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Tuesday, 16 January 2018

UK government in a bind over £4.1bn student loan sale

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Structured Finance
Unique transaction ready for launch, but it could prove costly

The UK government faces a dilemma over whether to proceed with a landmark sale of £4.1bn of student loans, the first in a series of transactions it hopes will raise £12bn for the exchequer over the next four years.

Officially announced back in February, the deal has now been on hold for eight months. It was extremely close to launching in the spring – but a general election was called in April, putting all work on hold.

Since then, the banks arranging the transaction – Barclays, JP Morgan, Credit Suisse and Lloyds – have spent the summer updating financials. The deal is now once again ready to go, and is just awaiting the green light from Whitehall.

MAJOR REVIEW

But a government decision earlier this month to launch a “major review” of student finance might once again jeopardise the deal, not least because the transaction could severely restrict the government’s room for manoeuvre in the review.

Although the terms of the deal allow the government to make changes to the student loan system, a compensation mechanism whereby the exchequer compensates investors for lost income resulting from such changes could leave it facing a hefty bill.

With the review looming, launching now could severely restrict government options for overhauling the system at a time when it is under acute political pressure to offer some relief to UK graduates.

“There will be a compensation mechanism for investors affected by the changes,” said one banker mandated on the deal. “You can always try and negotiate with investors, but ultimately the government will be locked into servicing the transaction.”

UNIQUE TRANSACTION

The unique nature of the deal is one reason the compensation mechanism was offered as a sweetener to investors. Although the UK has securitised student loans before, this is the first deal backed solely by income-contingent loans anywhere in the world.

Loans in the pool are income-contingent in that students only enter into repayments once they earn above £17,775 a year, and only pay 9% of what they earn above that level in repayments. Previous UK student loan deals had a fixed amortisation schedule.

The difficulty of modelling not only default rates, but inflation rates, salaries and employment rates for thousands of graduates with different degrees has led to a complex deal with five tranches with vastly different payouts to appeal to different investors.

It’s also led to the compensation mechanism. Investors will still be subject to the risk of graduates not earning enough, or earnings rising slowly, but the risk that the repayment plans will change has effectively been removed.

“This is the first transaction of its type, and the structure is the result of conversations with investors that could be key accounts,” said the banker.

According to some, the guarantee is unusual.

“The change of law-type risk is a possibility in many asset classes, but usually it is enough for investors that there is an alignment of interests – governments rely on private investors, and generally there is a confidence that there won’t be any material changes that would upset that alignment of interests,” said one ratings analyst.

SERIES OF SETBACKS

The review is the latest setback in the sale of income-contingent student loans. First explored by the Gordon Brown government in 2010, the decision to go ahead was actually taken more than four years ago, in 2013, when Barclays was mandated.

The process came to a halt a year later when Business Secretary Vince Cable cancelled the sale, saying there was “no longer any public benefit”. Only after the 2015 election, when the Conservative Party won a majority, was the sale reignited.

“Government sale of student loan book makes no economic sense … which is why I blocked it,” Cable, who is now leader of the opposition Liberal Democrat party, tweeted when the deal was revived in February.

The government, which faces pressure to raise cash at a time when it is still borrowing over £50bn a year, may not have long to make its decision as the deal’s financials will quickly become out of date. In an economy that is slowing, and with the uncertainty of Brexit on the horizon, investors may want more up-to-date information before buying.

The Department for Education declined to comment.

 

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