By: Keegan Ferguson, financial services analyst

October 9, 2022 – The Biden administration’s student loan relief plan is just one proposal in a litany of policy catalysts on the horizon for the higher education space as the president turns a critical eye toward for-profit universities and mulls new rules that pose significant risks to both loan servicers and for-profit education companies.

Although Capstone believes the Biden administration’s recently proposed student debt relief plan will be blocked in federal court, the journey will be a complicated one. And the effort is a symbol of the administration’s broader plans, which has implications that are more nuanced than is typically understood.

Keegan Ferguson, an analyst on Capstone’s US Financial Services team, spoke to Capstone’s Meg Gawron about his outlook on the Department of Education’s plans and the implications for businesses and investors operating in the education sector.

Meg Gawron: What do you think has been missing in the debate around Biden’s student debt relief plan proposed in August?

Keegan Ferguson: Even though the student debt relief plan is the headliner, it’s just one part of a three-pronged initiative. And there are a plethora of complicated pieces in play. The Department of Education (DOE) intends to provide up to $20,000 in debt relief for Pell Grant recipients and up to $10,000 for non-Pell Grant recipients if they earn less than certain income thresholds. The administration, responding to separate lawsuits, has twice adjusted the plan. To address tax issues raised by one suit, people now need to opt-in rather than be automatically covered, and in response to a different lawsuit, people can no longer consolidate their Family Federal Education Loan Program (FFELP) loans to become eligible for loan forgiveness. The original debt relief plan was expected to help as many as 43 million borrowers, but recent changes will reduce the number. The latest DOE figures show commercial lenders hold FFELP loans for roughly 4 million borrowers.

The second DOE initiative is to expand the Public Service Loan Forgiveness Program so borrowers employed by nonprofits, the military, or federal, state, or local government will have an opportunity to have their loans forgiven. The last part of the initiative is that the federal student loan moratorium, which has been in effect since early 2020, will end on January 1, 2023. The breadth of the approach creates a more complicated backdrop that poses risk to broad swaths of the sector. Although we believe the plan will be blocked, the path to that outcome will be a winding one.

MG: Who are the winners and losers here?

KF: My feeling has been from the get-go that loan servicers are losers in this equation and borrowers would be “winners” if the plan goes through. Federal student loan servicers are paid a set fee each month based on how many loans they service and what kind of loans those are. So, if a significant portion of loans are taken off their books, loan servicers will lose large chunks of revenue.

Nelnet’s large FFELP portfolio would have received a brief surge of cash from consolidations, though its long-term earnings would have softened. However, servicers will benefit from the loan moratorium ending because they can start collecting revenues for the first time since the pandemic. While the industry stands to lose from the initiative, it has been reluctant to challenge the plan. Student loan servicers will get a new contract at the end of 2023 when the current one expires, so servicers are hesitant to bite the hand that feeds them.

MG: If the loan forgiveness plan is blocked or overturned, does the industry just return to the status quo?

KF: It largely depends on what the administration decides to do. The industry benefits if the relief plan is blocked or significantly reduced. If the loan forgiveness does not enter into effect, folks are going to try to refinance or otherwise reduce their loan balances, which will drive additional revenues for servicers. However, they could still lose if the administration decides to come back with a narrower plan, likely minimizing debt without canceling it wholesale, to avoid lawsuits. There are a lot of moving parts that we are monitoring closely for our clients.

MG: What other risks do you see growing in the sector right now?

KF: One big one right now is the DOE is pursuing borrower defense repayment rules which we expect will go into effect next July. These rules would allow borrowers who have proof they were misled by aggressive or deceptive university recruiting tactics, like false claims about job placement statistics, to have their loans discharged. This is subject to change if there’s a change in administration, but as is, this means servicers will take a hit to revenue.

MG: Is there any silver lining for the sector?

KF: One opportunity is the 2023 contract, where servicers are likely to see an increase in the dollar value of their contracts. The previous contract is from 2014 and we anticipate that per-loan servicing revenue will likely rise significantly.  However, student enrollment in college is trending downward, potentially offsetting some of those gains.

MG: Aside from loan forgiveness, the Department of Education has been working to relieve pressure on borrowers. How will its other plans impact the industry?

KF: The DOE is working on two other impactful policy measures that relate less to servicers and more to for-profit education. The first is gainful employment rules which require a school’s graduates to meet specific debt-to-income ratios for a given number of years to be eligible for Federal Student Aid. These rules would likely be challenged by a future administration, but they are fairly significant and would be issued in 2023. This would limit who can capture federal financial aid dollars.

The second component involves online program managers (OPMs) and bundled services exemptions. OPMs partner with schools, but degrees offered in programs that use them don’t have the same weight as in-person programs. So, last year, the Government Accountability Office released a report saying the DOE needs to gather more information on these agreements and encouraged the department to give auditors more guidance when examining them. I think the department will develop tighter restrictions around OPMs and what tuition-share agreements look like, which would impact both private and public institutions.

MG: What should people in the private equity world be looking out for?

KF: The PE world should be watching whether the new approach to bundled services and gainful employment impacts profits. This is an area we closely monitor, because the devil is in the details, and has huge implications that are often underappreciated. They will want to monitor the space and think about their current investments because those rules will have significant implications for the way they partner with institutions of higher education and the revenue models they use. They also risk penalties if they violate gainful employment standards or new rules relating to bundled services, which is a space that Capstone can help navigate.