With the squeeze on traditional sources of funding for institutions, the spotlight naturally turns to where other funds may be found. Sadly, there is no ‘pot at the end of the rainbow’ on offer but consideration of alternative funds sources should include a closer inspection of the Sterling bond markets.
This article highlights funding opportunities from two key bond market alternatives and recommends diversifying sources of funding into these new areas. This includes targeting pension funds and insurance companies as longer term funders as well as individuals and alumni for shorter dated ‘retail’ bonds.
The UK bond markets offer a relatively untapped source of funding for the HE sector which, with a few exceptions, has typically funded itself via traditional bank lending. The credit crunch has shown that this lack of diversity in funding itself represents a risky strategy as traditional lines of credit and the willingness of lenders to lend (particularly for longer terms) has become compromised by credit and economic events.
Put very simply, bonds are debt instruments through which an investor lends money to an entity. The borrowing is for a defined period of time at a fixed rate of interest.
- A bond is a debt instrument issued by a bond issuer to bond holders. It is often termed a debt security, under which the issuer promises to (i) pay the holders interest (the coupon) at fixed intervals; and (ii) repay the principal (at the maturity date).
- Once issued to investors on behalf of the issuer by the lead manager (typically an investment bank) the ownership of the bond can be transferred by buying and selling in the secondary market. Bonds are issued by a huge variety of corporate, charity, municipal and state borrowers and do not need to be for a defined project or activity.
UK Public Bond Market
- This market is commonly called the Eurobond market. These bonds are issued in London in all major and many minor currencies; there is no need for a ‘Eurobond’ to be issued in Euros. The natural currency for HEI funding is of course Sterling.
- The Sterling Eurobond Market can accommodate a wide range of maturities; indeed, there have in the past been perpetual issues bearing no maturity date at all. However at the longer end where maturities of 30 years are common, the market is driven by UK based Pension Funds and Insurance Companies seeking to invest in long-term bonds to match their long-term liabilities. Being targeted at institutional investors, Sterling Eurobonds are issued in large denominations (usually £100,000). Covenant requirements in the bond prospectus (the main public document) are less severe than those required by banks for traditional lending, being typically limited to cross default and negative pledge. There will be no covenant tests or financial targets to meet.
- The institutional investor sector is currently very strong, reflecting the well-publicised decline in long dated UK Gilt yields. Thus bonds issued into this market are currently scarce and carry a price premium. Issuance will be at comparable cost or possibly cheaper than bank finance and very probably longer dated.
- In other words, the time is ripe to issue into this sector as funding is very cheap by historical standards.
- An additional beneficial factor has arisen out of the recent 30 year Sterling Eurobond issue by De Montfort University. The rating agency Moody’s rated this bond AA1 principally on account of its perception of an implicit guarantee provided by the UK Government to HEIs. Brunel and Keele also currently enjoy a Moody’s rating at this level. Cambridge University has also just received a AAA rating from Moody’s and immediately announced its intention to sell bonds for the first time in its 800 year history.
- The present ratings outlook therefore represents a useful springboard to prospective HEI bond issuers and an obvious window of opportunity in the current market.
- For HEI issuers not wishing to incur the expense of a formal rating, the Sterling Eurobond private placement market is, like the public market, currently very strong; as institutional investors will rate a private placement internally, formal ratings are usually not required.
Retail Bond Market
- The London Stock Exchange provides a listing and trading platform for the issuance of small denomination bonds denominated in Sterling called ‘Order-book for Retail Bonds’ or ‘ORB’.
- The listing and issuance process has been streamlined to facilitate simplified issuance and minimise cost, while covenant requirements are ‘light’ being similar to those prevailing in the Sterling Eurobond market.
- By virtue of denominations of £1,000, such bonds are targeted at individual rather than institutional investors. Buyers for retail bonds include higher net worth individuals, ISA and SIPP investors, as well as funds managed by stockbrokers. There is little if any overlap with the Sterling Eurobond market due to this difference in the investor base.
- We also see a strong additional opportunity for HEIs to access the alumni market with ORBs, resulting in additional strong diversification from traditional lines of bank funding.
- In 2011, £870m was raised on the ORB, demonstrating a consistently good investor appetite from a diverse range of issuers. There is currently very good demand for new issues, with many selling out as orders prior to their official issue dates. Issuers to date have included Places for People, Primary Health Properties, Tesco Bank and National Grid. However it is yet to be tapped by a HEI.