Over the past 48 hours a significant change has occurred in the operating landscape for proprietary higher education institutions.  While most investors and sell-side analysts debate the eventual outcome of the Department of Education’s “gainful employment” proposal, we think far too many people are quick to dismiss the implications of what the Department of Education has already proposed in its initial Notice of Proposed Rule Making (NPRM).  You can read the Department of Education’s press release on NPRM, which includes a link to the full document which was posted on the Federal Register for public comment this morning here.

The 500-page document includes a number of interesting insights into the Department’s thinking on a number of issues. It is clear that the Department is focused on restoring accountability and affordability in the higher education system and recognizes that a number of “unscrupulous” actors in the sector have manipulated the system for the benefit of their shareholders and at the expense of taxpayers.  The Department of Education’s 14 NPRM proposals all seek to create an environment of recourse for for-profit providers of postsecondary education. We think the changes to the incentive compensation, the ability to benefit program, and the misrepresentation language will grant the Department a greater number of tools through which it can pursue its stated goals.  We are surprised that the Department of Education’s decision to define a credit hour has not received more attention.  We think this proposal has the potential to significantly increase operating costs and reduce revenue per student for several operators in the for-profit education sector.  For some companies we think the impact of the standard credit hour definition could be larger than that of gainful employment.

The Credit Crisis in Higher Education

If you were to ask a school president, dean, financial aid advisor, or any other administrator about the problem with the credit hour construct in higher education they would likely identify the lack of transferability as the biggest issue. It is true, credit transfer policies are entirely discretionary at the institutional level.  In general, very few regionally accredited higher education institutions accept credit transfers from nationally accredited schools.  It is one of the most common complaints from students who have graduated or otherwise attended a nationally accredited for-profit institution. Due to the transferability standards, students are often required to retake classes which results in a much higher cost of education.  It’s a huge problem.

The Other Credit Crisis – Credit Hour Inflation

One thing that you will almost NEVER here an administrator complain about is the definition of a credit hour.  We might be “old fashioned” but we always seem to remember a credit hour representing at least one hour of class time a week that included 2-3 hours of work/study outside the classroom.  At most colleges and universities in the US classes are 3-credit hours, which means they meet three times a week over the course of a semester (16-weeks).  The responsibility of maintaining the integrity of the credit hour construct in the higher education system lies with the accrediting agencies.  They are the shepherds of the credit hour.

Over the past 25-years a number of new educational delivery models have emerged that have allowed schools to modify the traditional definition of a credit hour.  It started with the creation of quarterly programs, which enabled working adults to attend class all-year round and graduate from programs on an accelerated basis.  Even though quarterly programs are now fairly standard across the for-profit postsecondary education sector, we still do not understand how a class delivered over a 10-week period should be worth 4 credit hours, while one taught over a 16-week period should earn the student 3-credit hours.  Perhaps students attending schools spend more time in class and study than those matriculating at institutions with a semester based system.  We doubt it, most of the students at quarter based institutions are working adults and likely have less time to immerse themselves in their studies.  120 credit hours will get you a bachelor’s degree at most semester based schools, while it takes 180 credits to get a degree at an institution with a quarter system. It does not make any sense.

Over the past decade, the traditional credit hour systems has been further uprooted by the proliferation of single class education delivery models (APOL) and online degree programs.  One of the biggest benefits of attending a for-profit institution over a traditional college or university is time to completion.  Working adults are particularly sensitive to program length.  Many of the largest operators in the space have developed their academic programs so that students can earn their degrees within 50-75% of the time it would normally take.

As the amount of time in class has been in the process of being compressed, many operators in the space have started to increase the number of credit hours per class.  As we mentioned earlier, four credit hour classes are now standard at most quarter based for-profit education institutions. However there are an increasingly large number of institutions offering five and even six credit hour classes delivered over a 10-week period.  It’s been a financial home run, higher revenue-per-student, greater access to federal financial aid, and lower costs of educational delivery.  It certainly seems like on the surface, students and by proxy taxpayers are getting a whole lot less, for a whole lot more.

The Dept. of Education and Congress Are on the Credit Hour Case – HLC Gets Their Feet Put to the Fire

The accrediting agencies have effectively endorsed credit hour inflation.  As the independent arbiters on credit hour standards within higher education, the accrediting agencies are directly responsible for upholding the value of a credit hour to the student and the US tax payer.  Based on actions taken by both the Department of Education and Congress over the past 3-6 months, it is clear that the government has become increasingly concerned that liberal interpretation of the credit hour has potentially lowered educational quality, while increasing costs students and taxpayers all for the benefit of the institution.

Over the past year, the Department of Education’s Office of Inspector General was ordered to evaluate how three separate regional accrediting agencies – the Higher Learning Commission, the Middle States Commission, and the Southern Association of Colleges and Schools maintain and enforce standards for program length and credit hours.  You can read the OIG’s final report on the HLC here, and that for Middle States here.  There are more than 2,000 institutions accredit by these agencies that account for more than one-third of total higher education enrollments and whose students now obtain more than $60 billion in Title IV funding annually.

We want to focus on the OIG’s report: “Review of the Higher Learning Commission of the North Central ASsociation of Colleges and Schools’ Standards for Program Length” a bit more, we are surprised it hasn’t received more attention from investors in the for-profit education sector, particularly for shareholders of CECO.  The report focuses on HLC’s practices to insure the consistency and integrity of program length and credit hours at the agency’s member institutions.  The following summarizes the OIG’s conclusions on both the HLC’s standards for program length and credit hour:

“We found that the HLC does not have an established definition of credit hour or minimum requirments for program length and the assignment of credit hours. The lack of a credit hour definition and minimum requirements could result in inflated credit hours, the improper designation of full-time student status, and the over-awarding of Title IV funds because the US Department of Education provides Title IV funding to students based on the number of credit hours assigned to the courses the students take.“

Effectively, the OIG has argued that the largest accrediting agency in the US does not have program length and credit hour standards. It should come as no surprise that the HLC has become the accreditor of choice for schools offering non-traditional, accelerated degree programs. The OIG specifically highlighted HLC’s decision to accredit CECO’s American Intercontinental University even though peer reviewers identified the school’s assignment of credit hours for their programs as “egregious”.  Here is a summary of the OIG’s findings:

“Without establishing a minimum acceptable level for program length, credit hours, or student learning outcomes, HLC cannot ensure that the programs and courses being offered are of sufficient quality and quantity to be considered postsecondary education at the level represented to students, especially with regard to programs and courses offered in asynchronous, accelerated, or other non-traditional formats.“

In the past, regional accrediting agencies have been lauded for their academic rigor and enforcement of standards.  Apparently things have changed.  Regulatory oversight in the higher education system is comprised of a series of checks and balances between the Department of Education, who is responsible for ensuring the proper disbursement of Title IV funds, states, who ensure their standards are met, and the accrediting agencies, who are the overseers of academic quality.  Accrediting agencies are independent entities that are approved by the Department of Education, but otherwise for the most part are left to their own devices.  The Department’s decision to conduct these investigations and their findings is a clear statement that they feel academic quality and the integrity of many programs has been compromised and needs to be addressed.

Hearings on Credit Hour Inflation Leave Little Doubt the Accrediting Agencies Have Been Negligent in Maintaining Standards

The Department of Education is not the only entity in Washington concerned about the increasingly loose definition of credit hour and the program lengths accepted by once esteemed accrediting agencies such as the HLC.  Yesterday, the House committee on Education and Labor held a hearing based on the OIG’s review of standards of program length.  You can find more details and an archived webcast here.  Three individuals provided testimony:

• Sylvia Manning, President HLC
• Michale McComis, Executive Director Accrediting Commission of Career Schools and Colleges
• Kathleen Tighe, Inspector General, Office of Inspector General

While we don’t want to dismiss the testimony of Mr. McComis, we think it is more important to discuss Dr. Manning’s testimony and her responses to questions from various members of the House, including Representative Miller.  Here are some of the highlights from her testimony and responses to questions:

• “Accreditation relies more on judgement than metrics”
• “Credit hour definition is deeply understood in higher education…. we use the Carnegie hour as a guide post”.  If it’s deeply understood why isn’t the credit hour defined in the HLC’s principals of accreditation?
• “The 9 credit hour class should have been a 4.5 credit hour class [at AIU] and the six credit hour class a three credit hour class”
• “AIU’s content meets industry standards”
• “It is difficult to make a distinction between a 3 hour and 4 hour credit class”
• HLC visited AIU in March 2009 at which point 9 credit hour classes were being administered over a period of 5-weeks.  The school enacted changes in the fall of 2009 to extend the 9-credit hour classes from 5-weeks to 10-weeks.  HLC was not scheduled to visit the school again until next year to determine if its recommendations had been implemented. No enforcement actions were ever taken against AIU.
• HLC can work with the new credit hour definition

There are a few observations we would like to make here. First, it appeared that Dr. Manning is clearly focused on academic outcomes but seems indifferent about the implications that a loose definition of credit hour might have on program quality and cost.  At one point, Rep. Miller interrupted Dr. Manning to inform her that the difference between a 3-hour and 4-hour credit class is $613 to the student and spread across an entire network of campuses and schools billions of dollars.  The President of the HLC seemed unapologetic that for a period of at least 6-months students continued to enroll in AIU’s 9 and 6 credit hour classes presumably for a 5-week period, even though the accrediting agency’s own peer reviewers had deemed the credits assigned to those classes as egregious.  From our perspective, it seems the HLC has no concern for the rapidly growing student loan crisis and its potential role in it.

Second, President Manning has acknowledged that the new standards for credit hours could limit the development of new educational delivery models, but otherwise will not be difficult to implement.  The accrediting agencies are not going to push back on the Department of Education mandated definition of credit hour, which means change is coming.

The Department of Education and to a lesser Congress have exposed some of the deficiencies of the accreditation process, particularly as it relates to the definition of a credit hour which has a huge impact on tuition levels and program costs.  We thought the tone of yesterday’s hearing was relatively amicable, but its effect was to further discredit the standards accrediting agencies such as the HLC have used for program length and credit hours. We think the hearing adds further credence to the Department of Education’s efforts to establish greater oversight on the accrediting agencies and implement policies that improve accountability, affordability, and outcomes.

What Happened to the 3-Credit Class? CECO’s 8-class MBA Program

In order to better illuminate how “egregious” the credit hour policies at AIU have become, we thought it might be helpful to compare online classes and programs at several for-profit education institutions to that of a traditional academic institution.  In the table below we outline the credit hours earned, cost, length, and degree cost for a standard business undergraduate business program at AIU, Kaplan, DeVry, ITT, and UMass Online.  AIU offers degree completion programs to students.  Assuming the student has completed general education requirements, that individual can complete their degree program by taking ten 9-credit hour classes.  Based on the school’s class schedule that individual can complete a bachelor’s degree in just over a year.  Cognitively speaking are we to believe that someone who spends 12-15 months pursuing a particular degree program has the same outcome and mastery of subject matter as a student in a 2-3 year program?  It should also be noted that many of the classes offered at Kaplan University are 5 credit hours.  Credit hour inflation dilutes educational quality, worsens outcomes, increases the cost to the student, and improves operating margins for operators. In spirit, these are the issues that the Dept. of Education and to a lesser extent Congress have been trying to address.  Overall, based on the data below we would characterize AIU and Kaplan as the most aggressive in their definitions of credit hour and DeVry the least.

As egregious as a 9 credit hour class might sound, we think some people might be surprised to learn that a student only needs to take 8 classes to earn a MBA at AIU.  One-year, 4 quarters, and two classes a quarter will enable a student to earn an MBA. We are fully in support for innovative educational delivery models, but this appears to be extreme.  Every other program we analyzed required 14-16 classes to earn an MBA.

Establishment of Credit Hour Definition Could Change the Profitability Profile of Several Operators – WPO and CECO Are the Worst Positioned

The liberal interpretation of credit hour has enabled higher education institutions to develop and deploy innovative program structures, but it is important to remember what the benefits are to schools to increase the credit hour per class delivered. They include:

1) Increased revenue-per-student

2) Lower cost of educational delivery per class

3) The ability to market more rapid program completion to potential students

4) Greater access to Pell Grants funds for students that might be considered part-time otherwise.  Full-time students are able to access Pell Grants twice in one year.

5) Greater access to federal financial aid.  We have discussed this in the past, but it is still not well known that for Title IV purposes a student is considered a third year student once they have achieved 72 quarter based credit hours. Most associate’s degree programs are 96 credits in length among for-profit education providers.  This is how many providers in the sector generate such a high percentage of revenues from federal financial aid relative to what one would expect based on the loan limits and tuition levels.

The question is: how does the student benefit from credit hour inflation? Outside of accelerated degree completion,we can think of few other benefits.  On the heels of the findings from the OIG’s investigations of numerous schools at three of the largest regional accrediting bodies, the Department of Education has proposed to establish an explicit definition of credit hour in its NPRM.  Here is the Dept. of Education’s proposed definition:

“Under the proposed regulations, a credit hour is defined as a unit measuring the amount of work consisting of one hour of classroom or direct faculty instruction and at least two hours of student work outside the classroom over a set period of time. The required time period is fifteen weeks for a semester or trimester credit hour, ten to twelve weeks for a quarter hour of credit, and the equivalent amount of work for a different amount of time……A standard measure will provide increased assurance that a credit hour has the necessary educational content to support the amounts of Federal funds that are awarded to participants in Federal funding programs and that students at different institutions are treated equitably in the awarding of those funds.“

More or less, the Dept. of Education has re-established the Carnegie credit hour as the standard in higher education.  As we discussed above, many of the programs offered at AIU and Kaplan don’t appear to meet the proposed credit hour standards. Additionally, it is not clear that other 4-credit hour classes meet the new standards established by the Department of Education.  It seems that many sell-side analysts were dismissive of the  impact that the first set of proposals introduced as part of NPRM could have on the sector while everyone waits with baited breath for the gainful employment proposal. We would argue that the creation of a definition of a clear definition of credit hour and the government’s willingness to lean on and publicly expose deficiencies in the accreditation process could have far reaching implications for for-profit education providers.  We anticipate CECO (AIU), WPO (Kaplan) and other for-profit education providers might need to make significant revisions to their course delivery models in the next year which could lead to lower revenue per student, higher instructional costs, and increased balance sheet exposure due to lower Title IV funding levels.

As always, please act accordingly….