How DfE could design a university transformation and restructuring programme

As Wonkhe’s David Kernohan revealed earlier this month, there have been tantalising hints from the Department for Education (DfE) that £360m of loan funding might be available to help support structural change in the higher education sector.

Part of a (now-removed) job description in an advert for a “Deputy Director FE/HE Improvement and Intervention” made reference to:

Delivery of a major programme to support institutional restructuring, with budgetary responsibility for a facility of up to £360m of loan funding to support structural change.

Arguably this contrasts with the express statement by skills minister Jacqui Smith to the Commons Education Committee in November that there is not going to be a “government bung” to support transformation in the higher education sector. This may go some way to explain why the job advert was hastily removed.

However, a loan, by definition, implies repayment rather than an outright “bung” and would, in accounting terms, be an asset in the hands of the government, so maybe DfE’s thinking is starting to shift to accommodate the possibility that support for the sector may be forthcoming as long as that support is ultimately repaid.

Certainly a cash-strapped sector must be asking itself where the money is going to come from for the greater collaboration that the government has expressly said, in the Post-16 education and skills white paper, that it wants to see. Such collaboration often requires upfront capital with savings only realised further down the line – which is why Universities UK has advocated for a transformation fund to support merger and other forms of radical collaboration.

Play well with others

A brief look at previous attempts by the government to step in to help the HE and FE sectors leads to the conclusion that a provider seeking financial support from the public purse is likely to be faced with a government lender that expects to get its own way. In a sector which is already struggling with massive financial headwinds, support – if the government is ultimately minded to give it – needs to be part of the solution rather than the problem. Otherwise, like the Covid-19 “restructuring regime” take up will be low, with the concomitant risk (for the sector and the country) that efforts to achieve wider collaboration remain unrealised.

If the government is not minded to support the collaboration that it wants to see, or makes the conditions of support so unattractive that no reasonable provider would want to access that support, then publicly-funded institutions may find themselves drawn to closer collaboration with private providers. This unintended consequence (if it is indeed unintended) would surely be better achieved through deliberate design, rather than simply because the state-funded option was unattractive or non-existent.

However, there is no absolute need for a new loan regime to be wholly one-sided: DfE could structure the regime in a way which supports institutions, protects taxpayer funds and also doesn’t antagonise or cut across other creditors and stakeholders, such as banks and pension funds.

The starting point for a balanced and measured approach must be a realisation that the sector’s existing lenders have a pretty good grasp of what is going on. Whether one accepts that universities undertook an “avalanche” of borrowing after the demise of HEFCE, forecast aggregate external borrowing of £13.7bn, as OfS’ data indicates, feels like a pretty chunky number. However, one of the consequences of banks and bondholders’ sizeable exposure to the sector, when coupled with the current financial headwinds, is that those lenders are watching and working with the sector very closely indeed. Their day job is to monitor the financial health of their borrowers and they will have already agreed with universities the appropriate monitoring metrics and operational restrictions they require as part of their lending relationship.

If the government is getting into the business of lending, it should be taking its lead from those lenders, rather than seeking to impose an additional set of operational restrictions and controls.

What lenders expect

Lenders will typically prohibit certain activities (such as selling assets) without their consent, but will often include certain up-front exceptions to the general prohibition. In the example of a restriction on disposal of assets, those exceptions might be permissions for certain planned disposals of specific properties or a general permission allowing for disposals without consent, up to a certain monetary level. A benign approach by DfE might involve including similar restrictions but permitting activities without DfE consent where these are already permitted by another lender. Officials might object that this is effectively outsourcing the decision about whether to consent to other lenders. However, commercial lenders don’t tend to make such decisions lightly and, from a university’s point of view, it would prevent necessary operational decisions becoming logjammed by a raft of creditor approvals.

The need for a benign approach is particularly important in the realm of information provision. Lenders typically impose information undertakings, requiring borrowers to provide annual financial statements – and, increasingly in the current environment, quarterly or monthly management information – within specified timeframes. While it’s important that lenders have early warning of possible problems, the danger is that information provision can create its own mini-industry. DfE should resist the urge to seek data for data’s sake. Universities should be focused on preserving their financial health, not having to generate paperwork to support new reporting requirements.

DfE should also be wary of the itch to take security. On the face of it, taking a charge over a tangible asset, such as a university property, is the safest way for a lender to ensure that it will be repaid. If the borrower defaults, the lender will be able to appoint a receiver to sell the asset and get its money back. The problem with such an approach is that other lenders would need to consent to such security. Any well-drafted loan document will include a “negative pledge” preventing such security being granted without the prior lender’s consent.

As secured creditors rank higher on a borrower insolvency than unsecured creditors and as lenders to the higher education sector have often (at least historically) been willing to lend on an unsecured basis, a request for security from one lender risks a “land grab” by all lenders as they seek to improve their position by also taking security. Such security may also provide theoretical, rather than actual protection: will a lender really want to enforce over a university campus with all the bad publicity that would ensue?

This is not a challenge restricted to lenders: as major creditors of the sector, the USS and other defined benefit pension schemes are deeply concerned with not being in a worse position than other creditors. For example, under its debt monitoring framework, USS may require a university to grant it “pari passu” (or equal) security where security is being granted to other creditors. The message to the government is to tread carefully: all creditors are likely to play nicely provided that they don’t feel that one creditor is putting itself in a better position than the others.

Regime change

Any new government debt would also have to be structured in a way that was palatable to existing lenders. The amount loaned, and any interest or principal being paid, may well have an impact on existing financial covenants in lending documents. Some lenders will also have restrictions on universities taking out additional borrowings without consent. Existing lenders will be particularly sensitive to new lending which has as its purpose making fundamental changes to businesses or operating models unless the need for those changes is clearly articulated.

Ultimately, of course, such discussions may be entirely hypothetical. Reference to a pot of loan funding may have been a slip of pen or, if it does exist, it may be entirely earmarked for FE not HE. However, if the government is minded to create a restructuring programme, the experience of the pandemic “restructuring regime” teaches us that there is no point designing a regime so unattractive that few providers, if any, decide to use it.

If the government can design a programme which existing lenders can support and which removes the potential taboos and challenges around autonomous institutions taking the government shilling, then such a programme has the potential to unlock significant positive transformation in the sector. Perhaps the government should consider reissuing that job description.

This article is published as part of a partnership with Mills & Reeve.