Business of For-Profit Universities

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1 Credit Risk The Risky Business of For-Profit Universities Despite their tremendous growth in recent years, the risk of lending to for-profit universities is expected to escalate. Kevin Culbert and Deborah Stampfli Lately, the for-profit universities industry has come under significant scrutiny for its controversial reputation and recent surge in growth. For-profit universities also called proprietary colleges have a unique place in the education world. Unlike traditional public and private institutions, these schools are publicly traded and operate on a for-profit basis. By investing a huge proportion of their dollars into marketing, for-profit universities have attained massive enrollment rates. Indeed, on the basis of revenue and enrollment numbers alone, the steady growth of for-profit universities makes the industry an enticing one for lenders. However, even though their growth status allows them to rise above nonprofit schools in terms of profit and revenue, for-profit universities are coming under increasing government regulation. 42 istockphoto/thinkstock by

2 The RMA Journal November 2011

3 With public skepticism on the rise after news reports about unscrupulous business practices at for-profit schools, students may be less inclined to enroll in them. So before jumping into the pool, lenders must be aware of the substantial risks this powerful industry will face in the years to come. Growth and Marketing Though clouded by controversy, the industry does offer some key opportunities. For-profit universities have experienced solid and significant growth during the past 10 years. Despite the economic downturn, operators have enjoyed steady growth. Among four-year institutions, revenue is expected to increase With an already massive student base, for-profit universities will cater to an increasingly specialized audience over the next five years and reach out to certain demographics. 14.1% in the five years to The recession and high unemployment rates have led many people to return to school, and a large proportion have chosen to enroll in for-profit universities. While these universities are not any cheaper than traditional schools, the nonprofit colleges and universities are filled to capacity and they have restricted their enrollment rates. The loose enrollment standards of for-profit universities have allowed them to attract more students. In addition, these institutions have undertaken extreme marketing tactics, investing in television, radio, and Internet advertisements to attract greater numbers of students. Additionally, some for-profit universities have used sponsorships to strengthen brand recognition. The industry s largest player, the University of Phoenix, bought the naming rights to the Arizona Cardinals stadium in September 2006, reflecting the extreme marketing tactics that firms use. By developing these extensive networks, the industry has expanded its number of enrollees considerably. On the other hand, these same marketing strategies have been among the chief criticisms leveled by government authorities. Industry firms spend 25% of their total revenue on marketing, and some institutions are spending more on marketing than on the education they provide. This unbalanced spending has led the government to look further into the industry and its success rate among graduates. Despite their debatable marketing strategies to gain students and bolster revenue, the escalating growth of for-profit universities has presented an opportunity during the past five years. In 2009, a year when many industries faced plummeting demand due to the recession, revenue for the for-profit universities industry rose a massive 17.2%. In Figure 1 Billions ($) Industry Revenue Year Not-for-profit For-profit Source: IBISWorld contrast, nonprofit colleges and universities experienced a major decline in revenue in the period from 2008 to 2009, for a total loss of 9.1%. Diminishing budgets and capped enrollment rates exacerbated the decline. In this harsh economic environment, for-profit universities have been able to thrive by expanding their services and enrolling more students. In fact, during 2011 alone, for-profit universities are expected to generate $26.4 billion in revenue, an increase of 5.2% from During the past five years, a number of positive trends have placed the industry in a favorable position for lenders. First, for-profit universities maintain low overhead because they are not physical institutions. By focusing on Internet-based classes, the institutions have no need to limit enrollment numbers. With an already massive student base, for-profit universities will cater to an increasingly specialized audience over the next five years and reach out to certain demographics. In addition, firms will capitalize on the growing market by offering a greater number and different types of degrees. More people will likely consider for-profit universities for a graduate and post-graduate education, both of which represent strong sources of growth. Finally, the globalization trend will benefit this industry: More for-profit universities will expand overseas as the domestic market becomes more regulated and saturated. These trends have contributed to the industry s growth phase but for-profit institutions remain on unstable ground. Controversy and Criticism Despite strong growth and expansion into new and emerging markets, for-profit universities are facing controversy and criticism. Many people are questioning the tactics these universities use, making their future relatively rocky compared with the results of the past five years. In particular, opponents cite the industry s extensive marketing spending and loose enrollment policies. 44

4 In light of these practices, critics are questioning the quality of the for-profits educational services. As this industry heads into the next period, its universities will likely experience growth, but many will encounter setbacks as criticism and regulations accrue. Coupled with the industry s increasingly antagonistic relationship with the federal government, these factors will likely increase the risk of lending to for-profit schools in the years to come. Regulation will increase over the next five years, and increasing government scrutiny will lead to greater accountability. In August 2010, the Government Accountability Office (GAO) published a report that was highly critical of enrollment and recruiting practices among many for-profit Figure 2 20% 15% 10% 5% 0% -5% -10% Revenue Growth Not-for-profit For-profit Source: IBISWorld schools. In the report, which involved an undercover study of 15 for-profit colleges, the GAO stated that four colleges encouraged fraudulent practices and that all 15 made deceptive or otherwise questionable statements to GAO s undercover applicants. To comply with rising regulations and improve their reputations with students and government authorities, some for-profit universities are changing strategies. For example, University of Phoenix has started to revamp its recruiting practices. In November 2010, the company laid off about 700 employees, many of whom were admissions counselors. More schools are expected to follow this trend as recruitment practices are increasingly monitored and regulated. The Gainful Employment Rule The gainful employment rule is one of the primary regulations that will place severe constraints on the industry in the coming years. This rule will have an impact on schools recruiting policies, making it more difficult for for-profit institutions to enroll the significant numbers of students they have secured in the past. Though it was finalized in June 2011, institutions will not experience the full impact of the gainful employment regulation until 2015 at the earliest. According to the U.S. Department of Education, the new regulation will require that schools meet at least one of three requirements. 1. Institutions will need to ensure that 35% or more of their former students repay their loans, which is defined as reducing the loan balance by at least $1. 2. Universities will be required to confirm that a graduate s estimated annual loan payment does not exceed 30% of his or her discretionary income. 3. The estimated annual loan payment of a typical graduate cannot account for more than 12% of his or her overall income. These guidelines will force schools to be more selective, thereby limiting the pool of incoming students to those who are better positioned to succeed. The rule will also force for-profit schools to invest more in their programs. They will need to spend To comply with rising regulations and improve their reputations with students and government authorities, some forprofit universities are changing strategies. more on better faculty and physical facilities to raise their value. By investing in these areas, the industry will be viewed as more of an authority in the education sector. Since the gainful employment rule aims to reduce the risk of student loan defaults, schools will benefit in terms of developing a more solid foundation and reputation. Nevertheless, this drastic change will adversely affect enrollment rates at for-profit schools, posing a significant risk to the industry s long-term growth. Defaults and Deterrents Rising student loan defaults have fanned fears of a bubble in the for-profit universities industry. According to the U.S. Department of Education, Students at for-profit institutions represent 12% of all higher education students, 26% of all student loans, and 46% of all student loan dollars in default. For-profit schools have been criticized for lacking adequate enrollment standards. Students often come from backgrounds that are predisposed to financial problems, making them more prone to loan default. According to a study by the U.S. Department of Education, some 25% of students at for-profit schools enter default within three years, compared to 11% of students at public colleges and 10% of students at private nonprofit colleges. The risk of loan defaults by individual students is diminished for for-profit schools because the amount owed by a student is small compared with the total revenue generated by a student. Since for-profit universities have not concerned The RMA Journal November

5 themselves with loan defaults, regulations that address student loans may significantly inhibit growth. Possible changes to student loan regulation, including changes to the G.I. Bill and the 90/10 rule, will challenge for-profit universities. The 90/10 rule requires that schools obtain at least 10% of their funding from nonfederal sources. Currently, this equation does not include military aid from the G.I. Bill. If this funding were included, many schools would likely not pass, since veterans are a key market for many operators. For-profit universities have pursued veterans in the past, specifically marketing to them in order to gain funding from the government. In the future, this market may not be as considerable. Recent news reports have heightened the public s awareness of for-profit universities controversial recruiting tactics, discouraging military members from enrolling in for-profit universities. Furthermore, student loans are now issued directly through the government rather than through private lenders, meaning that additional government oversight will likely occur. These risks will slow industry growth to about 5% annually in the five years to Conclusion The for-profit universities industry has experienced astronomical growth over the past five years but, to some degree, its future is out of its hands. For-profit universities have towered over traditional colleges and universities in terms of revenue growth during the past 10 years, but their reputation has fared less well and they will continue to attract intense scrutiny. Several trends indicate that growth will slow but nevertheless continue, as institutions set themselves up to offer more degrees along with graduate and post-graduate programs. Despite these positive factors, government authorities have criticized the industry s marketing tactics, since firms designate a heavy proportion of their spending to sponsorships and advertising campaigns rather than educational services. The quality-versus-quantity debate will continue in full force, with operators catering to massive numbers of students and the outlook for graduates remaining bleak. To overcome these issues in the next few years, for-profit schools must curb marketing expenditures and focus on upgrading their facilities and faculty. Nevertheless, rising regulation will continue to hamper the growth of for-profit schools. Given these trends and a turbulent road ahead, the risk of lending to for-profit schools is expected to escalate in the years to come. v Kevin Culbert is a senior analyst at IBISWorld and Deborah Stampfli is an IBISWorld research editor. They can be reached at and ibisworld.com. istockphoto/thinkstock 46

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