Higher Education Landscape: Fundamental & Policy Update

Higher Education Landscape: Fundamental & Policy Update Education Market Monitor - March 2016 Highlights

March 24, 2016 In this edition of our "Education Market Monitor," we highlight recent trends in the federal student loan portfolio, credit performance Michael Tarkan, CFA of federal and private student loans, recent FFELP developments, servicing and debt collection trends, and brief updates in the for- 202.534.1390 profit and online enabler sectors. On the policy front, we provide updates on the regulatory environment for student loan servicers, [email protected] the push for student loan refinancing legislation, and November's impact on the higher education landscape. As a reminder, this report Isaac Boltansky includes an assortment of data tracking recent trends and upcoming issues to watch in higher education. 202.534.1396 [email protected] Andrew Eskelsen Focus Items 202.534.1383 [email protected] Federal student loans - balances and credit. Federal student loans outstanding stood at $1.2T as of 12/31/15, up 7% YOY and Companies Mentioned nearly double the level in 2009. From a credit perspective, 90+ day delinquencies of 11.5% remain near all time highs and defaults continue to increase at a faster pace than the overall portfolio. Ticker Price Target Rating APOL $8.00 Neutral Private student loans - balances and credit. Private loans totaled ~$100B as of 9/30/15, or 8% of the $1.3T in total debt outstanding. DV $18.00 Neutral We estimate the top three lenders (SLM, WFC, and DFS) comprise 85% of total primary loan originations of approximately $8-$10B ESI NC Neutral annually while "marketplace lenders" like Social Finance (SoFi), CommonBond, and Earnest are driving growth in the refinance FMD $4.50 Neutral market, which primarily targets federal student loans. Private credit continues to hold up well, with delinquency rates for the top six NAVI $11.00 Neutral lenders at the lowest level since before the 2008 crisis. NNI $52.00 Buy ONE $4.50 Neutral Servicing and debt collection. As of 12/31/15, PHEAA and Great Lakes serviced $254B and $209B of loans, respectively, for 8.5M PFMT $2.50 Neutral borrowers each. NAVI and NNI serviced $194B and $156B, respectively, for 6.9M and 6.5M borrowers. The four TIVAS will receive SLM $8.00 Buy a relatively smaller share of new volume versus the non-for-profit (NFP) servicers from 3/1-6/30/15 due to recent performance metrics TWOU $36.00 Buy that ranked all of the servicers together despite varying portfolio composition. From a collection standpoint, we continue to await the award of ED's new unrestricted collection contract, but 5 unrestricted and 6 small business collectors are currently receiving new volume.

For-profits and online enablers. Enrollment trends within the U.S. for-profit sector remain weak, regulatory scrutiny continues, and APOL agreed to be taken private for a relatively modest price. In the online enabler segment, TWOU continues to add new schools, verticals, and programs to its existing portfolio of top-tier institutions.

Election Risk. Secretary Clinton's persistent under-performance with younger voters leads us to believe that she will aggressively advocate for her higher education plan during the general election which will drive headline risk for the whole industry.

See Important Disclosures on page 33 of this report. Compass Point Research & Trading, LLC 2

Policy Corner

Democrats will continue pushing the “In On March 15, almost 30 Senate Democrats introduced their higher education affordability package known as the “In the Red Act.” The the Red” legislation – which includes package would: (1) allow qualified federal and private student loan borrowers to refinance their loans into government-backed loans with student loan refinancing language – but lower rates; (2) expand federal financial support for community colleges; (3) be paid for through a series of politically divisive measures there is no path to passage in this Congress. including a change to the treatment of carried interest, an end to unlimited write-offs of performance-based executive pay, a prohibition on corporate inversions, an end to certain oil industry tax subsidies, and the enactment of the Buffet Rule. We continue to expect the campaign to generate headlines during the upcoming Higher Education Act reauthorization effort and on the campaign trail but there is simply no path to passage for this package as currently constructed.

Secretary Clinton’s higher education plan Secretary Clinton continues to struggle among younger voters and as we head into the general election we expect her campaign to focus is not viable in its current form but intently on her higher education plan as a means of connecting with that voter demographic. Secretary Clinton has consistently struggled her difficulty with younger voters in the with younger voters and this election cycle is no different (e.g., she secured less than 20% of the under 29 demographics in both Iowa and primary suggests higher education policy New Hampshire). Our sense is that as Secretary Clinton shifts into the general election, she will begin aggressively advocating for her will play a central role in the general higher education plan which could pose headline risks and possibly even entice her GOP opponent to embrace similar proposals. Recent election campaign. polling shows that over 60% of all Americans, and 58% of Independents, agree with the idea that "no family and no student should have to borrow to pay tuition at a public college or university.”

As a reminder, Secretary Clinton’s plan would: (1) reduce student loan rates for ~25M borrowers through broader refinancing programs; (2) simplify income-based repayment (IBR); (3) enact a “Borrower Bill of Rights” which would increase student loan servicer responsibilities; (4) increase federal incentives for state funding of higher education; and (5) institute some form of institutional risk- sharing for colleges. Secretary Clinton’s higher education proposal is prohibitively expensive which ensures that its passage is highly unlikely if she does eventually win the White House but we expect the headlines to ramp up as we head into the general election.

The policy environment for student loan In recent months, there have been a series of negative policy developments for student loan servicers including: (1) in August 2015 servicers has been inhospitable and all Navient disclosed that it had received a Notice and Opportunity to Respond and Advise (NORA) from the CFPB; (2) in September signals suggest that will not change in the 2015 the CFPB released a report that both highlighted issues in the student loan servicing market and suggested new standards; (3) the near future. CFPB’s fall 2015 supervisory highlights included a discussion of concerns in the student loan servicing market; (4) in September 2015 the Treasury Department, Education Department, and CFPB released a detailed report outlining servicing market issues; (5) in November 2015 the CFPB released its most recent rulemaking agenda and for the first time announced that it may propose new rules covering student loan servicers; and (6) in February 2016 Secretary Clinton told an audience that Navient was “misleading people” and “doing some really terrible things.” Even after the recent regulatory avalanche, all signals suggest that the policy environment for student loan servicers will remain inhospitable through the election and possibly beyond. In the coming months, we expect a CFPB enforcement action against Navient, an unsuccessful but aggressive push for student loan servicing changes in Congress, and persistent headlines from the campaign trail.

The for-profit education industry’s On March 8 the U.S. Court of Appeals for the D.C. Circuit rejected the for-profit industry’s push to repeal the Gainful Employment rule. Gainful Employment Rule challenge As a reminder, the Gainful Employment rule, which went into effect in July 2015, requires colleges to demonstrate that their graduates failed. earn enough money to repay their loans.

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 3

Top GOP lawmakers show interest in In February 2016 the GOP leadership of both the Senate Finance Committee and the House Ways and Means Committee sent letters tuition increases and college tax breaks. to 56 colleges and universities with more than $1 billion in assets with questions regarding tax-free investment earnings for schools, the tax deductibility of donations, tuition increases, and numerous other issues. The letter states: “Despite these large and growing endowments, many colleges and universities have raised tuition far in excess of inflation.” There will be a heated discussion about tuition increases and higher education tax policy when lawmakers begin their work on reauthorizing the Higher Education Act, but it is difficult to see how anything meaningful can get done on this issue given access concerns and the electoral dynamics of the topic.

Higher Education Act headlines ahead but In 2015 lawmakers reauthorized the Every Student Succeeds Act (ESSA), the federal law covering primary and secondary education, passage remains unlikely. which was an unexpected bipartisan accomplishment and sets the stage for lawmakers to consider the Higher Education Act (HEA) in 2016. Senate HELP Committee Chair Lamar Alexander (R-TN) appears committed to considering the HEA in mid-2016 which should shift the conversations to FAFSA simplification, streamlining of IBR options, student loan servicing, and higher education institutional risk-sharing. Our sense is that there is only a 30% chance that lawmakers reauthorize the HEA in 2016.

Higher education priorities in 2017 will Higher Education Legislative Priorities in 2017 Under Different Electoral Outcomes* differ dramatically depending on the election but there are particular policy issues that will be in focus no matter who wins in November. Democratic Republican White House and Senate White House and Senate

· Student loan refinancing · Soften Gainful Employment Rule · Servicing "Bill of Rights" · Simplify taxation of 529 plans · Policy pressure for the for-profit · Potential changes to CFPB (e.g., shift to education industry (e.g., 90/10, GE) commission structure) · Community college funding increase · Change federal accounting rules · Federal-state funding partnerships · Increased private market participation · Change bankruptcy protection · Encourage other forms of postsecondary education

Regardless of the Election · FAFSA Simplification · Streamline IBR · Focus on data, counseling, accreditation · Push for NFP servicer volume increase · Institutional risk sharing debate

* We assume that whichever party wins the White House will have the coattails to carry the Senate and that the House will stay under GOP control

Notes: IBR = Income-Based Repayment; NFP = Not-for-profit; GE=Gainful Employment Rule Source: Compass Point

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 4

Key Themes in Higher Education

Theme Recent Developments Takeaways Fall 2015 postsecondary enrollment fell 1.7% YOY (split: 4-year public: +0.4%; 4-year private non-profit: -0.3%; 4-year for- Weakness primarily driven by for-profit sector due to recruiting challenges and increasing student price elasticity profit: -13.7%; and 2-year public: -2.4%)

Enrollment / NCES enrollment projections: the number of students enrolled at degree-granting institutions in the US are projected to Slowdown from the 45% growth experienced from 1997-2011, partially attributable to changing demographic demand trends grow by 13.9% from 2012 to 2022. trends

Peak season private student loan YOY origination growth: +7% for SLM, +11% for WFC Primary origination market growing mid-single digits; refinance market gaining traction

Impact from economic drag of student loan debt will likely continue to be a theme from the media and regulators in Average student debt stands at $29,194, up 5% YOY; balances are up 7% while recipients are up 2% Student debt 2016 relief Income-Based Repayment (IBR) and pay as you earn (PAYE) utilization continues to pick up - 12/31/15 balances and Expect these levels to continue to rise as ED and servicer outreach step up recipients rose 10-12% sequentially and ~60% YOY to $210B and 4M, respectively

FRBNY data - 4Q15 delinquency rate of 11.5% ticked down sequentially but remains near all-time highs Leading indicator for student loan defaults; increased attention contributes motivation to IBR/refi bills

Student credit Private student loan delinquencies are at the lowest level since the 2008 economic crisis Should drive lower provision expenses at NAVI; SLM credit remains manageable as portfolio seasons performance

Debt collection - bids for new ED collection contract submitted at the end of February Expect new contract award within the next several months

Higher Education Act (HEA) reauthorization activity should pick up during 2016 Expect ongoing headlines but little legislative movement in 2016

Added regulatory scrutiny brings headline risk for NAVI, NNI; new servicing contract recompete expected to Regulation CFPB servicing - push for higher touch servicing continues commence in 2016

CFPB / AG / FTC / SEC / ED for-profit investigations remain outstanding Operational and headline risk continues within the for-profit sector

2015/16 average annual rates: four year public, in state: +3.3% to $19,548; four year public, out of state: +3.5% to $34,031; Annual tuition increases continue to trend in the 3-4% range four-year private: +3.5% to $43,921; two-year public: +2.2% to $11,438 Tuition rates Average endowment returns rose just 2.4% in 2015 vs. the 15.5% in 2014 and 11.7% in 2013 Weaker endownment returns may prompt stronger tuition increases

1M-3M LIBOR spread has expanded to 19 bps, from 9 bps one year ago Fed rate hike, disruption in credit markets driving larger gap Interest rates Interest rate savings for 2016/17 trending at ~37 bps if current rates hold; could slightly decrease demand for Declining 10-year treasury yields should drive lower federal loan interest rates for the 2016/17 academic year private student loans

Early data indicates that MOOCs have relatively few active users, user engagement falls off dramatically after the first 1-2 MOOC impact on higher education remains in the early stages as completion rates remain modest MOOCs / online weeks of a course, and few users persist to the course end competitive developments 2U, Embanet (Pearson), Deltak (John Wiley) remain key competitors in online enabler space; Grand Canyon plans to enter We continue to expect a gradual shift towards online education as universities look for additional higher margin the space revenue sources

$110M of ABS issuance in February 2016; $11.2B over the past 12 months (-23% YOY) Declining FFELP assets, rating agency uncertainty, and relatively small private market should keep activity muted

Securitization Moody's and Fitch in midst of review of FFELP trusts for potential downgrade related to legal final maturity We expect downgrades will materialize; clarity on this issue is expected within the next 6 months activity

SoFi, Earnest have completed recent student loan securitizations of refinance loans This activity should continue as the refinance industry continues to expand

Source: Compass Point, National Student Clearinghouse, Department of Education, The College Board, TICAS, Sparkroom, FRBNY, SIFMA, company documents

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 5

Focus Item Discussion

Federal Student Loan Debt Outstanding: $1.2 Trillion

Total federal and private student loan As of December 31, 2015, total federal student loans outstanding were $1.22 trillion, up 7% from December 31, 2015 and nearly balances stand at $1.22 trillion and $100 double the level in 2009. Total federal student loan recipients increased 2% YOY to 41.8 million while average balances per recipient billion, respectively. rose 5% YOY to $29,194.

Outstanding Federal Loan Balances ($B)

$1,400 $1,212 $1,220 $1,200 $1,130 $1,040 $1,000 $948 $848 $800 $750 $657 $577 $600 $516

$400

$200

$0 2007 2008 2009 2010 2011 2012 2013 2014 2015 1Q16

*Fiscal year ends 9/30 Source: Department of Education, Compass Point

The $1.22 trillion is split: Direct Loans: $855 billion (+2% sequentially), FFELP: $357 billion (-2%), and Perkins: $8 billion (flat). Direct Loans and FFELP loans were essentially the same size by the end of FY12; three years later, Direct Loan balances have more than doubled those in FFELP. We provide more details by loan and repayment status below. We note that defaults, as well as utilization of income-based repayment (IBR) and pay as you earn (PAYE), continue to pick up and average balances in IBR and PAYE remain meaningfully higher than overall average balances.

• In-school/grace: outstanding balance: $171 billion (-5% YOY); recipients: 9.6 million (-5%); average balance: $17,802 (flat) • Current in repayment: outstanding balance: $662 billion (+13%); recipients: 26.3 million (+4%); average balance: $25,160 (+8%) • Deferment/forbearance: outstanding balance: $247 billion (-1%); recipients: 8.6 million (-9%); average balance: $28,767 (+8%) • Default: outstanding balance: $121 billion (+14%); recipients: 7.9 million (+8%); average balance: $15,278 (+5%) • IBR: outstanding balance: $172 billion (+48%); recipients: 3.1 million (+47%); average balance: $56,295 (flat) • PAYE/REPAYE: outstanding balance: $38 billion (+127%); recipients: 0.9 million (+122%); average balance: $42,088 (+2%) Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 6

Federal Student Loan Portfolio By Repayment Plan - 12/31/15

Deferment Forbearance 9% 11% Default 10% Other 1%

In-school 12%

Grace Repayment 2% 55% Source: Department of Education, Compass Point

Private Student Loan Debt Outstanding: $100 Billion

According to industry group MeasureOne, private student loan debt as of September 30, 2015, stood at $99.7 billion, or 8% of the $1.31 trillion in total student loan debt outstanding. Six lenders (Sallie Mae, Wells Fargo, Discover, PNC, Citizens, and Navient) comprise more than 67% of the entire market.

Federal vs. Private Student Debt Outstanding

Federal, $1,220B

Private, $100B

Source: Department of Education, MeasureOne, Compass Point

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 7

Top primary private student lenders. The primary private student loan origination market, which we characterize as those lenders who provide loans to students while they are in school to meet the cost of tuition continues to be dominated by Sallie Mae, Wells Fargo, and Discover. We estimate these three entities comprise 85% of the primary origination market. From a competitive standpoint, we continue to see a rational market with pricing relatively consistent over the past few years and not many new entrants. Despite relatively high yields on core private student loans (at an average of 8%), the small size of the market ($8-$10 billion of annual originations), high barriers to entry, and elevated regulatory and other headline risk keep many new potential entrants away. Navient continues to hold the largest portfolio of private loans, but the portfolio remains in run-off.

Top Private Student Loan Holders ($M) YOY Rank Institution 4Q14 1Q15 2Q15 3Q15 4Q15 Growth 1 Navient $29,796 $28,990 $28,107 $27,323 $26,394 -11.4% 2 Wells Fargo $11,936 $12,169 $12,016 $12,289 $12,241 2.6% 3 Sallie Mae $8,247 $9,701 $9,245 $10,767 $10,516 27.5% 4 Discover Financial Services $8,510 $8,696 $8,520 $8,769 $8,763 3.0% Total - Top 4 $58,489 $59,556 $57,888 $59,148 $57,914 -1.0% Source: Company reports, Compass Point

The refinance market is growing. Within the past few years, the student loan refinancing market has emerged, led by "marketplace lenders" Social Finance (SoFi), CommonBond, and Earnest, as well as banks like Citizens and Darien Rowayton (DRB). These entities primarily target refinancing higher rate federal student loans into lower rate private loans for high quality borrowers, capitalizing on the lack of underwriting from the federal government. As a reminder, borrowers receive the same interest rates on federal student loans regardless of their credit profile. Rather than going through universities themselves like most primary student loan originators, these entities primarily source borrowers through direct mail and online lead aggregators (e.g. Credit Karma, Lending Tree, and Credible).

Official data around the size of the student loan refinancing market is not available, but the five companies above have reportedly refinanced more than $5 billion of student loans since 2012, and growth is expected to remain strong over the next few years. While this remains small in the context of the overall $1.2 trillion market and considering that the federal government originates $100- $150 billion of Direct Loans annually, as the industry continues to grow, we expect it could lead to an adverse selection problem for the government. As higher quality borrowers refinance away, it will drive a relatively weaker pool of borrowers remaining on the government's balance sheet.

Student Loan Credit: Federal Delinquencies and Defaults Continue to Move Higher

The bifurcation of credit performance Federal student loan delinquency data. According to the Federal Reserve Bank of New York (FRBNY), the percentage of within student loans continues: Federal outstanding student loans in repayment that were at least 90 days delinquent remain elevated, at 11.5% in 4Q15, versus 11.6% in 3Q15 student loan delinquencies and defaults and 11.3% in 4Q14. The 11.5% remains near the 3Q13 all-time high of 11.8%. Additionally, total new delinquent balances rose 4% remain elevated while private student sequentially and 3% YOY to $30.7 billion. At a time when other consumer asset classes have experienced improving or benign credit loans continue to perform well. trends, student loans remain under pressure. Additionally, this data only captures loans that have entered into repayment---it therefore understates the true effective student loan delinquency rate.

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 8

Percent of Balance 90+ Days Delinquent by Loan Type

16% 4Q15: 11.5% QOQ -10 bps 14% Credit YOY +20 bps Card 12% Student 10% Loan 8% Mortgage 6% Auto 4% Home 2% Equity 0% 3 4 4 5 5 6 6 7 7 8 8 9 9 0 0 1 1 2 2 3 3 4 4 5 5 0 0 0 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 4 2 4 2 4 2 4 2 4 2 4 2 4 2 4 2 4 2 4 2 4 2 4 2 4

Source: Federal Reserve Bank of New York, Compass Point

Analyzing the true direct loan non-payer rate. Aside from the FRBNY delinquency data, we have also analyzed recently released delinquency and other data provided by ED for its Direct Loan portfolio (see tables on the next page). Out of the $855 billion Direct Loans outstanding, official delinquencies (which are embedded within the total loans in repayment bucket) totaled $64 billion. When factoring in loans in default, the total jumps to $119 billion, or 13.9% of total Direct Loans outstanding. Finally, when adding in loans in deferment and forbearance ($185 billion), we estimate a total outstanding balance of Direct Loans that are not being paid back at $304 billion, or 35.6% of total loans outstanding. We note that a majority of loans in deferment status are characterized as such due to students being still in school or in grace periods. However, even when excluding those balances, total non-payers amount to $229 billion, or 26.8% of total Direct Loans outstanding. From a growth perspective, total delinquencies and defaults are up 13% and 31% YOY, respectively, but total Direct Loans outstanding are only up 15%.

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Direct Loan Portfolio By Status - Outstanding Balance ($B)

2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Total DL Outstanding $669 $686 $727 $744 $787 $803 $841 $855 Current Repayment $230 $249 $247 $292 $311 $331 $332 $374 31-90 Days Delinquent $18 $23 $25 $26 $23 $27 $28 $28 91-180 Days Delinquent $15 $13 $15 $16 $18 $18 $17 $18 181-270 Days Delinquent $8 $9 $8 $9 $9 $11 $11 $11 271-360 Days Delinquent $4 $5 $5 $5 $6 $6 $7 $7 Total Delinquencies $44 $50 $54 $56 $56 $61 $63 $64 As % of total DL in Repayment 16.1% 16.6% 17.8% 16.1% 15.1% 15.4% 15.8% 14.4% Total in Repayment $276 $300 $302 $350 $368 $394 $397 $440 Total Defaults $37 $37 $40 $43 $45 $48 $51 $56 Total DQs and Defaults $81 $87 $94 $99 $100 $108 $113 $119 As % of total DL outstanding 12.1% 12.7% 12.9% 13.3% 12.7% 13.5% 13.5% 13.9% Deferment $91 $89 $95 $87 $98 $93 $99 $88 Forbearance $72 $75 $81 $87 $86 $87 $90 $97 Total DQ, Defaults, Deferment, Forbearance $244 $252 $270 $272 $284 $289 $302 $304 As % of total DL outstanding 36.5% 36.7% 37.1% 36.5% 36.1% 36.0% 35.9% 35.6%

Source: Department of Education, Compass Point

The total number of recipients in delinquent status is 2.9 million; when including those in default, the number increases to 6.5 million, or 21.6% of total Direct Loan recipients. After adding in recipients in deferment and forbearance, the level increases to 12.3 million, or 40.7% of total recipients. Even if we exclude those students in regular in-school or grace period deferments, nearly one-third of all students who could be paying back their loans, aren't. Additionally, recipients in default are up 24% YOY but total Direct Loan recipients are only up 6%.

Direct Loan Portfolio By Status - Recipients (M)

2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Total DL Recipients 26.5 26.7 27.9 28.5 28.7 28.8 29.9 30.3 Current Repayment 9.1 9.6 9.3 10.6 11.1 11.6 11.4 12.5 31-90 Days Delinquent 0.9 1.2 1.3 1.3 1.1 1.2 1.3 1.2 91-180 Days Delinquent 0.9 0.8 0.8 0.8 0.9 0.9 0.8 0.9 181-270 Days Delinquent 0.5 0.5 0.5 0.5 0.5 0.6 0.5 0.5 271-360 Days Delinquent 0.3 0.3 0.3 0.3 0.3 0.3 0.4 0.4 Total Delinquencies 2.5 2.8 2.9 2.9 2.8 3.0 3.0 2.9 As % of total DL Recipients in Repayment 21.7% 22.1% 23.5% 21.4% 19.9% 20.2% 20.7% 19.0% Total in Repayment 11.7 12.5 12.3 13.6 14.0 14.7 14.5 15.5 Total Defaults 2.5 2.6 2.7 2.9 3.0 3.2 3.3 3.6 Total DQs and Defaults 5.0 5.4 5.6 5.8 5.8 6.2 6.3 6.5 As % of total DL Recipients 19.0% 20.1% 20.0% 20.4% 20.1% 21.4% 21.1% 21.6% Deferment 3.6 3.4 3.6 3.4 3.5 3.2 3.4 3.1 Forbearance 2.5 2.5 2.7 2.6 2.6 2.6 2.7 2.7 Total DQ, Defaults, Deferment, Forbearance 11.1 11.3 11.9 11.8 11.9 12.0 12.4 12.3 As % of total DL recipients 42.0% 42.2% 42.6% 41.5% 41.4% 41.5% 41.5% 40.7%

Source: Department of Education, Compass Point

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 10

Default inventory continues to increase. Total inventory of defaulted federal student loans as of December 31, 2015 stood at $121 billion, up 14% YOY, 5% sequentially, and 26% over the past two years. Total recipients in default of 7.9 million are up 8% YOY, and average balances in default are up 5% YOY to $15,278, from $14,548 one year ago. The YOY growth rate in defaulted inventory continues to outpace growth in the overall federal student loan portfolio.

Federal Student Loans in Default ($B) Default Inventory Is Rising at a Faster Pace Than the Overall Federal Portfolio

$130 16% $121 YOY growth in Defaults $120 $115 14% $111 $106 $108 $110 $103 12% $99 $96 $98 $100 $94 10% $89 $90 8% $80 6% YOY growth in Federal Student Loans $70 4% $60 2% $50 0% 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16

Source: Department of Education, Compass Point Source: Department of Education, Compass Point

Finally, as illustrated below, new data provided by ED indicates that Direct Loans entering into default spiked during the quarter ended December 31, 2015 (1Q16). Specifically, $6 billion of Direct Loans across 336,000 borrowers entered into default during the quarter, up 29% and 12% YOY, respectively. Of that, $5.43 billion was derived from borrowers defaulting for the first time (91%) while $570 million came from borrowers who defaulted for at least the second time (10%).

Direct Loans Entering Default

Total Entering Default During the Quarter Loans Defaulting for the First Time Loans Defaulting for At Least the Second Time Recipients in Unique % of Borrowers in Repayment From Prior Borrowers Repayment That Borrowers Average Borrowers Average Quarter Quarter (thousands) Dollars ($B) (thousands) Defaulted Dollars ($B) (thousands) Balance Dollars ($B) (thousands) Balance 1Q15 12,290 $4.65 301 2.45% $4.13 278 $14,845 $0.52 24 $21,399 2Q15 13,620 $4.11 259 1.90% $3.69 240 $15,369 $0.42 20 $21,320 3Q15 13,960 $4.82 289 2.07% $4.26 266 $15,997 $0.56 24 $23,237 4Q15 14,660 $4.78 276 1.88% $4.21 254 $16,562 $0.57 23 $24,891 1Q16 14,520 $6.00 336 2.32% $5.43 314 $17,321 $0.57 25 $23,265 YOY Growth 18% 29% 12% -137 bps 31% 13% 17% 10% 1% 9%

*Fiscal year ends 9/30 Source: Department of Education, Compass Point

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 11

IBR / PAYE utilization continues to pick up. ED and President Obama's efforts to help struggling student loan borrowers through alternative repayment programs, like IBR and PAYE, continue to generate results. As a reminder, for qualified borrowers, IBR links monthly student loan payments to 25% of a borrower's discretionary income and if a borrower remains in IBR for 25 years, his/her loan balances are forgiven. The newer PAYE program lowers those thresholds to 20% and 20 years, respectively. Note, a carve-out program known as Public Service Loan Forgiveness (PSLF), which is only available to Direct Loan borrowers who work in public service, ties payments to 10% of income, with a 10-year loan forgiveness period.

As of December 31, 2015, there were approximately 4 million borrowers in IBR or PAYE, with a total outstanding loan balance of $210 billion. These totals have nearly tripled over the past two years. While the increased utilization is a clear positive for borrowers, the ultimate loan forgiveness balances continue to mount for taxpayers.

IBR/PAYE Balances Have Nearly Tripled Over the Past Two Years

$225 $200 $175 $150 $125 PAYE/REPAYE $100 IBR $75 $50 $25 $0 1 1 1 1 1 1 1 1 1 1 1 3 3 4 4 4 4 5 5 5 5 6 Q Q Q Q Q Q Q Q Q Q Q 3 4 1 2 3 4 1 2 3 4 1

*Fiscal year ends 9/30 Source: Department of Education, Compass Point

The total percentage of federal student loan recipients in IBR or PAYE as a percentage of total recipients that are current in repayment is now up to 15.1%, from just 5.4% two years ago. We expect this trend to continue as awareness of the programs continues to grow and delinquency and default rates remain elevated.

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IBR/PAYE Balance and Recipient Breakdown - 12/31/15* Growth 1Q14 1Q15 1Q16 YOY 2-Year Balances ($B) IBR $67.9 $116.0 $171.7 48% 153% PAYE/REPAYE $4.1 $16.9 $38.3 127% 834% Total $72.0 $132.9 $210.0 58% 192% As % of total in repayment 13.7% 22.7% 31.7% +900 bps +1,800 bps Recipients IBR 1,210,000 2,070,000 3,050,000 47% 152% PAYE/REPAYE 110,000 410,000 910,000 122% 727% Total 1,320,000 2,480,000 3,960,000 60% 200% As % of total in repayment 5.4% 9.8% 15.1% +530 bps +970 bps Average Balance per Recipient IBR $56,116 $56,039 $56,295 0% 0% PAYE/REPAYE $37,273 $41,220 $42,088 2% 13% Total $54,545 $53,589 $53,030 -1% -3% *Fiscal year ends 9/30 Source: Department of Education, Compass Point

Private Student Loan Credit Continues to Hold Up Well

Despite ongoing pressure within federal student loans, credit performance of private student loans continues to hold up well. Below we provide a snapshot of key 4Q15 credit metrics from several primary private student lenders:

• Sallie Mae (SLM): Overall delinquency rates were up 30 bps sequentially to 2.2% of loans in repayment, split out: 31-60 days delinquent: 0.9% of loans in repayment (+20 bps), 61-90 days: 0.4% (+10 bps), 90+ days: 0.2% (+10 bps). Loans in forbearance increased to 3.4% from 3.1% in 3Q. Annualized net charge-offs of 1.08% increased 25 bps sequentially. We continue to expect these metrics to migrate higher as the loan portfolio seasons.

• Navient (NAVI): 90+ day delinquencies were flat sequentially but fell 40 bps YOY to 3.4%; total delinquencies decreased to 7.2% from 8.1% in 4Q14; and net charge-offs as a percentage of average loans in repayment fell to 2.3% from 2.5% in 4Q14.

• Wells Fargo (WFC): 30 day delinquencies of $240 million fell 5% YOY and delinquencies as a percentage of loans declined to 1.96% from 2.12% in 4Q14. Net charge-offs of $44 million rose 16% from $38 million in 4Q14 while charge-offs as a percentage of average loans increased to 1.42% from 1.27%.

• Discover (DFS): 30 day delinquencies excluding purchased credit impaired (PCI) loans increased to 1.91% from 1.80% in 4Q14 while net charge-offs excluding PCI loans decreased to 1.30% from 1.40% in 4Q14.

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When expanding the dataset further, delinquency rates for the top six private student lending participants are at the lowest levels since before the 2008 economic crisis while forbearance rates remain relatively modest, according to MeasureOne.

Private Student Loan Delinquency and Charge-Off Rates Continue to Trend Down

10.00%

9.00%

8.00%

7.00%

6.00%

5.00%

4.00%

3.00%

2.00%

1.00%

0.00% 2 3 8 8 9 9 9 9 0 0 0 0 1 1 1 1 2 2 2 3 3 3 4 4 4 4 5 5 5 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3

30-89 (% of Repayment) 90+ (% of Repayment) Gross Charge-offs (% of Repayment)

Source: MeasureOne, Compass Point

Additionally, as illustrated on the next page, delinquencies and charge-offs have generally declined for each successive vintage in each quarter after origination.

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Delinquency Rates by Origination Vintages

Source: MeasureOne, Compass Point

Gross Charge-Off Rates by Origination Vintages

Source: MeasureOne, Compass Point

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FFELP Hot Topics: IBR, ABS, and M&A

The increasing utilization of IBR discussed above has driven a meaningful slowdown in repayment rates on FFELP loans to the point where many tranches of related ABS trusts would not be fully paid down by their respective legal final maturity dates. Moody's and other rating agencies have noted that non-payment by final maturity would technically trigger an event of default for the affected ABS, even though the underlying bonds would still pay off in full over time. The rating agencies are still in the process of reviewing the issue, but we expect they will ultimately downgrade a portion of the outstanding trusts (Moody's placed $30 billion of FFELP ABS under review for downgrade in June 2015). We should obtain clarity at some point over the next six months, but the ongoing uncertainty has caused significant spread widening in the ABS market, dampening the appetite for both buyers and sellers.

As a point of reference, spreads on 7-year AAA FFELP ABS have widened to approximately LIBOR + 155 bps, vs. LIBOR + 50-60 bps over the past few years, and student loan ABS issuance $11.2 billion over the past 12 months is down 23% YOY. While we await clarity, we expect Navient to continue to address the issue by amending trusts to include optional servicer purchase rights, exercising cleanup calls, and extending legal final maturity dates within existing trusts.

FFELP ABS - 7-Year AAA Spread - 1/04 to Today 400

350 Crisis average: 300 140 bps Current: 250 155 bps

200 Post-crisis average: 150 75 bps 100 Pre-crisis average: 10 bps 50 0 2/04 2/05 2/06 2/07 2/08 2/09 2/10 2/11 2/12 2/13 2/14 2/15 2/16

Source: Bloomberg, Compass Point

The M&A landscape: expecting a slowdown in FFELP acquisition activity. Since the end of the FFELP program in 2010, we have seen a consistent level of portfolio acquisitions from several of the larger FFELP holders as banks, specialty lenders, and non-profits that were previous lenders under the program have looked to shed non-core assets. Coincidentally, Navient and Nelnet have each acquired $21 billion of FFELP loans since year-end 2010, helping support earnings and the run-off of their existing portfolios. Large bank sellers over the past few years have included Citi, Wells Fargo, and CIT.

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Navient and Nelnet FFELP Acquisitions ($B) - 2011 through 2015

$12,000 Includes $8.5B portfolio $10,000 from WFC $8,000

$6,000

$4,000

$2,000

$0 2011 2012 2013 2014 2015

NAVI NNI

Source: Compass Point, company documents

JP Morgan, SunTrust, PNC, and U.S. Bancorp continue to hold large FFELP portfolios. We expect the four, which hold an estimated total outstanding balance of $17 billion, would entertain selling the assets if ABS spreads come back in. Note, U.S. Bancorp, which we estimate still holds approximately $2.4 billion of FFELP loans, intended to sell the portfolio in 2015. However, management pulled back the portfolio from held for sale as a result of market disruption. As of December 31, 2015, we estimate $214 billion of FFELP loans remain outstanding held by non-ED entities.

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Top 20 FFELP Holders ($M)

Actual Estimated Rank Institution 9/30/2014 9/30/2015 YOY Growth % of Total 12/31/2015 % of Total 1 Navient/Sallie Mae $108,681 $99,611 -8% 46% $97,613 46% 2 Nelnet $27,850 $28,954 4% 13% $28,325 13% 3 Brazos Group $7,760 $6,763 -13% 3% $6,627 3% 4 Penn Higher Ed. Asst. Authority (PHEAA) $6,966 $6,618 -5% 3% $6,486 3% 5 JP Morgan Chase $6,379 $5,554 -13% 3% $5,443 3% 6 Goal Financial $5,052 $4,736 -6% 2% $4,641 2% 7 SunTrust $5,326 $4,608 -13% 2% $4,922 2% 8 PNC $5,282 $4,321 -18% 2% $4,234 2% 9 College Loan Corp $4,939 $4,229 -14% 2% $4,145 2% 10 Access Group $3,701 $3,308 -11% 2% $3,241 2% 11 Educational Services of America $2,371 $2,913 23% 1% $2,855 1% 12 Northstar $3,177 $2,885 -9% 1% $2,828 1% 13 Utah State Board of Regents $1,403 $2,623 87% 1% $2,570 1% 14 US Bank $2,664 $2,265 -15% 1% $2,409 1% 15 Missouri Higher Education Loan Auth (MOHELA) $2,531 $2,151 -15% 1% $2,108 1% 16 Student Loan Xpress $2,378 $2,085 -12% 1% $2,043 1% 17 South Carolina Student Loan Corp $2,137 $1,908 -11% 1% $1,870 1% 18 Wells Fargo $10,927 $1,859 -83% 1% $1,822 1% 19 College Foundation $2,113 $1,853 -12% 1% $1,816 1% 20 ED South $2,012 $1,740 -13% 1% $1,705 1% National Total $240,839 $218,027 -9% 100% $213,667 100%

Source: Department of Education, Compass Point

Student Loan Servicing: Performance Tracker

We have analyzed recently released Direct Loan servicing data from ED that breaks down loan balance and recipient volume by servicer and loan status.

Analyzing Recent Student Loan Servicer Portfolio Balances. As of December 31, 2015, PHEAA and Great Lakes serviced $254 billion and $209 billion of loans, respectively, Data for 8.5 million borrowers each. Navient and Nelnet serviced $194 billion and $156 billion, respectively, for 6.9 and 6.5 million borrowers, respectively. In terms of composition by outstanding balance, PHEAA constituted 29% of the total Direct Loan servicing portfolio, followed by Great Lakes (24%), Navient (22%), Nelnet (18%), and ED's smaller non-for-profit servicers (7%).

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Direct Loan Servicing Portfolio Breakdown - 12/31/15

By Outstanding Balance By Recipients

Non- Profits, PHEAA, 8.5M, Non- Profits, $57B, 7% 26% PHEAA, 3.0M, 9% Navient, $254B, 29% $194B, 22% Navient, 6.9M, 21%

Nelnet, Great Lakes , $156B, 18% Great Lakes , Nelnet, 6.5M, 8.5M, 25% $209B, 24% 19%

Source: Compass Point, Department of Education

The overall portfolio balances grew 11% YOY and 1% sequentially while recipient totals increased 4% YOY and 0% sequentially.

Direct Loan Servicing Portfolio - YOY Growth by Servicer Outstanding Balance Recipients 3Q15 4Q15 1Q16 3Q15 4Q15 1Q16 PHEAA 22% 20% 19% PHEAA 6% 5% 6% Great Lakes 13% 12% 11% Great Lakes 5% 4% 4% Nelnet 16% 14% 11% Nelnet 7% 3% -1% Navient 11% 9% 8% Navient 6% 4% 1% Non-Profits -10% -6% -4% Non-Profits -7% 7% 16% Total 13% 12% 11% Total 5% 4% 4%

Direct Loan Servicing Portfolio - Sequential Growth by Servicer Outstanding Balance Recipients 3Q15 4Q15 1Q16 3Q15 4Q15 1Q16 PHEAA 3% 5% 2% PHEAA -1% 5% 1% Great Lakes 1% 4% 0% Great Lakes -1% 5% 0% Nelnet 1% 4% 0% Nelnet -1% 3% -1% Navient 1% 3% 1% Navient -1% 4% -1% Non-Profits -2% 1% -1% Non-Profits 0% 11% 4% Total 1% 4% 1% Total -1% 5% 0% Source: Compass Point, Department of Education

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Examining "Current in Repayment" and IBR/PAYE. Given that the new servicing fee structure primarily incentivizes servicers to keep students current in repayment, and considering the Obama administration's focus on increasing utilization of IBR and PAYE, we have examined portfolio trends within these categories for the servicers. Note, it is our understanding that the "current in repayment" category for the servicers includes loans that are delinquent---so analysis around true performance of borrower repayment trends by servicer is somewhat incomplete. Since the portfolio and recipient balances vary depending on the servicer, we have looked at composition by status within each servicer's portfolio.

Since 2Q14, each of the four servicers has seen an increase in balances that are "current in repayment" as a percentage of overall portfolio balances, with PHEAA and Navient leading the way. After factoring in the non-profit servicers, approximately 56% of the direct loan portfolio is considered current in repayment. Similarly, from an IBR/PAYE perspective, each of the four servicers has experienced an increase in utilization, with PHEAA and Navient posting the greatest composition of loan and recipient balances.

Composition of DL Servicer Portfolio --- Current in Repayment

By Outstanding Balance By Recipients 59% 52% Navient PHEAA 50% PHEAA 54% Navient Great Lakes Great Lakes 48% Nelnet Nelnet 46% 49% 44% 44% 42% 40% 39% 38% 36% 34% 34% 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16

Source: Compass Point, Department of Education

Composition of DL Servicer Portfolio --- Income-Based Repayment (IBR) and Pay As You Earn (PAYE)

By Outstanding Balance By Recipients 35% 16% PHEAA PHEAA 14% 30% Navient Navient Great Lakes 25% 12% Great Lakes Nelnet Nelnet 20% 10%

15% 8%

10% 6%

5% 4% 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16

Source: Compass Point, Department of Education

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New allocations to favor non-for-profit (NFP) servicers over TIVAS despite widely different portfolio composition. On March 2, 2016, ED announced performance results for the September and December quarters as well as new volume allocations for its servicers for the 3/1/2016 through 6/30/2016 period. Note, this was the first time performance for the TIVAS (Navient, Nelnet, PHEAA, and Great Lakes) was combined with the NFPs as required by a provision in the Consolidated Appropriations Act of 2016. As illustrated below, while the NFPs ranked towards the top of the list, the comparison of the portfolio categories is not apples-to-apples given the significant difference in portfolio composition between the two groups. According to ED:

"the NFP portfolio is overwhelmingly made up of accounts received from the Direct Loan Servicing Center in 2011-2012. These loans were already in repayment and current at the time they were selected for transfer. As a result, the loans are more stable and mature than the portfolios of the other federal loan servicers. FedLoan Servicing (PHEAA), Great Lakes Educational Loan Services, Inc., Navient, and Nelnet have high volumes of new borrowers who are more likely to go in and out of delinquency. These four federal loan servicers also service Federal Family Education Loan (FFEL) Program loans purchased through the Ensuring Continued Access to Student Loans Act of 2008 (ECASLA), Pub. L. 110-227 and loans of all statuses received from the Direct Loan Servicing Center. Although the NFP members of the federal loan servicer team began receiving new borrowers in early 2015, most of those loans are still in an in-school status."

ED plans to develop new common metrics to take effect no later than July 1, 2016 to account for the variation in portfolio composition. We expect allocations for the TIVAS will trend back up once the calculations are modified.

Direct Loan Servicer Rankings - Year-to-Date Credit Metrics Survey Metrics

Servicer Current in 91-270 Days 271-360 Days Borrower Federal Personnel Total Effective Servicer Type Repayment Delinquent Delinquent Survey Survey Score Allocation MOHELA NFP 9.0 10.0 10.0 8.0 7.0 88.5 16% ESA/Edfinancial NFP 10.0 8.0 8.0 4.0 6.0 71.0 13% Granite State - GSMR NFP 6.0 7.0 7.0 7.0 3.0 65.0 12% VSAC Federal Loans NFP 7.0 5.0 9.0 5.5 5.0 63.8 12% CornerStone NFP 8.0 9.0 5.0 3.0 8.0 59.5 11% Great Lakes TIVA 4.0 2.0 3.0 9.0 10.0 56.0 10% OSLA NFP 5.0 6.0 6.0 5.5 4.0 54.3 10% Nelnet TIVA 1.0 1.0 1.0 10.0 9.0 45.5 8% PHEAA TIVA 3.0 3.0 2.0 2.0 1.0 24.0 4% Navient TIVA 2.0 4.0 4.0 1.0 2.0 22.5 4% Weightings 30% 15% 15% 35% 5% 550.0 100% Source: Department of Education, Compass Point

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Debt Collection: Still Awaiting ED's New Collection Contract

Revisiting the collection contract saga. We are still waiting on ED to award the new Direct Loan collection contract for "unrestricted" private collection agencies (PCAs). To our knowledge, bids for the RFP have now been submitted (as of February 29, 2016). As a reminder, 17 unrestricted and 5 small business PCAs were operating under the 2009 contract. We provide a timeline of recent events surrounding the contract below:

• July 3, 2013. ED released an initial solicitation for its new default collections contract.

• August 13, 2013. Bids from PCAs for the contract are due. At that point, a contract award was expected in January 2014 and a projected start date for the contract was April 1, 2014.

• April 4, 2014. ED announces 28 "unrestricted" PCAs have advanced for Phase 2 of the bidding process.

• October 2014. ED announces that it has awarded the new small business collections contract to 11 PCAs.

• February 27, 2015. ED announces plans to wind down the contracts with five vendors: Pioneer Credit Recovery (Navient subsidiary), Coast Professional, Enterprise Recovery Systems, National Recoveries, and West Asset Management. These firms, which we estimate comprised 20-25% of ED's collection activity, were allegedly providing inaccurate information to borrowers regarding ED's loan rehabilitation program. Pioneer, a subsidiary of Navient, had been the leading ED collector over the past several years---we estimate it held 7-8% market share, nearly 100 bps ahead of the next closest competitor.

• April 21, 2015. The existing contract expires. PCAs who were on the 2009 contract that were not part of the group of five above were permitted to continue to collect on their existing inventory. ED also selected five PCAs to receive new volume during the interim period ahead of the new contract award: Account Control Technology, ConServe, FMS Investment Corp, Windham Professionals, and GC Services.

• December 11, 2015. ED released a new RFP for the contract and canceled the existing RFP. PCAs have to submit a response by January 22, 2016 to be considered under the new contract. While we do not have insight into why the prior RFP was canceled and a new one was released, we suspect it may be at least partially related to ED adding new language surrounding compliance and negative judgments in order to survive any potential protests. Specifically, bidders must now provide a summary of "negative judgments" against the bidder since October 1, 2012. Negative judgments include but are not limited to: "loss of a civil lawsuit (not to include settlements), criminal conviction of a corporate official that was related to financial mismanagement of the Offeror’s organization, and/or a fine or loss of a license as determined by a governing body."

• January 19, 2016. ED extends RFP response date to February 16, 2016.

• February 12, 2016. ED extends the deadline for RFP responses for the majority of sections to February 22, 2016. The sub- contracting plan and small business participation submissions are moved to February 29, 2016. Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 22

RFP takeaways - fees and term. (1) Fees are consistent with the prior RFP - PCAs will receive $1,710 per rehabilitation (although language was added for low balance loans whereby PCAs will receive the principal balance if the loan is below $1,710). Based on our analysis, we expect average rehabilitated loan balances industry-wide are trending in the $17,000-$18,000 range. Historically, PCAs were paid approximately 11% of the loan balance upon rehabilitation, translating into a payment of approximately $1,870-$1,980 to the collectors---i.e. slightly ahead of the new $1,710 fixed payment. In our view, moving to the fixed-pay model creates less incentive for PCAs to rehabilitate higher balance loans and more incentive to rehabilitate lower balance loans. (2) The term of the contract has not changed - it will carry a 5 year initial term, 5 year extension, and an additional 2-year "in-retention" period.

Four key questions remain. (1) How quickly will ED turn around the RFP responses and award the new contract? We do not have visibility into (a) how quickly ED will be able to evaluate those responses and award the contract; and (b) when the new contract will start after it has been awarded. Our sense is that given how long it has taken ED to get to this point, the turnaround time could be relatively short. (2) How many PCAs will ultimately be included under the new contract? The prior contract included 17 unrestricted PCAs and 5 small business PCAs. Similar to the contract award/start date question, we do not have visibility into the number of vendors at this time. However, our sense is that given what appears to be a larger focus on compliance, and considering the new language added to the responses surrounding any negative judgments, we believe there is a chance ED shrinks the current number of unrestricted vendors to 12 or less. All things equal, a lower number of PCAs would drive higher relative market share for those included under the contract. (3) How will servicing changes and IBR utilization impact longer term growth/economics for the PCAs? Higher-touch servicing and a larger emphasis on helping students prior to default should help slow growth in defaulted inventory over time. (4) What is the progress of the new Treasury pilot program, whereby ED and Treasury effectively perform collections work in house as opposed to outsourcing it to PCAs? We have limited visibility into the success of this program at this point.

Implications for companies under coverage. We do not expect Navient will win a spot in the new contract given ED's decision to wind down its prior contract and considering the ongoing CFPB investigation. However, ED has begun allocating volume to small business collectors and two companies that were also terminated by ED as part of the 2009 contract, Coast Professional and National Recoveries, did receive volume in the December 2015 quarter (see table on the next page). As a result, while we continue to believe the odds are very low, we believe the door remains slightly ajar for Navient to come back as one of ED's unrestricted collectors.

Separately, we do expect Performant will win a spot in the new contract. The company recently stated that it is in the top third from a compliance standpoint and the CFPB's civil investigative demand (CID) was dismissed in June 2015 with no enforcement actions necessary. At this point, we assign an 80% chance to PFMT winning the award. Why this contract matters: prior to the recent slowdown, Performant's quarterly revenue run-rate under the contract was $10-$15M vs. the current $0-$5M pace, and ED defaulted inventory continues to increase 10-15% annually.

A look at 4Q15 collections data. ED has disclosed collections data for its 25 PCAs for the November 1, 2015 through December 31, 2015 timeframe (see below). As expected, the five unrestricted PCAs that were selected to receive new volume from ED in this intermediate period (Account Control Technology, FMS Investment Corp, ConServe, Windham Professionals, and GC Services) have the highest inventories at this point, with each adding $987 million of new volume in the quarter. These five accounted for 47% of total ED inventory at the beginning of the period. ED has also now begun assigning volume to six small business PCAs: Immediate Credit Recovery, Coast Professional, National Recoveries, Credit Adjustments, Central Research, and Action Financial Services. As discussed above, Coast and National Recoveries were essentially terminated from the prior contract, so we were somewhat surprised to see them receive new volume from ED this quarter. Immediate Credit Recovery, Credit Adjustments, Central Research, Action Financial Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 23

Services were all awarded a spot in the new small business contract in October 2014 (in additional to Coast and National Recoveries), before the contract was delayed. Average recovery rates (i.e. recoveries as a percentage of beginning inventory) are trending in the 4-5%-range.

Default Recovery Summary by Private Collection Agency - November 1, 2015 through December 31, 2015

Beginning Inventory Added Recoveries Recovery Private Collection Agency (PCA) Contract Award PCA Status Inventory ($M) Share Inventory ($M) ($M) Rate* Received New Volume - November 1, 2015 through December 31, 2015 Account Control Technology, Inc. 2009 Contract Unrestricted $6,800 11% $987 $184 2.7% FMS Investment Corp 2009 Contract Unrestricted $5,765 9% $987 $171 3.0% ConServe 2009 Contract Unrestricted $5,763 9% $987 $168 2.9% Windham Professionals, Inc. 2009 Contract Unrestricted $5,540 9% $987 $149 2.7% GC Services LP 2009 Contract Unrestricted $5,441 9% $987 $130 2.4% Immediate Credit Recovery, Inc. 2009 Contract, New Contract Small Business $2,450 4% $863 $75 3.1% Coast Professional, Inc. 2009 Contract, New Contract Small Business $638 1% $864 $73 11.4% National Recoveries, Inc. 2009 Contract, New Contract Small Business $412 1% $680 $43 10.5% Credit Adjustments, Inc. New Contract Small Business $0 0% $772 $1 NA Central Research New Contract Small Business $0 0% $588 $1 NA Action Financial Services New Contract Small Business $0 0% $484 $1 NA Did Not Receive New Volume - November 1, 2015 through December 31, 2015 Allied Interstate, Inc. 2009 Contract Unrestricted $3,638 6% $0 $147 4.0% Van Ru Credit Corporation 2009 Contract Unrestricted $2,991 5% $0 $80 2.7% NCO Financial Systems, Inc. 2009 Contract Unrestricted $2,535 4% $0 $91 3.6% Progressive Financial Services, Inc. 2009 Contract Unrestricted $2,511 4% $0 $92 3.7% Diversified Collection Services, Inc. (PFMT) 2009 Contract Unrestricted $2,483 4% $0 $104 4.2% Premiere Credit of North America, LLC 2009 Contract Unrestricted $2,383 4% $0 $89 3.7% CBE Group 2009 Contract Unrestricted $2,316 4% $0 $120 5.2% Collecto, INC dba EOS-CCA 2009 Contract Unrestricted $2,253 4% $0 $93 4.1% Financial Asset Management Systems 2009 Contract Unrestricted $972 2% $0 $48 4.9% West Asset Management, Inc. 2009 Contract Unrestricted $1,180 2% $0 $80 6.7% Enterprise Recovery Systems (ERS) 2009 Contract Unrestricted $890 1% $0 $92 10.4% Pioneer Credit Recovery, Inc (NAVI) 2009 Contract Unrestricted $608 1% $0 $56 9.2% Collection Technology Inc. 2009 Contract Small Business $2,915 5% $0 $86 2.9% Delta Management Associates, Inc. 2009 Contract Small Business $2,156 3% $0 $57 2.7% *Recovery rate denotes recoveries as a percentage of beginning inventory Companies highlighted in green denote unrestricted PCAs selected to receive new volume from ED prior to new contract award Companies highlighted in red denote those whose prior contracts were wound down by ED

Source: Compass Point, Department of Education

For-Profits - Fundamentals Remain Under Pressure, Regulatory Headline Risk Continues, and M&A Arrives for Apollo

Student demand remains weak in the U.S. 4Q15 results among the publicly traded for-profit schools continue to demonstrate challenging new and overall enrollment growth. Specifically, new starts at DeVry University fell 31% in the November session and 29% in the January session, reflecting the 21st consecutive quarter of negative new enrollment growth. New enrollment at Apollo Group fell 31% in 1Q15 (ended November 30), following declines of 31% in 4Q15 and 13% in 3Q15. Likewise, ITT Education (ESI) posted a 17% decline in new start growth, American Public Education (APEI) saw new course registrations fall 24%, Career Education (CECO) posted a 15% decline in new starts, and Capella (CPLA) and Strayer (STRA) experienced new start declines of 6% and 5%,

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respectively, We expect marketing inefficiencies, ongoing regulatory and media scrutiny, and a greater focus on student outcomes are all contributing to the pressure.

Regulatory risk continues - interagency oversight task force, new enforcement group. Several governmental agencies, including ED, CFPB, Department of Defense (DOD), FTC, SEC, and a number of state attorneys general have joined forces in ensuring oversight of the for-profit industry. Within the past two years, we have seen specific actions taken by the DOD against Apollo, FTC against DeVry, and SEC and CFPB against Corinthian and ITT. We expect more actions to come, likely driven by the interagency oversight task force and the new student aid enforcement unit.

Defense to repayment negotiated rulemaking should be monitored. ED's negotiated rulemaking sessions around borrower defense to repayment should be tracked for investors in for-profit education and we believe specific attention should be paid to discussions around circumstances under which ED would require a college to post a letter of credit to create a funding reserve in case the institution is ordered to cover the cost of successful defense to repayment claims. ED has proposed more than a dozen "automatic triggers," including a violation of an existing loan agreement, a failure to file annual or quarterly filings with the SEC, and a state or federal lawsuit filed against the school within the last three years. Four other "discretionary triggers," including high annual dropout rates and "a significant number" of borrower defense claims, would give the Secretary of Education the option of requiring a letter. The draft language would base a letter of credit's value on how many triggers were breached, with each trigger costing at least 10% of the institution's Title IV funding.

Apollo takes out Apollo for a relatively modest price. After posting what was arguably the worst quarter in the company's history, Apollo agreed to be taken private by a consortium of investors affiliated with Apollo Global Management and Najafi Companies for $9.50/share, valuing the company at $1.1 billion. After backing out net cash of approximately $6 per share, the purchase price represents 7x 2017 consensus EPS estimates. The company expects the transaction will close by August 2016, however, we expect the timeline could get pushed out as ED and accreditors look at the terms and structure closely.

Online Enablers - Growth Continues, Competition Remains Relatively Dormant

We continue to see colleges and universities slowly begin offering fully online degrees or hybrid degrees as ways to defray campus- based costs and expand enrollment. Below we highlight recent trends within three of the online enablers that we are able to obtain data on - 2U, Deltak, and Pearson. All three have been expanding partnerships with schools, which has translated into significant revenue growth for the companies.

• 2U (TWOU). As of December 31, 2015, TWOU had 14 school partners and 29 programs under contract. The company's 4Q15 revenue of $43 million rose 41% YOY and its 2015 revenue of $150 million increased 36% from 2014. Management has indicated that it plans to launch 6 new programs in 2016, 9 in 2017, and at least 12 in 2018. The company's top 10 programs by new enrollment in 2015 are illustrated below.

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 25

Top 10 Programs by New Student Enrollment for the Year Ending December 31, 2015

Rank University School 2U-Enabled Program Launch Date 1 The University of Southern California School of Social Work MSW@USC October 2010 2 Simmons College School of Nursing and Health Sciences Nursing@Simmons October 2013 3 The University of Southern California Rossier School of Education USC Rossier Online April 2009 4 The George Washington University Milken Institute School of Public Health MPH@GW June 2013 5 Simmons College School of Social Work SocialWork@Simmons July 2014 6 Syracuse University Martin J. Whitman School of Management MBA@Syracuse January 2015 7 The University of North Carolina at Chapel Hill Kenan-Flagler Business School MBA@UNC July 2011 8 Georgetown University School of Nursing & Health Studies Nursing@Georgetown March 2011 9 University of California, Berkeley School of Information datascience@berkeley January 2014 10 Washington University in St. Louis School of Law @WashULaw January 2013

Source: Compass Point, company documents

• Deltak. Deltak ended October 2015 (2Q16) with 39 school partners and 216 programs under contract, versus 37 and 181, respectively one year ago. The unit's 2Q16 revenue of $23.2 million rose 18% YOY and 1H16 revenue of $43.7 million is up 22% YOY.

• Pearson Embanet. Course enrollments for 1H15 grew 24% YOY to more than 134,000, boosted by the company's Arizona State University Online agreement, which was renewed during the year.

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 26

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 27 FFELP and Private Student Loan Portfolio Tracker

Top 20 FFELP Holders ($M)

Top Private Student Loan Holders ($M)

YOY Rank Institution 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 Growth 1 Navient $37,512 $30,949 $30,324 $30,476 $29,796 $28,990 $28,107 $27,323 $26,394 -11.4% 2 Wells Fargo $11,361 $11,703 $11,633 $11,916 $11,936 $12,169 $12,016 $12,289 $12,241 2.6% 3 Sallie Mae NA $7,208 $7,436 $7,779 $8,247 $9,701 $9,245 $10,767 $10,516 27.5% 4 Discover Financial Services $8,148 $8,372 $8,251 $8,494 $8,510 $8,696 $8,520 $8,769 $8,763 3.0% Total - Top 4 $57,021 $58,232 $57,644 $58,665 $58,489 $59,556 $57,888 $59,148 $57,914 -1.0% Source: Company reports, Compass Point Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 28

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 29

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 30

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 31

Valuation

Please refer to our most recent reports for additional valuation discussions for companies mentioned in this report:

SLM: https://compasspoint.bluematrix.com/docs/html/c22df8ef-dad9-4acd-a34f-9963ba0e93ba.html NAVI: https://compasspoint.bluematrix.com/docs/html/628f68d8-9c4e-4271-ab0d-aa9a06cc6ce1.html NNI: https://compasspoint.bluematrix.com/docs/html/84545bfb-66ac-4f26-b60a-9a1711dd2ea2.html TWOU: https://compasspoint.bluematrix.com/docs/html/a0aae147-acb4-48b8-82df-fd3c7839d298.html PFMT: https://compasspoint.bluematrix.com/docs/html/5a850892-be32-4bb7-b1db-7d3fe80aa37b.html ONE: https://compasspoint.bluematrix.com/docs/html/511f2e21-4ecc-45e8-8b00-4846c5604d79.html FMD: https://compasspoint.bluematrix.com/docs/html/34eeb730-aa48-4a76-92ad-7352372b3aa8.html APOL: https://compasspoint.bluematrix.com/docs/html/08345f1a-35a0-4488-b838-23d8e77ac0b4.html DV: https://compasspoint.bluematrix.com/docs/html/ab908e32-abda-417b-9191-0377dba19af3.html ESI: https://compasspoint.bluematrix.com/docs/html/9800a600-7bd8-4175-a722-241fbbfa0ed6.html

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 32

Risks

Please refer to our most recent reports for additional risk discussions for companies mentioned in this report.

Regulation. The education industry faces significant regulation by states, the FDIC, the Department of Education, and the Consumer Financial Protection Bureau (CFPB). If institutions were found to be non-compliant with existing regulations, or if future regulations were to add additional restrictions, profitability could be meaningfully impacted. For the for-profits, given that a significant percentage of revenues comes from federal student aid, existing and future regulations could have a meaningful impact on earnings.

Macroeconomic. Changes in the U.S. and global economy could impact enrollment levels and student default rates. While rising unemployment usually results in higher default rates, it can also drive increased demand for higher education services. That said, conditions may deteriorate to the point where students become reluctant to add additional debt, and employers become less willing to sponsor educational opportunities for their employees.

Competition. For-profit institutions face intense competition in the higher education market from both public and private institutions. Given the heightened regulatory environment and increasing scrutiny of student outcomes, competition for higher quality students will likely continue to intensify.

Capital Markets Risk. SLM Corporation, Navient Corporation, and Nelnet utilize capital markets for funding purposes. Rising volatility may negatively impact liquidity and drive up the companies’ cost of capital, adversely affecting profitability.

Credit Risk. SLM Corporation, Navient Corporation, and several for-profits face credit risk within their student loan portfolios. Deterioration in the overall economic environment may lead to weaker overall credit performance, potentially driving higher provision expenses and reserves, and lower profitability.

Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected] Compass Point Research & Trading, LLC 33

Important Disclosures

Analyst Certification I, Michael Tarkan, CFA, hereby certify that the views expressed in this research report accurately reflect my personal views about the subject securities or issues. I further certify that I have not received direct or indirect compensation in exchange for expressing specific recommendations or views in this report.

Isaac Boltansky is Compass Point's Washington Policy Strategist. His contributions to this document relate solely to Washington Policy and should not be attributed to any company specific research, ratings, or conclusions.

Coverage Universe Investment Banking Relationships Rating Number Percent Rating Number Percent Buy 62 50 Buy 14 23 Neutral 60 48 Neutral 8 13 Sell 3 2 Sell 1 33 Total 125 100% Total 23 100% *Percentage of Investment Banking Clients in Coverage Universe by Rating

Ownership and Material Conflicts of Interest

Within the previous 12 months, Compass Point has co-managed a public offering of securities for the following company: 2U, Inc..

Within the previous 12 months, Compass Point has received compensation for investment banking services from the following company: 2U, Inc..

During the 12-month period preceding the date of distribution of this research report, the following company was (were) a client (clients) of Compass Point: 2U, Inc.. The type of services provided were investment banking.

Ratings, Coverage Groups, and Views and Related Definitions

The information and rating included in this report represent the long-term view as described more fully below. The analyst may have different views regarding short-term trading strategies with respect to the stocks covered by the rating, options on such stocks, and/or other securities or financial instruments issued by the subject company(ies). Our brokers and analysts may make recommendations to their clients that are contrary to the recommendations contained in this research report. Such recommendations or investment decisions are based on the particular investment strategies, risk tolerances, and other investment factors of that particular client or affiliate. From time to time, Compass Point and its respective directors, officers, employees, or members of their immediate families may have a long or short position in the securities or other financial instruments mentioned in this report. Current Stock Ratings System (NOTE: As of January 11, 2016, Compass Point has changed the definitions of Buy (B), Neutral (N) and Sell (S) in its Stock Ratings System to the definitions contained herein): Buy (B): We expect the stock to outperform its peers on a risk adjusted basis over the next 12 months. Neutral (N): We expect the stock to perform in line with its peers on a risk adjusted basis over the next 12 months. Sell (S): We expect the stock to underperform its peers on a risk adjusted basis over the next 12 months. Not Rated (NR): The investment rating and target price have been removed pursuant to Compass Point policy when Compass Point is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances. Rating Suspended (RS): Compass Point Research has suspended the investment rating and price target for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price Compass Point has suspended coverage of this company. Not Covered (NC): Compass Point does not cover this company. Not Available or Not Applicable (NA): The information is not available for display or is not applicable. Not Meaningful (NM): The information is not meaningful and is therefore excluded.

[Prior Stock Ratings System for all Research Reports Published BEFORE January 11, 2016: A Buy (B) represents a total rate of return potential of 15% or more on a 12-month horizon.

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A Neutral (N) represents a total rate of return of -15% to +15% on a 12-month horizon. As of July 31, 2015, an analyst may assign a Neutral (N) rating even if the total rate of return is not between -15% and +15% if the analyst does not feel conviction that the stock is a Buy (B) or a Sell (S) and particular circumstances exist, such as, for example, if the stock has an extraordinarily high dividend yield or is low-priced. If an analyst assigns a Neutral (N) rating utilizing the foregoing exception, they will provide an explanation as to their reasoning. A Sell (S) represents a total rate of return -15% or below on a 12-month horizon. Return potential represents potential and projected dividends and the price differential between the current share price and the price target expected on a 12-month time horizon associated with the price target. Price targets are required for all covered stocks.]

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Compass Point Research & Trading, LLC expects to receive or intends to seek compensation for investment banking services from the subject company(ies) in the next 3 months. The research analyst(s) named in the certification above receives compensation based upon various factors, including, but not limited to, the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues generated by Compass Point Research & Trading, LLC's investment banking activities. This report is based upon public information that Compass Point Research & Trading, LLC and the research analyst named in the attestation above assume to be correct. Assumptions, opinions, forecasts, and estimates constitute the research analyst’s judgment as of the date of this material and are subject to change without notice. The research analyst’s judgments may be wrong. Neither Compass Point Research & Trading, LLC nor its affiliates, nor the research analyst, are responsible for any errors, omissions, or results obtained from the use of this information. Past performance is not necessarily indicative of future results. The securities and/or financial instruments mentioned in this research report, and the trading strategies related thereto, may not be suitable for all investors. You must consider your specific investment goals and objectives prior to transacting in any security or financial instrument. Consult with your financial advisor before making any transactions or investments. © Compass Point Research & Trading, LLC 2016. All rights reserved. Reproduction or quotation in whole or part without permission is forbidden.

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Michael Tarkan, CFA | 202.534.1390 | [email protected] Isaac Boltansky | 202.534.1396 | [email protected] Andrew Eskelsen | 202.534.1383 | [email protected]