For a better investment return, buy a stake in a student

For investors starved of yield, it was an appealing proposition: a potential 13 per cent return. You just had to be willing to take a punt on the future earnings of 1000 software coders.

That was the payout being targeted late last year for incomesharing agreements tied to students and recent graduates of the California-based coding academy Lambda School, according to a presentation from an online lending platform that specialises in student-loan alternatives.

The students who take part in these agreements pay no tuition upfront, but pledge to pay back 17 per cent of their incomes for 24 months after they land a job that pays more than US$50,000 ($79,000) a year. Repayment is capped at US$30,000.

Lambda is one of several schools experimenting with similar incomesharing agreements (ISAs). Universities including Purdue University in Indiana and the University of Utah offer the contracts, as do a handful of other coding bootcamps and technical training programmes.

In some cases, the agreements are bundled and sold to investors. Interest in the contracts is growing at a time of persistently low yields around the world and ballooning US student debt — an increasingly high-profile issue in Washington.

“ISAs play a potentially important role addressing systemic issues of access, affordability and quality of higher education and skills training in the US,” says Chuck Trafton, president of Edly, the investment platform behind the presentation. Trafton cofounded Edly with former Merrill Lynch structured products head Chris Ricciardi, known for pioneering collateralised debt obligations.

Investors in the Lambda offering receive the ISA payments from a group of 1000 students until they reach a 13 per cent return on their investments after fees, the documents show. Lambda takes 60 per cent of any residual cashflow after that, while investors get 40 per cent. About 10 per cent of students in the investment pool were working and making payments in December, 28 per cent had graduated and were expected to begin making payments in the coming months and the remainder were still in school.

The estimated default rate on the

Lambda agreements was 8.6 per cent, according to the presentation. Nationwide, about 11 per cent of student debt was seriously delinquent or in default at the end of 2019, according to the Federal Reserve Bank of New York.

Lambda’s use of the ISA model has come under fire in recent days after online technology magazine The Verge and New York magazine reported that some students were unsatisfied with the education they received at the school and asked to be released from their ISA agreements.

New York magazine also called into question Lambda’s claim that 86 per cent of graduates get hired within six months in jobs that pay more than US$50,000 annually.

The investor documents seen by Bloomberg list a six-month job placement rate of 54 per cent. In a web conference for prospective ISA investors, Lambda School chief executive officer Austen Allred said the figure represented a placement rate “basically at its bottom” and said it had been “much higher recently”. He said the company was relying on “conservative assumptions from our historical outcomes” to help price the investments.

The numbers used in the presentation were based on all students who completed the Lambda curriculum at the time, regardless of their level of engagement with the school’s career services team or what courses they completed, and as such were a conservative indication of outcomes, a representative for the programme said via email.