University financial health check 2014

Source: Sam Falconer

Download full data on how the institutions compare, 2012-13

Given the sharp decline in capital funding from the state, institutions must self-fund the new buildings and facilities they need to attract students

Have former polytechnics been the biggest winners under England’s £9,000 fees system? Are universities set to embark on a borrowing spree to fund the buildings they need to attract students under the new, more competitive system?

Our annual financial health check, looking at university finances in 2012-13 using figures compiled for Times Higher Education by accountancy firm Grant Thornton, points to possible emerging trends in the first year of the new fees regime. The figures may offer some early indicators as to the financial winners and losers.

“The big theme is that surpluses have taken a small step back,” says Bob Rabone, chair of the British Universities Finance Directors Group. “And that comes after a small step back the previous year.”

Despite the introduction of £9,000 fees in England, 2012-13 saw the average surplus across the UK sector fall to 3.7 per cent of income, down from 4 per cent the previous year and 4.5 per cent the year before that. And this was despite a rise in the sector’s income in 2012-13 to £29.1 billion, up from £.7 billion the previous year, according to THE’s figures.

This shrinking financial buffer could expose some universities to damage, as some believe that the accumulation of a decent surplus is necessary in the face of future uncertainty.

Rabone, who is also chief financial officer at the University of Sheffield, thinks the fall in surpluses may have something to do with increased volatility in student numbers under the new system. A decrease in numbers will hit income before a university has a chance to reduce its costs in line with the decline. But a rise in home undergraduate numbers is likely to produce only a marginal financial benefit – given that any increase in student numbers requires more spending on teaching or accommodation.

So do the figures indicate who is set to benefit from the new fee regime? One vice-chancellor of a research-intensive university, speaking anonymously, notes high surpluses at some post-92 universities. “Many of us thought that they were the big winners of the 2012 fee deal,” he says, adding that newer universities tend to have less in the way of expensive-to-teach science and engineering subjects, “get lots of student opportunity funding” and may “pay out little” on bursaries and outreach schemes.

One criterion for examining financial health is to look at the net operating surplus (before exceptional items) as a percentage of total income. On this measure, the two best performers were small institutions: Norwich University of the Arts (18.7 per cent) and University College Birmingham (17.8 per cent).

Close behind were two larger post-92 institutions, Edge Hill University (16.0 per cent) and the University of Huddersfield (15.8 per cent), and the smaller Liverpool Institute for Performing Arts (16.0 per cent).

Arts University Bournemouth, the University of Bedfordshire, Birmingham City University, Bishop Grosseteste University, Leeds Metropolitan University, Liverpool Hope University and the University of Winchester all had surpluses of more than 10 per cent. By contrast, the London School of Economics was the only sizeable pre-92 institution to record such performance.

Meanwhile, Russell Group members the University of Exeter and the University of Birmingham recorded a small deficit (-0.7 per cent of income) and a marginal surplus (1.3 per cent of income), respectively.

John Cater has been vice-chancellor of Edge Hill in Lancashire since 1993, making him the longest-serving current head of any UK higher education institution.

He talks about not wanting to “waste the good years” by failing to build up surpluses during the £9,000 fee era, given the amount of uncertainty looming in the future.

Universities are guaranteed £9,000 fees for the next few years. “If you can’t create your reserves and resources during that period of time, it has to be a matter of concern,” he says.

When Cater looks into his crystal ball, he says his thoughts about university finances are “not very positive”. He notes that £9,000 fees will be worth about £8,200 to universities by 2016 because of the lack of inflationary increases since 2012; that there are “enormous amounts of uncertainty in teacher education”, a form of provision that is vital at Edge Hill; that the predicted demographic decline in the population of 18-year-olds in the North West “hits bottom in 2020-21”; and that there could be a new government with a new funding policy in 2015.

“Yes, I would like a war chest, I suppose,” he says. A surplus means “you are able to manage processes of change without making large numbers of staff redundant”, he adds.

When folk boast about the financial health of the sector, we need to note that the surpluses can’t help but emerge if pay is capped at 0.5 to 1 per cent per annum

On how the surplus is achieved at Edge Hill, Cater says: “I think we were right to charge £9,000 from day one, which has helped to support income flow. One third [of institutions] didn’t do that and perhaps lost some of the advantages they may have gained from so doing.”

All staff at his university are paid more than the living wage, he says, so saving on staff costs would not appear to be a driving factor in the surplus. But Cater stresses that Edge Hill has “very low central administration costs”, “very manageable debt” and runs “all our own student accommodation”.

The university works from a zero-based budget every year. “No one has any money they have inherited [from a previous year],” Cater says. “We budget from the centre – there is limited devolution.”

What about the theory of the research-intensive vice-chancellor, who thinks the £9,000 fee settlement benefited post-92 universities most?

“If you sat there and said: ‘Who are the principal beneficiaries of research funding, from the significant investment that has gone into science?’ That is not the post-92s,” Cater answers.

“Some post-92 institutions coped with the year of transition to the £9,000 fee rather better than others.”

He jokes: “If the [research-intensive] vice-chancellor would like to run Edge Hill and I’ll run the [research-intensive] institution, I’ll do a deal.”

Rabone thinks the fact that some post-92 universities enjoy the highest surpluses is “true generally”, rather than being a reflection of the new regime. “At any point in the past, you would have noticed that difference,” he argues, highlighting the fact that post-92 universities have expanded quickly and thus had to accumulate surpluses to finance buildings.

What does Andrew McConnell, director of finance at Huddersfield, make of the argument that £9,000 fees have benefited some post-92s, with their lower-cost subjects, most?

“There is probably some merit in that argument, in that you’ve got the opportunity to charge fees of up to £9,000 right across the board. If you’ve got a low cost base – which you have in Bands C and D [lower-cost classroom-based subjects] – then you make more out of a £9,000 fee,” he says.

And would Huddersfield have a lower cost base, in terms of subjects taught, than a Russell Group university? “It probably would – our average band is C, that is where the bulk of our provision is,” McConnell says.

Stewart Ward, head of education at RBS Corporate and Institutional Banking, says that “it is those post-92 institutions that have a well-defined strategy and have implemented a significant proportion of that strategy…that have probably been the biggest beneficiaries from the change in the system”.

The point about building up a surplus is not an abstract one. They are “absolutely essential” for universities to embark on capital investment, McConnell says. Given the sharp decline in capital funding from the state, institutions must self-fund the new buildings and facilities they need to attract students – and competing to attract students is now vital under a system based on student choice rather than centrally allocated undergraduate numbers.

The only alternative to funding building by using surpluses is to borrow. This looks set to rise in the coming years, with new models of borrowing such as bonds likely to become more popular.

The sector’s borrowing stood at £7 billion in 2012-13, according to THE’s figures. On average, each institution’s borrowing was equivalent to 24 per cent of its income.

The Higher Education Funding Council for England also looked at borrowing in its annual review of the financial health of institutions, published in March.

Big surpluses may lead to questions from the student population and the bank of mum and dad, around ‘is our £9,000 fee just paying for surpluses?’

Financial forecasts for 2013-14 “show that the sector plans to significantly increase expenditure on capital infrastructure” to £3.9 billion, from £2.6 billion in 2012-13, Hefce says.

To help fund this, the sector will draw £2.2 billion from its own cash reserves and borrow an additional £560 million, which will raise total sector borrowing to £6.8 billion by July 2014 (equivalent to per cent of total income), Hefce predicts.

The funding council adds some observations on liquidity, which is a measure of cash and other assets that can easily be turned into cash, and is an important index of an organisation’s ability to meet its financial obligations. “While borrowing is forecast to rise in 2013-14, forecasts show that net liquidity is expected to fall by £1,173 million to £6,224 million by 31 July 2014, below the projected sector borrowing level,” Hefce says.

As Hefce also notes, “strong liquidity is necessary for HEIs [higher education institutions] efficiently to manage the potential increased volatility and unpredictability arising from the changes in the funding system”.

For projected liquidity to fall below sector borrowing is unusual, McConnell says. “Cash reserves are falling, borrowing is increasing. That is the only way you can fill the gap if you’re not generating enough cash. In the time I’ve been in the sector, I think the sector has always had more cash than debt,” he observes.

Universities that have taken out bonds – debt sold to investors such as pension funds in which money is borrowed over a long period, for example, 30 years – have already recorded higher debt levels.

De Montfort University, which took out a £90 million public bond in 2012, stands seventh highest in terms of borrowing as a percentage of income (56.5 per cent). And the University of Manchester, which took out a £300 million bond in 2013, is 11th (52.2 per cent).

Only four institutions had borrowing equivalent to more than 70 per cent of income: the University of Surrey (70.2 per cent), Oxford Brookes University (75.7 per cent), the University of Worcester (100.3 per cent) and Queen Margaret University (162.9 per cent, after borrowing to build a new campus).

Chris Hearn, head of education at Barclays, says UK higher education’s financial health and level of surplus is “pretty remarkable”. The sector’s borrowing level of £7 billion needed to be judged against its considerable asset base (which stands at £37 billion), he argues. Looking at borrowing against capital produces a measure known as gearing.

“When you look at the borrowing level against the assets employed across the whole of the sector and you look at the amount of surpluses it is actually creating, the sector continues to be relatively low geared,” Hearn says.

The apparent relatively high debt of a university such as Manchester is not the full picture, he continues. “That is because when you raise finance from a bond, as they did in 2013, all the debt comes on to their balance sheet immediately.” More orthodox bank borrowing is drawn down gradually.

But Manchester with its bond “will also be sitting on very high sums of cash as well”, Hearn adds. “I would be amazed if the bond community doesn’t continue to be massively interested in UK universities,” he continues.

For universities, the attraction of bonds is that their main asset – their estate – “needs to be constantly maintained”, Hearn says. “I think the sector will always have to have a certain level of debt, just to be able to fund its investment in new infrastructure.”

He believes that it makes “an awful lot of sense” to pay off the debt long-term as the asset is used over time – and this is reflected in the structure of a bond.

RBS’ Ward believes that some universities took a cautious approach on new buildings, holding back before the introduction of the new fee regime because of uncertainties about future cash flow. These institutions are now “having to catch up and increase their debt capacity” – because if they do not build they may “damage [their] reputation with students”.

But Ward believes that, in general, there is “the scope for quite significant future borrowing across the sector”, both in terms of bond placements and more orthodox bank lending.

Highlighting the strong credit ratings assigned to De Montfort, the University of Cambridge and Manchester in their bond placements, he says there is “not a wealth of single A and triple A institutions coming to market”, meaning there will be “appetite for investors to be sourcing capital into the higher education space”.

But Andrew McGettigan, author of The Great University Gamble, has concerns about “non-amortising debt” – debt in which regular payments do not pay off the principal sum of the loan, only the interest.

“We are currently seeing a large increase in investment using reserves and borrowing,” McGettigan says. “This, in part, represents an attempt to rectify historic underinvestment. On the other hand, the steep climb away from the sector norms of the past decade and the vogue for non-amortising debt (such as bonds) raise concerns.

“Charity guidelines impress upon governors the need for ‘prudence beyond what would be expected in a commercial operation’. It’s not clear how to assess the new tensions arising between long-term stewardship and the competitive edge to market positioning.”

While the financial picture under the first year of £9,000 fees is generally positive for universities, some observers offer words of caution.

David Palfreyman, director of the Oxford Centre for Higher Education Policy Studies, says that “when folk boast about the financial health of the sector, [we] need to note that the surpluses can’t help but emerge if pay is capped at 0.5 to 1 per cent per annum” – as rises have been in recent years.

While the prospect of the University and College Union and the sector’s other unions winning a big pay award is a distant prospect, Palfreyman notes that “financial health fades away if ever UCU got a catch-up pay award. This has nothing to do with skilled and wise management!”

With the chance of having to shell out for possible pay rises, impending rises in costs in both the Universities Superannuation Scheme and the Teachers’ Pension Scheme, as well as an increase in employer National Insurance contributions in April 2016, there is plenty to keep a university finance director awake at night.

David Barnes, partner and head of education at Grant Thornton, says that with the high level of capital expenditure, increasing pension costs and “salary inflation coming in some form”, there are certainly “some quite big cash outflows coming”.

And while capital expenditure is often being pursued with the goal of making campuses more attractive to students, Barnes asks how much of the new building “is genuinely income-enhancing”.

Ward, of RBS, cautions that there is even a potential downside to positive financial results. “Those universities that are doing extremely well are starting to generate some very significant surpluses, much bigger probably than universities anticipated…The challenge that creates for some universities is public perception.”

When you look at surpluses in cash sums, rather than as a proportion of income, some of them look rather large. And here, it is the Russell Group that has the largest surpluses. The biggest were Imperial College London (£64.9 million), the University of Oxford (£49.5 million), Manchester (£38.4 million), the University of Edinburgh (£37.5 million) and the London School of Economics (£30.6 million).

Ward believes that big surpluses “may lead to some questions from the student population and the bank of mum and dad, around ‘is our £9,000 tuition fee just paying for significant surpluses in the sector? What’s happening to that cash?’ ”

He argues that the sector, the government and Hefce should ensure the public understands that surpluses are “needed to ensure we remain a world-dominant sector”.

As competition and the more marketised higher education system take hold, we are likely to see even bigger winners and even bigger losers among England’s universities in the future.