Editor's Choice

How to Short the Student Loan Bubble

Jordan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Houston, we have a problem.

After years of more and more aid, more loans, and fewer jobs, the student loan bubble looks ready to pop. The Federal Reserve Bank of New York released a report that indicated that 35% of people under 30 who have student loans are at least 90 days late. Despite all the talk of an economic recovery, more people under 30 are now late on their payments than in 2008.

How you can short student loans

Student loans cannot be discharged in bankruptcy, and they stick with the student for life. A system of laws ensures that every dime is paid back in full. The government even allows lenders to garnish wages to ensure payments are made on time.

Unlike in the housing bubble, there's no clear short when it comes to the loans themselves. Banks aren't the ones feeling the pinch from defaults and delinquencies.

The best way to short the student loan bubble is to short the most questionable recipients of Federal student aid and loans: for-profit universities. Lawmakers in Washington, D.C. are already investigating the economics of for-profit colleges and coming to the conclusion that the value they provide to the United States is significantly less than the amount of money Uncle Sam sends to for-profit schools. For-profit colleges leave their graduates with fewer jobs and higher debt levels.

Some potential shorts include companies that receive all or most of their revenues from federal aid. These publicly traded for-profit colleges are:

DeVry (NYSE: DV)

DeVry takes in 75% of its total revenues from Title IV funding, which includes federal grants and loans. State grants made up 2% of revenues, while private loans made up 1% in 2011, the last year data was available. Students supplied the remaining 22% of their education expenses.

The company operates online and offline universities with enrollment of more than 80,000 students. At 12 times earnings, and 10 times forward earnings, the stock's cheap so long as federal aid keeps coming in. If the gravy train stops, though, the company doesn't have much of a balance sheet to fall back on. Its reliance on offline programs makes it a higher-cost institution than others.

Apollo Group (NASDAQ: APOL)

The owner of the University of Phoenix, this company is by far the largest for-profit college operator in the United States. In 2012, some 84% of its revenues came from federal aid programs, which was down slightly from 86% in 2011 and 88% in 2010.

Most concerning is the level of defaults among graduates. The company's graduates had a 17.9% default rate on their loans as of 2010. The company trades at only 6.1 times forward earnings because it suffers from 13% year over year declines in enrollment. The University of Phoenix has lost its valuable goodwill that enables it to bring in more and more profitable students.

ITT Educational Services (NYSE: ESI)

Students who attend this well-known for-profit university obtain 80% of their tuition assistance from the federal government, most of which comes from the Stafford loan program. The company trades at a single-digit earnings multiple as it is already undertaking steps to cut enrollment to stay within the 90/10 rule for tuition assistance and Federal aid limits.

This stock will be least responsive to the threat of cuts to federal aid because investors are already pricing it for big changes in enrollment. ITT Educational Services makes a bet on Apollo and DeVry look that much more attractive.

With the government budget being a primary focus in Washington D.C. and family dinner tables, the title IV funding to for-profit universities will be a talking point for some time to come. While the regulatory environment is anything but predictable, the number of graduates coming out of for-profit universities with record debt loads and no possibility for employment solidifies my belief that a combination of regulatory action and changing perceptions of for-profit colleges will eventually end the industry.

valuemagnet has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus