Borrowing by UK universities is big news. In recent times, it has become an important and legitimate enabler of investment in the estate.
But, often, the real purpose of that borrowing is buried in the small print and overshadowed by the financing deals themselves, which dominate the headlines.
The issue is that, for some universities, the focus on such deals risks borrowing becoming an end in itself, perpetuating an assumption that debt, or certain types of debt, must be desirable. Instead, borrowing ought to be a means to a strategic end.
As such, there needs to be a rethink of the way university leadership teams approach financing strategy for their institutions, starting with the broad question of ‘what is the right way for us to fund our plans?’
The familiar, but over-simplistic, story
We all know the brief: unprecedented structural and regulatory change in higher education, including reduced central funding and so-called ‘marketisation’ of the sector, has prompted many universities to invest in their academic, residential and virtual estates to enhance their competitive position and the student experience. The scale, pace and strategic priority of that investment has driven substantial borrowing by HEIs.
There appear to be trends in how top-tier institutions borrow to fund estates investment. From 2012, we saw a round of public bonds issued primarily by Russell Group institutions. 2017 may well be remembered as the year of the HE private placement for the Russells and other high-ranking HEIs. Increasingly, universities are opting for off-balance sheet options for financing student residence development, with the investment in academic facilities being financed on-balance sheet.
But, while it’s easy to write headlines about bumper debt deals by leading universities, we should avoid oversimplifying the issue of how universities should finance their futures. It’s simply not accurate to suggest that the UK’s many universities all have the same opportunity to access long-term funding through the capital markets (such as bonds and private placements). It is also over-simplistic to suggest that the capital markets should be the primary port of call, even for those universities which can access them with relative ease, or that the best way to fund student residences is off-balance-sheet.
A tale of many sectors
One issue is that what we conveniently refer to as ‘the’ higher education sector, in reality, comprises a very broad range of institutions. From a financing perspective, it can even be unhelpful to think in terms of categories of university: the Russells, the other top-tiers, the research-intensives, the post-1992s, and so on.
Ideally, we should be thinking about a sector which is made up of over 160 individual institutions, each with its own business profile, plans, aspirations and culture – and its own stakeholders including senior management, governors, staff, students, existing lenders and regulators. While all universities face similar macro challenges, the most appropriate financing strategy for any individual university should reflect the dynamics of that university alone.
The ‘disconnect risk’
Borrowing strategy should be an enabler of and fully aligned with, a university’s specific business strategy. In other words, a means to a strategic end, but crucially not the only means at a university’s disposal. However, recent and current borrowing trends in higher education show that many universities are opting to pursue similar (and relatively traditional) financing solutions for investment in their estates. That’s the case, notwithstanding often significant differences in institutional profile and strategy, and a broad range of available funding options.
It wouldn’t be right to suggest that the numerous universities which have executed traditional financing solutions to support their estates investment have all got it wrong. But, could they have done it better – and could conversations that university decision-makers are having about financing be more challenging and unlock more opportunity?
In our view, these borrowing trends reflect a possible disconnect in the intrinsic link between business strategy and financing strategy within some universities. This, in turn, creates the potential for inappropriate borrowing and missed opportunities.
Developing a robust financing strategy
In this context, we believe a redefined approach to financing strategy for universities should consist of four key elements:
1) Ask broad questions to preserve options
If a particular strategic initiative gives rise to an implied funding requirement to deliver it, asking ‘what is the best way to fund this investment?’ would be a far better a starting point than ‘could we fund this investment with debt?’
2) Benchmark decisions against clearly defined objectives, not influenced by pre-determined solutions
Clear objectives drive the most appropriate solutions, aligned with business strategy. Specific financing routes or structures – loans, bonds, long or short-term debt, even borrowing generally – are not objectives; they are solutions, and bringing them into the conversation too soon risks the tail wagging the dog.
3) Consider both conventional and alternative objectives to avoid missed opportunity
Conventional objectives include issues such as maximising affordability, reducing refinancing risk, maximising operational or capital structure flexibility during periods of transformation or ensuring relevant KPIs continue to be met.
Alternative objectives include issues such as transfer of risk, accessing third-party expertise, greater scale or pace in capital investment delivery, improving engagement with industry or other local stakeholders, navigating financial constraints such as lender or regulatory consents, navigating optical or cultural constraints such as perceptions among staff, students or the media, and safeguarding the university’s estate and legacy.
Not every university will have the same objectives, priorities or constraints. Therefore, defining those objectives up front, and rigorous ongoing reference back to them as a university develops its financing strategy, should result in the most appropriate solution for the institution.
4) Be realistic: focus on achievable plans, not aspirational visions
Good quality, deliverable financing transactions tend to result from plans which can withstand detailed scrutiny, and which are realistically achievable, with the flexibility to navigate an element of the unknown. In reality, not all universities or capital programmes are easy to finance. Even liquid credit markets with HE sector appetite can be selective, the bond and private placement markets tend to be the preserve of top-tier institutions and, in uncertain times, even these institutions should take care over borrowing if there is no clear near-term use for the capital raised.
Appropriately tailored solutions, aligned with objectives
The above approach creates a sophisticated platform for open-minded consideration of a far broader set of potential funding options. It supports higher-quality governance of the university’s financing strategy by providing clear benchmarks for decision-making. The principles-based and values-based nature of this approach also avoids the risk of conflating value for money with cost, given its ability to demonstrate that the cheapest option may not always be the most valuable to the organisation.
By encouraging this approach to the development of financing strategy, we have seen a range of outcomes that reflect the sector’s diversity. This includes advice given on a wide range of borrowing transactions, from bank financing to private placements, landmark EIB loans, government-wrapped bond transactions, and off-balance sheet structures. We have also been involved in alternative approaches, including university partnerships with peer HEIs, the NHS and industry, or projects focused on pensions, working capital, outsourcing, and organisational efficiency more broadly.
In some cases, these alternative solutions have arisen directly from objectives focused on minimising borrowing, driving solutions which first target improvements in underlying business performance, cash flow, and surplus. Alternative solutions also reflect the fact that the role of universities is increasingly expanding beyond that of teaching and research, towards HEIs becoming anchor stakeholders in regional communities and economies. This drives greater collaboration with industry and other regional stakeholders, but also creates a level of commercial complexity within the institution that can affect the appropriateness of traditional financing solutions.
Borrowing is not the story
Successfully raising debt from sophisticated lending institutions may well demonstrate the strength of a university and its plans. But let’s not forget that lenders are financial investors, in the business of making money from lending money. For a university, borrowing is a financial commitment which should be approached prudently, with due consideration of the fullest range of options available.
There are many ways to fund investment – and many ways to borrow. A university governor recently told me: “We may be raising debt but borrowing is not the story. When this deal is done, we need to be clear that we’re investing to transform the lives of our students and our city for years to come”. Now that’s definitely a headline worth running.
