The Class The Loans Fell On

by John A. Byrne on

Dubbed “The Class The Dollars Fell On” by Fortune magazine, the 1949 graduates of the Harvard Business School were undoubtedly the most celebrated group of MBAs in history. Though the 700 or so members of the class graduated with modest expectations, more than a third would become CEOs and well over half would end up as multi-millionaires.

As author Laurence Shames would write in The Big Time, one of two books that documented the group’s unprecedented success,  “the class would become emblematic of the mysterious potency of the MBA degree back when it was still exotic, a rare golden ticket to action.”

Fast forward to this year’s incoming class at the University of Pennsylvania’s Wharton School. The 845 students who start their first classes on Sept. 7 are among their generation’s best and brightest. Unlike the men of 1949—there were no women–the Wharton group is as diverse as any in history: A record 45 percent are women and 36 percent hail from outside the U.S. To come to the Philadelphia campus, they left some of the most prestigious organizations in the world where they already were on the fast track to success. Some 36 students founded or co-founded businesses.

But there’s one other very big difference between this year’s incoming Wharton class and the most renowned: debt and lots of it. Largely funded by the GI Bill, few members of Harvard’s class graduated with any debt. If the Class of 1949 had been the most wildly successful of all the MBA classes ever, it can be said with certainty that Wharton’s Class of 2013 will be the most heavily in hock.

Call them the “Class The Loans Fell On.”

DEBT AND INTEREST FOR A SINGLE MBA CLASS: A RECORD $112.4 MILLION

In all likelihood, this will be the first MBA class in history to pay more than $100 million in loans and interest payments for the privilege of gaining the degree. In fact, if the Class of 2013 continues to borrow at rates similar to their predecessors, it will take on a staggering $112.4 million in debt, loan origination fees, and interest payments. That heart-stopping sum includes interest payments of about $33.5 million. All this, for just a single class of MBAs, one in four of which is likely to incur no debt at all.

Brought down to individual terms, a typical Wharton MBA in this class will graduate with average debt of nearly $124,000. With monthly payments of $1,477 over ten years, the total would come to $177,256, including nearly $53,000 in interest alone. It would be the proverbial bite that would be hard to chew for most because a graduate would need an annual gross salary of $176,560 to comfortably pay down the loan, according to financial advisors. That’s not a comforting thought when the median starting pay of a Wharton grad last year was only $110,000. (You can crunch your own numbers on an online loan calculator to estimate the impact of your own debt.) And none of these numbers include the debt assumed by students during their undergraduate years.

Paying over a longer period of time—18 years—would bring down the monthly payments, but would also significantly increase the costs of borrowing. An MBA would have to pay $1,028 a month for 18 years, bringing the total payments to $221,994, including $98,014 in interest. A person borrowing this much money would generally need an annual salary of $123,330 to afford the loan. The higher interest payments piled on the class would bring the cumulative debt to $140.7 million in loans and interest from $112.4 million. (See the assumptions made to calculate these numbers).

‘CAN STUDENTS PAY TUITION ON AMERICAN EXPRESS?’

It seems oddly appropriate that for several weeks this summer the post that rose to the top of the class’s e-Talk forum was one regarding the use of credit cards to pay the fall semester tuition bill due by the end of July (a fee of 1.5% was assessed if an incoming student failed to meet the deadline). An incoming MBA candidate asked, “Can students pay tuition on credit cards, in particular American Express?” (The answer, by the way, is yes. Wharton’s parent university allows online payment of tuition through an Amex card but adds a “2% convenience fee” to the bills of students who choose this option.)

Truth is, Wharton students show little concern about the costs of the degree. They rightly believe the school’s brand is among the best in the world and will payoff in the long run. The investment is something of a “calculated risk.” As one incoming student puts it, “The tuition is a big number when you look at it. But I think an MBA or an education in general is a long-term investment. When you graduate from a program, you might get a salary, which is not all that great. But that’s a short-term phenomenon. At the end of the day, you take a calculated risk. There’s a lot more that I’ll gain from the program, and if I have to repay the loan over a longer time, that’s okay.”

This is the final article in a three-part series on MBA debt. Part one, MBA Debt: The Burden Grow Heavier & Gets Scarier, was published on Wednesday (Aug. 17), and part two, An MBA Vows To Graduate Without A Dollar of Debt, appeared Friday (Aug. 19).

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  • daunting figures

    This figures are sobering. As I make my way through the b-school admission process, I also crunched the numbers myself using the NPV technique described. Assuming no financial aid and “median” after-tax earnings in the jurisdiction in which I want to work, the NPV is negative.

    Obviously if I hit a big bonus, then numbers turn, but given that I have no desire to go into financial services or consulting, the prospect of that occurring is low enough that I can’t count on it.

    I will reevaluate once I receive admits/dings, but if one school offers significant scholarships, and given similar career prospects, the choice from a financial perspective is clear.

    I think the MBA has different value to people who are coming from a banking/PE/consulting background and plan to return than to people who come from non-traditional backgrounds and do not want to go down the traditional path. Paying $200k+ all-in is daunting for that group.

  • Arthur Dullsworthy

    Where of you get these numbers for class indebtedness?

  • Arthur Dullsworthy

    John, I’m not sure about your math. If the average indebtedness of Wharton’s 2013 class is projected to be $124,000 and 75% of the class is projected to graduate with debt, then the amount of class indebtedness is 610 times $124,000 = $75,640,000.

    If your number for class indebtedness were correct, then the average indebtedness would be $100,000,000 divided by 610 = $163,934.

    As for the amount of the borrowing, I continue to believe that the Wharton crowd are uniquely disposed to borrow more. As you know, a huge number of them come from finance. They borrow more in the belief that their expected incomes (including various forms of bonus) will far exceed the burden of debt service.

    People go to business school just for the opportunity to work for McKinsey. It’s not Blackstone and KKR, but it’s extremely coveted. Even the most elite law school grads (after three years of borrowing to pay the same astronomically high amounts of tuition) would rather work at McKinsey than Cadwallader. It is unquestionably true that going to business school will preclude the opportunity to live out one’s post-MBA career as an underachiever.

    As for the NPV calc, I’d value Schraga’s incremental income ($115,000-$85,000) as a growing annuity. I’ll assume a pull through rate of 60%, an interest rate of 7.9% (the higher borrowing rate from your article) and G equal to 3.63% (July 2011 inflation). This gives an PV for going to Wharton of $12,000/(7.9%-3.63%)=$281,000. THAT’S A CONSERVATIVE CALCULATION.

    A more optimistic kid who expects his income to grow at a mere 6%/year assigns a PV to his education of $12,000/(7.9%-6%)=$631,579. Some kids are even more optimistic and expect that their income will grow faster than 7.9% a year, but under these two scenarios, one conservative and the other optimistic, the NPV of an education at Wharton (net of borrowing costs) is $157,000 and $504,000.

  • http://poetsandquants.com/members/jbyrne/ John A. Byrne

    Arthur,

    We did a separate sidebar on how we came up with the number in the story. Here it is:

    http://poetsandquants.com/2011/08/22/the-first-mba-class-with-more-than-100-million-in-debt/

  • Arthur Dullsworthy

    John, I looked at the sidebar. Still your numbers look dodgy. See my first two paragraphs.

    I agree that these are huge amounts to borrow. Nevertheless, I demonstrated that the NPV of a Wharton education for two scenarios, one conservative and one somewhat more optimistic, is between $157,000 and $504,000. For someone who assumes a rate of salary growth faster than 6%/year the sky’s the limit. This analysis would apply to any expensive MBA that provided an incremental income bump of around $20,000 pre-MBA to post-MBA. (A somewhat more complex calc that values the post-MBA income stream as a finite growing annuity would reduce NPVs to some extent.)

    That HBS class of ’47, what were their starting salaries? The ratio of post-MBA salaries in our era to the population median is quite high. I’d wager that the ratio of salaries of HBS grads in ’47 to salaries in the general population was relatively low compared that ration in our unhappy era. Those guys saw income growth follow the success of the post-war economy. Unfortunately, in our era opportunity, like real estate, is fully valued.

  • phyllis holtzman

    Your representation of the loan default rate for University of Pennsylvania graduates is incorrect. According to the National Student Loan Data System (a division of the U.S. Department of Education), the rate of default for all University of Pennsylvania graduates is less than 1 percent, among the lowest in the nation, and not anywhere near the 30 percent you cited.

  • http://poetsandquants.com/members/jbyrne/ John A. Byrne

    We did not report the 30% figure as a default rate. We reported it as having difficulty paying back their loans. That can mean a number of things, from missed payments, extended loan periods, and defaults.

  • Mike S

    ever stop to think that students are “maxing” out their loans and using the money for startup financing, travel, etc? given the fact that many students can borrow money at 3-4% interest and pay only interest expense until after graduation – many just borrow the max amount due to the low cost of borrowing. a very one-sided article that leaps to a conclusion and then grasps for data to justify, i expect better methods from a site that evaluates top MBA programs.

  • Celesta

    It is a very interesting article. The numbers don’t matter as much as the underlying concern.
    As far as numbers go though, a couple of things to consider.
    1) When I was at a b-school in 2007-2009, our loans had a 30-year term. It makes a huge difference. The minimum monthly payment is less than $300 and the debt is cheap (currently 2.81%). Anything is relative, but I say it is not outrageous.
    2) In an npv calculation, it is important to acknowledge that MBA is not only for people who target consulting or financial careers with a glorified but predictable salary progression, but also for people who are or will be entrepreneurs building their own businesses. For this category, sky is the limit – they can be Bill Gates, Steve Jobs and Donald Trumps of tomorrow. Of course, if one only hopes to earn $100-200K in the horizon of 15 years while living large and saving for a nice cozy 401k, npv produces a sad picture, but that is not what all MBAs should aspire for.
    The financial liabilities associated with getting an MBA should not be taken lightly, but aspiring MBA candidates should think seriously if so glorified McKinsey or JP Morgan careers are the true answer to this question. There is more in life to aspire for.

  • http://theturkinrussia.blogspot.com The Turk in Russia

    @jbyrne

    Hello John,

    I have a suggestion for you. I think a detailed article about U.S. business schools which provide loans for international students w/o a co-signer will be very helpful for all international MBA applicants in their school selections.

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