(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 (Te Manatū Whakahiato Ora the 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 in the table below.
| Actual 2021 ($000) | Fair and nominal values | Actual 2022 ($000) |
|---|---|---|
| $10,394,584 | Opening fair value | $10,841,485 |
| $(1,494,745) | Repayments | $(1,604,679) |
| $1,430,689 | Borrowings transferred from Ministry of Social Development | $1,294,249 |
| $(468,594) | Fair value write-down on new borrowings | $(489,063) |
| $745,000 | Fair value remeasurements | $(1,113,000) |
| $234,551 | Interest unwind | $279,550 |
| $10,841,485 | Closing fair value | $9,208,542 |
| Current and non-current apportionment | ||
| $1,355,000 | Student loans-current | $1,506,000 |
| $9,486,485 | Student loans-non-current | $7,702,542 |
| $10,841,485 | Fair value student loans | $9,208,542 |
| $16,134,561 | Opening nominal value | $16,260,483 |
| $1,430,689 | Borrowings transferred from Ministry of Social Development | $1,294,249 |
| $(1,494,745) | Repayments | $(1,604,679) |
| $116,368 | Penalties | $120,678 |
| $92,836 | Interest on overseas-based borrowers | $68,605 |
| $21,996 | Administration and establishment fees | $21,821 |
| $(41,222) | Death and bankruptcies | $(23,918) |
| $16,260,483 | Closing nominal value | $16,137,239 |
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 1 or more significant inputs is not observable.
Inland Revenue's financial assets as at 30 June 2022 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'.
Schedule of non-departmental assets (2022)
| Actual 2021 ($000) | Valuation technique Level 3 - significant non-observable inputs | Actual 2022 ($000) |
|---|---|---|
| Financial assets | ||
| $10,841,485 | Student loans | $9,208,542 |
The next section provides details on the model, and the table on page xxx outlines the significant assumptions and sensitivities for the level 3 valuation technique.
At the end of the year, the student loan portfolio is revalued to fair value by an independent external valuer using actuarial models. Tatauranga Aotearoa Stats NZ collates most of the data for the actuarial valuation model from Inland Revenue, Te Tāhuhu o te Mātauranga the Ministry of Education and Te Manatū Whakahiato Ora 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 2021. In addition, supplementary data from Inland Revenue and Te Mana Ārai o Aotearoa the New Zealand Customs Service, about loan transactions and borrowers' cross-border movements for the period up to 31 March 2022, 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 2022 is a decrease of $1,113 million. This increase incorporates the following changes to the fair value.
- The discount rate adjustments have decreased the value of the scheme by $1,670 million (2021: $221 million increase). This is largely due to risk-free rate and risk adjustment 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 adjustment. Since 30 June 2021, risk-free rates have increased, which has decreased the fair value of the student loan portfolio by $993 million. The risk adjustment increased from 1.65% to 3.08%, which is in line with market data, decreasing the fair value by $653 million.
- The non-COVID-19 related expected repayment adjustments have increased the value of the student loan portfolio by $443 million (2021: $257 million increase). They are:
- Updated macroeconomic assumptions (non-COVID-19 related) - these have increased the fair value by $242 million (2021: nil). Salary inflation assumptions have increased this year, resulting in higher projected domestic incomes, New Zealand-based borrower obligations and repayments. Updated salary inflation assumptions have increased the fair value by $269 million.
- The experience variance - this has increased the value by $89 million (2021: $80 million), largely due to expected negative impacts from COVID-19 not eventuating over the year and write-offs being lower than expected.
- Updates to the expense assumption - these have increased the value by $68 million (2021: $4 million). This is largely due to Inland Revenue restating product costs for prior years to exclude business transformation costs. These costs were not meant to be included and so expenses in previous years have been overstated.
- Other modelling changes, including the roll forward of data - these have increased the impaired value by $44 million (2021: $173 million).
- Expected payment adjustments for the impact of COVID-19 increase the fair value by $76 million (2021: $230 million increase). It is now expected that fewer New Zealand-based borrowers will be adversely impacted by COVID-19. However, we now expect more overseas-based borrowers to be impacted.
- From 1 April 2021 to 31 March 2022, repayment levels have been positive for New Zealand-based borrowers, indicating little COVID-19 impacts. We now expect fewer New Zealand-based borrowers will be unemployed or underemployed than originally expected. This increased the fair value by $35 million.
- The 2021 valuation included a provision for deterioration in value as a result of COVID-19 for New Zealand-based and overseas-based borrowers. As the economic outlook is looking favourable for New Zealand-based borrowers and in recognition of this positive experience, we have released half of the domestic COVID-19 allowance. This has increased the fair value by $41 million. The remaining $35 million of the domestic COVID-19 allowance is no longer required, and has now been transferred to the COVID-19 allowance for overseas-based borrowers, resulting in a total provision of $135 million. This transfer had no impact on the fair value.
- There were no macroeconomic changes specifically identified as relating to COVID-19 this year (2021: $128 million).
A breakdown of the fair value remeasurement - student loans reported in the 'Schedule of non-departmental gains and losses' is set out in the table below.
Schedule of non-departmental gains and losses (2022)
| Actual 2021 ($000) | Remeasurement | Actual 2022 ($000) |
|---|---|---|
| $(391,000) | Risk-free rates | $(1,017,000) |
| $612,000 | Risk adjustment | $(653,000) |
| $221,000 | Discount rate adjustment | $(1,670,000) |
| n/a | Macroeconomic effects | $242,000 |
| $80,000 | Experience variance | $89,000 |
| $4,000 | Expense assumption | $68,000 |
| $173,000 | Data and modelling changes | $44,000 |
| $257,000 | Expected repayment adjustment | $443,000 |
| $54,000 | COVID-19 impacts-model changes | $76,000 |
| $48,000 | Experience variance | n/a |
| $128,000 | Macroeconomic effects - impacts of COVID-19 | n/a |
| $230,000 | Expected repayment adjustment - impacts of COVID-19 | $76,000 |
| $37,000 | Repayment collection allowance | $38,000 |
| $745,000 | Total fair value remeasurement-student loans | $(1,113,000) |
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. 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.
- The proportion of over-based borrowers making a repayment is an important metric for the scheme, as the value of the loans of these borrowers hinges on their compliance. We have seen some deterioration in the proportion of overseas-based borrowers making a repayment in recent data and this has been reflected in the model. We have also allowed for a further deterioration through the COVID-19 allowance of $135 million. The duration and severity of this deterioration is still uncertain, as the impact of COVID-19, subsequent variants and other global factors on overseas countries remain extremely uncertain. There is therefore a risk that the deterioration is underestimated or overestimated in the valuation.
- There is uncertainty in the domestic and global economies as the COVID-19 pandemic progresses and economies around the world experience high inflation. For overseas-based borrowers, this has been accounted for in the COVID-19 allowance, the limitations of which are discussed in the above risk. For the domestic economy, the Treasury do not currently expect any large increases in unemployment in the short to medium term. There is a risk that this expectation may change, which could decrease expected future payments from New Zealand-based borrowers and hence decrease the value of the scheme.
- Migration in and out of New Zealand has been severely impacted by the government response to the COVID-19 pandemic. With the borders recently fully reopened, there is uncertainty around whether net migration will return to pre-pandemic levels for student loan borrowers, or whether there may be a spike in the number of borrowers leaving New Zealand due to pent-up demand. No allowance has been made at this valuation as there is too much uncertainty about future net migration. There is a risk that experience may differ significantly from our assumptions.
- There have been substantial changes in key data sources as a result of Inland Revenue's business transformation and a number of issues were identified at this valuation. All identified issues have either been resolved or had workarounds applied. There is a risk that applied workarounds are not sufficient to correct the data, placing additional uncertainty on our results. There is also a risk that further errors in the data used in this valuation could be identified in the future.
The significant assumptions and sensitivities behind the fair value are as follows.
| 2021 | Assumptions and sensitivities | 2022 |
|---|---|---|
| Assumptions | ||
| $10,841,485 | Fair value ($000) | $9,208,542 |
| 3.95% | Discount rate | 7.36% |
| 2.4% to 5.00% | Interest rate applied to loans for overseas-based borrowers | 2.8% to 5.2% |
| 1.16% to 2.38% | Consumer Price Index | 1.76% to 6.56% |
| 2.43% to 4.49% | Future salary inflation | 3.00% to 6.12% |
| Sensitivities | ||
| $109,000 | Impact on fair value of a 1% increase in average wage earnings inflation over 5 years ($000) | $102,000 |
| $(113,000) | Impact on fair value of a 1% decrease in average wage earnings inflation over 5 years ($000) | $(106,000) |
| $153,000 | Impact on fair value of a 2.5% increase in overseas-based borrowers making repayments ($000) | $130,000 |
| $(160,000) | Impact on fair value of a 2.5% decrease in overseas-based borrowers making repayments ($000) | $(99,000) |
| $(598,000) | Impact on fair value of a 1% increase in discount rate ($000) | $(404,000) |
| $668,000 | Impact on fair value of a 1% decrease in discount rate ($000) | $444,000 |
| $67,000 | Impact on fair value of a 1% increase in borrowers going overseas ($000) | $24,000 |
| $(38,000) | Impact on fair value of a 1% decrease in borrowers going overseas ($000) | $(19,000) |
| $46,000 | Impact on fair value of a 1% increase in borrowers returning to New Zealand ($000) | $51,000 |
| $(53,000) | Impact on fair value of a 1% decrease in borrowers returning to New Zealand ($000) | $(56,000) |
| $71,000 | Impact on fair value of a 1% increase in borrowers moving from low earner to high earner ($000) | $53,000 |
| $(65,000) | Impact on fair value of a 1% decrease in borrowers moving from low earner to high earner ($000) | $(56,000) |
The student loan portfolio is exposed to a variety of financial instrument risks, including credit risk and interest rate 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 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.
A detailed explanation and insight into the performance of the scheme is available in the Student Loan Scheme Annual Report, available on the Education Counts website.