Sunday, January 19, 2014

Student loan problems at ITT

The giant for profit ITT is being investigated by the Consumer Financial Protection Bureau and the SEC for the way it tried to meet the 90% rule---the Education Department rule that no more than 90% of its tuition revenues may come from federally backed student loans. Gretchen Morgenson explains:
For-profit entities exceeding the federal funding limit for two years lose access to that money for their students. That could be a death sentence for the institutions. In 2012, some 80 percent of ITT’s revenue came from government aid programs.
This is typical among for-profit schools. Because these schools cost more than public universities or community colleges and recruit students of reduced means with little access to private funds, students at these institutions rely heavily on government programs.
As the private loan pool dried up, some schools had a tougher time meeting the 90-10 rule. In January 2010, ITT came up with a solution: the Peaks Private Student Loan Program, which increased the amount of private money available for its students.
The program was financed by an off-balance-sheet trust that raised over $300 million from investors, to whom it issued debt. This debt was guaranteed by ITT, but an unaffiliated lender used the cash to make loans to ITT students. Those loans were then put into the trust.
Because the lender was unaffiliated with ITT, the loans qualified as private money under the 90-10 rule. The company, therefore, ensured that its students could keep tapping into federal grants for the other 90 percent of their education costs.
The idea was creative and immensely helpful to ITT, as it kept revenue coming in. But the Peaks program, which ended in 2012, is becoming problematic now. Many of the loans in the trust are defaulting. In its most recent quarterly filing, ITT said it projected default rates in Peaks and a similar pool of loans to be as high as 59 percent.
Contrast this to the 14.7 percent default rate for students three years after starting repayment of federal loans, according to the Department of Education.
Signaling that the Peaks trust is teetering, ITT began making payments to it on behalf of students to help them avoid default. ITT said it had paid $7.65 million as of the quarter that ended in September.
As the guarantor of Peaks trust debt, ITT is on the hook for its loans. So far, the company has set aside reserves for possible losses of $40 million.
Bradley Safalow, founder and chief executive of PAA Research, an independent research firm in New York, reckons that based on ITT’s default projections, it could be forced to make additional payments for Peaks liabilities of over $100 million.
“There’s no question that 90-10 compliance was a major motivation for ITT to set up the Peaks trust,” he said, “and it was a huge source of cash generation for them.”
There’s another potential problem with the company making payments on behalf of borrowers: the possibility that those payments would imperil its compliance with the all-important 90-10 rule when the loans were made.
The magnitude of ITT’s projected default rates of up to 59 percent may also be of interest to regulators who are increasingly concerned that lenders weigh borrowers’ ability to repay such obligations. The company may argue that it did not originate the loans, and thus could not be considered responsible.
No, it did not originate the loans. An entity it created and funded through debt it sold to investors originated the loans, and herein may lie a problem with the SEC.
But, speaking generally and not specifically about ITT, Mr. Chopra of the consumer protection bureau said: “When a lender originates a loan that they expect to fail, that raises questions about their broader incentives. Our concern is normal market forces may not be working properly.”
ITT is fielding inquiries from another regulator as well. Last February and again last May, the company received subpoenas from the Securities and Exchange Commission asking for information about its Peaks program. It is cooperating.
At this point, Morgenson cannot confirm from investigators that the Peaks loan workaround is at the heart of the investigation, but it certainly seems probable.

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