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University of Phoenix Maxing Out on Defaults

Adam Rust's picture

Posted June 26, 2012

A new filing from the University of Phoenix (ticker: APOL) suggests that student default rates at the nation's largest university are surging to a level that could endanger the ongoing viability of the company.

The federal government will cease to offer Pell Grants and some loans to students at colleges and

universities where default rates are too high. At for-profit schools, the federal government is virtually the only customer. In the most recent year, federal payments made up 91 percent of revenue at the University of Phoenix.

This dependence underscores why it is so important for the prospects of the school that students repay their loans.

The Higher Education Opportunity Act of 2008 re-engineered the rules surrounding how schools remain qualified for their students to get Title IV funds. The new rules include a criterion which measures the success or failure of repayment over three years. Previously, the only view was after two years. Cohort default rates for the three years beginning in 2009 are going to be reported shortly. If the CDR exceeds 40 percent in one year or 30 percent for two consecutive years, then the school loses its funding.

The University of Phoenix says that it believes that when its three-year CDR is released in September, the score will be 26.7 percent. If that is true, it means that APOL has narrowly avoided having their 2009 student repayment rate count against them, but it also means that even a slight deterioration in repayment would put the school on watch.

Existing legislation could hammer the school. There is a rule, commonly referred to as the "90/10" rule, which stipulates that the portion of a school's revenue which is derived from federal sources cannot exceed 90 percent. True, APOL's number for the prior term was 91 percent. However, schools are allowed to exclude the portion which comes from the military. A new proposal would drop the percentage to 85 percent and move military funds from the "other" to the "federal" category.

"in January 2012, the Protecting Our Students and Taxpayers Act was introduced in the U.S. Senate and, if adopted, would reduce the 90% maximum under the rule to the pre-1998 level of 85%, cause tuition derived from Title IV programs for military personnel to be included in the 85% portion under the rule instead of the 10% portion as is the case today, and impose Title IV ineligibility after one year of noncompliance rather than two. If this or other proposals are adopted as proposed, University of Phoenix would have to make material changes to its business to remain eligible to participate in Title IV programs, which could materially and adversely affect our business."

How military payments are factored is very significant to the company. When the company is allowed to put military payments into the non-federal category, APOL's number drops to 86 percent.

Under the 90/10 rule (or possibly the "85/15" rule), federal payments must exceed the threshold in consecutive year .

Holly Petraeus, assistant director of the Consumer Financial Protection Bureau, is actively exploring the relationship between GI bill benefits and private for-profit schools. Most for-profit schools spend a significant portion of their admissions efforts on veterans. Part of her frustration is that money which is intended to go toward training veterans for civilian work is going toward marketing and admissions costs. Apollo spent $655 million on marketing in 2011 and another $415 million on "admissions advisory." Since it is virtually impossible to not gain admission to the school, the fact that it spends so much on admissions suggests that staff are not spending most of their time reviewing personal statements. Instructional costs only amount to 47 percent of all expenses.