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.