Tuesday, 2 February 2016

High finance

Are you sitting comfortably? Good. Then I’ll begin.
Once upon a time universities in the UK were funded by the state, through an arms-length body which was fairly non-interventionist, and received money to cover every-day operating costs and salaries, and money for building projects and other capital costs. Polytechnics and higher education colleges were funded by the state too, though in their case it was through local authorities and later an arms-length body. There was money to give students grants, too, so that they could afford to study instead of work.
More people started to go to university, and polytechnics and colleges got called universities too, but the amount of money they received didn’t keep up with the extra costs. The arms-length body invented some very clever ways to get universities to do a great amount more for a little extra more, and then tell them that it wasn’t a one-off effort, but the new normal. And so, especially in the former polytechnics, resource got stretched very thin. There was still money for recurrent costs and capital, but less than it used to be, given the extra students they were teaching. And the money, being thinly spread by the state, meant that there was less to fund students during their study.
Everyone saw that this couldn’t last. And so after much deliberation a scheme was agreed to ask students to pay towards the cost of their study, and a fund was set up so that students could borrow, at a reasonable rate, to support themselves whilst at university. Did this work? Not really. More and more people went to university; students continued to struggle to pay for their time at university; universities struggled to put in place good facilities; and class sizes went up. It wasn’t right. Another think was needed.
And so another think happened: and this time universities were allowed to charge a lot more in fees, and a much bigger fund was put in place, so that they could borrow to do this. But the government allowed universities to charge higher fees than they had budgeted for, and so paying for the bigger fund meant that universities received less and less in grants, both for particular annual costs and for capital projects. And the whole thing was still too expensive …
It isn’t much of a story, I know, but put some detail in and it’s not far off a history of UK higher education funding since the 1970’s. I haven’t taken up a creative writing course – don’t worry! – the point of this is to illustrate why universities are taking to borrowing money.

The UK HE sector has moved from being directly publicly funded to being publicly funded via a market mechanism. That is, most home tuition fee income comes via the Student Loans Company, which is definitely public money, but depends upon students actually choosing to go to the university in question. This is life and death for some universities, and for all it is critical in determining how much resource there is to spend. Student recruitment matters more than ever, and universities therefore like to present their best face – hence the need for investment in facilities, in staff and so on. Additionally, investment requires a stock of money; tuition fee income comes in flows. So a pile of borrowed cash, which can then be re-payed over time, makes a lot of sense.

There’s two other lessons to be learned from this, which arise from how universities are going about their borrowing.

Universities are borrowing in new ways. Yesterday for instance, Cardiff University announced it had issued a bond worth £300m, at a historically low rate of interest (there may be a paywall on this link, sorry). Other universities have issued bonds too: Liverpool (£250m), Manchester (£300m), Cambridge (£350m) and De Montfort (£110m) – this isn’t an exhaustive list.

Bond issues are long term – 30, 40 or 50 years, typically. Universities pay interest annually on the amount borrowed, and at the end of the period are liable to repay the whole amount. The interest rates are low at the moment – Cardiff is paying 3.1% on its borrowing, meaning that it must repay interest at £9.3m per year – but this will be cheap, particularly if, or when, inflation rates rise. Cardiff gets this low rate because it is regarded as a very safe investment – rated as Aa2 by Moody’s, which means it is regarded as “high quality and … subject to very low credit risk“.

And this leads on to the two other important things about university management which I hinted at.

Firstly, if you’re committed to repaying a lot every year – remember the £9.3m per year that Cardiff is signed-up to – you need to be sure that you can afford it. And that means that the investments you make from the capital need to show a return – additional students with additional fee income; more research grants with additional overheads; reduced operating costs with actual savings in expenditure. These conversations already happen in universities, but they’ll be a little sharper where there’s a loan repayment in mind. And in the larger universities, where perhaps there’s been a little more slack in the past, things will tighten up.

Secondly, stability is the watchword. The low interest rates achieved by universities (you’d bite the hands off a bank offering a fixed-rate mortgage at 3.1% for 40 years) only come about because of the very good credit rating they receive – the Aa2 in Cardiff’s case. This is based on an assessment of the long term risk that the university won’t pay the debt. A more unstable funding scenario doesn’t necessarily mean that loans won’t be available, but they do affect the interest rate. So uncertainties about fee levels, student number caps, research funding, all contribute to difficulties in other universities getting such good rates.

I don’t imagine that many university senior managers started their careers thinking that they’d be engaging in high corporate finance, but it’s an inevitability given the move to the market that we’ve seen. The universities that do best will be those that become the sort of organisations that can deliver in a good business-like way without changing their core values. And they’ll all live happily ever after.

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