Breaking Wall Street Market News & Reports

What is the “Gainful Employment Rule”

The proposed “gainful employment” rule, which has been anticipated by for-profit colleges and short-sellers alike, would cut off federal aid to programs whose students have the highest debt burdens and lowest loan-repayment rates, while limiting enrollment growth at hundreds of other programs. For-profit lobbyists are calling the rule “unwise and unnecessary.”

In a conference call with reporters, the Education Department said it was seeking to protect students and taxpayers from the high costs of student-loan defaults.

“While career colleges play a vital role in training our work force to be globally competitive, some of them are saddling students with debt they cannot afford in exchange for degrees and certificates they cannot use,” said Secretary of Education Arne Duncan in a written statement.

Department officials estimated that 5 percent of programs would become ineligible for student aid under the rule, while 55 percent would be subject to growth restrictions and required to warn consumers and current students about the dangers of excessive borrowing.

The share of borrowers defaulting on their student loans in the first two years of repayment has climbed steadily in recent years, reaching a 10-year high of 7.2 percent this year, according to the Education Department.

For-profit colleges, which educate less than 10 percent of students but receive close to a quarter of federal-student-loan dollars, account for a disproportionate share of those defaults. Two years into repayment, roughly 12 percent of borrowers who attended for-profit colleges have defaulted on their federal loans, compared with 6 percent of those who attended public colleges and 4 percent who attended private colleges.

When the government is unable to collect on defaulted loans, taxpayers are on the hook for the losses. Borrowers, meanwhile, face damaged credit histories, are ineligible for additional federal aid, and may have their wages and tax refunds seized by the government.

Though federal law has long required for-profit colleges to demonstrate that they are preparing their students for “gainful employment,” that term has never been defined. The Education Department tried to do so late last year, convening a panel that included consumer advocates, for-profit-college officials, and student advocates to re-examine the rule. But the panel was unable to reach agreement, leaving the department free to offer its own definition.

The new rule comes as Congress is turning up the heat on the for-profit sector, raising doubts about the cost and quality of some proprietary institutions. In late June, Sen. Tom Harkin, Democrat of Iowa, chairman of the education committee, held a hearing in which lawmakers vowed to crack down on “bad actors” in the rapidly growing sector. A second hearing is planned for early August.

Still, lawmakers and Education Department officials recognize that for-profit colleges will be critical to achieving President Obama’s goal of leading the world in college completion by 2020, and are wary of taking steps that could cripple the sector. Today’s rule does not go as far as the department’s original proposal, which would have ended aid to programs in which a majority of students’ loan payments exceeded 8 percent of the lowest quarter of graduates’ expected earnings, based on a 10-year repayment plan.

For-profit colleges lobbied vigorously against that proposal, warning that it would force them to shutter thousands of program serving millions of students. The colleges have spent hundreds of thousands of dollars pushing an alternative that would require programs to provide prospective students with more information about their graduates’ debt levels and salaries.

The department’s revised rule would replace the 8-percent cap with a two-part test that would take into account the share of borrowers repaying their federal student loans and the relationship between total student loan debt and average earnings.

Under that approach, programs whose graduates carried debt-to-earnings ratios of less than 20 percent of discretionary income or 8 percent of total income, or where at least 45 percent of former students (graduates and nongraduates) were paying down the principal on their loans, would be fully eligible for aid.

Programs whose graduates carried debt-to-earnings ratios above 30 percent of discretionary income and 12 percent of total income, and where fewer than 35 percent of former students were paying down principal on their loans, would be ineligible for aid.

Programs that fell somewhere in between would face restrictions on enrollment growth, would be required to demonstrate that employers support their program, and would have to warn consumers and current students of high debt levels.

In the press call, department officials said their goal was to separate the “bad actors” from the good.

“The many good actors should be protected from being tainted or tarnished by the small minority that are doing a disservice to the industry,” Mr. Duncan said.

But lobbyists for for-profit colleges say they’re unhappy that the department stuck with its “metrics based” approach to measuring gainful employment, rather than simply requiring more disclosures, as the colleges suggested. In a statement, Harris N. Miller, the president of the Career College Association, called the department’s proposal “unwise, unnecessary, unproven,” and “likely to harm students, employers, institutions, and taxpayers.”

“Adjusting the numbers in the original gainful-employment formulation is not the issue,” he said.

Groups representing students and consumers, meanwhile, welcomed the proposal, saying it would protect students and taxpayers from programs that overpromise and underdeliver.

“It is encouraging that the administration has proposed a regulation with some teeth,” said Pauline Abernathy, vice president of the Institute for College Access and Success. The gainful-employment rule is one of 14 that the department and college stakeholders have been negotiating over the past nine months. The other regulations, including one that would tighten a ban on incentive compensation for college recruiters, were published in mid-June. After a period for public comment, they will likely be combined in a package of final rules

Results Out Today

The final version of the regulatory acts against for-profit education companies is far less troublesome on the surface than what had been originally proposed.  It is also far less stringent than many investors had feared.  The Department of Education is now targeting a federal gainful-employment regulation that will effectively block federal aid to students with excessive debt at graduation who cannot get jobs that allow them to afford that debt.  These institutions and their students must meet some employment benchmarks to quality for future federal aid. At least 35% of graduates must be paying their student loans.  The other criteria is that annual loan payments must not be more than 30% of discretionary income nor more than 12% of a graduate’s total earnings.

For-profit education stocks are soaring on the news even if this seems harsh on the surface.

Strayer Education Inc. (NASDAQ: STRA) was called “in full compliance” by RBC… Shares are up 29% at $151.00 versus a 52-week range of $113.25 to $255.65.