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Was it a sale? ONS decisions (3 of 5)

January 3, 2018

In order for the securitisation to be classified as a sale, the government needs to have shed all risk associated with student loan repayments.

Transferring those risks to the private sector required all of the junior tranches to be sold. Did the government shift the risk off its books by selling unrated bonds very cheaply? That’s a good question and one that’s hard to answer given that there was no market price in these assets – either the loans or the securities – beforehand.

The Manual of Government Deficit and Debt, is the EU guide to the relevant national accounting. Its section on securitisation contains the following paragraphs, which the government endorses:

V.5.3.1.50-51: “The sale of a financial asset to the securitisation entity will not affect the government net lending/borrowing.”

V.5.3.1.54: “In national accounts, the disposal of assets should be recorded at the market price that prevails at the time the transaction takes place. It is generally the observed sale price, the price agreed in the contract. However, if there is evidence that the observed sale price is lower than the market value it may indicate that the operation is not carried out on a pure commercial basis and that there is an implicit support of the securitisation entity. In such a case, it is necessary to record a capital transfer from government to make up the difference between the observed price and the market value as the sale is recorded at market price in national accounts”

The “securitisation entity” here is the special purpose vehicle that will take ownership of the loans. In this case, Income Contingent Student Loans 1 (2002-2006) Plc. Was there “implicit support” for the securitisation entity and indeed the process of securitisation? Whether there was or not determines whether the sale is categorised as a ‘revaluation’ or a ‘capital transfer’. The government would far prefer the former as it would mean that any losses associated with student loans and the sale would have no impact on the deficit.

A full sale and transfer of the asset to the private sector also requires that the special purpose entity holding the loan accounts be independent of government. (Although the securities can be traded, the underlying loans are not being sold, but transferred to the SPE.)

This means there are two related issues that are in the purview of the Office for National Statistics.

  • Were the loans sold at market price?
  • Is Income Contingent Student Loans 1 (2002-2006) Plc sufficiently independent of government?

The next paragraph in the MGDD explains:

V.5.3.1.55. “If there is no obvious market price for specific assets, then, in order for an arrangement to be recorded as a sale, there should be a process by independent bodies to determine an equivalent market price, on the basis of the usual valuation methods used in business areas. The absence of such a process could be interpreted as a lack of autonomy of the securitisation entity, such that it should be classified to government.
(my emphasis in bold)

No independent body, as far as I am aware, has been involved in the sale process. The government would argue that the prices achieved through the securitisation were equivalent to market prices: there is only a market as a result of the securitisation. But the final sentence points to the general issue for the ONS to address.

Even if it is agreed that a market price was achieved, there is a general question about the status of the Special Purpose Entity that now owns the loans. It has to be independent to be taken off the public books. If its operations are circumscribed by government, then it should probably be classified to government.

Here is how the Manual characterises the requisite autonomy:

V.5.4.6.77 “… the SPE should have autonomy of decision in respect of the management of the debt securities that it issues: indicators of this are issuance rhythm, debt management, repayment strategy, etc. It should be clear that the SPE does not act on behalf of government. It should also have complete autonomy concerning the management and disposal of its assets. Otherwise the SPE should not be recorded as separate institutional unit.”
(my emphasis in italics)

Most of the evidence available suggests that Income Contingent Student Loans 1 (2002-2006) Plc could be seen to lack the requisite autonomy.

  • The SPE has not conducted the securitisation, it was set up subsequent to it – indeed its title indicates that a separate company will be set up for each sale process;
  • Under the terms of the 2008 Sale of Student Loans Act, the SPE cannot sell on the loans without government permission: it cannot dispose of its assets;
  • HMRC and the SLC will continue to administer loan collections on behalf of the SPE and purchasers;
  • DfE remains the ‘Master Servicer’ – with responsibility for transferring repayments to the SPE – and the government has undertaken various warranties and contingent liabilities as part of the sale process (see Part 5).

ONS hasn’t reached a decision yet on these classification issues. I will update this post when it does.

The next post will look at the resulting accounting issues. If the sale is classified as a capital transfer or the SPE is deemed not to be independent, then the government will probably have to book a £2bn hit to expenditure and the deficit: the difference between the £1.7bn raised and the £3.7bn face value of the loans transferred.

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