October 24, 2019

No Resolution for Gainful Employment, as Expected

ed_mn_logoUpdate from William Blair’s Timo Connor

• On Friday, December 13 the final Gainful Employment 2.0 hearing ended with no
resolution, as expected. With no consensus from negotiators on what the rules
should look like, the Department of Education (ED) will proceed unilaterally in
publishing final rules. The ED has until November 2014 to get them published in
the Federal Register in order to go effective in 2015.
• We believe recently released draft rules will be weakened significantly in the
final version, much like they were when Gainful Employment 1.0 rules were
published in 2011 (e.g., debt-to-income thresholds were increased from 8% to
12%).
• We believe that no matter what the final rules look like, they are likely to face
significant legal and legislative challenges from the industry and legislative
supporters of the industry. We note that Gainful Employment 1.0 rules were
challenged in court, and a federal judge struck down the rules on the basis that
some of the quantitative thresholds were “arbitrary.” We also note that a
Republican House is largely supportive of the private-sector colleges and could
mount a legislative challenge of gainful employment through the ongoing Higher
Education Act reauthorization process or through the budget process by
challenging the funding of ED.

In addition, gainful employment data is reported on a multiyear lag, and we
believe that significant changes to improve student ROI made by private-sector
schools over the past few years will greatly improve regulatory metrics over
time. While we continue to expect regulatory scrutiny of the sector, a gradually
narrowing range of potential negative regulatory outcomes should support
multiple expansion for the postsecondary stocks in the coming years.

Recapping the Gainful Employment Process
ED held a series of Negotiated Rule-Making hearings this fall discussing draft gainful employment rules. The first three-day
session began Monday, September 9, the second three-day session began November 18, and the third and final one-day
session took place on December 13.
• The previous iteration of the rule, finalized in 2011, was challenged by an industry group and vacated in 2012 by a
federal judge who found the metrics “arbitrary,” so ED was forced to start the process over. Because no consensus was
reached by the negotiating panel, ED will move forward with new rules, which would likely go into effect in 2015,
potentially eliminating Title IV student loan eligibility for programs at some schools in 2019 and beyond.
• The draft language, though very similar to the prior rule, appears more onerous for the sector this time around;
however, the initially proposed rules from the previous gainful employment NegReg were watered down significantly
in the final language, with debt-to-income ceilings rising from 8% to 12% and repayment floors falling from 45% to
35%, for example.
• In particular, the use of “and” rather than “or” forces the schools to pass all metrics, not just one; the re-introduction
of a “caution zone” for programs close to failing; the elimination of an extended debt amortization schedule for
bachelor’s and graduate programs; and the elimination of a transition period in which generally higher BLS incomes
could be substituted for actual earnings are negative changes for the schools in the space. The table at the end of this
note offers the details on the new rule and the school’s debt-to-income and CDR exposures.

• The schools have already begun adapting to potential rules by freezing or cutting tuitions or the number of credits
required for graduation as well as reducing exposures to low-salary fields like criminal justice or certain fine arts
studies, while also screening out unprepared students who are more likely to default or not repay loans. As a result,
we believe regulatory metrics will likely improve in the years leading up to the instatement of any potential rules.
• We believe the political climate has shifted significantly since the gainful employment NegReg process began in 2009,
and believe there is more political support for the private-sector schools, particularly among Republicans, who now
view further ED regulations as anti-business. Although NegReg remains a non-legislative process, Congress controls
funding for ED, and we believe the rules are significantly more likely to be softened than toughened following this
fall’s sessions and the ensuing public comment period. We also note that the schools successfully appealed the prior
rules and are likely to appeal again, so it could be a lengthy process to put the rules in place (if they’re put in place at
all).
Source: Timo Connor, CFA William Blair & Company, L.L.C. Link to report

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