Higher Education Financing – A Lender and Investor Perspective

Introduction

As a borrower it’s helpful to understand the thought process of a lender, and which issues feed into their risk assessment of a specific borrower or project.

Not all lenders are identical in their approach – their relationship managers, analysts and credit sanctioners are human after all and their collective views will combine with the institutional culture to drive the overall approach of the lender. Each lending entity whether an institutional investor or a traditional bank will have its own Higher Education (“HE”) credit policy and that may be influenced by many factors such as:

• Its existing exposure to the sector
• Current risk assessment of the sector / and the individual borrowing counterparty
• Competition for its funding resources (can the lender achieve higher returns in other sectors with similar risk parameters)
• Market intelligence, or the performance experience of its own portfolio of investments in HE

Some of the core credit principles remain as fundamental as ever and lenders remain focused on:

• An institution’s strategy, financial performance and balance sheet strength, both historic and forecast
• Reputation, quality, external measures such as league table positioning, National Student Survey results etc
• Quality of management and governance

These aspects whilst critically important are generally well understood and most borrowers will have rehearsed their stories to present a positive credit proposition to lenders. However, it is the external landscape that we believe some lenders are currently considering more closely.

Over the last few months there has been plenty of Higher Education press coverage, most of which has been negative in tone. Whether some of this commentary is justified or purely scaremongering is a decision for the lender to either take note of or ignore. Without doubt though, there is a strong political influence becoming evident across issues such as:

• The “Value for Money” debate, student contact time, and Vice Chancellor remuneration
• Theresa May announcing a freeze for 2018-19 on UK/EU Undergraduate (UG) fees, and whether these signals the start of a more aggressive policy on UG fee levels
• Whether government might introduce a lower cap on fees for lower cost humanities subjects or at least limit the extent to which the Student Loan Company will fund these subjects
• The sustainability of the current student loan mechanism and a widely publicised figure of UGs graduating with up to £50,000 of student debt, more students predicted not to fully repay their loans, interest rates of 6%+ on post Sept 2012 student loans.
• Concern over recruitment prospects with demographics showing fewer 18-year olds and EU applications declining, the first dip in applications since 2012.
• The impact of Brexit, and the uncertainties of a “No deal” scenario on EU staff and students’ status, and EU research funding accepting that many commentators feel that common sense will prevail with a transition period on these issues
• USS Pension deficit and the affordability of higher contributions
• A revised regulatory position with the passing of the Higher Education and Research Act and the introduction of the Office for Students

Perhaps these points will give further credence to students considering alternatives to the traditional University route post-compulsory education. There seems to be a growing awareness that progression to University is but one of the options available now. It remains true however that the quality of our HE  provision in the UK is still strong overall and that many students benefit from a University experience.

UniversitiesUK published their latest Facts and Figures document recently

• Overall Student Satisfaction 84%
• Recruitment levels from 18-year olds in lower participation areas at record levels
• Employment rates and median salaries continue to be higher for graduates
• England and Scotland saw an increase in Full Time student recruitment in 2015-16

However, the initial indicators for 2016-17 show there are signs that that these growth trends may be reversing.

During August there was plenty of commentary that HE Institutions were nervous about recruitment, citing the toughest ever student recruitment season. Figures from UCAS, the admissions clearing house, have shown a sharp fall in the number of applications for undergraduate study from UK-based students for the first time since 2012, as the shrinking demographic pool of secondary school leavers has combined with fewer applications from mature and part-time students.

In previous years, applications from EU and non-EU students have been an area of growth. But the Brexit referendum and its associated uncertainty has seen a marked decline in EU applications, despite strenuous efforts by the government and the higher education sector to reassure prospective students that they won’t be affected by any fall-out from the UK leaving the EU.

This represents the first drop in volumes of EU applications over the past decade – a period which has otherwise been marked by steady and substantial growth in EU student applications to British institutions (in sharp contrast to the apparent trend for 2017/18, applications from EU students increased by 7.4% between 2014 and 2015 and then again by another 6% from 2015 and 2016, but EU applications are down 5% for 2017 compared to 2016).

The latest UCAS figures that show the number of people who had applied to UK universities for the coming academic year by the 30 June deadline was 649,700 – compared with 674,890 in 2016.

There have been reductions in applicants from all four countries in the UK for 2017 and the trend reversal can be seen below:

Lenders will be scrutinising these recruitment indicators and the actual performance of individual institutions that they are considering investing into. Lenders will always consider investment opportunities on a case by case basis, historically they may have drawn comfort from the perceived level of government support for the sector and the fact that demand out stripped supply with student numbers historically demonstrating an ever-increasing trend (other than 2012 when the £9,000 tuition fee regime was introduced but even then, application numbers recovered very quickly to pre-2012 levels).

The latest HEFCE Financial health of the higher education sector: 2016-17 to 2019-20 forecasts publication issued in October 2017 commented:

“Our analysis of the sector’s financial results for 2015-16 showed a sound financial position overall. However, there was an increasingly significant variation in the financial performance of individual HEIs, and a widening gap between the lowest- and highest-performing institutions.”

“Sector borrowing [in English Universities] is projected to rise from £8.9 billion at the end of 2015-16 to £11.7 billion by the end of 2019-20. Relative to total income, sector borrowing levels are projected to reach 36.8 per cent by the end of 2018-19, before falling to 35.1 per cent by the end of 2019-20.

“Borrowing levels are expected to exceed liquidity levels in all forecast years, by £577 million at 31 July 2017, increasing significantly to £5 billion at 31 July 2020. While this does not raise an immediate viability concern, the current trajectory of increasing borrowing and reducing liquidity is unsustainable in the long term”

Lenders are looking much more closely at the prospects for individual institutions. It is too early to draw any clear conclusions regarding lender appetite, but we expect lenders to become more selective in the investments that they support and to reflect the potentially higher credit risk in the margins that they charge as well as greater differentiation between the terms provided to different institutions. This, coupled with the anticipated rise in interest rates will put more cost pressures on some Universities.

How can Centrus assist?

Centrus can:

• Review existing debt and derivative portfolios to ensure your institution has the optimal funding and interest rate risk management structure, providing advice on restructuring if appropriate
• Undertake feasibility studies to ascertain debt capacity, reporting on market appetite and pricing as well as consideration of funding options across different providers of debt in the banking, private placement and public bond markets
• Support the feasibility and structuring of financing in relation to specific projects under consideration on a recourse, limited recourse or non-recourse basis
• Working with institutions to present their credit profile, organising a funding process and facilitating the execution of a debt transaction either in the bank or the institutional market
• Determine accounting impacts, such as hedge accounting costs for a range of options.

For more information, please contact Robert St John, Director – Centrus

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