounting loan losses and tighter credit markets.
For-profit education companies have had a rocky history that includes run-ins with regulators and investigations into practices in the student-lending industry. Investigations have involved inquiries into how graduation and job-enrollment rates are reported, admissions procedures and financial record keeping.
Despite falling recently, ITT and Career Education shares have bounced back. Both have jumped about 30% since Jan. 22, while Corinthian is up by about 20%.
The problem is that the schools will likely struggle to sustain their growth rates because of the tight lending environment and the slower-growing economy. If students have a tougher time borrowing, they may need to pay more out of their own pockets. But if their job prospects are looking rocky, or if they are worried they could be laid off from existing jobs, they won't want to shell out the tuition themselves.
This leaves the schools in a quandary. They can try to save their profit margins by cutting back on advertising, which can total 25% to 30% of revenue, but that could make revenue and enrollment growth fall even further. Or they can keep advertising and hope students can keep borrowing.
The real issue for investors in these companies is what is already priced into the shares. Boosters argue the stocks are reasonably priced because students will be able to find other places to borrow, so the companies will maintain their growth rates. The companies continue to forecast enrollment increases of nearly 10%. At the same time, price-to-earnings multiples for all three companies have fallen markedly in recent months.
The bearish case is that these multiples still imply a fair amount of growth, which could prove elusive. ITT is trading at about 20 times expected 2008 earnings, according to Thomson Financial, while Career Education is priced at about 17.6 times forecast profit. Corinthian, which operates on a June fiscal year, trades at about 22 times expected earnings for the fiscal year ending June 2008 and about 17 times the following fiscal year's projected profit. The Standard & Poor's 500-stock index is trading at about 13.7 times expected 2008 earnings.
A spokesman for ITT declined to comment, as did a spokeswoman for Career Education. A spokesman for Corinthian referred to a statement issued in response to Sallie Mae's move in which Chief Executive Jack Massimino said the company was "confident we can arrange financing for the vast majority of our incoming students."
Shares in ITT fell 32 cents, or 0.35%, Friday to 91.52; Career Education's stock rose 36 cents, or 1.7%, to $22.10; and Corinthian jumped 55 cents, or about 6.5%, to $9.
The companies' current price-to-earnings multiples look especially shaky given that a large portion of their programs cater to students seeking diplomas or two-year degrees. These students are seen as having less earnings potential than those going through four-year or graduate programs and as having a higher default risk. That means the companies are at greater risk during a recession.
The three companies also have the highest default rates among for- profit educational companies among students taking out federal financial aid, according to Education Department data for 2005, the latest year available.
The defaults rate for such loans hovered around 10% at each of the schools, compared to a national average of about 4.6%. It bears noting that those higher default rates came during a time of good economic growth and easy lending, as opposed to the much-tighter, subprime- inspired conditions now.
Sallie Mae's actions didn't affect its intention to provide federally backed loans to students of all three schools. That federal education assistance comprises the bulk of funding, and in turn, revenue, at such schools.
On Jan. 22, ITT said it had arranged for three new lenders to provide loans to students, effectively replacing Sallie Mae. Kevin Modany, ITT's president and chief executive, said on the company's earnings call that discussions with new lending partners had been going on for several months.
"Since we have already made new funding arrangements with the three new lenders, the termination of our agreement with Sallie Mae will not have any substantive impact on the funding available to our students or on our anticipated operating results," Mr. Modany said.
Still, investors are concerned, given the importance of private lending in making up the difference between loans and grants from the federal government and the tens of thousands of dollars some programs cost. Private lending accounted for about 35% of revenue at ITT, about 22% at Career Education, and about 13% at Corinthian.
While the schools may be able to line up new lenders, those lenders are likely to charge higher interest rates on the loans to reflect tighter lending-market conditions.
That will pinch students and, combined with a slower-growing economy, make it more difficult for the schools to boost tuition. At the same time, securitization markets for private student loans have practically shut down. This means lenders will have to keep loans on their own books; that will make them even choosier about the risks they accept.
Despite potential upside from ITT's current share price, "the uncertainty surrounding alternative loans, and its potential impact on profitability and balance-sheet quality, causes us to sit on the sidelines until visibility improves," Morgan Stanley concluded in a recent report.
