The academic year 2015/6 saw a number of significant financing deals within the higher education sector. In February, Cardiff University raised £300 million through a public bond, with a record low borrowing cost for universities of three per cent. A raft of smaller privately placed bonds and substantial loans from the European Investment Bank also helped the sector react to a more competitive student market by investing heavily in estates and facilities, and funding that investment with large-scale borrowing. In November, a Higher Education Funding Council for England (HEFCE) report on the financial health of the sector suggested that this was just the start, revealing that universities planned to spend £4.2 billion on capital expenditure up to 2020 - an increase of 60 per cent from the previous four year period - and that most of this would be funded by borrowing.
Nor will the vote to leave the European Union entitle an investor – either a bank or a bondholder – to require a loan or bond to be repaid early. To our knowledge there are no examples of specific Brexit defaults being included in commercial loans or bonds and, while it may theoretically be possible for a bank to require early repayment, this is highly unlikely to happen in practice. It would have to demonstrate that the vote to leave had materially and adversely impacted on the university’s business and/or its ability to meet its immediate repayments. While the implications of the Brexit vote on the university sector remain theoretical and uncertain, it would be very difficult for a bank to show that such a test had been met.
But what should concern any university with borrowing is how far the fallout from Brexit weakens its underlying financial strength. Any funding document will contain ongoing obligations that are binding so long as a debt remains outstanding. These obligations might include key financial tests that need to be met and restrictions on the operation of the university’s business.
For so long as the university can demonstrate that it is complying with these tests and obligations, and is paying its scheduled payments of interest and/or principal on time, the impact of Brexit is likely to be minimal. However, it is more important than ever to be aware of what those restrictions are, and to consider what the impact of, for example, a reduction in EU research funding or EU student numbers might be on the university’s overall financial position and on those key financial tests. Far better to address potential problems in advance with any funder rather than wait for a breach to occur.
Similarly, when it comes to borrowing from the European Investment Bank, which has lent £2.1 billion to UK universities since 2010, nothing has changed, for the moment. There is no contractual right for the EIB to require early repayment of its debt as a consequence of Brexit, and it would be subject to the same questions as banks in exercising a material adverse change clause.
Immediately after the Brexit vote, the credit ratings of universities (with the exception of the University of Cambridge) were downgraded. This followed the downgrade of the UK government a day earlier and happened as a consequence of the universities’ close government links rather than concerns about their specific financial position or performance.
A lower credit rating attributes a higher risk to the credit of an institution, and, in theory, will feed into higher pricing of future university bonds. It does not have any impact on the actual interest paid on bonds already issued by those universities whose ratings have been downgraded, as these are fixed over the term.
The price of a public bond is made up of two elements – the reference gilt rate and the spread. The gilt rate is the rate at which government debt is being traded and the spread is the assessment of risk that the market attributes to a particular institution, based on the formal credit rating it receives. So in theory, a downgrade of the UK government should push up the gilt rate and a downgrade of a university should lead to a higher spread – which all adds up to a more expensive bond.
But gilt rates are now at historic lows because investors have reacted to market uncertainty by buying government debt. So, while universities are now being offered slightly higher spreads, this is partially offset by the fall in gilts. To put it into context, University of Cambridge issued a bond in 2013, with a spread of 0.65 per cent giving it an overall price of 3.75 per cent. Today, a bond could be issued at a spread of 1.65 per cent, and still achieve the same overall price as that of Cambridge’s bond. Indeed, for any university thinking of issuing a bond, this might be a good time to act, as the cost of funding remains cheap.
However, while investors might still see the university sector as a safe haven, it would be wrong to think that they are unconcerned about the post-Brexit future. In order to sell debt to an investor, a university has to paint a picture of where it is now and where it is going, how it is going to develop and what its place will be on the world stage over a long period. The current uncertainty makes that difficult.
At the same time, universities have to continue to adapt and develop. Competition for students – both domestic and overseas – means that continued investment in campus buildings is perhaps more necessary than ever.
HEFCE highlighted in its report a growing divergence in financial performance within the sector. The fallout from Brexit is likely to increase that divergence, with those the market perceives as the strongest performers still able to access the cheapest forms of funding and the “weaker” performers left behind. And investors have always taken great comfort from the fact that a university has never been allowed to fail. If that does occur, and a bank or investor is left out of pocket, even the stronger performers may find that their credit ratings drop again and the cost of funding starts to creep upwards.
This article first appeared on Research Fortnight’s HE.
Then came Brexit.
Most of those universities who have already borrowed money will have done so at a fixed rate, so nothing will change in the short term. The interest rate is fixed over the period of the loan or bond, and, regardless of what happens to underlying interest rates or gilts – or even the credit rating of the university itself - the interest payments on that existing debt will remain the same.Nor will the vote to leave the European Union entitle an investor – either a bank or a bondholder – to require a loan or bond to be repaid early. To our knowledge there are no examples of specific Brexit defaults being included in commercial loans or bonds and, while it may theoretically be possible for a bank to require early repayment, this is highly unlikely to happen in practice. It would have to demonstrate that the vote to leave had materially and adversely impacted on the university’s business and/or its ability to meet its immediate repayments. While the implications of the Brexit vote on the university sector remain theoretical and uncertain, it would be very difficult for a bank to show that such a test had been met.
But what should concern any university with borrowing is how far the fallout from Brexit weakens its underlying financial strength. Any funding document will contain ongoing obligations that are binding so long as a debt remains outstanding. These obligations might include key financial tests that need to be met and restrictions on the operation of the university’s business.
For so long as the university can demonstrate that it is complying with these tests and obligations, and is paying its scheduled payments of interest and/or principal on time, the impact of Brexit is likely to be minimal. However, it is more important than ever to be aware of what those restrictions are, and to consider what the impact of, for example, a reduction in EU research funding or EU student numbers might be on the university’s overall financial position and on those key financial tests. Far better to address potential problems in advance with any funder rather than wait for a breach to occur.
Similarly, when it comes to borrowing from the European Investment Bank, which has lent £2.1 billion to UK universities since 2010, nothing has changed, for the moment. There is no contractual right for the EIB to require early repayment of its debt as a consequence of Brexit, and it would be subject to the same questions as banks in exercising a material adverse change clause.
Borrowing after Brexit
Going forwards, it may be a slightly different story. For now, the UK government remains a shareholder in the EIB and UK projects in the pipeline will probably still be funded. However, as it is central to EIB lending policy that all lending has to promote the interests of the European Union, it is hard to see how UK university infrastructure projects will pass that test once the UK leaves. This means an important source of low-cost debt would no longer be available.Immediately after the Brexit vote, the credit ratings of universities (with the exception of the University of Cambridge) were downgraded. This followed the downgrade of the UK government a day earlier and happened as a consequence of the universities’ close government links rather than concerns about their specific financial position or performance.
A lower credit rating attributes a higher risk to the credit of an institution, and, in theory, will feed into higher pricing of future university bonds. It does not have any impact on the actual interest paid on bonds already issued by those universities whose ratings have been downgraded, as these are fixed over the term.
The price of a public bond is made up of two elements – the reference gilt rate and the spread. The gilt rate is the rate at which government debt is being traded and the spread is the assessment of risk that the market attributes to a particular institution, based on the formal credit rating it receives. So in theory, a downgrade of the UK government should push up the gilt rate and a downgrade of a university should lead to a higher spread – which all adds up to a more expensive bond.
But gilt rates are now at historic lows because investors have reacted to market uncertainty by buying government debt. So, while universities are now being offered slightly higher spreads, this is partially offset by the fall in gilts. To put it into context, University of Cambridge issued a bond in 2013, with a spread of 0.65 per cent giving it an overall price of 3.75 per cent. Today, a bond could be issued at a spread of 1.65 per cent, and still achieve the same overall price as that of Cambridge’s bond. Indeed, for any university thinking of issuing a bond, this might be a good time to act, as the cost of funding remains cheap.
However, while investors might still see the university sector as a safe haven, it would be wrong to think that they are unconcerned about the post-Brexit future. In order to sell debt to an investor, a university has to paint a picture of where it is now and where it is going, how it is going to develop and what its place will be on the world stage over a long period. The current uncertainty makes that difficult.
The future face of funding
Much depends on how confident universities feel about entering into long-term borrowing commitments and about meeting interest obligations over a sustained period, with all the challenges posed by Brexit. Most will be grappling with the financial implications of a potential fall in research funding, a drop in EU students, departure of EU academics, and uncertainty over immigration policy and over funding from central government.At the same time, universities have to continue to adapt and develop. Competition for students – both domestic and overseas – means that continued investment in campus buildings is perhaps more necessary than ever.
HEFCE highlighted in its report a growing divergence in financial performance within the sector. The fallout from Brexit is likely to increase that divergence, with those the market perceives as the strongest performers still able to access the cheapest forms of funding and the “weaker” performers left behind. And investors have always taken great comfort from the fact that a university has never been allowed to fail. If that does occur, and a bank or investor is left out of pocket, even the stronger performers may find that their credit ratings drop again and the cost of funding starts to creep upwards.
This article first appeared on Research Fortnight’s HE.