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.
- 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.
- 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.