Concession Renegotiation and

Project Refinancing in Practice

in England

Kevin HanlonDirector, 4ps

April 2008

the UK PFI/PPP programme to date

• PFI was launched in 1992 in the UK and is now used to build Houses, Schools, Hospitals, Roads, Waste Plants….

• The UK has successfully closed over 900 deals, over £54 billion is invested and UK liabilities stand at around £155billion

• Services are being delivered on over 450 operational projects• PFI will continue to be chosen as the procurement option where it delivers

the best value for money

• PFI represents 10-15% of UK capital investment per year

• Current UK PFI investment levels for the 3 years 2007/08 – 2009/10 is £12billion

• Major PPP schemes: £26billion London TUBE Underground; NHS Connecting for Health £12billion, MoD Air Tankers £13billion, £5billion M25 road expansion

closed UK PFI deals

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Cap

ital V

alue

()

즡

0

20

40

60

80

100

120

Num

ber o

f Pro

ject

s

Capital Value ( )즡 No. of deals

Source: HM Treasury, PFI: strengthening long-term partnerships, March 2006

Note: Between 2006 and 2010, based on returns in 2005

closed UK PFI deals by sector

Chart 2.7: Total capital value of projects by department

20%

2%

11%

19%

12%

18%

5%

3%3%

4% 3%

DoHDEFRAMODDfESHome OfficeODPMDW PHMRCDevolved AuthoritiesDFTOther

Source: HM Treasury, PFI: strengthening long-term partnerships, March 2006Closed deals excluding London Underground

UK PFI deal pipeline

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1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Health MOD Educationand Skills

DFT Scotland NorthernIreland

ODPM DEFRA Wales Other

즡

Preferred bidder Post-OJEU Pre-OJEU Projected spending

Source: HM Treasury, PFI: strengthening long-term partnerships, March 2006

Realising Returns in PPP/PFI

• Dividends, Interest and Margins on debt, operating profits and certainty of 25 year cash flows

• Variations to service, revised tax treatments, restructuring cash flows, robust SPV and cost management

• Disposal to secondary market (A increasing number of large UK PFI contractors have sold PFI/PPP investments to the secondary market as their business matures).

• Securitisation of cash flow (dividends) by raising additional finance now against the secure income stream (dividends).

• Refinancing the deal (a number of early PFI deals refinanced with very large returns)

Refinancing

• Research to date shows about 47 Government PPP/PFI deals have refinanced securing £137million for the Government. Prior to July 2002 their was no code for sharing gains between the public and private sector with the private sector ‘winning’.

Activity is currently subdued due to market conditions.

Refinancing

• Research shows to date 32 large UK PFI/PPP contractors (Carillion plc sold £24m of investments for £46m, Jarvis plc liquidated all its investments due to cash problems, MillGroup sold its investments to Land Securities etc) have sold their investments and there is consolidation in PPP/PFI investment by major city funds (e.g. the £1billion Land Securities Trillium fund buying up investments)

• Issued in the UK July 2002 the Voluntary (Office of Government Commerce) PFI Code requires 50:50 share in refinancing gains

• Refinancing has focused on larger projects in transport and health

• Smaller projects could be pooled and refinanced

• Refinancing is complex, time consuming and can be expensive in advisory fees. The outcome can be very different between the public/private sector.

PFI/PPP Refinancing Deals – Norfolk Hospital

Refinanced deals: Norfolk & Norwich NHS £197million Hospital PFI. The value of the contract is £1.3 billion over its term. In 2003 year 6 of the project post construction the 20 year bank debt was switched to cheaper 32 year bond financing leading to lower NPV as repayment of borrowings was pushed back giving a £29 million gain; and slightly lower funding costs Guilt+ 81bps (LIBOR+51bps) replacing LIBOR + 125bps a £5 million gain. Borrowings were increased by £81million and released to shareholders with the project term increasing from 34 to 39 years and expected returns taken early. Increase in IRR to shareholders post refinancing 16% to 60%. Full £115million in gains split 70:30 private:public sector.

PFI/PPP Refinancing Deals – Norfolk Hospital

Note: The Trust’s terminationliabilities would be payable as a lump sum equal to Octagon’s outstanding debt if the Trust defaults on its contractual obligations or chooses to end the contract early (for reasons other than Octagon defaulting on its

contractual obligations).

Note: Based on information provided by Octagon at the time of the refinancing the maximum potential immediate cash flow benefit to Octagon’s investors following the refinancing was £129 million. After agreeing to share the refinancing gains with the Trust, the available immediate cash benefit to Octagon’s investors was £81 million.

PFI/PPP Refinancing Deals – Fazakerley prison

• In 1995 the signed Fazakerley prison worth £247million over 25 years refinanced in 1999. The refinancing: extended the contract and debt from 20 to 26 years (£5.2million gain); reduced lending margins from 150bps to 90bps (£2.6million gain); redeemed early subordinated debt (£0.3million gain) and arranged a fixed hedged rate of interest covering the full loan term (£2.6million gain) total £14.1million. The returns to the contractor increased by 61% from £17.5million to £28.2million.Early termination costs increased by £13.5million due to the refinancing. The public sector received only £1million as a share of the deal (very poor due to a lack of guidance and understanding). .

PFI/PPP Refinancing Deals – Fazakerley prison

How increasing the maturity of the senior debt facility for the Fazakerley project created £5.2 million of additional value for shareholders

Increase in termination liabilities would

be up to £13.5 million.

PPP Refinancing Deals - NATS

• An Air Traffic Services Partnership deal refinanced due to severe financial difficulties £600million investment deficit arising after (9/11) and a decline in passenger numbers against original forecasts.

• Refinancing included: • Major cost reductions (£200million) and less

aggressive prices decreases to be passed to airlines agreed by CAA (£100million)

• Reduced risk from volume in traffic down turn as its charges increase as traffic declines

• £600m of bank debt refinanced into bonds

• New equity investment by Government, BAA and shareholders £300million

• Banks fees now determined by credit ratings

• Cost of refinancing £55million in fees

PPP/PFI Concessions

• PPP/PFI contracts typically are 10-25 years

• Most Operational Projects will make changes (variations). Research shows in 2006 about £180million was spent on operational PFI project variations many where poor VFM (source NAO 2006).

• Most PPP/PFI projects have Benchmarking provisions in years 5,7,10 then every 5 years for soft services and utility/volume services

• PFI/PPP is seen as inflexible in undertaking minor variations

• The change mechanism in PFI contracts can be unwieldy

• Disputes can be expensive

• The majority of operational PPP/PFI projects reviewed by KPMG, PUK, 4ps and others in the UK are seen to be working well in terms of services with issues mainly around benchmarking; refinancing and variations (cost)

Concession/Renegotiation Challenges

• Problems arise during the concession due to:

Poorly costed private sector bids loosing money (traffic volumes, service costs) and seeking recompense or change

Poor Service Specifications and frequent changes

Poorly managed risk transfer (services, latent defects, utility volume/price risk, insurances)

Poor project management during the operational phase of PPP/PFI contracts

Lack of market testing variations for VFM

Lack of Due diligence (costs; vfm; specifications; flexibility; demand) by the public sector prior to signing the deals

• Contract managers avoid making legal variations for all but the largest cases and informal processes have been developed by contract managers to allow for efficient management of (mostly small) changes

Concession/Renegotiation Challenges

• Most High value changes to Operational PPP/PFI projects are not tendered (source NAO making Changes in Operational PFI/PP projects 2006)

• The costs of even minor changes can vary greatly. Opposite graph shows the cost of installing an electrical socket in PFI varied from £32 to £302 (source NAO making Changes in

Operational PFI/PP projects 2006)

Competitively tendered22%

Not suitable for competitive tendering

43%

May have been suitable for competitive tendering

35%

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Concession/Renegotiation

• The UK Treasury has set up the Operational Taskforce (PUK/4ps) to provide guidance and support to operational PPP/PFI projects• Guidance includes:

Technical Notes on BenchmarkingTechnical Notes on VariationsContract Management Guidance A help desk for enquiries and consultancy (banking/legal/finance) support

• Standard 4ps/Treasury contracts exist in the UK for PFI/PPP to deal with:• Benchmarking• Contractor dispute resolution• Market testing and • new Change Protocol drafting is being introduced in 2008 to deal with

variations with standard prices and processes• The UK NAO recommends: Market Testing cost variations for vfm; better use of

guidance and use of professional advice

The Developing PPP European Market

Country Major PPP Investments

Germany Roads, Defence

Spain Roads

Portugal Hospitals

UK Schools, Hospitals, Defence, Roads, Housing, IT

Holland Water Works

Greece Roads

Italy Roads

Contact

Kevin Hanlon

Projects Director, 4ps

kevin.hanlon@4ps.gov.uk