Financial Monitoring & Credit ratings
In a previous post in this series on debt, we mentioned that the government has tabled an amendment to the Higher Education & Research Bill granting the new Office for Students that power to monitor the financial sustainability of HE providers ‘who are in receipt of, or eligible for, certain kinds of public funding’ and to report annually to parliament on the state of the sector.
The crucial question will be whether these powers replicate those currently exercised by Hefce. New enthusiasm for market exit (as a sign of a well-functioning market) would suggest otherwise. As does the fact that this monitoring power wasn’t in the original draft of the Bill.
As universities look to increase to their capital investment and borrow to do so, it may help focus minds to look at how Moody’s, the credit rating agency, views the situation. (A rating from Moody’s or other agencies is essential if universities seek to issue the kind of public bond we’ve been discussing recently).
A recent report of theirs emphasises how the ‘strong regulatory framework and oversight’ provided by Hefce is central to its view of English Higher Education. It stresses that:
… a reduction of support for higher education in government policy as well as a reduction in the oversight exercised by HEFCE would hurt the sector’s credit profile ….
The report goes into more detail about what Hefce does here:
HEFCE’s oversight mechanisms are wide-ranging. Its powers include annual “desk-based” monitoring of budgets and academic performance as well as debt service limits. This oversight by an established regulatory body adds credit strength to the English university sector. Poorly performing universities are subject to intensive reporting and supervision in order to ensure that they correct financial imbalances and/or redress governance/managerial failures. Depending on the nature of the institution’s problems, HEFCE may engage with the university to suggest downsizing, merger with other, more financially viable institutions or a change in the scope of institution’s mission. In certain circumstances, HEFCE might also offer interim resources. However, due to the recent reform of sector’s funding …, HEFCE now distributes significantly lower amount of government grants than in the past, which marginally weakens its financial capacity to deal with a liquidity distress within the sector. … In May 2016, the government released its white paper on reforming the higher education sector, which also sets out changes to regulation of the sector. As part of the reforms, a new Office for Students will be created and it is expected that the functions of HEFCE except for research grant funding will continue with the OfS with a remit to monitor financial sustainability, efficiency and governance in the sector.
The question will be whether ‘monitoring’ goes along with the forms of engagement described above – particularly the offer of interim resources. Moody’s emphasises that Hefce’s ‘oversight and intervention powers’ are even more important given the uncertainty around Brexit, student numbers and new forms of recruitment competition.
Separately, Moody’s assesses that there is a ‘high likelihood’ of government intervention were a university to face ‘acute liquidity stress’. This assessment of likelihood is based on what’s happened in the past and continuing political sensitivity around universities.
The high likelihood of support reflects the various remedial measures available to HEFCE in cases of financial distress and our assessment of its willingness to assist a struggling university. However, it also recognizes that overall formal powers of the regulator are marginally weaker than in other government-related sectors in the UK. English universities have been historically stable and there is no record of any university defaulting. In the few cases of mergers, the government has ensured that all outstanding financial obligations were fully respected. Moreover, higher education in the UK remains a politically sensitive issue.
But one way of reading the government’s recent comments on market exit is to see expressed the view that historical stability has prevented its desired form of competition from arising. Ever since the 2011 White Paper, ministers have insisted that it is not the government’s job to shore up unviable institutions.
You might want to mark the important nuance between liquidity stress and solvency here. That said, Moody’s recognises that its assumption may no longer be tenable.
The sector is changing, however, with reforms proposed in the government white paper in May 2016. We will continue to monitor developments and assess the credit implications for the sector noting that a weakening of the ties between the Higher Education Sector and the UK government could have an adverse impact on our current assessment of extraordinary support. Moody’s also assigns a very high default dependence between the university and the UK government, reflecting their strong financial and operational linkages.
All in, these two components (financial regulation and likelihood of extraordinary support) boost a university’s rating with Moody’s by a couple of notches (Cambridge excepted). Two points doesn’t currently represent the difference between investment grade and non-investment grade, since the lowest rated English university (at Aa2) is still 7 notches above that border (Baa3/Ba1). But weakening credit ratings will mean costlier borrowing (to reflect creditor risk), even if the operational uncertainties already mentioned (in particular around international and EU students) do not lead to financial stresses.