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Which university bonds will the Bank of England buy?

A week or so ago, Tomas Hirst alerted me to the fact that the Bank of England extended its Corporate Bond Purchase Scheme at the beginning of November to include four university bonds as eligible for purchase. These large public issues from Cambridge, Manchester, Liverpool and Cardiff were all made in the last 5 years and illustrate my previous points about the ‘tenor’ of new university debt. These four bonds all come to maturity in the 2050s.

As Thomas’s image illustrates, this makes the university bonds long-dated even when considered alongside the housing associations and utility companies in the new tranche of bonds eligible for BoE purchase.

click to enlarge – Cardiff is under ‘C’, the other 3 are under ‘U’

cbps-nov-3

The Corporate Bond Purchase scheme is part of the Bank’s post-Brexit extension of Quantitative Easing.

The Bank buys corporate bonds off the current holders in order to reduce the yields and thereby reduce the likely cost of new issues. The plan is that this interention should lower the borrowing costs for new investment. (It also enables bondholders to switch their asset portfolio positions exchanging bonds for money now and encouraging those after higher yields to seek out riskier investments).

The Bank’s press release emphasised how pleased it was that this new development would support ‘social outcomes, including Housing Associations and universities’, indicating that they are keen for further large-scale investment from universities.

Although these four bonds are all from Russell Group universities and lie in the region of £250-350m there are significant differences in the balance sheet impact of this borrowing.

Last year, Liverpool issued £250m at 4.25% per year (£40m was private placement, £210m public). In its accounts for 2015/16, its total long-term debt (bond plus other loans) comes to £300m. This represents 61% of its total annual income of £490m.

Cardiff is similar. It issued £300m in February. The Bank of England gives its annual coupon as 4.25% but the Financial Times reported that Cardiff would only pay investors 3.1% per year. The £300m would represent 62.5% of Cardiff’s £480m turnover in 2014/15. (Cardiff had under £18m of long-term debt at the end of July 2015 when it prepared its last published accounts).

Both these universities are much smaller financially than the other two, meaning that the bonds represent a much bigger investment move. Remember that the historic debt:income norm for the sector is around 20%  and the average is currently around 30%.

Manchester has a turnover of nearly £1000m. One of my favourite HE facts is that this figure exceeds the combined turnovers of Manchester City and Manchester United, which only come to around £850m.

Manchester’s £300m bond was issued in 2013 when its borrowing went over £400m. This means its current debt to income ratio is only just above 40%.

Finally, Cambridge. I wrote at more length about this bond and the projects it will fund back in 2013. At £350m, its bond is the largest out there, but  Cambridge’s annual income is over £1600m. It only really has its £350 bond as long-term debt, making its debt:income ratio only about 20%. Moody’s rates Cambridge at Aaa (stable), which is better than the British State. It’s been around longer after all!

p.s. English university borrowing is expected to pass £10bn in 2019. These four bonds on their own represent 10% of that figure.

What’s noteworthy about English HEI debt?

In the previous post, I quoted Hefce’s latest report on the financial health of universities. I may be wrong but I think this is the first time its warnings about sustainability have been cashed out in terms of ‘net debt’.

§16 Borrowing levels are expected to exceed liquidity levels in all forecast years, with the sector expecting to be in a net debt position of £49 million at 31 July 2016, increasing to £3.9 billion at 31 July 2019. The trend of increasing borrowing and reducing liquidity is unsustainable in the long term.

Net debt measures cash and other similar assets minus liabilities. So this year, there was a small excess of debt in English HE (£49million) but that is set to increase markedly in the next three years to hit nearly £4billion. This change is due to capital investment being funded by external borrowing.

There are two reasons to caveat this measure.

  1. English universities are increasingly using non-amortising debt: bonds, interest-only mortgages, interest-only loans. What this means is that the principal borrowed is only repaid at the end of the lending period, rather than being paid off over the course of that period. This makes the borrowing cheaper to service each year prior to the last.
  2. The lending periods enjoyed by universities, the ‘tenor’ of borrowing, are unusually long, often 30-50 years away from when the borrowing is first drawn down.

Together these two features mean that the change in debt highlighted by Hefce is unlikely to impinge on liquidity for several decades.

Take the example from the last post of Bristol University. Its £250m long-term debt is comprised of two interest-only loans from Barclays, both issued at 5.6%. £100m is due in 2038 and £150m is due in 2047, but until then the university only has to pay £14m each year.

With that to mind, it is hard to see net debt as a very enlightening measure of the sector’s financial health: it obscures important features that make English universities different from commercial entities and even US universities, where lending periods are much shorter.

English universities are diverging from historic norms of borrowing – that’s evidenced by the debt:income ratios used in the previous posts. The attraction of increased borrowing in this period is in part down to a response to the new competition in recruitment, but also reflects the desire to lock down large sums at cheap annual costs for several decades.

It is reasonable to assume that two to three decades of inflation will erode the value of Bristol’s £250m and that Barclays or another lender would be prepared to roll  over or refinance it in future.

The problems with increasing long-term debt may lie elsewhere.

Firstly, as noted last time, lenders impose covenants on borrowers, these can limit institutional autonomy in ways that may not be obvious and these may increase if the Office for Students is seen to be operating a more relaxed financial regime (i.e. if it doesn’t have something akin to MAA’s). Manitaining an investment grade credit rating is one such requirement set out in bond covenants -this may be more difficult post-Brexit. (Universities are also currently benefiting from credit ratings boosted by the agencies’ belief that the government will intervene in the event  of liquidity crises. Something that doesn’t sit well with current government talk about market exit being a sign of healthy markets).

Second, maxing out the balance sheet eats up a university’s ability to respond to events and policy developments. If Bristol moves to borrow another £300m it may have played its hand and fixed its strategy for two decades (unless its plans generate major new income streams).  It is not often noted that – whatever your view on its current strategy – London Metropolitan’s ability to respond to its recent problems and avoid meltdown was largely down to the fact that it had no debt in 2012, besides the £30m fine it owed to Hefce. Hefce was persuaded to defer an agreed repayment plan.

 

 

University debt & financial monitoring

A story from the Bristol Post last week tells of plans for a new Bristol University campus.

With a first phase of development requiring £300m of investment, the campus will accommodate 5000 students and ‘house a new digital innovation hub and a business school’, with subsequent phases leading to a ‘a residential village’.

Such ambitious developments are not uncommon these days, but this announcement comes hot on the heels of Hefce’s annual warning about the sustainability of English university finances.

§16 The trend of falling liquidity (cash) and increasing sector borrowing reported previously is set to continue in the forecast period.
The sector expects its liquid funds to fall from £9.1 billion as at 31 July 2015 to £6.5 billion as at 31 July 2019, equivalent to 83 days of expenditure.
At the same time, the sector expects borrowing to increase from £8.3 billion at the end of July 2015 to £10.5 billion at the end of July 2019.
Borrowing levels are expected to exceed liquidity levels in all forecast years, with the sector expecting to be in a net debt position of £49 million at 31 July 2016, increasing to £3.9 billion at 31 July 2019. The trend of increasing borrowing and reducing liquidity is unsustainable in the long term.

Prior to 2012, the sector averaged a debt to income ratio of roughly 20% – a figure that had been stable for a decade. In the last five years this has climbed to 30%, a marked change given that universities, as charities, are expected  to exercise  prudence when it comes to capital investment and its associated risks.

Hefce include the following chart showing that ratio (projected for 2018/19) for each institution in the sector and how the sector average masks a large spread. (The one outlier excluded is likely to be Northampton, which has a debt:income ratio somewhere close to 300% after issuing a bond guaranteed by the Treasury and accessing loans from the Public Works Loan Board).

external-borrowing-by-institution

It is not clear if Bristol’s new plans were already factored into the submission on which Hefce based this chart. But its latest Financial Report (for 2015/16) shows that it already had £250m of long-term borrowing through two loan arrangements with Barclays. Against its annual income of £575m that leaves a debt:income ratio of 43%.

Bristol’s net current assets of £180m (at 31 July 2016) mean that it does not have significant levels of cash to contribute to the newly required £300m and it does not appear to have earmarked any assets for disposal (to raise funding for the new campus). The options would then appear to be third party financing (perhaps more likely for the second-phase of student accommodation) or further borrowing which would push it close to the 100% mark in the chart above.

In its annual report (p.10), Bristol notes: “HEFCE sets limits through its Memorandum of Assurance and Accountability process for borrowing by universities. Under this the University currently has a borrowing limit of £310m.”

This is a total borrowing limit based on a multiple of EBITDA (earnings before interest, tax, depreciation and amortization). There are two general points to note here. Hefce’s borrowing cap is due for review and it has indicated that it is likely to abandon EBITDA and move to a measure based on adjusted operating cashflow. But, more pertinently, Hefce is due to be wound up and replaced by the Office for Students.

The latter is being created by the Higher Education and Research Bill that has just completed its third reading in the House of Commons. Section 39 of the first draft of HERB gives OfS the power to set terms and conditions on grant or loan payments to registered HEI’s but no commitment to continue with the current MAA practice is stipulated. On a related note, Jo Johnson has just tabled an amendment giving the OfS power to monitor the financial sustainability of the sector. An explanatory note attached to the amendments reads:

This new clause, which is for insertion after clause 61, requires the OfS to monitor the financial sustainability of registered higher education providers who are in receipt of, or eligible for, certain kinds of public funding. It requires the OfS to include in its annual report a summary of conclusions which it draws from that monitoring regarding patterns, trends or other matters which it has identified relating to the financial sustainability of some or all of the providers monitored and which it considers are appropriate to be brought to the attention of the Secretary of State.

Given its preference for a market with provider ‘exit’, it would consistent for the government to prefer the current MAA arrangements to be relaxed and leave universities to make their judgements about external borrowing in peace.

There’s more to be said here, but I plan over the next year to use this blog to look in more detail at university debt and individual cases (a donation might sway me to look at a particular institution!).

One final point, Hefce notes that covenants on borrowing appear to be increasing which means that borrowers are setting conditions on universities that must be met if the lending is not to be revoked. These covenants relate to ‘financial performance’ and ‘balance sheet strength’. Its vital to note though that some bond covenants out there stipulated Hefce’s continued oversight of the sector through MAA’s as one of a pair of conditions that could trigger demands for bondholders’ funds to be returned. If the new monitoring arrangements are seen to breach that part of the covenant, then the second one becomes crucial: the university has to maintain an investment grade credit rating.

 

 

Market nuances

A blog by Warwick Mansell has alerted me to a speech given by Nick Timothy before the referendum, when he was head of the New Schools Network.

The relevance for HE lies in the manner in which he outlines his view of competition in education, particularly the idea that free schools should be opened in areas served by poor schools, rather than in areas suffering from a lack of places.

The following paragraph is critical for shedding further light on the topics of the two posts published on here this week about changes to HE policy after Theresa May’s elevation to prime minister.

The government is trying to create a market in the education system. This … is the right track for reform, but at the moment there’s a risk that we’re building in the potential for market failures too. A functioning market needs enough genuinely new entrants to challenge existing providers, enough capacity for competition to be meaningful, enough information for providers and users alike, ways of breaking up failing or monopolistic providers, and exit points for providers that aren’t doing a good enough job. The direction of travel is the right one, but there’s a lot that still needs to be done.

Picking over the bones of those sentences, I would focus on the emphatic use of ‘enough’ (remember proposed free schools go through an application process that has to evidence demand and need) and the more activist line on ‘breaking up’ failing or monopolistic providers. That is, market exit isn’t just about having plans in place if providers decide to shut down their education provision; there’s a role for the interventionist state in precipitating market exit if provision is deemed to be poor.

CANCELLED Talk: The New Higher Education Settlement (Keele, 20 October)

Critical Education

I’m afraid I’ve had to postpone this talk owing to ill health. (12 October)

The New Higher Education Settlement: Does it Add Up?

This summer’s White Paper for Higher Education, Success as a Knowledge Economy represents a new settlement for English universities and colleges.  The White Paper heralds an intervention in settled notions of institutional autonomy and academic freedom as powers will be extended to establish a market for quality.  The three-pronged justification for this reorientation is degree inflation, student dissatisfaction, and employer complaints about graduate abilities.  Lurking in the background a further dimension has become clearer – the government as investor has not seen the expected return: an increase in graduate salaries.  At the same time, the expansion of undergraduate places over the last two decades has not been accompanied by the predicted increase in British productivity, despite successive governments’ faith in the generic value of a degree…

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Fairness, Social Mobility & HE Markets

To follow the last post, I thought it might be worth making a few points based on Theresa May’s second speech to the Conservative Party conference.

May set out a vision of a meritocracy, a country ‘that works for everyone’, where if you ‘put in the hours and effort you will be rewarded’.

The emphasis was on fairness – a word repeated 15 times in the speech –  and establishing a single, clear set of rules so that people could know how to get on in life.

May recognised – in a way that Osborne and Cameron had failed to do – that Britain is plagued by a sense that theworld works well for a privileged few’ but that the majority have seen their opportunities and standards of living decline in the last decade.

In this way, May tapped into common complaints about the apparent decline in social mobility. A crisis in the rules of the game of wealth accumulation (housing and pensions, primarily) that has underpinned the post-war social settlement.

This is sometimes described as a problem of intergenerational equity but I think it’s more accurate to see it as breakdown affecting the formation and reproduction of the middle classes.  (I see this point as complementing Chris Dillow’s discussion of ‘May’s Challenge to Marxism’ – it is in the interests of capital to also seek ‘the defence and stability of the social order’).

More speculatively, what might May’s change of tack mean for higher education given the supposed centrality of higher education in improving life chances?

If May is consistent then I would expect to see a shift away from the idea that competition (with easier market exit and entry) will drive up quality and a move to shore up (or impose) standards so that ‘university means university’.

It’s not enough for there to be a single set of rules governing social mobility, those rules must be clear. That imperative runs counter to the consumer faced with an overwhelming choice of courses and institutions.

May announced a more interventionist policy with a bigger role for the state here, citing utility markets as a contender for reform.

That’s why where markets are dysfunctional, we should be prepared to intervene.

Where companies are exploiting the failures of the market in which they operate, where consumer choice is inhibited by deliberately complex pricing structures, we must set the market right.

Is there a more complex pricing structure than the HE fee-loan regime? What you borrow is not what you repay.

Moreover, from a certain perspective (that of the lender), the HE market looks dysfunctional with a large amount of misinvestment or even over-investment if you buy the analysis of groups like the Chartered Institute of Personnel and Development.

So I would now expect a more interventionist approach through the TEF and less inclination to let the market determine high quality courses.

If, as Amber Rudd announced, international students are going to be given clear signals about poor and high quality courses through the visa system, then I would expect something similar for Home students – probably through access to student loans.

Going back to Milton Friedman, the idea of a loan-funded system of higher education was always about the access to the professions (vouchers are appropriate to fund general boosts to citizenship and leadership).

The formation of human capital was meant to trump natural ability. I expect to see more questions and concerns about whether HE courses are imparting the skills and knowledge that warrants government loan support.

Students & Net migration targets

Following the Conservative party conference last week, the sector is reeling. It’s become clear that the government does not view higher education as an export success that should be supported in unqualified manner.

Amber Rudd, Home Secretary, announced a review of ‘the hundreds [sic] of different universities providing thousands of different courses across the country’ and whether the ‘generous offer’ of allowing universities to sponsor visas for international students ‘is really adding value to our economy’. This echoes comments I reposted on here last month – comments made in 2012 by Theresa May when she held Rudd’s post.

Rudd seems to see universities as good for attracting the ‘best talent’ to the UK, but is much less keen to see international fee-paying students as valued customers who can take their fees elsewhere. The final word of the next  pair of sentences struck me:

I’m passionately committed to making sure our world-leading institutions can attract the brightest and the best. But a student immigration system that treats every student and university as equal only punishes those we should want to help.

It’s a strange choice of word, assuming somehow that non-UK students should be seen as opportunities for potential philanthropy (‘the deserving student’). She goes on:

So our consultation will ask what more can we do to support our best universities – and those that stick to the rules – to attract the best talent … while looking at tougher rules for students on lower quality courses.

Is the point here to flag up to international students that they would be better off avoiding ‘low quality’ courses. Is identifying courses as such to be part of the second phase of the Teaching Excellence Framework?

At the same time, the government also reiterated its wish to bring net migration down to below 100.000 per annum and that student numbers would be included in that target.

Many commentators have noted that Nick Timothy, May’s advisor, wrote last year about targeting university students to hit that migration measure. In an article for the Telegraph, Timothy appeared to identify 100 000 students at colleges and ‘non-Russell Group universities’ who would lose out under the ‘student visa cap’ he proposed. (That would leave 70 000 at Russell Group universities).

The Home Office estimates that the number of foreign students at Oxford and Cambridge is a little more than 4,000, while there are about 66,000 at the remaining Russell Group universities. That leaves more than 95,000 foreign students at non-Russell Group universities and more than 18,000 attending colleges.

That’s a startling proposal with the potential to damage finances. University of the Arts London for example gets one third of its annual income from non-EU fees.

This looks like unthinking vandalism but there is more to Timothy’s analysis. His Telegraph article cites two practices employed by universities that he thinks bend the rules.

Some have formed partnerships with colleges to allow foreign students to work as they study, circumventing the tough rules designed to stop economic migrants masquerading as college students. Other universities – which are often based hundreds of miles away from the capital – have set up London campuses to attract foreign “students”, many of whom simply want to work in the UK.

London campuses were one of the very few HE policy issues mentioned in the 2015 Conservative part manifesto. They were opposed to them – though we’ve yet to see any concrete policy measure brought to bear. (And will any spotlight be turned on Warwick’s Business School in the Shard or Liverpool’s London site?)

The first point, though, is the one that may offer most insight to what’s going on. Students at ‘Hefce designated’ universities (what we would have called ‘publicly funded’ a year or so back) have the right to work while studying, those at private colleges do not. Students at different institutions also face different post-study visa conditions on the right to stay and find or maintain employment.

What Timothy has to mind is a form of partnership agreement whereby a ‘Hefce designated’ institution sponsors the students at another college (perhaps as part of a franchising or validation arrangement) so that the students come in to the country as students of the established partner for the purposes of the visa, but are taught at the private partner.

It is a deal of this kind that was bound up in the travails at London Metropolitan four years ago. Theresa May intervened as Home Secretary after learning of LMU’s deal to sponsor 5000 London School of Business & Finance students each year. LMU had its licence to bring in international students suspended and the deal with LSBF was cancelled shortly after.

Do Timothy and May think such practices are widespread? I’m not sure. But it is clear that partnership arrangements of all kinds are much less common amongst the Russell Group than other universities.

And it’s clear that Theresa May’s focus on rules and fairness in her second conference speech may start to cast some shade on higher education institutions that are seen to be gaming the system or not up to scratch.

(The nominal minister for HE, Jo Johnson, seemed to be caught unawares by Rudd’s speech. Before June, it was necessary to watch the Treasury to understand HE policy, now it’s the Prime Minister’s Office setting the agenda).