The financial health of the higher education sector is a matter for debate every year – but with rising interest rates, cost rises, and a fee freeze 2022 has seen yet more attention paid to the topic.
We should start with liquidity. Many larger universities are starting the year with a good position on both counts – as has been noted by those highlighting the high level of reserves held in some parts of the sector.
Marc Finer, KPMG’s UK head of Higher Education Debt Advisory, explained to me that:
Many universities paused non-essential capital spend, and sought cost savings elsewhere, during the Covid-19 pandemic, meaning they built up cash. Some accessed additional borrowing facilities. The hope was that the 2022-23 academic year would see a strategic invigoration and return to investment, supported by a relatively healthy liquidity position – but energy costs, borrowing costs, and inflation will now put pressure on available funds and challenge strategic priorities.
As we’ve been over on Wonkhe already, some (but not all) universities have locked in their energy costs at a fixed price until April next year via collective purchasing agreements or working with energy brokers. Beyond April (including for those on market rates as government support is likely to end), there are huge potential additional costs.
Another coming pressure – amplified by the recent University and College Union success in achieving a national strike mandate and action taken by Unison and others – is on salary costs. Staff, rightly, expect their salaries to rise at least to match inflation – especially after two years of compromise on pay to help meet Covid-19 costs. With salaries constituting a large proportion of recurrent outgoings for most providers, this presents an issue – university income will not be rising to match inflation.
In both cases – recurrent, rather than capital, funding is needed – salaries and energy costs need to be paid every year. Sensibly, this should come from sustainable cashflows (generally a surplus on core business) – though it is certainly possible to pay salaries from cash reserves these would be exhausted (even for larger, well off, universities) if not replenished through strong trading performance.
In recent years it has been comparatively easy for higher education providers to access finance – banks and other lenders see them as a reliable place to invest. In 2022 universities are still able to borrow, however – as Finer put it:
The cost of borrowing, pound for pound, is materially higher now than it was even 6 months ago.
This increase in finance costs comes when many key capital projects (major refurbishments and much-needed additional capacity) have been paused for two or three years. With costs rising for contractors too (particularly on logistics and materials – the price of copper, for instance, has practically doubled overnight), previously agreed fixed price contracts may not still be commercially viable – and contractors themselves may be at risk of insolvency, increasing the potential for delays and cost increases for major projects.
Marc Finer notes that:
Where universities have existing floating rate debt maturing in the near term, refinancing will be far more expensive. And where financial covenants (business-related performance conditions within loan agreements) are linked to operating performance, including surplus or cashflow measures, HEIs may find themselves under further pressure to reduce spending.
Given that fees will not rise with inflation, borrowing more to manage this pressure will be a last resort for many – with the cumulative cost of borrowing at higher rates putting more pressure on the very cashflows that universities are trying to enhance. Finer cautions that:
All providers will need to be paying close attention to their financial resilience and reassuring governors in an environment where it is far less easy to predict what may becoming next
The difficult work that banks do in supporting providers is not often seen. There are a number of providers that have been engaged in bank-supported restructuring and business support measures in recent years – getting support in making the difficult and painful decisions that keep a university viable. There have been many stories from the sector about efficiency drives with the proceeds used to pay down debt – and more frequent financial covenant testing making for a more constrained environment for decision-making by senior leaders.
However lean and ready this process has left a university, it is of little comfort when a set of crises like the current crop hit and more liquidity is needed. As Finer asks:
If financially weaker providers need more liquidity quickly – where do they go? It shouldn’t be taken for granted that lenders will able or willing to plug the gap. So the big question is, can those providers strip out even more cost, and what’s the trade off between managing a short term cash crunch and delivering plans for future investment?
If you’ve worked as hard as some providers have to bring down the cost of borrowing, it must sting to see it rise again – and this time, the business decisions needed to afford it could be even more painful.
I should be clear this is a worst-case scenario – there are no signs of an imminent burning platform given the work done by providers to shore up their finances during Covid, but there is clearly no room for complacency.
Some better-off providers have few worries about liquidity – but need to think carefully about capital allocation. Strategic investment priorities will have changed since the Covid freeze and are likely to be changing rapidly.
On the availability of capital and the management of existing borrowing, Marc Finer notes that:
Long term debt investors still have lots of appetite for the sector – though borrowing will be expensive in the current climate, so generally we would only expect providers to be approaching the market to refinance maturing debt or fund critical investment. In the context of a wider refinancing exercise, a point-in-time opportunity may exist for providers to refinance or restructure legacy long term, fixed rate loans. It was prohibitively costly to do this when interest rates were really low, due to high breakage costs, but those costs could be negligible now.
Many of the capital projects we’ve been discussing are becoming urgent again because many providers over-recruited in the last few cycles and the pressure on estates and equipment has become acute. We’ve heard stories of crowded lecture rooms and packed labs, but the story that has really cut through has been on accommodation. I asked Marc whether the time had come for providers to think more strategically about investing in halls of residence again.
Over the recent period universities have been thinking about bringing more accommodation back within their control for these reasons. But right now, the pressing need is to conserve cash so, given there’s a marketplace for funding student residence development, if someone else can build halls that could be the preference.
The challenge here is that the whole real estate market has been dealt a blow by a rise in the cost of borrowing and the inflationary impact on construction costs. For investors in student residence development, cost of capital and yield requirements have fundamentally changed, in a segment where there are clearly limits to which students can be expected to pay the kind of rents that would make that investment attractive, especially with the cost of living already skyrocketing.
But universities can’t recruit first and plan later. And operational concerns – about the estate and the quality of student experience – can quickly become financial challenges if providers are reactive rather than proactive in their planning and governance processes.
What’s very clear from talking to Marc is that – even more so than in previous years – there are no quick fixes and no easy answers for universities in the 2022-23 academic year and beyond. It is all up to sound, strategic decision-making and good governance this time.