The University of Cambridge (rated Aaa by Moody’s) became the first UK university to return to the public bond markets recently, when it issued £600 million of new bonds across two tranches. One £300 million tranche was a fixed rate, bullet repayment note with a 60-year maturity, similar in structure to the £350 million 2054 note that the university issued in 2012.
It is the second £300 million tranche, the interest payments on which are linked to the consumer price index that has attracted the greatest interest from market observers. This tranche of the issue also amortises from year 10, meaning that the principal and interest will have been substantially paid down by the final maturity date in 2068.
Cambridge becomes the first UK university to issue an index-linked note, and it is interesting that the inflation index selected was CPI rather than the more traditional retail price index, which is the more historic and conventional measure of inflation in the UK. The UK government has to this point only issued RPI-linked gilts, although there is speculation that this could change in the future.
There has been widespread criticism of RPI as a measure of inflation, based on technicalities in its calculation, but also on the basis that it constantly overstates inflation, partly because it includes not only housing mortgage costs but also house prices. RPI ceased to be an official national statistic for the UK in 2013 and Mark Carney, the governor of the Bank of England, has described the RPI measure as being of “no merit”. Cambridge has therefore selected the more progressive CPI measure as its benchmark for this issue.
Cambridge’s rationale for issuing in index-linked format is a simple one. It wants to diversify its investor base and diversify the formats in which it funds, partly to match anticipated revenue streams from future housing and other projects. Among the advantages of issuing CPI-linked debt is the low cash coupon payable and the ability to enjoy a “capital repayment holiday”, as Cambridge has for the first 10 years of its CPI-linked deal. Given these benefits, it seems clear that this structure will have appeal for other higher education institutions in the UK as they contemplate their own capital programmes.
The reaction from bond investors to Cambridge’s CPI-linked deal was extremely positive. This tranche of the issue was more than three times oversubscribed, with the banks involved noting just how many investors were clamouring for an allocation in this tranche. Cambridge’s unique and powerful brand and its extremely rare Aaa rating were definitely factors in this. However, the diversification offered by a higher education institution, away from the usual issuers of index-linked bonds in the sterling bond market – notably utilities – was a big factor in the success of this deal.
As it did in 2012, when it was the first UK university to issue a public bond, Cambridge has clearly opened the door for others to follow. At a size of £300 million, its own CPI-linked deal is large in the context of this market – in fact, it is the largest single CPI-linked tranche from any issuer to date (the £200 million issued by Thames Tideway was the previous largest). Other UK universities may not have the same size requirement, but they are likely to find buyers for smaller sizes in the private placement market where volumes in the £25 million to £100 million range should be achievable.
For institutions concerned that such a structure might leave them exposed to rapidly rising inflation in the UK, it is worth noting that Cambridge’s CPI-linked deal has a “0-3” structure whereby inflation is floored at zero but capped at 3 per cent. Exact structures will vary from deal to deal, but it seems clear that CPI-linked offers are something new and different for the UK higher education sector – and where Cambridge has pioneered, others are likely to follow.
Dominic Kerr is managing director of Debt Capital Markets at HSBC, a joint bookrunner on Cambridge’s bond issuance.