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Student Loan Crisis: Why So Many Colleges May Fail?

Posted by Larry Doyle on May 19, 2012 7:21 AM |

“We know the model is not sustainable,” said Lawrence T. Lesick, vice president for enrollment management at Ohio Northern University. “Schools are going to have to show the value proposition. Those that don’t aren’t going to be around.”

(The New York Times; May 14, 2012)

Very few topics have received as much attention here at Sense on Cents as the student loan crisis.

In my opinion, the size, scope, and impact of this problem is an enormous anchor weighing down  our next generation and our nation’s economy.

Make no mistake, this anchor is not only impacting thousands of students and families but is also having an equally burdensome impact on colleges and universities nationwide.

I choose my words carefully here. The other day I entitled my commentary, Student Debt Bubble: Impending Doom for Colleges.

Doom is a strong word. Why did I choose it? Let’s navigate.

Embedded within a very recently released Bloomberg commentary is a study by Richard Kneedler, President Emeritus of Franklin & Marshall College. In light of the economic crisis that hit our shores and continues to envelop our nation, in early 2009 Kneedler released a very granular review of the economic condition of close to 700 private colleges and universities. For anybody with even a passing interest in this issue, Kneedler’s work, is a MUST read.  What do we learn?

1. Using this post-crash model (and may it not be “mid-crash”), 207 colleges and universities—31% of the 678 institutions in the database— have, under at least some circumstances, more debts than cash and marketable investments. I designate them “at risk.” In the model these 207 inadequate-capital institutions have projected net financial asset balances ranging from a negative few hundred thousand dollars to nearly a negative $400,000,000. More than half of the 205 had negative projections from ($10,000,000) to ($100,000,000).

2. This means that the inadequate-capital institutions (which might include a third or more of NAICU members) are exposed to severe disruption from negative factors such as declines in cash and investments, escalation of interest payments on variable-rate debt, and required accelerated repayment of principle, particularly if several negative factors were to coincide.

In those circumstances, any of the inadequate-capital institutions and perhaps some of the marginally positive schools might find themselves unable either to meet their increased payment obligations or to repay their debts. The institution could then be effectively insolvent, even if its operations were otherwise healthy. While the institution might not be bankrupt, creditors could demand control of major operating decisions. This is, essentially, what has been happening to sectors of the business community, such as homebuilders, retailers, and newspapers, that have lost credibility with banks. That has apparently not happened to independent Higher Education, but the warnings from S&P and Moody’s about our sector’s prospects are ominous and could foreshadow a shift by rating agencies based on enrollment, or other, data.

Bingo. With student debt burdens soaring ever higher. Demand for many of these at risk institutions will inevitably decline. Subsequently, these schools will get squeezed and be forced to close their doors. Kneedler highlights the gap that exists between the haves and have-nots.

… there is a consistent, large financial gap between high capital and inadequate-capital institutions that is exacerbated in a time of financial trouble.

He provides a compositie average profile of the at risk school.

Average inadequate-capital institution :
Undergraduate enrollment: 2,800
Endowment and other investments: $45,000,000
End-of year cash on hand: $9,000,000
Bonds and mortgages outstanding: $62,000,000
Annual revenues/expenses/margin: $102,000,000/$95,000,000/$7,000,000
Model Post-Market-Drop Score: ($24,000,000) (-24% capital score)

Where are these schools predominantly located?

States/Regions. Areas with more inadequate-capital than adequate-capital institutions and, thus, more exposure to the crisis’ effects in Higher Education include:
1) Previously high-growth states Arizona, Florida, Nevada, and Washington;
2) Appalachian states West Virginia, Kentucky, and Tennessee;
3) Rust-Belt states Illinois, Michigan, New York, Ohio, and Pennsylvania., and
4) Two other clusters – Alabama and Mississippi and a final one in Plains States from Iowa to Oklahoma.

Is there a correlation between students carrying high debt burdens and the high risk schools? Rut-ro…

Students’ Aid Eligibility. Financially-at-risk students disproportionately enroll at financially-at-risk private colleges. 63% of our inadequate-capital institutions had student populations in which 25% or more of full-time undergraduates were eligible for financial assistance under Title IV of the Higher Education Act. By contrast, only 14% of adequate-capital institutions in the study did. Inadequate-capital private institutions play a critical role in giving low-income students access to college. This is a major national policy issue that our entire sector needs to continue to work hard to resolve.

Kneedler concludes,

Inadequate-capital institutions are less prepared to absorb potential revenue losses from drops in enrollment, alumni giving or investment income. They are less able to meet increased demands for financial aid for students or higher interest payments on variable rate debt. From whatever direction trouble arrives, these colleges may lack resources to weather the crisis, and their difficulties will tend to compound faster than will those of their better-off peers because they have less cash to spend, fewer assets to sell, and less budget “fat” to trim.

Inadequate capital institutions more often use bank credit lines, loans from trustees or vendors, and other arrangements vulnerable to cancellation or repricing to obtain capital and operational financing.

This discussion indicates that there is a significant subset of inadequate-capital private colleges and universities that provide essential access to higher education for low-income and minority students, access that could be denied if these institutions are damaged. In a time of severe economic challenges for the country, this access to higher education is an important national priority and needs to be considered as the country works it way through and out of the present crisis.

For those who care to read and review Kneedler’s entire report, I submit: Financial Crisis Creates Big Risks for Private Colleges and Students They Serve.

Given the widespread interest in this topic, I welcome including other commentaries I have written as well:

1. Are Student Loans an Impending Bubble? Is Higher Education a Scam?April 26, 2011

2. Are Student Loans an Impending Bubble? Is Higher Education a Scam?: Part II;June 22, 2011

3. Very Disturbing UPDATE: Student Loan Bubble and Seeking ArrangementsAugust 4, 2011

4. Student Loan Debt Bomb’s Collateral DamageFebruary 28, 2012

5. The Prohibitive Cost of Higher Education: A Racket?April 10, 2012 

6. Student Debt Bubble: Impending Doom for Colleges; May 14, 2012

Navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

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