Top universities opt for public bonds to plug the funding gap
With universities struggling to maintain student numbers and find new sources of funding, the latest report from the Higher Education Funding Council for England (Hefce) doesn't make the landscape any cheerier.
It highlights significant financial challenges for the higher education sector in 2013-14 that will demand a more innovative approach to raising money. Among these are further public spending cuts and a rise in the cost of borrowing.
Innovate now or risk being left behind
The increase of tuition fees to £9,000 a year has increased expectations from prospective students, and universities are realising they need to take action now to ensure the continuing success of their institution.
Having better facilities increases their chances of maximising revenue streams, and will give them the edge over other institutions in attracting students that expect world-class services and study environments. If they don't innovate now, there is a real risk of being left trailing in the wake of other, more adaptive institutions.
The report points out that the latest financial forecasts for 2013-14 already show that the sector plans to increase capital infrastructure expenditure, and this will continue to grow. So how can universities secure the long-term funding they need to prosper?
Despite the changing government funding landscape, the diversity of commercial money-raising options open to universities has actually never been greater.
Bonds help universities raise capital
One of the most successful methods we have seen in the last two years is the issuing of public bonds by universities. The University of Cambridge and the University of Manchester were two early adopters, tapping into the capital markets and issuing public bonds worth £350m and £300m respectively.
Bonds are essentially loans. The university raises money by issuing bonds to institutional investors that can then be traded on the Stock Exchange. Each bond obligates the university to pay the bondholder the principal amount of the bond when it reaches its maturity date and to pay a fixed interest rate throughout the life of the bond. This funding method is common in the corporate world, but was previously unseen in UK higher education.
Bonds enable universities to raise large amounts of capital over a very long period and at a low fixed cost. While they cannot be easily repaid before the end of the term, there are typically fewer obligations and ongoing restrictions attached to a public bond issue than a bank loan.
In practice, a public bond issue needs to be for at least £150m, so it will only be suitable for universities with larger debt requirements. A privately placed bond issue with a smaller number of investors will work for those institutions looking to borrow £20m or more. A private placement is not listed on a stock exchange, and does not require a credit rating, so is simpler and cheaper to put in place.
An aggregated bond issue – where a number of universities with smaller requirements join together – is another viable option that has been used successfully by 18 Cambridge colleges.
Highly regulated and low risk – an ideal investment opportunity
Higher education is a very attractive sector for institutional investors. The demand from universities to borrow over a long term is exactly matched by the desire from investors to find places to put long-dated sterling debt.
Lending to a highly regulated, low-risk sector, which benefits from implicit government backing but provides a better return to investors than buying straight government debt, is an appealing proposition. This was certainly reflected in the high level of demand from investors for the Cambridge and Manchester bonds, and the consequent downward pressure on pricing.
The money-raising options now available to universities are widespread and do not just exist on the debt capital markets, but there is no guarantee that these opportunities will remain forever. Underlying gilt rates will start to move upwards at some point, and this will have an impact on the pricing that can be achieved.
Despite the rapid changes to the sector, universities with a clear strategy and a strong business plan are attractive investments. However, they will need to act fast to take advantage of the current benign funding environment – and ensure they mind the funding gap.
Sarah Seed is banking partner at national law firm Mills & Reeve and a member of the team that completed the University of Manchester's first public bond issuing in 2013.

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