During the current recession, one sector has performed well relative to the market. Enrollments in for-profit postsecondary schools are currently at record levels. Many laid off workers as well as currently employed workers are flocking back to school in order to make themselves more marketable. Despite record growth, we are starting to see some hesitation in stock movements.

ITT Educational Services (NYSE: ESI) is a for-profit provider of technology-oriented postsecondary education. The company’s career-focused degree programs serve about 62,000 students. ITT operates 105 institutes and nine learning sites in 37 states. A learning site is an institute location where educational activities are conducted and student services are provided, but does not offer all of the services of a full-fledged institute. Currently about 80 percent of students are pursuing an associates degree and 20 percent of students are enrolled in bachelor’s programs. Of the six schools of study, IT, electronics, drafting and design, make up the core technology programs.

In ITT Education Services’ 10-K filing (February 18, 2009), we found new disclosure on bad debt expense expectations for 2009. We believe this is a significant disclosure due to increasing concerns with the quality of loans made to students. In 2008, bad debt expense as a percentage of revenue among the for-profit education sector was around 4.2 percent. ESI’s was 4.3 percent. The company is now guiding bad debt expense to between four and six percent in 2009.

When Apollo (NASDAQ: APOL) (parent company of University of Phoenix) reported Q1 fiscal 2009 earnings (ended November 30, 2008), bad debt expense rose higher than expected. Apollo’s bad debt expense jumped from 3.0 percent to 3.6 percent on a sequential basis.

There were a few reasons for the increase. Both macro as well as micro trends are putting pressures on students who took out loans. On the macro side, the company had trouble collecting receivables due to the economy. On the micro side, assuming unemployment continues to rise, it’ll be harder for graduates to start paying off the loans as they become due.

We expected companies in this sector to have similar bad debt issues. So the discovery of the 2009 bad debt expense guidance validated our original thesis. Although bad debt expense is rising in the sector, we don’t see this as surprising and we don’t believe this will have a material impact on the bottom line. However a prolonged economic downturn would increase bad debts even more and start having a material impact on net income.