Sale of Student Loans – Part 1 (of 5)

There has been a two-month hiatus on this blog as my other projects, including Fine Art Maths Centre, led to an increase in teaching commitments last term. My workload is much lighter in coming months so I will be able to catch up on various financial developments in English HE.

The obvious place to start is with the government’s efforts to sell income contingent student loans to the private sector. This post will introduce a short series on various aspects of the sale, including value for money, the complex structure of the deal and a pair of classification decisions that now sit with the Office for National Statistics. The series will aim to address the key question: what has the government achieved with the sale? I begin with an introduction and some basics.

Back at the beginning of December, Jo Johnson announced that the first ever such had been completed raising £1.7bn for the government. With the exception of the Financial Times, the mainstream media largely failed to cover this significant deal. As Johnson told the Treasury Select Committee when he appeared before it as a witness on 19 December,

We are establishing a new asset class in the market. It is a ground-breaking transaction in that respect, and it is part of a much bigger programme of student loan sales that should raise £12 billion for the Treasury over the relevant financial period. That is an important contribution towards how we are going to sort out our public finances.

There wasn’t previously a market in income contingent loans: earlier sales had only dealt with the older fixed period repayment loans, so-called “mortgage-style” loans, issued to those who started undergraduate study before 1998. Attempts to sell ICR loans stretch back a decade and have been repeatedly promised.

This government finally achieved its aims with a complex securitisation deal. As a result, there are now in existence “securities” of different kinds that can be traded: notes with a minimum denomination of £100,000 that entitle the owner to a share of the future repayment stream generated by the loans sold.

What has been sold are not the loans outright, but a right to a share in future loan repayments. Ownership of the loans will pass to a special purpose vehicle, Income Contingent Student Loans 1 (2002-2006) Plc. This company is designed to be independent of government (but see Part 3) and its only purpose will be to receive the cash inflows and dispense the appropriate payments to those holding the securities. The government has been keen to emphasise that conditions for borrowers will not change as a result of the sale and that collection will continue to be made through HMRC and the Student Loans Company.

The government will in future provide a fuller report to parliament, which will focus on the two main aims of the sale:

• how risk has been moved to the new company and security purchasers so that the loans will be reclassified as a private asset: that is the loans will be moved off the government’s balance sheet;
• and how the government has assured itself that the sale has achieved value for money.

As explained before on this blog, the government can pass its own Value for Money test and still make a loss on loans.

An analysis by the FT suggests that the sale will have cost the public coffers £800m; that the government sold assets worth £2.5bn to raise that £1.7bn. That is, by holding on to the loans more value would have been realised than by receiving cash today.

The FT has not published the workings behind its analysis and we may not get a definitive answer on the loss until Department for Education accounts are published later in 2018. But there are plans for four further loan sales, potentially involving much higher sums and therefore repeat large losses for government.

Loans earmarked for sale are “pre-2012 loans”, those issued to students who started before 2012. At the end of March 2017, outstanding balances on these accounts amounted to £45bn, but they were valued in the government’s accounts at £33.7bn to reflect the subsidies built in to ICR loans: write-offs and interest rate subsidies. (Interest on pre-2012 loans accrues against outstanding balances at the lower of bank base rates plus 1 percentage point or RPI. Current interest is therefore 1.5%, a long way below the specified inflation rate, which is currently 3.9%. This makes an outright sale unattractive to investors and so the government chose a complex securitisation structure to maximise the price achieved.)

With this first sale, the income streams associated with 411,000 accounts have been sold, the outstanding balances of which amounted to roughly £3.7bn, less than one tenth of the £45bn stock of pre-2012 loans.

The government has been keen to manage expectations by reminding people that these loan accounts will not generate repayments equivalent to that amount. These are old accounts relating to maintenance loans made to those first starting undergraduate study between 1998 and the early 2000’s. Repayments first fall due in the April after students leave university; the accounts sold belong to the cohorts where repayment commenced between 2002 and 2006 inclusive (hence the name of the new company). Only around 50% of the original accounts remain open and government analysis shows that of those remaining live accounts, only 60% recorded any repayments in financial year 2015/16, even though the repayment threshold for these loans was only £17,335 that year.

The £1.7bn price was below the £3.7bn face value; this was to be expected. What matters is that the price was also below what the government values the loans in its accounts. If the FT analysis is correct, then repeated losses from these sales could amount to several billion.

There are another 9 repayment cohorts that could potentially be sold (2007-2015 inclusive) and these are more sizeable – outstanding balances are bigger – as they are more recent (so less time to make repayments) and include tuition fee loans for the later cohorts (tuition fee loans were first offered to those starting in 2006 and so make their first appearance in the 2010 repayment cohort).

The next post will look at the structure of the securitisation deal – its four tranches – and consider further the value for money issue. Part 3 will look at the classification decisions facing the ONS. Part 4 will look at the accounting implications and the final part will focus on the warranties offered by government as part of the deal.