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What’s noteworthy about English HEI debt?

November 28, 2016

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.

 

 

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6 Comments
  1. dkernohan permalink

    Hi Andrew – the continued “pricing in” of government intervention in the case of a financially failing institution by ratings agency has worried me for a while. Will the first orderly exit of an established provider from the sector (under HE&R Bill terms) prompt a re-rating and thus cause problems for other highly leveraged institutions?

  2. In March 2013, Roshana Arasaratnam, Vice President, Moody’s told me:
    “Our overall assessment of the level of extraordinary support considers the following main factors:
    * HEFCE’s powers as a regulator including the financial memorandum of understanding [MAA] with universities; and it’s powers through the Charity Commission .
    * The overall regulatory environment including relevant legislation, past history of interventions, and the strength of support from the government.”

    So, yes, both OfS replacing Hefce and an institutional failure would cause this to be revised. At the moment I think this ‘uplift’ is worth one grade on the ratings scale.

  3. nratcliffe permalink

    In considering capital developments, particularly those funded by borrowing, universities are damned if they do and to some extent damned if they don’t. Students have raised expectations of the quality of teaching and living accommodation, which not every university can meet without new investment.

    However, not all universities are rushing headlong to borrow and build. This story shows the University of Manchester suspending plans to replace student accommodation at Owen’s Park, because contractors were tendering well above what the university had budgeted.

    http://www.constructionenquirer.com/2016/05/23/manchester-uni-halts-170m-student-halls-as-bids-soar/

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