Getting rid of their debts before they do

The 2007 Budget announced a programme of sales of student loans, the aim of which is to transfer the risks of the loan book to investors in return for an improved flow of cash into the national accounts.

The Sales of Student Loans Bill would authorise the first sale of student loans since the pre-1998 student loan book was sold off in the late 1990s. The book value of the student loans is at present around £17bn and growing; the sale of the first tranches of debt are expected to raise around £6bn by the end of 2010-11 and to transfer from the government as much risk — default, for instance — as is possible whilst maximising the cash value of the transactions.

There will be no change for students as the terms and conditions for individual borrowers will remain unchanged and the Student Loans Company will continue to administer the loans.

The arrangements will differ somewhat from the previous sales. Then two tranches were sold — £1bn to Greenwich NatWest in 1998 and £1bn to a consortium of Deutsche Bank and Nationwide in 1999. The portfolios consisted of ‘mortgage style’, subsidised student loans because of their low interest rate (RPI) and the ability to defer debt service indefinitely (for income below a threshold, currently £25,000). The portfolios were sold to the consortia at par and generally, deals went to those prepared to take the least subsidy from the government. Generally, the government retained responsibility for paying a market-rate of interest on all deferred loans, and the consortia took on the risk of default.

The original purchasers refinanced themselves in the European capital markets by issuing rated securities to institutional investors backed by expected future cashflows generated by the portfolios (known as asset-backed securities or ABS).

These loan sales were seen as complex deals at the time because of the unusual loan features and the resulting uncertainty of future cashflows. Even after a costly and complicated rating process, they were an unfamiliar asset class in a relatively small (but growing) ABS market.

The post 1998 system is more straightforward in some ways. The loans are now on an income contingent repayment (ICR) basis, meaning that people now pay on the basis of what they earn, not on what they owe. HM Revenue and Customs collects loan repayments direct from the employer at a rate of nine per cent on earnings above £15,000 (£90 per £1,000). As before, the borrower interest rate is RPI. Though the loans no longer have the deferral features which complicated the original analysis, the timing and amount of future payments on ICR loans continue to be uncertain.

The ABS market is far more sophisticated than it was in 1998/1999 and is used to seeing a wide variety of assets and risks. The size of the market has also increased enormously — from around €44bn of new bonds sold in 1998 to €470bn in 2006; though the credit crunch has reduced volumes significantly — around €45bn issued during August, September and October compared to €132bn during the same period last year . The European ABS market (which is largely comprised of banks, fund managers, insurers/pension funds and hedge funds) still has an appetite for bonds backed by this kind of asset as evidenced by the refinancing (again) in 2006 of one of the original deals on favourable terms.

Unlike the 1998/1999 one-off deals with specific consortia, future loan sales may be made on a programmatic basis (possibly several times a year) direct to the capital markets through ‘special purpose vehicles’.

For the government it would seem that the only question is the degree of risk that can be transferred with the sale and the cost of transferring those risks. As long as it gets a good deal, and it ought to even in today’s market, the sale looks like good value for tax payers.

Parliamentary Brief Research Department.