(References to surplus and deficit in this note refer to the surplus and deficit of ‘the Financial Statements of the Government of New Zealand’).
StudyLink (Ministry of Social Development) administers the initial capital lending and issues student loans, which are then transferred to Inland Revenue. Inland Revenue holds the total nominal debt, administers the initial fair value write-down expense and any subsequent fair value adjustments, and is also responsible for the collection of debt.
Student loans are designated at fair value through surplus or deficit under PBE IFRS 9 Financial Instruments.
The difference between the amount of the student loan and the fair value on initial recognition is recognised as an expense. The initial fair value is lower than the amount of the initial student loan for a number of reasons, including that:
- some borrowers will never earn enough to repay their loans
- some overseas-based borrowers will default on their payment obligations
- because there is no interest charged on New Zealand-based borrowers’ balances, the time value of money will erode the value of future repayments.
At the end of the year, actuarial models are used to compare the carrying value to the fair value of the student loan portfolio and the difference is recognised in the surplus and deficit of the Financial Statements of the Government of New Zealand. Details of the models are provided later in this note.
We use the following key terms to help us define student loan values.
- Fair value - The market value of student loans if they could be exchanged between knowledgeable, willing parties in an arm’s-length transaction.
- Nominal value - The total amount owed by borrowers at a point in time, including loan principal, interest, fees and penalties.
The nominal and fair values of student loans are shown below.
|
Actual 2020 ($000) |
Actual 2021 ($000) |
|
|---|---|---|
| $10,730,696 | Opening fair value | $10,394,584 |
| $(1,477,268) | Repayments | $(1,494,745) |
| $1,412,774 | Borrowings transferred from Ministry of Social Development | $1,430,689 |
| $(506,118) | Fair value write-down on new borrowings | $(468,594) |
| $(97,000) | Fair value remeasurements | $745,000 |
| $330,993 | Interest unwind | $234,551 |
| $507 | Other | – |
| $10,394,584 | Closing fair value | $10,841,485 |
| Current and non-current apportionment | ||
| $1,256,000 | Student loans - current | $1,355,000 |
| $9,138,584 | Student loans - non-current | $9,486,485 |
| $10,394,584 | Fair value student loans | $10,841,485 |
| $16,033,775 | Opening nominal value | $16,134,561 |
| $1,412,774 | Borrowings transferred from Ministry of Social Development | $1,430,689 |
| $(1,477,268) | Repayments | $(1,494,745) |
| $86,795 | Interest on overseas-based borrowers | $92,836 |
| $24,192 | Administration and establishment fees | $21,996 |
| $98,294 | Penalties | $116,368 |
| $(44,394) | Death and bankruptcies | $(41,222) |
| $(114) | Voluntary repayment bonus | – |
| $507 | Other | – |
| $16,134,561 | Closing nominal value | $16,260,483 |
Financial instruments - fair value hierarchy disclosures
For those instruments recognised at fair value in the ‘Schedule of non-departmental assets’, fair values are determined according to the following hierarchy:
- quoted market price (level 1) - financial instruments with quoted prices for identical instruments in active markets
- valuation technique using observable inputs (level 2) - financial instruments with quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in inactive markets and financial instruments valued using models where all significant inputs are observable
- valuation techniques with significant non-observable inputs (level 3) - financial instruments valued using models where one or more significant inputs is not observable.
Schedule of non-departmental assets
Inland Revenue’s financial assets as at 30 June 2021 were valued using significant non-observable inputs (level 3). There are no quoted market prices (level 1) and no observable inputs (level 2).
The following table analyses the basis of the valuation of classes of financial instruments measured at fair value in the ‘Schedule of non-departmental assets’.
|
Actual 2020 ($000) |
Valuation technique Level 3 - significant non-observable inputs |
Actual 2021 ($000) |
|---|---|---|
| Financial assets | ||
| $10,394,584 | Student loans | $10,841,485 |
The next section provides details on the model, and the table outlines the significant assumptions and sensitivities for the level 3 valuation technique.
Student loan valuation model
At the end of the year, the student loan portfolio is revalued to fair value by an independent external valuer using actuarial models. Stats NZ collates most of the data for the actuarial valuation model from Inland Revenue, the Ministry of Education and the Ministry of Social Development. The data is made up of borrowings, repayments, income, educational factors and socio-economic factors. It is current up to 31 March 2020. In addition, supplementary data from Inland Revenue and the New Zealand Customs Service, about loan transactions and borrowers’ cross-border movements for the period up to 31 March 2021, is also included.
The fair value movement, recognised in the surplus and deficit, relates to changes in discount rate and a reassessment of the expected repayments of loans.
The fair value movement at 30 June 2021 is an increase of $745 million. This increase incorporates the following changes to the fair value.
- The discount rate adjustments have increased the value of the scheme by $221 million (2020: $343 million). This is largely due to risk free rate and risk premium changes. The discount rates used for determining the fair value are equal to the Treasury’s prescribed risk-free rates for accounting valuations plus a risk premium. Since 30 June 2020, risk free rates have increased, which has decreased the fair value of the student loan portfolio by $448 million. The risk premium decreased from 2.66% to 1.65%, which is in line with market data, increasing the fair value by $612 million. The market spreads have been gradually reducing back to pre-COVID-19 levels.
- Adjustments for the impact of COVID-19 increase the fair value by $230 million (2020: $507 million decrease). It is now expected that fewer borrowers will be adversely impacted by COVID-19. Since the 2020 June valuation, more data on overseas repayments has been available to assist with reviewing the COVID-19 allowances. In summary, the New Zealand economy has shown remarkable resilience to date. In terms of unemployment, there are specific regions and industries that have suffered more than others. On aggregate, the previously assumed spike in unemployment has not materialised to date and the Treasury does not expect this spike to happen in the latest forecasts. The Treasury’s expectations around when border restrictions will ease, and when net migration will return to pre-COVID-19 levels, remain unchanged (migration is assumed to return to its normal patterns from 1 April 2022). Finally, for overseas repayments, there is no indication of a decline or any evidence of deterioration in overseas compliance so far. The adjustment includes the following.
- Updated modelling assumptions for employment have increased the value by $102 million. The actual experience for the first year of our COVID-19 allowance, which is the period 1 April 2020 to 31 March 2021, has been positive, indicating little impact from COVID-19 to date on student loan repayments. The consequence is that fewer borrowers are predicted to be unemployed or underemployed as at 31 March 2021 than originally expected. This in isolation has increased the fair value by $48 million. The explicit allowances in the models have been reduced for a shock to future employment outcomes by 33%, which increased the fair value by $54 million. This impact relates to 1 April 2021 and onwards. The migration allowance and the provision for a potential deterioration in overseas compliance in unchanged.
- Updated macroeconomic assumptions have increased the fair value by $128 million (2020: $131 million decrease), of which $106 million relates to updated salary assumptions. Salary inflation assumptions have mostly increased this year, resulting in higher projected domestic incomes, domestic borrower obligations and repayments.
- Other expected repayment adjustments have increased the value of the student loan portfolio by $80 million (2020: $27 million increase).
- Other modelling changes, including the roll forward of data, increased the impaired value by $173 million (2020: $16 million).
A breakdown of the fair value remeasurement - student loans reported in the Schedule of non-departmental gains and losses is set out below.
|
Actual 2020 ($000) |
Actual 2021 ($000) |
|
|---|---|---|
| $36,000 | Repayment collection allowance | $37,000 |
| $548,000 | Risk free rates | $(391,000) |
| $(205,000) | Risk premium | $612,000 |
| $343,000 | Discount rate adjustment | $221,000 |
| $(276,000) | COVID-19 impacts - model changes | $54,000 |
| – | Experience variance | $48,000 |
| $(131,000) | Macroeconomic effects | $128,000 |
| $(100,000) | COVID-19 impacts - provision | – |
| $(507,000) | Expected repayment adjustment - impacts of COVID-19 | $230,000 |
| $(10,000) | Expense assumption | $4,000 |
| $25,000 | Experience variance | $80,000 |
| $16,000 | Data and modelling changes | $173,000 |
| $31,000 | Expected repayment adjustment | $257,000 |
| $(97,000) | Total fair value remeasurement - student loans | $745,000 |
The student loan valuation model reflects current student loan policy and macroeconomic assumptions. The fair value is sensitive to changes in a number of underlying assumptions and judgements, including future income levels, repayment behaviour and macroeconomic factors, such as inflation and discount rates. As noted by the valuer, it is not possible to assess with any certainty the implications of COVID-19 on the fair value of the scheme or the economy as a whole, in terms of the length or degree of impact. There is a small amount of data available to determine the impact of COVID-19 and the modelling adjustments made involve significant judgement and were based on input from the Treasury and other experts. For these reasons, the valuation has a high degree of inherent uncertainty and there is a significant risk of material adjustment to the fair value in future accounting periods. The key risks are as follows:
- Before COVID-19, there were improvements in overseas compliance. We expect that overseas compliance will deteriorate as a result of COVID-19, but there has been no evidence of deterioration so far. There is a risk that the deterioration is underestimated in the valuation.
- The model assumes that low-earner borrowers will remain low earners for the same duration in the future as they do currently. There is a risk that this group will increase due to COVID-19 and rising unemployment. If the length of time that borrowers remain low earners increases, a decrease in fair value may result.
- The proportion of borrowers becoming low earners (that is, earning below $29,600 per annum) continues to be above 50% for those studying lower-level certificates. If this trend continues, long-term earners not in substantive employment will increase and a decrease in fair value may result.
- The modelling for migration is based on a four-year average of cyclical migration trends rather than current peaks and troughs in migration. This year, explicit modelling has been done for COVID-19. There is a risk that migration trends may be different to what has been modelled and, therefore, impact on the fair value.
- There have been substantial changes in key data sources used for the valuation model as a result of the implementation of the new START system delivered by Inland Revenue’s transformation programme. A number of data issues were identified and fixed during the valuation process, but there is a risk that additional errors may be identified in the future.
- The risk premium methodology will be reviewed in 2021-22 (delayed from 2020-21). A change in methodology is a possibility and may have a significant impact on the fair value.
The significant assumptions and sensitivities behind the fair value are shown in the following table.
| 2020 | 2021 | |
|---|---|---|
| Assumptions | ||
| $10,394,584 | Fair value ($000) | $10,841,485 |
| 4.03% | Discount rate | 3.95% |
| 1.9%-5.0% | Interest rate applied to loans for overseas-based borrowers | 2.4%-5.0% |
| 0.53%-2.0% | Consumer Price Index | 1.16%-2.38% |
| 0.03%-3.52% | Future salary inflation | 2.43%-4.49% |
| Sensitivities | ||
| $109,000 | Impact on fair value of a 1% increase in average wage earnings inflation over 5 years ($000) | $109,000 |
| $(114,000) | Impact on fair value of a 1% decrease in average wage earnings inflation over 5 years ($000) | $(113,000) |
| $121,000 | Impact on fair value of a 2.5% increase in overseas-based borrowers making repayments ($000) | $153,000 |
| $(128,000) | Impact on fair value of a 2.5% decrease in overseas-based borrowers making repayments ($000) | $(160,000) |
| $(602,000) | Impact on fair value of a 1% increase in discount rate ($000) | $(598,000) |
| $674,000 | Impact on fair value of a 1% decrease in discount rate ($000) | $668,000 |
| $65,000 | Impact on fair value of 1% increase in borrowers going overseas ($000) | $67,000 |
| $(23,000) | Impact on fair value of 1% decrease in borrowers going overseas ($000) | $(38,000) |
| $47,000 | Impact on fair value of 1% increase in borrowers returning to New Zealand ($000) | $46,000 |
| $(52,000) | Impact on fair value of 1% decrease in borrowers returning to New Zealand ($000) | $(53,000) |
| $70,000 | Impact on fair value of 1% increase in borrowers moving from low earner to high earner ($000) | $71,000 |
| $(65,000) | Impact on fair value of 1% decrease in borrowers moving from low earner to high earner ($000) | $(65,000) |
The student loan portfolio is exposed to a variety of financial instrument risks, including credit risk and interest rate risk.
Credit risk
Credit risk is 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 risk of death or default cannot be quantified.
The Student Loan Scheme 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 Student Loan Scheme does not have any material individual concentrations of credit risk.
The credit risk is reduced by the collection of compulsory repayments through the tax system. This is less effective with overseas-based borrowers. Many New Zealand-based borrowers earning over the income threshold have compulsory deductions from salary and wages to repay their loans. Overseas-based borrowers are required to make repayments twice a year based on their loan balance. Inland Revenue uses a variety of communications and campaigns to reduce the risk of non-payment of obligations.
Loans are written off on death, for hardship, bankruptcies and in other special circumstances.
Interest rate risk
Interest rate risk is the risk that the value of financial instruments will fluctuate due to changes in interest rates.
Changes in interest rates impact discount rates. The risk is that if interest rates rise, the value of the scheme will significantly decrease as the discount rates applied to the expected future repayments will be higher, decreasing their value.
Changes in interest rates could also impact on the Government’s return on loans advanced. The interest rate and the interest write-off provisions attached to student loans are set by the Government.
Performance of the scheme
A detailed explanation and insight into the performance of the scheme is available in the Student Loan Scheme Annual Report on the Education Counts website.
Student Loan Scheme Annual Reports - educationcounts.govt.nz