Is there a way to use the best know-how of financial markets to transform an institution created to offer student loans? Is it possible to broaden Higher Education Loans Board’s (Helb) sources of funding to bridge its growing deficit? And how does one convert credit extended to students into tradable assets?
The quick (but not the simplest) answer is Asset-Backed Securities (ABS). ABS are standardised marketable financial instruments packaged from a pool of assets with consistent cash-flows (such as car loans, mortgages, student loans) through a process known as securitisation. But can this work?
Getting there in a moment. But first some useful background information. Last financial year ending June, the student loan agency announced that its loan recoveries had topped Sh4 billion, up from Sh3.9 billion in the previous year.
It further said a total of 169,909 graduates had fully repaid loans worth Sh13.2 billion by September 2017 and that some 136,783 beneficiaries were servicing loans worth Sh20.7 billion.
Nonetheless, the ever growing new student population and dwindling top-ups from the Exchequer pushed the agency into a Sh2 billion funding deficit. The writing was on the wall. Time to rethink the old funding model had come.
So, to answer our key question; can ABS help? A straight-forward answer is yes. How? Helb sells its “good book” to access fresh financing and keep lending while the buyer (issuer) packages the loan cash flows into ABS and sells to the market. That said, several problems immediately arise. One, public student debt is a little unconventional. It has more favourable conditions for the borrower—no credit checking is involved, it’s charged at four per cent interest, it’s generally uncollateralised and beneficiaries don’t start accruing interest until after a year on graduation.
Two, a high rate of delinquency is typical. In 2017, the agency carried a massive Sh9.6 billion non-performing loan book. Further, 17,000 out of 85,000 defaulters cannot be traced. Third, no one knows what percentage of the ones paying are on a repayment or deferral programmes. All together, these risks represent enormous rollout challenges.
To counter some of these challenges, here are few suggestions. One, the Capital Markets (Asset Backed Securities) Regulations, 2007 provides for “guarantees” from credit enhancers to reduce the riskiness of the product.
Here the government can play the guarantor part to help deal with the collateral risk and default risk. Moreover, the “skin in the game” condition adds a new layer of protection for investors.
In this case, Helb would be required to have some risk retention. Two, to tackle interest risk, the ABS can be designed as an impact-focussed investment. In other words, the ABS trust can be designed to interest education-focussed Impact investors who care to empower the agency fulfil its funding mission to needy students.
Turning to the realm of structured finance may possibly breathe into the agency a new lease of life. If it works, student loan ABS’s present a wonderful opportunity to ease the funding crisis. Plus, there’s an opportunity for private investors to profit as well. It’s a win-win.