Business Is Up in Keeping Default Rates Down

July 11, 2010

How big are the stakes for colleges with a high proportion of students defaulting on their loans? Consider this: Several for-profit colleges recently hired a company that specializes in preventing kidnappings in order to tap its network of private investigators and trove of data resources.

The colleges used the company to track down former students and get them to seek forbearances on their student loans to avert default—and to help keep institutions' own default rates down.

The business of keeping a lid on the rate of loan defaults at colleges, which keeps the spigot of federal funds from being shut off, doesn't typically require cloak-and-dagger expertise. But default management has become a flourishing practice and business in its own right, and colleges are seeking help on that front with increasing urgency.

Because of several recent changes in federal law, the industry is poised for another boom, fueled particularly by heightened interest from for-profit colleges and a concern among all colleges that the sour economy will force more and more borrowers to default on their loans.

The rise of the default-management industry may bring some unwelcome consequences.

Sophisticated tools, creative tactics, and expressions of good intentions typify the industry, but default management also features business models laced with inherent conflicts of interest that can allow colleges to game the system and do a disservice to students.

"Default management is an objective for a school, debt management is an objective for the borrower," says Lauren Asher, president of the Institute for College Access and Success, which sponsors the Project on Student Debt. "There are times when borrowers' interest and the schools' interest may not be aligned."

The misalignment of interests can be intensified when colleges are footing the bill for the services and are motivated chiefly by the desire to lower their default rates.

Students who can't afford to start paying their loans have the option of avoiding default by entering into income-based repayment plans. They can also obtain a deferment or a forbearance, which allows them to delay the start of repayment, typically for six months or a year. During a forbearance period, the cost of the interest gets added to the principal of the loan. Forbearances are notoriously easy to get. In some cases, borrowers can do it with a phone call to their lender or loan servicer and don't even have to sign a form.

"To really be an advocate for the borrower, you need to be a neutral third party," says Paul Combe, president of American Student Assistance, an agency that guarantees student loans. "If it takes you 15 minutes to explain an income-based resolution and it only takes two minutes to talk about a forbearance, it's going to go in that direction."

Default management is sometimes carried out by colleges on their own, sometimes by the agencies that guarantee student loans or companies that service them, and sometimes by the half-dozen or so companies that specialize in it and are paid by colleges for advice or hands-on involvement. Some nonprofit colleges get involved in default management, but the practices and the industry are focused largely on the for-profit sector, where default rates are higher.

Companies that help colleges cut down on their defaults maintain that their foremost goal is to be advocates for students. (At one, Wright International Student Services, the message callers hear when they are put on hold for a loan counselor proclaims, "We are on your side.") But Mr. Combe and other loan-industry experts say a desire for expediency can sometimes outweigh the best of intentions.

The high-tech tools the companies boast of in their marketing materials can be effective for helping students manage their debt. One such example is the "cohort calculator" sold by ECMC Solutions that colleges can use to identify which of their former students are months, weeks, or days away from defaulting. But tools like the calculator can also be deployed to help a college know exactly when to beef up a push for forbearances in an effort to keep its default rate from getting beyond the trigger point that could disqualify the institution from federal student-aid programs.

The fear is that colleges and the companies they hire can have a "very limited view of success" that involves staving off high default rates only during the period being measured, says Michael T. Ryan, vice president of borrower services for American Student Assistance. It's "winning the game of 'beat the clock.'"

Putting Time on Their Side

Beating that clock, or perhaps more accurately beating the calendar, is about to get tougher.

For years colleges have been measured by the default rates of their students for a period of up to two years, starting six months from when they graduate or leave school. Soon, however, the Department of Education will hold colleges accountable for defaults of that group, or cohort, of students during a period of up to three years. Using deferments or forbearances to keep students out of the calculation will be harder to do once the period goes to three years. Sanctions for high three-year default rates won't go into effect until late in 2014. But estimates of colleges' three-year rates, released by the department in December, indicate that measuring over the longer period could pose a problem for for-profit colleges in particular.

Of the 20 degree-granting colleges that would have default rates so high that they would be disqualified from federal student-aid programs if the rule were in effect now, 17 are for-profit colleges.

Most for-profit colleges enroll more low-income and working-adult students than higher education does as a whole, and college leaders in that sector say that is a major reason for their high default rates. But some critics say the high debt levels are sometimes caused by colleges' push for growth, which drives them to recruit students who can't succeed and drop out lacking job skills and carrying levels of debt they can't afford.

According to an analysis by the Project on Student Debt, default rates at 183 for-profit institutions were at least 15 percentage points higher for the three-year window compared with a two-year window. That suggested that the colleges were aggressive about keeping defaults down during, but not after, the government's tracking period. Those 183 colleges enrolled 9 percent of all students attending for-profits. By comparison, the analysis found, only 20 colleges from other sectors saw similar increases.

Other analyses have suggested that many more colleges, including more campuses owned by the Apollo Group, Corinthian Colleges, and Kaplan, would run afoul of the new rules, based on how much higher the colleges' rates were when defaults occurring in that third year were counted.

With unemployment still high, default rates are expected to continue to rise for the next few years.

"Schools are terrified of what their three-year rate will look like," says Christopher Miller, a debt-management consultant for United Student Aid Funds.

USA Funds, as the company is called, began developing its default-management expertise while working primarily as a guarantor of student loans. The elimination of the federal bank-based student-loan program this year will eventually reduce the need for guarantee agencies, leading many of them to seek new business opportunities. USA Funds is now weighing whether and how to move more aggressively into the default-management business, as are several other guarantee agencies.

"With these new three-year cohort-default rates and the rise of the proprietary sector, there are some definite opportunities," says Robert P. Murray, vice president for corporate communications at USA Funds.

At least a half-dozen companies went courting new customers during the Career College Association's annual convention last month in Las Vegas, setting up exhibit-hall booths with signs that reminded college executives that "High Cohort Default Rates Can Devastate." There was "a lot of interest," says David Hawn, president of ECMC Solutions, a newly created for-profit subsidiary of Educational Credit Management Corporation that provides default-management services to about 100 mostly for-profit-college clients.

Champion College Services, a major company in the field, with about 300 college clients, also mostly in the for-profit sector, says business has been so brisk in the past couple of years, it's had to create a waiting list for several colleges seeking to become clients.

Managing Borrowers Longer

For-profit colleges have responded to the three-year default data released by the Education Department by saying they are not indicative of what the colleges' rates will be by 2014. That's because the department's figures, the colleges say, don't reflect the impact of applying default-management strategies to the borrowers for the third year.

"We do not believe it is appropriate to put much value into the current three-year analysis when our schools were doing nothing to manage borrowers during the third year of the measurement period," says a written statement from Westwood College. A Westwood campus was among those that would have had too high a default rate to continue to qualify for federal aid had the three-year rule been in effect.

And manage them they will.

Corinthian Colleges, parent company of Everest, Heald, and WyoTech Colleges, has been especially public about its intentions, announcing that it will spend $10-million over the next year to strengthen its default-management efforts. The announcement came shortly after calculations released in December showed that three of its institutions would exceed the thresholds of the new law if it were in effect now. Corinthian plans to hire three outside companies and add more than a 100 people in-house to work with them.

"We're going at it full-bore," says Mark L. Pelesh, executive vice president for legislative and regulatory affairs. He said top executives at the company now hold twice-weekly conference calls to update one another on their progress. In addition to advising borrowers about deferments, which are available to borrowers by right if they meet certain conditions, and forbearances, which are granted by lenders at their discretion, the company has said it would be encouraging borrowers to take advantage of new income-based repayment options.

After initially agreeing to share more details about its planned approach with The Chronicle, Corinthian declined to make other officials available to discuss it. Westwood and another privately held college company, Education Affiliates, both of which were identified by their default-management companies as clients with interesting strategies, also declined interviews. So did Kaplan, which would have one college (Tesst College of Technology) in violation of the new three-year rule, and Apollo, another giant higher-education company. Both operate campuses where estimates of the three-year-default rates approached the threshold.

Apollo, Kaplan, and Westwood each noted in written statements that their approaches to reducing defaults involve improved communication with students. Kaplan said it had also instituted new admission policies designed to better screen out ill-prepared students. Apollo said it was adding a financial-literacy component to a free, three-week orientation program it had already been offering to ensure that students enrolling with little college experience understood not only the academic burdens they were about to undertake but also the financial ones.

Hand Holding

What exactly do companies do to avert defaults?

It can be as simple as getting up-to-date contact information for students before they leave the institution and as high-tech as the analysis that goes into ECMC's cohort calculator.

USA Funds is promoting another software tool that helps colleges predict which students are likely to default by crunching 100 variables, such as a student's ZIP code and whether he or she is the first in the family to attend college. The tool was developed by a student-services consulting firm, Noel-Levitz, to help colleges improve retention by identifying which students are most likely to drop out. USA Funds is now looking to apply that information to default management, since students who leave college without a degree are more likely than graduates to default on their loans.

Keeping track of students once they leave is also crucial. That's why some default-management companies now recommend that colleges get borrowers to provide contact information for as many as 10 friends or relatives. Mr. Miller, of USA Funds, says one way colleges can get that information is by asking students when they enroll to fill out a "graduation sheet" listing the people they'd like to invite to their commencement.

Colleges and companies could then use those references to get in touch with former students about unpaid loans if the college has lost track of the borrower during the six-month grace period between the time he or she left college and the starting date to begin repaying his or her loans, or during the subsequent 270 days before the loan goes from delinquency to default. (The boots-on-the-ground tracking down of former students done by that investigative company, Altegrity Risk International, for colleges it declined to identify was far more intensive than the efforts most companies employ in locating dropped borrowers.)

Wright International says most of its clients ask the company to contact only borrowers who have fallen into delinquency. Other companies and colleges say default aversion is more effective if the stream of reminder e-mails, letters, and even phone calls begin as early as the grace period.

Mary Lyn Hammer, president of Champion, recommends finding ways to give students a greater sense of ownership over their loans, especially as the process of taking on college debt has become more automated. She encourages her client colleges to ask student borrowers to physically sign the form that grants them the routine in-college deferment on beginning repayment, even though it's not required.

"It gets them over the phobia" of dealing with the red tape that can be associated with default aversion, she says, and may make forms like that seem less intimidating later, when they are asked to approve them again to stay out of default.

Costs for default-management services vary widely. Wright International, for example, receives $80 from colleges for each delinquent loan it "cures," or keeps from going from delinquency to default. The firm counsels borrowers about all their options, but John K. Beal, the company's owner, estimates that about 90 percent of the time the delinquencies it manages are resolved through forbearances.

Champion's payment plans are more complex. Ms. Hammer says colleges with delinquency rates of below 10 percent pay an average of $3.25 per borrower per month. Those with delinquency rates of about 15 percent would pay $6 or $7 per borrower per month. Most of her clients come to her with delinquency rates much higher than that, so they pay more at first. But she says that their average delinquency rate drops by half within three years, and that colleges that have used her services for several years have seen their default rates drop from an average of 18 percent to below 8 percent.

Some default-management tactics have come under fire by the government and by borrowers. In 2008, for example, the Department of Education's inspector general accused the Technical Career Institute of trying to improperly lower its default rate by paying off students' loans for them, and then going after the students later for the money.

In 2009 three former students at the University of Phoenix made similar accusations in a lawsuit first filed in Arkansas and then refiled in California. The lawsuit is close to being settled on undisclosed terms, according to a Phoenix lawyer. Lawyers for the three plaintiffs did not respond to inquires seeking comment. Phoenix executives declined to discuss the settlement but said in a written statement that the allegations were "without merit."

Back in School

Default-management approaches can be problematic even when they do not involve allegations of overt manipulation.

Some colleges encourage borrowers who've dropped out to re-enroll. That allows the student to further defer payment on loans and could help the college by keeping loans in good standing beyond the two-year or three-year period in which they are counted for the official default rate.

But the tactic could hurt students. If they are unsuccessful a second time, they could end up with more debt and more loans on which they might default. Some students might be better off re-enrolling at a different, less-expensive college instead.

Often colleges' entreaties appear designed with the borrowers' interest in mind. But for students like Glenda Brooks, who enrolled and then dropped an Art Institutes online course in digital design, messages urging her to "Get Your Education Back on Track" are not necessarily viewed that way. Before she enrolled this February, Ms. Brooks, 60, says she told the recruiter she didn't want a loan. But in the "rush, rush" of signing up for the course, she says, she found herself signing for a $9,000 loan (refunds lowered it to $1,200) and in a course too technical for her to manage.

"I don't want to go back," she says. She's been making that clear to the Art Institutes since April. Her loan is scheduled to go into default in a couple of months. And her lawyer, Deanne Loonin, who is with the National Consumer Law Center, suspects that the steady stream of e-mails Ms. Brooks continues to receive, including three in June, are no coincidence.

The Art Institutes' parent company, Education Management Corporation said in a written statement "purposely misleading or misadvising students is not tolerated."

Both Champion and USA Funds offer services to colleges to encourage re-enrollment. (Mr. Beal, of Wright International, says he doesn't.) Champion even provides special "scripting" for its employees to use for students who have left college. "By first recovering their loan, we establish trust that leads into our referral back to the school's admission staff to encourage re-enrollment," its materials boast.

Ms. Hammer, who founded Champion 21 years ago and considers herself the godmother of the default-management industry, says she sees nothing improper about encouraging students to re-enroll. She views that as part of her advocacy on behalf of students, saying she believes in their ability to succeed if they go back. Ms. Hammer herself is an alumnus of a for-profit, Brooks College, in Long Beach, Calif.

Ultimately, she says, the decision to re-enroll is the student's choice: "That's not for us to decide."

In accordance with her company's mission to put students first, Ms. Hammer, who has served on the Career College Association's Board of Directors and is active in federal policy debates over student-loan rules, says she recently turned down four colleges as clients because they wouldn't agree to follow her student-focused advice, such as providing easy-to-understand loan counseling to borrowers while they're still in college.

Mr. Hawn, of ECMC, says the practical realities of default-management protect against abuse, as does the ethos of the industry.

For one thing, he notes, with colleges soon to be accountable for defaults over a three-year-window, default managers recognize that they will now need to do more than just find students late in their delinquency periods and arrange for a forbearance to push them beyond the window and out of the default calculation.

Colleges aren't looking to cut corners either, Mr. Hawn adds. "So far I've not run into any school that's saying, 'Dave, just focus on the easiest thing,'" he says.

Advocacy groups that represent student borrowers, however, say the colleges have intractable conflicts of interest when they have so much on the line.

When the college is paying for default management, says Ms. Loonin, the lawyer, it is likely that "it's not for the interest of the borrower, it's for the interest of the school."

Jeffrey Brainard contributed to this article.