Bank warns sector of default contagion risk

Unexpected institutional failure would accelerate 'polarised' borrowing trend. Simon Baker reports

January 5, 2012

A number of universities are at risk of a financial contagion crisis similar to that in the eurozone, banking experts have suggested.

If an institution were to fail in an unexpected and uncontrolled way, it could immediately transform lenders' views that higher education is a "safe" sector, causing them to ramp up the costs of borrowing for others, thereby imperilling the survival of some universities.

But unlike the sovereign debt crisis, which has hit countries previously thought of as secure such as France, it is likely that the elite research-intensive universities would be insulated from the shock wave.

The warning - made by a senior figure at RBS, one of the major lenders to the sector - comes as evidence emerges that banks are already making it more expensive for some universities to borrow because of the risk that they may struggle to recruit students when tuition fees rise.

There has also been a retraction of lending for the construction of student accommodation for similar reasons.

Minutes from a Higher Education Funding Council for England board meeting in July indicate that banks are considering "changing their pricing" and setting differential interest rates for individual institutions.

The minutes - recently published online - state that Steve Egan, Hefce's deputy chief executive, "noted the risk relating to changes in attitude from banks in terms of lending to the sector".

"The risk of default on covenants on bank loans linked with [the] volatility of public funding presents a significant risk for institutions," he warned.

Stewart Ward, head of education sector at RBS Corporate and Institutional Banking, which currently directly lends about £1.25 billion to the sector, told Times Higher Education that in the past six months the spread in the price of borrowing for higher-ranked institutions and those lower down the league tables had widened.

"I think that is to do with the perceived risks [to] student demand of higher tuition fees," he said.

Although Mr Ward asserted that presently there were no concerns among the banks that universities were at risk of failing in an unmanaged way, if such an event did occur, the "polarisation" of the sector in terms of varying prices could quicken.

This would carry particular risks for those perceived to have similar problems to a failed institution in attracting students or research funding.

Mr Ward said: "You probably could sit back and look at them and say, 'Well, if that's happened there, could the contagion spread to similar institutions?'"

He argued that it was imperative that universities and Hefce gave early warnings to the banks of any problems at individual institutions to avoid such a scenario.

"What you don't want to do is allow an institution to fail just to demonstrate why austerity works or why austerity should take place," he said.

The latest complete figures on debt in the sector show the scale of the risk from any financial shock.

By the end of July 2010, the academy's total borrowing amounted to just under £5 billion, or about one-fifth of its income, according to a financial health check carried out last year by accountants Grant Thornton.

Interest payments on debt, including those paid on pension liabilities, were £446.4 million in 2009-10.

Hitherto this has not been a problem as universities benefit from very low interest rates on lending.

This is because investors have always believed that Hefce and the government would bail out any failing institution.

Support no longer taken for granted

However, there is growing uncertainty over whether regulatory reform and public funding pressures will allow Hefce to continue to support struggling universities.

Andrew McConnell, chair of the British Universities Finance Directors Group, said the current funding agreement between Hefce and higher education institutions, the financial memorandum, was crucial in giving investors confidence as it allowed careful monitoring of the sector.

But the government is set to propose a set of arrangements that could change the way higher education is viewed by lenders.

Mr McConnell said that uncertainties surrounded "that whole regulatory area".

Others have warned that even with the right regulation, Hefce may not have the resources to help failing universities.

The National Audit Office said in a report last year that the funding council could be stretched if there were a bigger caseload of struggling institutions.

Mr Egan has acknowledged that Hefce will have a central role in assuring lenders.

"Institutions in the traditional sector currently receive finance at extremely low rates because that confidence is there," he told the Private Provision in UK HE conference in London last month.

"If that confidence diminished, that finance would either not be available or be far more expensive."

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