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).

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.