Student loans

Student loans are recognised initially at fair value plus transaction costs and subsequently measured at amortised cost using the effective interest rate, less any impairment loss. The effective interest rate discounts estimated future cash flows through the expected life of the loan to the net carrying amount of the loan, excluding future credit losses. Interest is recognised on the loan evenly in proportion to the amount outstanding over the period to repayment.

Allowances for estimated irrecoverable amounts are recognised when there is objective evidence that the loan is impaired. Impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the loan, and that a "loss" event (or events) has an impact on the estimated future cash flows of the student loan book that can be reliably measured.

The student loans balance reflects the change in accounting policy which requires student loans to be initially recorded at fair value and subsequently reported at amortised cost (refer to "Changes in accounting policy" on page 122). Prior year comparatives and the Main Estimates have not been restated for the fair value change.

Student loans book value

Student loans are recognised initially at fair value plus transaction costs and subsequently measured at amortised cost using the effective interest rate method, less any impairment loss.

Fair value is the amount for which the loans could be exchanged between knowledgeable, willing parties in an arms-length transaction. Fair value on initial recognition of student loans is determined by projecting forward the expected cash flows to a willing buyer and discounting them back at an appropriate discount rate.

Inland Revenue and the Ministry of Social Development have adapted the Ministry of Education's valuation model to be compliant with International Accounting Standards and to reflect the recently introduced student loans interest-free, amnesty and voluntary repayments legislation.

As student loans are subsequently measured at amortised cost, the model projects all future cash flows to the Crown associated with the loan and calculates the effective interest rate at initial recognition. This is used to spread the Crown's interest income across the life of the loan and determines the loan's book value at each reporting date. If the timing of future receipts is revised, the book amount at reporting date is adjusted to reflect the revised estimated cash flows at the loan's original effective interest rate. The adjustment is recognised as income or expense in the Statement of Financial Performance.

The Model's substantive information has remained consistent with previous years, incorporating educational, demographic, income and loan. As such, the fair value is sensitive to changes on a number of underlying assumptions, including future income levels, repayment behaviour and macro economic factors such as inflation and the discount rate.

The significant assumptions are as follows:

Assumptions	30 June 2006	30 June 2005
Weighted average effective interest rate	6.63%	Not applicable
Interest rate applied to loans for overseas borrowers	6.9% (6.7% out-years)	7.0% (6.8% out-years)
Cost of administration as a percentage of the average outstanding loan balance	0.15%	0.20%
CPI	3.2%	2.8%
Future salary inflation	3.6%	3.4%

Student loans fair value

Fair value is the amount for which the loan book value could be exchanged between knowledgeable, willing parties in an arm's-length transaction as at 30 June 2006. The estimated fair value of the student loan debt at 30 June 2006 has been determined to be approximately $4,992.5 million ($5,342 million at 30 June 2005).

The fair value calculated is sensitive to underlying assumptions chosen. For example, a 1% increase in the discount rate would decrease fair value by approximately $339 million, whereas a 1% decrease in the discount rate would increase fair value by approximately $391 million.

Through the everyday operations of the student loan scheme the Crown is exposed to the risk that borrowers will default on their obligation to repay their loans or die before their loan is repaid, causing the scheme to incur a loss.

The student loan scheme policy does not require borrowers to provide any collateral or security to support advances made. As the total sum advanced is widely dispersed over a large number of borrowers, the scheme does not have any material individual concentrations of credit risk.

The 2006 Student Loan Annual Report contains more information on the student loan scheme.

Impairment

An amount is recognised at reporting date if there is objective evidence of impairment as a result of:

one or more loss events that occurred after the initial recognition of the loan, and
the loss event (or events) has had a reliably measurable impact on the estimated future cash flows of the collective book of student loans.

For the student loan scheme, this involves a comparison between the amortised cost of the loans to the present value of the estimated future cash flows of the loans discounted at original effective interest rate. The present value of estimated future cash flows excludes future credit losses that have not been incurred.

Amortised cost

The amortised cost of the financial asset is the amount at which the financial asset is measured at initial fair value, less principal repayments, plus the cumulative interest unwound using the effective interest rate, less any reductions for impairments or non-collectibles.

Loan repayments

For the year ended 30 June 2006, there was a total decline of 3.7%, the equivalent of $20.9 million, in loan repayments. In 2006-07, repayments are expected to be slightly higher than 2005-06 repayments, regardless of the decrease in the interest component of loans.