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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

ISN’T IT TIME to subscribe to all my work via e-mail, an RSS feed, on Twitter or Facebook?

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.

  • JP

    Good morning Larry,

    Quick fyi ….I have borrowed student $ from Wells Fargo for the last 4 years.Each event took 10 minutes on the computer and a check was sent within 10 days.

    I was turned down this year because I have too much outstanding debt{18,000}.

    I then applied at Sallie Mae and was approved within 10 minutes. This tells me that Wells Fargo has decided to be less aggressive with their originations. {pretty interesting}.

  • WP

    It is the taxpayer who will be screwed. We are on the hook for these bad loans.

    Just more politicians trying to get elected by giving people “free” stuff.

    • Taxpayer Revolt

      Yep. Someone has got to pay for the millionaire salaries and pensions of the faculty jerkoffs and bureaucrats.

      UCSF Chancellor Susan Desmond-Hellman was handed a $850,000 salary, a university-provided house, a $15,000 per year automobile allowance and relocation expenses. And when she leaves her post she will get relocation expenses, a guaranteed faculty position at UC, a low-interest home loan and a generous pension and health care package.

      Another chancellor from UC Davis was given a salary of $800,000, a 27 percent increase over her predecessor.

      The salary increases were approved at the same time the regents voted to raise student fees by over 20 percent — in a meeting where they denied students the right to be fully heard on this issue.

  • Lucius

    “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.”

    ACCESS to college? they are getting back so much for that access too, no? that population needs more technical training. hands down.

    oh, and we need our smart kids back in real jobs. not in “Finance”. what a joke!!!

  • JoeThePimpernel

    The feral government did the same exact thing to higher education that it did to the housing market, the same exact way, and for the same exact reasons.

    It destroyed the housing market by forcing banks to make housing loans to people who were not going to be able to pay it back. If blacks were being discriminated against, their default rates would have been lower than everyone else,’ which was not the case. Blacks had higher default rates, which means they were being given preferential treatment even before the feral government got involved.

    In higher education, schools were forced to admit non-qualified blacks, and the only way they could do it was to give them “scholarships” paid for by charging non-minority students higher tuition, which the students paid for by borrowing more.

    Just as the housing bubble collapsed and will take years to recover, the education bubble must collapse and will hopefully never recover. All those Lefty perfessers have been living high on the hog on the backs of the loans their students are carrying. Those Lefty perfessers need to find real jobs.

  • Ron Larson

    I’m in my late 40’s, and I know a lot of coworkers who are taking on these debts and attending night “schools” such as Univ. of Phoenix. They are deeply in debt now.

    I really don’t know what to make of this. I feel pressured that I also need to go in to debt to finance further education in order to compete in the job market. But I don’t feel that these degrees offer any value, especially at the scary high prices.

    Do employers just laugh when they see an Univ. of Phx MBA on a resume? I can’t help but suspect they do. I feel like I would be just as well off printing up my own diploma at home on my laser printer.

    If I were in charge of sales at such for-profit schools, I would give one employee at a large company a scholarship, then watch the peer pressure drive his/her coworker peers into paying full price to compete. Perhaps choose one that is perceived to be weaker by the others, which will scare them when they realize that this weak worker will look better on paper than them.

    I’ve asked my coworkers about how they plan to pay off the loan. They shrug their shoulders. No clue… A problem to deal with later. Today, their only concern is surviving the next round of layoffs, by whatever means necessary.

    This attitude, and the desperation to not be left behind, smells just like the 2007 real estate market. I guess I should short private education stocks.

  • Jon

    Dead horse issue but I’ll comment on it anyway as I have some new insight into the matter:

    One start would be stop paying administrators more than teachers…education from elementary school up until college needs to be reformed. If you stopped over-paying admins then you would save billions annually which could contribute to student aid.

    Or you could stop having corporate jobs require college degrees for entry level positions and instead make it an incentive for more pay by progressively getting a part-time education over the length of your career so that the money is distributed more evenly. This will reduce the need for loans and increase the profitability of the loan market because the total amount will not exceed present earning capability.

    However, at the end of the day it’s the same as the housing situation. Some people actually COULD have afforded the homes but it’s because they are underemployed or unemployed that their mortgage is under the water.

    Student loan debt is the least of our concerns when the highest turn over for loans is in the housing market. Home value appreciation and positive growth in that market will obviously offset credit card/student loan and other debts because it is the primarily historic american mechanism for profit generation other than actually working. Home value is the Middle Class American’s investment portfolio. Fix the job and housing market and you fix almost everything else.

  • Rick

    like anything else govt touches, they drive up the costs…..by jumping into the education business with unlimited funds (try to hold back an override in MA…it’s for the ‘children ‘ don’t you know tho most of it is for the retirement fund for sure) and you’ll see….in higher ed the same thing..If Univ of CT is out there competing for teachers, those who might have taken less have a floor on their salary and act accordingly…there is no free market at work here and no merit pay…
    just pure government…and union determined prices even where there is no union..it’s just implied…

    one of the things that drives me nuts is the chutzpah of univ and college presidents…..they take no risk and make entrepreneurial returns..






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