Introduction
There are some core differences in the student loan markets across the United Kingdom (UK) and United States (US), most of which are product and origination related and the differing timing and conditions of repayment obligations. The US market also includes a private origination element that, as yet, doesn’t exist in the same way in the UK with it being a purely government funded operation.
However, there has been a lot of focus placed on the student loan markets in both UK and US. Media attention is heightening and it has been marked in many circles as a potential credit bubble. While this may be true, the unique nature of the repayment terms and loan behaviour characteristics are needed to be fully understood in order to make sound valuation decisions.
Both markets have been seeing activity over recent months but before summarizing those developments it is worth providing some background in relation to the products and size of the respective markets.
An Overview of the UK Student Loan Market
The U.K. student loans market, as at June 2013, accounted for some £45 billion in outstanding public debt, with over 4.4 million student loans (“borrowers”). This excludes the current 2013/2014 academic year intake. It is envisaged that this debt will reach approximately £55 billion by 2017. The U.K. student loan market is much smaller compared to the U.S., which has had an active market for student debt for a much longer period.
Table1 shows the last 3 available academic years data for current outstanding debt for England, Scotland and Wales and associated number of loans. As can be seen from the data shown, England covers off the majority of this sector. Loans have increased by some 30% in value over the 3 academic years shown, and based on recent changes detailed later will show further significant increase.
Table 1: Source Student Loans Company-a composite of three statistical series
Students in the U.K. are able to apply for loans to help pay for tuition fees and the cost of living whilst on their courses. The body which manages what are now termed “income contingent repayment” (ICR) loans is the Student Loan Company (SLC). The SLC is a government owned non-profit making institution, set up for the specific purpose of providing the loans and managing the debt and repayment.
The SLC with its student loans is a relatively recent phenomenon in the United Kingdom. This has come about due to a number of social and political/economic changes. Over the last few decades in the U.K. there has been an increased political and social focus on the need to enable all young people, no matter what their background, to have the opportunity to gain better and higher qualifications, and so employment opportunities. This has led to an increased number of higher education courses, more higher education institutions, and so an expanding student population. With it has come an increased burden on the government purse, and pressure on the academic institutions with their ability to manage associated costs. Given the economic issues prevailing, over the last few years in particular, it is not surprising that not only have tuition fees been implemented instead of the old system of grants (see history below), but we have also seen the first signs of the government looking to divest itself of the burden attached to the increasing student debt, in terms of both ownership, management and repayment to the public purse (HM Treasury).
It is perhaps useful context to provide a brief simplified history to the launch of current student loan debt in the U.K. and some of the key factors relating to it. More detail about the current loan vehicle is given later in this piece:
• Student Loans first came under an Act of Parliament in 1990/91. Prior to this there was a grant structure. These were provided with no repayment required unless the student did not complete their course, and even then only repayment was required for the year in which they terminated such. Additionally students from more difficult backgrounds could also apply for a maintenance loan which would top up their income to ensure they could manage. These were non-repayable.
• During the 1990’s grants were effectively phased out and the first version of Student Loans known as “Mortgage Style” replaced these. 1998 was a pivotal year. From this point on all students receiving support, including maintenance support now received this as a loan, repayable under the specified terms and conditions.
• For each student with such a loan these became repayable in the April after the final term of the degree course, providing the individual’s income from employment exceeded 85% of the national earnings figure (currently c. £29k). If their incomes stayed below this then the debt remained unpaid with an effective zero level interest rate as they were inflation linked. Over that income level then the debt was repaid over a 60 month period. Hence the term “mortgage style repayments”
• During the period 2006/2007 tuition fees were allowed to be increased by universities with initial maximum capping of £3,000 per year. The Student loan “income contingent” product we see today came fully into being. The total amount of loan that can be received is still determined by assessment of criteria relating to family and personal circumstances. Students following the end of their course, irrespective of completion, become liable to repay a set figure directly from their monthly salary payments via a direct payment to the Student loan Company (through PAYE where applicable). There are criteria set regarding how much is paid back set in relation to the student’s salary as it increases over time. (See Table 2)
• The proposals set out in November 2010, effecting students from 2012/13 academic years, allowed for an increase in fee caps to £9,000. Plus interest rates on loans will be more market rate aligned with rates of 3% plus inflation during the years up to graduation, and then post-graduation the rate will be inflation plus a rate of up to 3% when earnings reach £41k, i.e. between £16k and £41k there is a scaled rate applied. The term for debts to be written off is extended from 25 to 30 years. These were encompassed in the 2011 Education Act.
Student loans have a potential commercial value. This has become a topic of interest to both government and market players, both of whom see a value in transferring some, or all, of this debt into the private sector. We have seen an initial “test pilot” where two pools of circa £1 billion each of the “mortgage style” loans were sold by the government to private investors, during 1998 and 1999. Borrowers were kept on the same terms and conditions. This meant that with the interest rates on student loans being below market rates, the DES (The Government Department for Education and Science) who are responsible for the loans, agreed to pay a subsidy (via HM treasury) to the purchaser to reflect this, making the deal sufficiently attractive.
Following from this initial foray, with the major impacts in the market since 2007, the government has stepped back from further activity awaiting a point where the price to be achieved matched internal requirements. In late June 2009 in a review of the “sale of student loans” bill, they stated they would await better market conditions to ensure a good return for the taxpayer and they would look for sale opportunities when market conditions improved. During the middle part of 2013 there has been renewed activity around divesting further assets and it is likely we will see more transactions undertaken as the market appetite and pricing improves.
This new activity is, in part, driven by the markets, but also supported by the changes to the relevant terms and conditions following the 2011 Act.
In terms of the levels of activity the following Tables (4a and 4b) will hopefully provide some useful insight. We use information for England to show the trends in the student debt market as this covers the majority of the student loan debt.
Table 3 shows the level of interest rates for income contingent loans from 1998 onwards to date. With the change to repayment rates for this new academic year onwards this will further support the likelihood, and appetite, for purchasing student loan debt as and when the government decides to bring further tranches of these assets to market.
Rates for student loans are no longer based on RPI inflation alone but now have an additional 3% over RPI added during the term of the period of study. Following graduation, the rate charged is scaled with an RPI plus a rate between 0-3%, the 3% figure being applied when students reach a £41k earning figure. Table 3 will show an upwards curve going forward. These new cohorts will certainly provide options for the government as regards potential sales into the markets to investors. No doubt some guarantees will be offered by the government to incentivize the divestment of existing loan pools under pre 2012/13 arrangements as seen previously.
Table 3: Interest rates on income-contingent student loans
Source: House of Commons Standard Note Student Loan Statistics
The average loan outstanding has seen a large increase in the last 5 years in particular, which corresponds to the significant changes in tuition fees and increased cost of living (e.g. rent, utility bills, food, study materials). It has moved from £2,620 in 1999/00 to over £18k in the most current year.
Average debt outstanding will increase based on the changes to tuition fees Tables 4a and 4b show the average loan outstanding, and number of borrowers, for those students with income contingent loans in England, who are now liable to repay. These figures are as at each tax year end. This pattern is reflected for Scotland, Wales, and Northern Ireland.
Table 4a: Average Loan/Debt Amount Outstanding for Students in England: Source SLC
Table 4b: Numbers of Students/Borrowers with Loans/Debt outstanding in England: Source SLC
The debt for each cohort is known at the point when they become liable to repay. To know the debt one year later we have to allow an additional year for the repayment notification information to pass from HMRC to SLC. Hence, in the table for outstanding balances there is no update for the debt of the 2012 cohort. The only change for that cohort is an increase in numbers (from 278,000 in April 2012, to 279,700 in April 2013) as a result of borrowers joining this cohort after withdrawing from their course.
Borrowers are grouped by their earliest repayment liability date (i.e. the point when they first became liable to repay) and there are a proportion of borrowers within each cohort who will, at some point, return to higher education. They will take out additional loans to cover costs of tuition and/or living costs (e.g. Post grad/ or teacher training courses). This debt is included in the data in the tables and explains why the outstanding debt increases in the years after entering repayment rather than decreasing as may be expected. The effect of interest applied in the financial year also may outweigh the amount repaid for some customers in this first year or two of repayment which will also contribute to an increasing debt after repayment. The 2000 repayment cohort is atypical as it represents a higher proportion of borrowers who withdrew from their course and or who were on a one year course of study.
For each additional year that a cohort of borrowers is liable to make repayments, the proportion that has been fully repaid increases. The 2011 cohort only recently entered repayment and 4% had fully repaid their loan by April 2013; in contrast the 2000 cohort has been in repayment for longer and 47% have fully repaid their loans. Of the c.2.3 million borrowers who had at least one full tax year processed (cohorts 2000 to 2011), 17% had fully repaid their loans by April 2013. A further 47% exceeded the earnings threshold and were making repayments via the UK tax system.
In terms of the payment behaviour of the borrowers/students, it is difficult to gauge the level of impact the new rates of interest, and changes to levels of tuition fees will have. In terms of assessing how post graduate students are coping with repaying their debts in a more challenging employment environment Table 5 below gives some indication of current levels of arrears being seen for the most recent 2 years available in England. Most of the balances with arrears sit in the old style mortgage repayment loans.
Table 5: Student Loan borrower activity, financial year 2012-13, England
Loans which are a smaller percentage of the overall numbers involved. It will be interesting to note, from a market and political perspective, how this analysis of arrears changes as we progress through the next few years. There will undoubtedly be an increased credit burden as the students with larger debt/loans come into the employment market (or not), and are subjected to the ability to repay through finding suitably remunerative employment. That ability will be stressed by the repayments being based on increased interest rates, with increasingly stronger terms, e.g. a 30 year period before debt is written off. This potentially means many individuals will be faced with the prospect of addressing student debt across a large proportion of their working life.
Overall student debt will continue to grow. Whilst we may see a decline in the number of students taking up higher education as the costs to do so may become a constraint, the need to achieve suitable educational qualifications means student debt will continue to grow overall.
The U.K. government has affected the necessary legislation to allow for student loans to be placed into the open market and for investors to purchase pools of these assets, following appropriate due diligence and analysis. No doubt there will be terms and conditions attached that the government will want to see in place, but nevertheless this is a likely course of action given what has been outlined.
UK Market Activity
In terms of recent market news and activity it has been reported (Sunday Times – 20th October) that the coalition government have appointed two investment banks (reportedly Rothschild and Barclays) to construct a feasibility plan regarding the sale of the estimated £46.5bn student loan portfolio to the private sector.
There is material public opposition, most notably in the form of an online petition, to the privatization of the loans. Presumably the expectation of increased debt collection activity driven by the desire for returns on investment sought by the private sector is the material grievance with the proposed strategy. The governments view is that the growing nature of the portfolio makes it a burden on public finances and forecast it to grow to 6.7% of GDP in 20 years time if a solution is not materialized.
The imminent sale of a c. £900m is being used to test the market and, whilst expectations of a material discount exist, the removal of the debt from the public’s balance sheet is seen a positive from the coalition’s perspective. The political sensitivity will be a core driver for the discount from a buyer’s perspective thus, inevitably, causing a public challenge to the government as to whether they have optimized the return for taxpayer’s money.
Subsequently, on November 25th, the BBC reported that the sale of £890m portfolio had been completed to a debt management consortium for £160m, or c.18 pence on the pound.
Erudio Student Loans won the bid to buy the remaining 17% of mortgage-style loans taken out by students between 1990 and 1998. Erudio is backed by a consortium including consumer debt management companies CarVal Investors and Arrow Global. Arrow Global, which will be the “master servicer” for the entire portfolio, is described as one of Europe’s largest providers of debt solutions. It has invested £11m in acquiring the student loans and has a commitment to invest up to £22m extra in assets by January 2016. CarVal Investors is one of the largest purchasers of consumer loans in the UK market. Student leaders secured assurances from ministers the terms and conditions of the loans would not change.
Two previous sales of mortgage-style loans in 1998 and 1999 saw £2bn of loans transferred to the private sector. About one million borrowers remained with the Student Loans Company following those sales, and 69% of those have now fully repaid their debts. The government has received £2.9bn in repayments.
Of the latest tranche of 250,000 loans sold:
• 46% of borrowers are earning below the repayment threshold
• 40% are not repaying in accordance with the terms and conditions of their loans
• 14% are repaying
The government said Erudio would have to adhere to Office of Fair Trading guidelines on the treatment of vulnerable borrowers and those in financial difficulty.
The political sensitivity of such transactions is highlighted by the comments of National Union of Students president Toni Pearce when he said the move was “extremely concerning” as it would see “the public subsidizing a private company making a profit from public debt”.
“The impact of this sale won’t only affect borrowers, but will affect everybody.”
“The simple fact is that having these loans on the public books would be better off for the government in the long run.”
“Selling off the loan book at a discount to secure a cash lump sum now doesn’t make economic sense.”
These loans, superseded in 1997, “are a closed portfolio of ageing debts that are becoming harder to collect with time”, the Student Loans Company said in its 2013-14 business plan.
Universities Minister David Willetts said: “The sale of the remaining mortgage-style student loan book represents good value for money, helping to reduce public sector net debt by £160m.”
“The private sector is well placed to maximize returns from the book which has a deteriorating value.”
“The sale will allow the Student Loans Company to focus on supplying loans to current students and collecting repayments on newer loans.”
“Borrowers will remain protected and there will be no change to their terms and conditions, including the calculation of interest rates for loans.”
Current State of United States Student Loan Market
As of September 2013, the student loan market had over $1 trillion in outstanding student loans, making it the second largest source of household debt after mortgages. There has been a significant increase in the total outstanding in recent years. The student loan market was at $240 billion just ten years ago.
The Consumer Financial Protection Bureau (CFPB) reported over 7 million borrowers in default on a federal or private student loan and also estimate that roughly a third of Federal Direct Loan Program borrowers have chosen alternative repayment plans to lower their payments. That number is likely to go higher if interest rates rise because most private student loans, unlike federal loans, are variable rate loans linked to Libor or the prime rate.
Data released in June 2013 by the Department of Education National Student Loan Data System indicates the Federal Direct Loan and the Federal Family Educational Loan (FFEL) Programs troubling current state of the market.
Table 6
The SLM Corporation, or Sallie Mae, the largest provider of private student loans in the United States, announced on May 29th it would split itself into two companies. One company will specialize in education loan management and hold $165 billion of assets consisting of federally insured student loans. The other company, retailing the name Sallie Mae, will hold the remaining $10 billion in assets and specialize in private student loans and consumer banking.
JPMorgan Chase has sent a memorandum to colleges notifying them that the bank will stop making new student loans in October, according to Reuters. The move is eerily reminiscent of the subprime shutdown that happened in 2007. Each time a bank shuttered its subprime unit, the news was presented in much the same way that JPMorgan is spinning the end of its student lending. JPMorgan’s actually the second big private lender to step away from the business. Last year US Bancorp exited the business.
Student Loan Types
The U.S. Department of Education has two federal student loan programs:
The William D. Ford Federal Direct Loan (Direct Loan) Program is the largest federal student loan program. Under this program, the U.S. Department of Education is your lender. There are four types of Direct Loans available:
• Direct Subsidized Loans are loans made to eligible undergraduate students who demonstrate financial need to help cover the costs of higher education at a college or career school.
• Direct Unsubsidized Loans are loans made to eligible undergraduate, graduate, and professional students, but in this case, the student does not have to demonstrate financial need to be eligible for the loan.
• Direct PLUS Loans are loans made to graduate or professional students and parents of dependent undergraduate students to help pay for education expenses not covered by other financial aid.
• Direct Consolidation Loans allow you to combine all of your eligible federal student loans into a single loan with a single loan servicer.
The Federal Perkins Loan Program is a school-based loan program for undergraduates and graduate students with exceptional financial need. Under this program, the school is lender.
How much money can be borrowed in federal student loans?
Undergraduate student:
• Up to $5,500 per year in Perkins Loans depending on financial need, the amount of other aid received, and the availability of funds at your college or career school.
• $5,500 to $12,500 per year in Direct Subsidized Loans and Direct Unsubsidized Loans depending on certain factors, including year in college.
Graduate student:
• Up to $8,000 each year in Perkins Loans depending on financial need, the amount of other aid received, and the availability of funds at your college or career school.
• Up to $20,500 each year in Direct Unsubsidized Loans.
• The remainder of college costs not covered by other financial aid in Direct PLUS Loans.
If you are a parent of a dependent undergraduate student:
• The remainder of the child’s college costs that are not covered by other financial aid.
Federal student loans vary from private student loans. The table below illustrates the main features and attributes associated with each loan type:
Default Rates
The U.S. Department of Education reports annually the rate at which borrowers default on federal student loans. The Department reports default rates using three separate measures of default (cohort, budget lifetime, and cumulative lifetime), each of which focuses on different borrowers, loan programs, and time periods.
The Department also publishes default rates for different types of institutions of higher education – including two-year, four-year, private non-profit, public, and proprietary institutions. The data illustrated below indicates a strong correlation between college type and degree path.
More established colleges with four year professional degree plans tend to have a lower default rate compared to the two-year trade based programs.
By law, the U.S. Department of Education considers a borrower to be in default when he fails to make on-time repayment of his loans for nine consecutive months. This definition applies to all measures of default rates discussed below.
Cohort Default Rates
Because the cohort default rate only measures defaults over a two-year period directly after a cohort of students enter repayment, it does not provide the total default rate over the life of the loans. Instead, it primarily captures borrowers who never begin making payments on the loan or who default within the first year after entering repayment.
The Department of Education calculates cohort default rates for schools as well as for private lenders that participated in the now-defunct Federal Family Education Loan program. Federal law requires that the Department of Education use the cohort default rate to test colleges’ eligibility for federal student aid programs.
Budget Lifetime Default Rates
The Budget Lifetime Default Rate measures the anticipated default rate for Subsidized and Unsubsidized Stafford loans (unless otherwise noted) that entered repayment in a particular fiscal year over an estimated twenty year life of the loan.
In other words, it estimates the percentage of loan volume that enters repayment in a given year and is expected to go into default over the following twenty-year period.
Cumulative Lifetime Default Rates
Cumulative Lifetime Default Rates measure the percentage of all federal loans (Subsidized and Unsubsidized Stafford, Parent PLUS, and Grad PLUS) that entered repayment in a given fiscal year and have defaulted at some point since, calculated through the most recent fiscal year. Because the cumulative rate captures defaults that occur from the point at which a cohort of loans enters repayment through the current fiscal year, it changes as more years of loan performance are collected and included in the updated annual calculation. It is intended to be an indicator of the risk of default over the life of a loan.
Table 7: Comparison of 2-Year Official National FY 2010 Cohort Default Rates to Prior Two Official Calculations
Table 8: National 2-Year Cohort Default Rate
Cure Rates
Cure rates associated with student loan debt is declining over the long term. This is another indicator that some borrowers are not able to re-perform on their obligations despite the strong collection abilities associated with federally guaranteed student loans.
It is likely that the cure rate will continue to decline as the borrowers who incurred student loan debt over the last few years leave school and the forbearance period and enter into repayment.
Table 9: Student Loan Cure Rates
Recovery Rates and Default Avoidance Assistance for Borrowers
There are consequences to the borrower if they defaulting on a federal student loan. Borrowers in default on a federal student loan might see their tax refund taken and their wages garnished without a court order, unlike other consumer credit.
There are multiple avenues the borrower can choose to repay a defaulted federal student loan. The below table illustrates how borrowers within the repayment, deferment, and forbearance segments of the June 2013 market are repaying:
Table 10
For loans issued in fiscal year 2013, the Department of Education reports three separate measures of default recovery rates as a percentage of outstanding principal and interest at the time of default. These include a cash recovery rate that includes the principal, interest, and penalty fees that that the Department expects to collect on defaulted loans made in fiscal year 2013; a cash recovery rate net of collection costs that measures recoveries after excluding collection fees assessed on the borrower that the Department of Education must pay to private collection agencies it hires to recover defaulted loans; and a net present value recovery rate that measures recoveries net of all collection costs that is adjusted for the time it takes to collect an a defaulted using the “time-value” of money.
According to the president’s fiscal year 2013 budget request, the federal government expects to eventually recover only 81.8 percent of the principal and interest due at the time of default on Subsidized Stafford loans made in fiscal year 2013 that go into default at any point during repayment.
Table 11: Fiscal Year 2014 Estimated Federal Student Loan Default and Recovery Rates
David Pickles, MIAC Acadametrics – U.K.
david.pickles@miac-acadametrics.co.uk
Joe Macklin, MIAC Acadametrics – U.K.
joe.macklin@miac-acadametrics.co.uk
Joseph A. Furlong, SVP, Capital Markets Group, MIAC – U.S.
joseph.furlong@miacanalytics.com
MIAC Perspectives – Winter 2014
A Brief Introduction to the Student Markets of the U.K. & U.S.
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