The pandemic is likely to disrupt the enrollment of overseas students, which would tighten the screws on English universities' finances. As reported in April 2020, S&P Global Ratings expects the COVID-19 pandemic to slash enrollment figures of international students for academic year 2020/2021 (see "COVID-19 Means International Students Could Give English Universities A Pass," published on April 9, 2020). Over the past years, as government grants steadily fell, English universities turned to international students to sustain their revenue and performance. They will need take decisive action to address the financial effects of a dearth of overseas student enrollments. Maintaining performance across the sector will rely on individual management teams adjusting their cost structures, while preserving the quality of teaching.

More-reputable universities tend to have a higher proportion of international students as a percentage of total enrollment. We therefore believe that these universities are most at risk to potential losses of income-compared to universities with a domestic focus. That said, these universities are probably better placed to weather the financial pressure. They can use their brands to attract more domestic students and achieve higher cost savings than newer universities that typically operate on leaner cost bases.

S&P Global Ratings currently has a negative outlook on 50% of its rated portfolio, reflecting the current challenges affecting the sector. In our view, while financial performance will deteriorate in the interim, we expect universities to retain high levels of financial resources to prevent a structural decrease in creditworthiness. Compared with their U.S. peers, English universities have smaller endowment funds; therefore, we expect them to be more proactive in cost management to ensure adequate liquidity position over the next year. We anticipate that operating expenditure (opex) items, such as payroll, will be reviewed and capital expenditure (capex) relating to new projects will largely be paused. Institutions that cannot make such cost savings could end up drawing on established liquidity lines or new facilities obtained in the capital markets to provide a liquidity buffer.

Fortifying Finances For The 2020/2021 Academic Year

The higher education sector in the U.K. was battling financial headwinds even before the pandemic. Wage inflation and increasing pension contributions were hiking up operating expenditure and weighing on operating margins.

Despite recording low operating performance, universities were still able to generate steady positive operating cash flows. They often used these to fund capex, rather than relying solely on debt funding. As the pandemic emerged during the financial year ending July 31, 2020 (FY2020), we believe this gave many universities time to drastically reassess capital programs in light of near-term uncertainties on income. In our view, this resulted in a large number of entities entering FY2021 with more cash and financial resources than usual.

Universities' cash flows are often lumpy intrayear, with cash being generated in enrollment windows, chiefly October and January. Disruption to October's window could bring acute liquidity strains at the start of the academic year for some universities. To combat this, the U.K. government announced that it would reprofile tuition fee grants, such that the majority were received at the start of the 2020/2021 academic year, rather than the end. This should help reduce the risk of liquidity problems if there is a material reduction in enrollment. That said, it is a short-term measure and more liquidity could be required toward the end of the year, especially with tuition fee grants now being front-loaded.

Domestic Students Will Not Compensate For Lost Overseas Income

We expect domestic enrollment at most universities to hold up well, largely due to a weakening labor market and temporary travel restrictions in many countries. Traditionally, students would often choose to defer studies to have a gap year in which to work or travel. Given such options are more limited during the 2020/2021 academic year, we believe domestic enrollment will remain strong. In the next few years, we expect an increase in the number of 18 year olds within the U.K. to contribute to a structural rise in demand.

In contrast, a high level of uncertainty looms over international student enrollment because the pandemic has led to restrictions on air travel and stricter entry requirements for many countries. Our base case assumes that international student numbers, in particular, those postgraduate students attending one-year courses, to see a material reduction. They are likely to opt to defer their studies for 12 months in order to get a better student experience or take courses in their home countries.

While we expect fewer international students, application data suggests there is still appetite to study in England. Demand may have been supported by stricter border policies at other English-speaking destinations, such as the U.S. and Australia. In addition, these destinations offer somewhat less favorable working permits following graduation. This could make the U.K. the default place to study if students are open to travelling. We expect international students to enroll throughout October, some remotely. Universities are therefore likely to have a clearer view on whether strong application data has been converted into enrollments in November.

We anticipate that universities that generally enroll significant levels of international students will take a financial hit to their income over the next 12 months if overseas enrollment dwindles. Although domestic enrollment may increase for these universities, such students generate narrower margins than international ones--they will not entirely make up for lost income (see chart 1).

Chart 1

The Evolution Of Spending

We expect many universities to implement measures to reduce opex. Payroll is one of the largest cost areas for universities, which may consider releasing savings in this area, through measures such as reducing hours and voluntary severance programs. Aside from payroll, we expect universities to save on discretionary spending, where possible. That said, preparing to teach online has temporarily increased costs for universities, even though we understand many institutions already provided online teaching, in some form. We could also see costs spiking if universities need to adapt campuses to make them safer. Overall, we expect large cost-cutting measures to be introduced across the higher education sector to reduce the financial gap created by weaker international demand. These measures should offset any short-term cost increases due to the pandemic, resulting in an overall drop in universities' operating expenditure.

Capital programs are also likely to be paused in the interim, as universities seek to conserve cash. We expect any pause in capex to be temporary--many universities undertake extensive capital programs to ensure their facilities remain competitive.

Newer, post-1992 universities tend to operate on a tighter cost base than older universities. They have less revenue flexibility because they have had fewer international students. Therefore, it may be harder for them to cut costs this year. Universities that already have lean cost bases, or those with small capital programs, could increase borrowing to shore-up their liquidity. We expect to see some drawing on credit lines and some making private placements on the capital markets.

Banking On Brands

Although higher-ranked universities may be most affected by a fall in the number of international students, we believe they have more options when it comes to offsetting the resulting financial pressure.

Attracting students during a pandemic requires a strong brand. The removal of the 5% temporary student cap--introduced to reduce competition in light of reduced international enrollment--will probably benefit higher-ranking universities more by enabling them to increase domestic enrollment. Furthermore, teaching at humanities-orientated universities, such as Oxford, should be shielded from disruptions, to some extent, because these subjects rely less on practical work.

A strong brand also implies that the university may have more leeway to cut costs now. Recent revenue growth may mean that the university has not been operating on the leanest cost base possible. If so, higher-ranking universities may now be able to make easy savings in the short term, which are not available to universities that have been operating on stricter cost bases. For example, research-orientated universities with strong reputations could save on marketing and travel expenses. The reputation of the university should support enrollment in the short term, while reduced travel by academics during the pandemic will help materialize some immediate cost savings.

The creditworthiness of English universities depends heavily on the size of their financial resources and management's ability to reduce costs without jeopardizing teaching provisions.