The Problem With Too Big To Fail Colleges

ITT Tech / Via itt-tech.edu

ITT Educational Services, one of the country’s largest for-profit college operators, has fallen into a financial and regulatory spiral that many observers say it is unlikely to emerge from. The company, which had 51,000 students as of March, is slowly running out of options to stay afloat.

Except, of course, for one: enroll more students.

The government, experts say, has yet to figure out how to deal with companies in situations like ITT’s: large school chains in perilous financial situations that continue to enroll students and collect loan dollars and financial aid, potentially putting a growing number of students at risk as their schools step onto shakier financial and regulatory ground.

Students, lawmakers and investors are still reeling from the collapse of Corinthian Colleges, which sold off the bulk of its campuses before stranding 16,000 remaining students last month when it abruptly went out of business. But ITT’s troubles draw attention to what may be an even bigger problem: a cadre of other massive for-profits in circumstances perilously close to those that toppled Corinthian.

Critics call the Education Department’s oversight systems inadequate, saying that it takes too long to intervene in cases where evidence of wrongdoing has stockpiled. In Corinthian’s case, several investigations by state attorneys general had catalogued false promises of jobs and deceptive enrollment tactics dating back to 2006. But by the time it reached an agreement with the Education Department last year to sell off or close its campuses, it had been in financial distress for years and had no money left with which to pay penalties or restitution to students.

“What the Department of Education is going to be confronting, time and time again, is the phenomenon of ‘too big to fail’ by the time they’ve caught up to the facts,” said Barmak Nassirian, a policy analyst at the American Association of State Colleges and Universities and a longtime critic of the industry. “In a more perfect world there’d be early warning systems and real money to go after when there’s wrongdoing.”

Since early last year, ITT has lost the confidence of once-loyal investors, flubbed a key real estate deal, fallen behind on its financial filings, and become mired in a government lawsuit that likely prevents it from selling any of its schools. Earlier this week, fraud charges against the company and its top executives by the Securities and Exchange Commission sent its stock plummeting 45% in a single afternoon; the shares are down 98% since a high point in 2008.

Nicole Elam, a spokeswoman for ITT Tech, said that the school was "excited about our future and the ability to help students improve their lives."

"While the piling on of attacks against career colleges and our institutions continues, our focus remains on our students and those employers who hire them," Elam said. ITT, she said, was instituting a tuition freeze and planned to give out tens of millions of dollars in scholarships to students.

In January of 2014, many for-profit colleges were already floundering financially. But ITT Tech was still considered a “darling” of small-cap investors, said Trace Urdan, a financial analyst who covers the industry: its stock was on a steady rise, trading 200% higher than it had a year before.

Since then, ITT has fallen 94%, to $2.50. First, in February of 2014, was a lawsuit by the Consumer Financial Protection Bureau, which sued the company alleging a predatory lending scheme that manipulated students into taking out pricy loans that it knew would likely go into default. In August, ITT’s plan to raise $119 million by selling off its real estate fell through, and its CEO said he planned to resign, sending its stock plunging 46%.

Then, in September, just days after the company notified investors that it might face a lawsuit from the Securities and Exchange Commission, the Education Department penalized ITT for failing to submit financial statements; the company hasn’t filed an annual report with the SEC since 2013.

Now, said Urdan, “It’s burned through its investors, and it sort of has nowhere to go. It’s descending into penny-stock land.”

Urdan said he doesn’t believe that ITT is “the next Corinthian:” it has much more cash on hand, some $200 million, compared to Corinthian’s paltry $28 million at the time of its collapse. But, he admits, “they’ve taken all of the obvious steps they can take” to turn themselves around. “There’s not an obvious next step for them.”

In other industries, bankruptcy is an obvious option for troubled companies, allowing them to reorganize while shielded from creditors. But federal regulations essentially prevent colleges from declaring bankruptcy except in the most dire of circumstances, because schools that do immediately lose access to federal loan money. For most for-profit schools, which get up to 90% of their revenue from the federal government, bankruptcy means instantly going out of business.

These regulations are part of the reason that colleges descend so far into financial distress before seeking help, said Joseph Smolinsky, a partner at the law firm Weil, Gotshal & Manges who specializes in restructuring. "Schools start very late in the process — they continue to litigate, they continue to lose money, until the only option for them is a fire-sale. They don't have the time or money to conduct a prudent sale."

In ITT's case, however, even a sale is likely not an option. The CFPB lawsuit, said Urdan, is “keeping potential buyers away. It’s an unknown entity: no-one knows how the case will be adjudicated or what the liability will be.”

"The way that ITT becomes Corinthian is that its enrollments don't get better," said Urdan. "If the enrollments don't get better in any meaningful way, and they can't shake off the lawsuits, then they're stuck — they can't sell themselves, they can't retire."

As ITT fights to defend its company and executives against the SEC and the CFPB, "It will simultaneously redouble its efforts to enroll new students and rack up as much as possible in terms of federal loan money," Nassirian said. "Should that not prove sustainable, at some point all of that will be handed to the federal government to deal with."