More universities will borrow by issuing bonds as the interest rates on offer plummet and Russell Group institutions are deemed “particularly creditworthy” by investors, according to advisers in the market.
Cardiff University announced last week that it had issued a £300 million public bond, due to be repaid in 2055, with an interest rate of 3 per cent – described as the lowest ever yield on a bond in UK education.
Low interest rates are seen as an opportunity for UK universities to borrow on the bond markets to finance new buildings as government capital funding declines. But sector experts also note that institutions with bonds must ensure their finances remain healthy enough to keep up yearly interest rates and to fund the repayment of the bond at the end of its maturity.
Cardiff, whose bond was described as being for “general corporate purposes” including investment in teaching and research facilities, follows the universities of Cambridge, De Montfort, Liverpool, Manchester and Northampton, along with the London School of Economics, in issuing public bonds.
The Welsh institution, which was given an Aa2 credit rating by Moody’s as part of the bond process, gained a deal that compares favourably with that of Cambridge, which was rated AAA.
Francis Burkitt, a managing director in debt advisory at Rothschild, which has acted as adviser on four of the public bond issues by universities, including that of Cardiff, said interest rates on a bond are calculated in reference to “the interest rate at which government could borrow today at the same maturity”.
“Each individual borrower then has to pay a slightly higher interest rate than the government does, to reflect its individual credit quality; this is called a ‘borrowing margin’ or a ‘spread over gilts’,” he continued.
In explanation of why Cardiff gained a lower interest rate than Cambridge, Mr Burkitt said: “Cambridge borrowed a couple of years ago when gilt yields were higher – that government reference rate was higher. Cardiff borrowed [last week] when gilt yields were lower.”
So the interest rate is mainly “a reflection on the time they decided to do the borrowing”, he continued.
Cardiff’s bond was packaged out among a number of investors. “The classic traditional UK life assurance company and pension funds are the mainstay of buying these very long-dated and very high quality bonds,” said Mr Burkitt.
“Bond holders have latched on to the idea of the Russell Group being particularly creditworthy,” he continued, adding that membership of the group is seen as a “badge of quality” by investors.
Guy Bagshaw, a Rothschild director, said of the attractiveness of the Russell Group: “The bond investors like the fact these universities are investing in new research facilities which attract research income – and the quality of research flows through to the level of academic taught quality, which then flows through to the level of student demand and application.”
Mr Burkitt said that universities are “doing a fantastic amount of investment in their real estate”. He added: “It’s just very – in a way – lucky, that this has corresponded to a period of time when interest rates are unbelievably low.”
Universities with a bond will have to pay interest each year – and then repay the principal amount at the end of the bond term.
Any institution planning to issue a public bond must secure a credit rating first. A key factor in universities’ good credit ratings is the sector’s strong regulation.
Moody’s said its rating for Cardiff “takes into account the strong regulatory framework and generally stable funding of the Welsh higher education sector, as directed by the Higher Education Funding Council for Wales”. It also says that a “weakening in the oversight exercised by HEFCW would negatively impact the sector's credit quality”.
In England, the government plans to merge the Higher Education Funding Council for England into a new consumer-focused regulator, the Office for Students.
Could that switch harm the creditworthiness of English universities and potentially raise their borrowing costs?
Mr Burkitt does not believe so. “The underlying fact…is that it’s a sector that is regulated in some form or other by the government, and that gives great additional comfort to investors,” he said.
Bob Rabone, chair of the British Universities Finance Directors Group and finance director of the University of Sheffield, said of bond issues: “As the price has dropped and the demand for long-term capital to commit is even clearer after the spending review [which brought cuts in government funding], I believe it is very likely that other universities will follow.”
Andrew McGettigan, a writer and researcher on higher education, wrote on his Critical Education blog that universities may find it difficult to judge what constitutes prudent levels of borrowing.
He added of bond borrowing: “What is a sustainable level of debt for large, not-for-profit institutions like universities? What is being funded with the borrowing and does it create significant new revenue streams that can be used to service the debt?”