Universities challenged

I recently received a call from my alma mater to contribute to its student fund, which got me thinking about how the higher education system is funded.

Universities have undoubtedly faced big challenges in funding in recent years, along with the rest of the public sector.

The increase in tuition fees was designed to address some of the funding issues, but there have been concerns that this will lead to a drop-off in admissions or be restrictive to students from “the squeezed middle”.

David Willetts, the government’s universities and science minister, said recently: “Funding for university teaching is expected to grow by 10% over this parliament.

“Although the central HEFCE grant is falling, more money will reach institutions as resources follow the decisions made by students.”

But that will do little to ease the budget concerns of vice-chancellors up and down the country.

Recently I wrote of Transport for London debt, which is currently AA-rated by a number of ratings agencies. The transport authority derives its credit rating partly as a result of its status as a public body with 49% of its income coming from government grants.

Why shouldn’t there be more university issuers of debt?

There are a lot of similarities: guaranteed revenue streams in the fees, government funding, private sector sponsorship. Fees are in turn augmented by higher levels paid by foreign students.

According to the Student Loans Company, during the first two months of the 2011/2012 academic year, 948,100 students had been awarded grants, allowances or loans – equivalent to approximately £7.6 billion. During 2010/2011, the Student Loans Company collected £1.3 billion in loan repayments.

It’s pretty hard to believe that, no matter how badly a university is run, the government would close down an entire institution.

At the moment there are few university issuers of debt in the UK (for some of the reasons why, see the expert view from Moody’s Thomas Amenta below),

Would fixed income managers be interested?

There certainly seems to be an active market in the US, with many universities and colleges stateside involved.

Furthermore there is also a market for asset-backed securities consisting of student debt.

Ratings agency Fitch Ratings says US student loan asset-backed securities are resistant to defaults, because of the US government’s guarantee on Family Federal Education Program (FFELP) loans, despite a report from the Federal Reserve Bank of New York that revealed as many as 27% of all student loan borrowers are more than 30 days past due.

Private student loan asset-backed securities, which are not backed by the government, are likely to face different challenges, with the rise in past-due and defaulted loans a higher risk, according to Fitch.

Asset-backed securities are likely to be a less popular option for investors, given the stigma of structured finance after the credit crisis and the role played by mortgage-backed securities.

Indeed, with a graduate’s career path anything but certain, particularly in the current employment market, the risk of default or delayed payments may be too great.

The expert view:

Thomas Amenta is a senior vice president at Moody’s

On issuance

“Issuance has been low due to low-cost financing from banks that has been sufficient to meet the limited funding needs of UK universities. The imposition of tuition fees by themselves would not drive issuance, as total sector funding (in the form of government grants and the upfront funding of fees by the government) is remaining roughly constant as part of reforms. HEFCE reports that schools in the aggregate are restraining capital spending (and with it the need for new financing), after a period of substantial investment leading up to the reforms.”

On impact of tuition fees

“Despite the near-term challenges of adjusting to new funding and admissions requirements, some schools may still be looking ahead to substantial future investments; and they will be weighing their financing options. Those schools with strong national and international reputations and which could support expansion under the current funding regime may have good reason to look at larger investment and financing programmes. These schools may be particularly well placed in the international markets for professors, and increasing shares of undergraduate and graduate students, and have the possibility to attract both additional research grants and student fees.”

On US comparison

“The comparability of issuance of US institutions is difficult. US schools can raise even single-digit million borrowings under the US tax-exempt bond system. US state-controlled schools also face fewer controls on student numbers and funding rules, which may offer them greater structural flexibility for capital investment and funding.

“In the UK, thresholds for tapping capital markets are perceived to be £100m or more, with this lower amount only recently tested in the housing association market. Still, regulatory demands for higher capitalisation continue to put pressure on the abilities of banks to offer safe-but-low-margin lending, particularly for long tenors. This could raise interest in capital-market issuance as part of dedicated financing of student housing or directly on balance sheet.”

On what rating universities would achieve

“We cannot speculate as to what the rating for individual universities would be, as this would require us to know the university’s current finances, its plans, its ability to adjust to current reforms, etc.”