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Higher Fees Lead to Marginal Net Financial Benefit Enrolment Reforms Make Revenues Less Predictable Student Demand May Change In An Era Of Higher Tuition Fees Creditworthiness Will Hinge On Management Demographic Challenges Ahead Related Criteria And Research
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More importantly, the new funding system will increase universities' exposure to another major reform: the relaxation of controls on student numbers. As some universities choose to expand their student bodies, others are likely to contract, leading to higher revenue volatility than the sector is used to managing. We therefore believe that management skill and expertise in setting fees, marketing the universities, and managing ongoing changes to student
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demand in the context of an evolving public policy framework will become increasingly crucial to universities' credit profiles. We believe that universities that fail to adapt effectively to the changing environment may see increasing volatility in their revenues, leading to a potential decline in credit quality. That said, in the event of impending financial failure, we generally believe there is a moderately high likelihood that the U.K. government, through the funding councils, would act so as to avoid a cash default, probably by brokering mergers or advancing grants where necessary.
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Nevertheless, there are some aspects of the funding shift that could be positive from a credit perspective. First, it could lead to greater revenue autonomy for those universities able to raise their fees without undermining demand. Second, universities wanting to spend less on capital investment and more on operating expenses may have more flexibility than under the old system, which had greater restrictions on use of the capital grant. And third, universities with stable demand may find that their revenue base is more predictable, and less dependent on ad hoc government policy decisions. However, these potential advantages should not be over-stated. Tuition fees are still capped at 9,000, and we do not see this limit rising in line with inflation in the context of the political sensitivities we describe above. And the more research-intensive universities are still materially exposed to government decisions affecting research funding, whether through funding council grants, research councils, or research contracts with other public sector entities. Although the shift to tuition fees from grants is a big conceptual change, universities will in practice continue to benefit from the stability of public sector revenue sources. This is because, for the most part, the SLC pays tuition fees directly to the universities on students' behalf. And importantly, it is the SLC, not the universities, which has direct exposure to the repayment rates on these loans. That said, we understand that the SLC will make advances to the universities in fewer installments over the year than funding council grants, causing some necessary adjustments to universities' working capital requirements.
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Another change that the new funding system has brought about is that universities will become more sensitive to volatility in student recruitment. Under the previous system, the HEFCE teaching grant was payable as long as universities recruited within 5% of their enrolment targets. Under the new system, if a typical university (with, say, annual undergraduate enrolment of 3,000 students and turnover of 250 million) recruits 5% less undergraduates than planned, it could face a budget shortfall of 0.5% of revenues. This would not be insignificant in a sector that typically posts low margins. HEFCE forecasts, for instance, that the higher education sector in England will average an operating surplus of less than 2% in financial 2013.
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Looking ahead to financial 2014, we expect that enrolment may continue to be volatile. Given that most universities do not publicize their plans for enrolment, it can be difficult for them to accurately forecast what proportion of their offers will lead to enrolments. And universities will be reluctant to make too many offers beneath ABB that they are then obliged to honor, as they could risk penalization by HEFCE for recruiting above limits remaining under the block grant. That said, the further relaxation of the limit to include ABB grade students should enable mid-to-high-ranking universities to increase recruitment of students at that level, to compensate for reductions in their AAB+ grade enrolments. This, in turn, may of course depress the numbers of students that the less popular universities recruit, particularly universities that enroll ABB students but do not want to bid for the additional student places on courses costing less than 7,500 per year. We believe that expansion is likely to be limited to where existing infrastructure capacity allows it. Given the uncertainty over how this reform will develop over time, it's unlikely that many universities will be willing to increase investment in infrastructure to support a material expansion of home and EU undergraduates. Furthermore, many, but not all, of the universities with the strongest demand tend to be more interested in expanding their numbers of postgraduates (to help with research activities) and overseas students (because they pay higher fees), than home and EU undergraduates.
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Table 1
Source: UCAS, as of the January application deadline. We note that some universities accept applications after this date.
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Table 2
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trend towards students living with their parents, we will continue to follow any changes in this area, and any consequent pressure that this might place on universities' relationships with project companies.
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The U.K. think tank Higher Education Policy Institute estimates that the 18-20 age group--which forms the majority of undergraduate applicants--will decline by 13% in the 10 years to 2020/2021, before rising again at least partially. In what we view as the most likely scenario, we believe that this decline will be largely offset by other factors, such as increasing participation rates in the U.K. and growth in overseas students. But if universities are unable to take advantage of such offsetting factors, then a demographic shift could lead to noticeable fall in demand, until the demographic trend reverses. In this light, the impetus for well-targeted recruitment and a clear management strategy is timely, and may even fortify credit strength over the long term.
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