Lending overhaul could be trouble for ITT

New student-lending rules proposed by the Obama administration could wipe out as much as two-thirds of profits at Carmel-based
ITT Educational Services Inc., some analysts believe.

That’s because new data released by the U.S. Department of Education show that former students of the for-profit college
system repay their loans at very low rates, causing the government to question whether an education at ITT allows them to
obtain “gainful employment.”

The Department of Education would require ITT to boost significantly the rate at which its former students repay their loans
to the federal government. Only 31 percent of former ITT students either have paid off or are actively paying down their student
debt four years after leaving ITT's schools through either graduation or quitting.

Modany

The company earned $300 million last year on revenue of $1.3 billion—results analysts believe would be impossible to
sustain under the new rules.

Federal student loans account for about 80 percent of revenue. And with its high-priced programs and low-income students,
ITT will be hit harder than most other publicly traded education companies, some Wall Street analysts predict.

“It’s game-changing. It’s game-changing,” Kevin Modany, CEO at ITT Educational, said of the proposal.

Investors agree. Since the government published its new rules July 23, the company’s shares have lost 38 percent of
their value and now trade for about $53. The plunge wiped out $1.1 billion off the company’s market value.

Modany declined to say what the company might do to adapt to the rules, which are scheduled to be adopted Nov. 1 and to take
effect next summer. The Department of Education could change them after receiving public comments, but does not need approval
from other officials to implement them.

Wall Street analysts suggest the company will have to institute a mix of price reductions, tighter admissions standards and
the elimination of some programs that lead to lower-income careers.

The new rules would try to ascertain how well for-profit schools prepare students for gainful employment by using a two-part
test. Each part of the test would be applied not to for-profit companies as a whole or even to their individual campuses,
but to their individual degree programs, such as information technology or business accounting.

The first part would calculate graduates’ annual payments on their student loans, then divide that figure by the annual
income that gets reported to the Social Security Administration.

If that ratio is higher than 8 percent, a for-profit degree program would be restricted from growing its enrollment. If that
ratio is above 12 percent, new students in that program would be ineligible for federal student loans.

An alternative method for that test would measure former students’ loan payments, divided by their disposable income.
If that ratio is less than 20 percent, a for-profit degree program still would qualify for federal student aid.

The second test would require ITT Educational and its peers to see at least 45 percent of their former students making progress
on paying down their student loans four years after graduating or leaving the school.

If their degree programs fell below that level, the federal government would restrict their access to federal student loans
so that couldn’t grow their enrollment. If degree programs fell below 35 percent on repayment rates, they would be ineligible
to have any new students qualify for federal student loans.

Federal student loans typically must be paid off in 10 years after a student stops attending schools. However, various programs
can allow former students to stretch out their loans as much as 30 years.

Crunching numbers

Data to calculate loan-payment-to-income ratios have not been released by the Department of Education. But one analyst,
Deutsche Bank’s Paul Ginocchio, estimates ITT’s bachelor’s degree graduates are paying roughly 16 percent
of their starting salaries in loan payments. ITT’s associate’s degree graduates are paying just under 12 percent
of their incomes to repay student loans.

Ginocchio estimates it now costs more than $56,000 to earn a bachelor’s degree from ITT and more than $30,000 to earn
an associate’s degree.

“The proposed gainful employment language, we believe, will impact ITT Technical Institute’s business model the
most of any of the publicly traded for-profits,” Ginocchio wrote in a July research note.

“We believe that ITT will likely have to lower tuition costs and significantly
increase admissions standards to reduce drops and increase graduation rates, thus increasing repayment rates.”

If the proposed rules were in effect this year, Ginocchio estimated, ITT’s profits would drop 65 percent.

The company is still crammed with displaced workers seeking new skills during the recession. That enrollment growth has it
on pace this year to turn a profit of $380 million, a spike of 27 percent from last year.

Other analysts agree ITT will be hit harder by the new rules than most, but aren’t as bearish as Ginocchio.

Barclays Capital analyst Gary Bisbee downgraded his rating on ITT, as well as on peers Corinthian Colleges and Lincoln Educational
Services. He said those schools could see their profits cut as much as 30 percent in the next two years, but no more than
that.

“We expect an earnings impact from the gainful employment proposals, but believe that it will be manageable for the
industry,” Bisbee wrote in an Aug. 16 research note.

Tracking repayment

The U.S. Department of Education has tried to track repayment rates of for-profit colleges since they were first
approved for federal student loans in 1972. But it has never measured them in the way the Obama administration is now proposing.

Executives at some for-profit schools were surprised when they saw their numbers released Aug. 13 by the Department of Education.
For example, Strayer Education had told investors it expected to exceed the 45-percent threshold—because it scores better
than most on the existing standard for schools—the rate of loan defaults.

But Strayer’s repayment rate was a woeful 25 percent. In a conference call on Aug. 16, Strayer executives called the
new data “inaccurate” and “nonsensical,” and said they would file a Freedom of Information Act request
to see the underlying documentation behind the government’s numbers.

The major for-profit school that performed best in the repayment rate database was Arizona-based Apollo Group, which operates
the University of Phoenix. It had a repayment rate of 44 percent.

Some of the lowest rates were for private for-profit operators. For example, Indianapolis-based Harrison College had a repayment
rate of 24 percent. The school, formerly called Indiana Business College, has experienced torrid enrollment growth during
the recession.

Harrison College executives did not respond to requests for comment before IBJ’s deadline.

The Department of Education database included repayment rates for all colleges, including those with publicly subsidized
tuition, such as Indiana University, as well as for expensive private colleges.

The department did not calculate an average repayment rate for for-profit schools. But the Institute for College Access &
Success, a California-based group advocating stiffer regulation of for-profit schools, reports that figure as 36 percent.

“This regulation is an important step in protecting the investment of both students and taxpayers in federal financial
aid,” said Debbie Cochrane, a program director for the institute.

Her group even has asked the Obama administration to strengthen its regulation to “make sure that schools that have
a bad track record in preparing students for gainful employment are pressured to improve.”

She cited a study by the Career College Association, a for-profit college trade group, that showed students are twice as
likely to default on loans if they attend a for-profit institution than if they attend a public college.

But Modany cited research that concluded students with lower incomes, higher ages or who are minorities are less likely to
repay their loans than other student groups. ITT and its for-profit peers serve higher proportions of African-Americans and
Hispanic students than their public university counterparts.

And ITT’s programs, especially, serve poorer and older students. The average enrollee is 29 years old with an annual
salary of $17,000. Upon graduating, ITT students with two-year degrees earn about $30,000 and those with bachelor’s
degrees earn about $40,000.

Modany thinks the new rules could force schools like ITT to admit fewer of those students, in order to keep up their repayment
rates.

“We’re potentially closing the door on some people who benefit from these programs as a result of this regulation,”
he said.•