As with clothes, holiday destinations and cars, corporate finance is subject to fashions and fads. The latest one in the higher education sector is for bonds to fund investment. But one size doesn’t fit all, and an ill-fitting finance product is far harder to fix than an ill-fitting suit.
For those looking for long-term funding and certainty, a relatively low price and a deal that generates publicity, bonds could be the way to go. Many also worry that if they borrow shorter term, the financing landscape will be so different when the debt needs to be repaid that attractive refinancing options won’t be available.
But this isn’t the only variable when looking 20 or 30 years ahead. How will the university’s investment priorities change over that period? How might its strategy evolve? What pressures or opportunities will arise from the regulatory landscape? And does any of this change in the wake of the Brexit vote?
And therein lies the challenge – bonds can be inflexible if the university’s needs or its marketplace changes. Once you have the money, you can’t pay it back early if you don’t need it (or not without compensating the bondholders), and renegotiation can be tricky. Yes, recent Russell Group bonds have been free of covenants restricting how the university is run and how it can deploy funds. But bonds are all credit-rated, and that rating is in essence a promise to the financial markets that the institution is going to be run in a certain way.
We also shouldn’t forget that size matters. A university needs to be looking for at least £150 million for the bond market to be interested, meaning that this isn’t an accessible market for smaller institutions or for those with more modest funding requirements.
There are also pros and cons to other financing options, of course. But the point is that there are other options, and the debt markets are at their most benign since the financial crisis. University College London, advised by KPMG, is a prime example of a large university that has looked beyond the bond market to fund its estates capital programme, recently supplementing a £280 million loan from the European Investment Bank with the sector’s first self-arranged “club revolving credit facility”: a flexible bank loan that enables the borrower to draw, repay and redraw funds in accordance with its cash-flow requirements.
The EIB’s future role supporting UK social infrastructure is one of the myriad questions thrown up by the Brexit vote, but its hitherto long-term funding has generally been a cheaper option than the bond market for funding multiple estates projects because the funds don’t need to be drawn all in one go up front.
And then there is the “private placement” market: borrowing from a small number of private investors, typically institutional. Several universities have taken advantage of its medium- and longer-term funding structures with a range of draw-down and repayment options. Project-specific finance can enable assets such as student accommodation schemes to be ring-fenced and funded separately, offering risk-management advantages as well as potentially enhancing the quantum of debt the university can raise. And let’s not forget traditional banks, which are increasingly returning to lending to quality borrowers on terms that can compete on pricing, maturity and other areas.
So, when it comes to deciding, where should you start? It’s perhaps easiest to say where you shouldn’t. Certainly, the process shouldn’t begin with weighing the pros and cons of a bunch of financing options in a vacuum. One university’s pro could be another’s con. It’s vital to do detailed up-front work to develop a financing strategy that flows directly from the university’s own business plan and investment strategy. The aim is to determine not only how much money is needed, but to identify your institution’s priorities, opportunities and risks – including now how these may have changed since 23 June.
You might not be able to get everything you want from a financing deal, but where there could be a trade-off, such as between long-term maturity and having flexibility to protect against an uncertain future, you can make sure the deal reflects what’s important for you. Or, to put it another way, the capital structure should be an enabler of the university’s strategy. The undesirable alternative is to have to run the business within the limiting constraints of an inappropriate capital structure.
By following such a disciplined process, you may well conclude that a bond really is right for you. But you’ll have done the right thinking needed to make that choice – rather than just dedicatedly following fashion.
Marc Finer is associate director of KPMG Capital Advisory.