Download - Pfi Credit Crisis
-
8/4/2019 Pfi Credit Crisis
1/37
HM Trsr
Financing PFI projects in the creditcrisis and the Treasurys response
RepoRT by THeCoMpTRolleR andaudiToR GeneRal
HC 287
SeSSion 20102011
27 july 2010
-
8/4/2019 Pfi Credit Crisis
2/37
The National Audit Ofce scrutinises public spending on behal o
Parliament. The Comptroller and Auditor General, Amyas Morse, is an
Ofcer o the House o Commons. He is the head o the National Audit
Ofce which employs some 900 sta. He and the National Audit Ofce
are totally independent o Government. He certifes the accounts o all
Government departments and a wide range o other public sector bodies;
and he has statutory authority to report to Parliament on the economy,
efciency and eectiveness with which departments and other bodies
have used their resources. Our work leads to savings and other efciency
gains worth many millions o pounds: 890 million in 2009-10.
Our vision is to help the nation spend wisely.
We apply the unique perspective o public audit
to help Parliament and government drive lasting
improvement in public services.
-
8/4/2019 Pfi Credit Crisis
3/37
Ordered by the House o Commons
to be printed on 26 July 2010
Rrt th Cmtrr atr Gr
HC 287 Session 20102011
27 July 2010
London: The Stationery Oce
14.75
This report has been
prepared under Section 6
o the National Audit Act
1983 or presentation to
the House o Commons
in accordance with
Section 9 o the Act.
Amyas Morse
Comptroller and
Auditor General
National Audit Oce
22 July 2010
HM Trsr
Financing PFI projects in the creditcrisis and the Treasurys response
-
8/4/2019 Pfi Credit Crisis
4/37
This report examines the eects o the
credit crisis on privately nanced government
inrastructure projects, the Treasurys response
and the challenges ahead.
National Audit Ofce 2010
The text o this document may be reproduced ree o charge in
any ormat or medium providing that it is reproduced accurately
and not in a misleading context.
The material must be acknowledged as National Audit Ofce
copyright and the document title specifed. Where third party
material has been identifed, permission rom the respective
copyright holder must be sought.
Printed in the UK or the Stationery Ofce Limited
on behal o the Controller o Her Majestys Stationery Ofce
2378668 07/10 STG
-
8/4/2019 Pfi Credit Crisis
5/37
Contents
Summary 4
Part One
The Treasurys response
to the eect o the credit
crisis on privately nanced
inrastructure projects 14
Part Two
The eect o the new
nancing terms on contracts
let since the credit crisis 20
Part Three
The inrastructure challenges
in the current economic
environment 26
Appendix One
Methodology 29
Appendix Two
PFI Benchmarking 31
Appendix Three
Case Studies 32
Glossary 34
The National Audit Oce study team
consisted o:
Mark Halliday, David Molony,
Colin Ratclie, Jonathan Tang and
Richard Wade, under the direction
o David Finlay
This report can be ound on the
National Audit Oce website at
www.nao.org.uk/inrastructure-
nancing-2010
Photographs courtesy o
xxxxxxxxxxxxxxxxxxxxxxxx
For urther inormation about the
National Audit Oce please contact:
National Audit Oce
Press Oce
157-197 Buckingham Palace Road
Victoria
London
SW1W 9SP
Tel: 020 7798 7400
Email: [email protected]
Website: www.nao.org.uk
Twitter: @NAOorguk
-
8/4/2019 Pfi Credit Crisis
6/37
4 Smmr Financing PFI projects in the credit crisis and the Treasurys response
Summary
Introduction
Economic and social inrastructure orms the backbone o economic activity1
in the United Kingdom, and enables the delivery o public services across thecountry. The term inrastructure encompasses social and economic sectors such as
communications, education, energy, health, transport, waste and water.
In the ve years to April 2010 approximately 30 billion per year was invested in2
UK inrastructure. Future investment is orecast in the range o 40-50 billion per annum
until 2030. Investment is nanced in a range o ways:
Finance can be provided by private companies, but with some orm o explicit
public regulation or implicit public support. Examples include the water and energy
sectors, which are largely privately owned and nanced.
Finance can be provided by public resources only, or or large one-o projects
such as the Olympics, with a mixture o public and private resources.
Finance can also be provided under the Private Finance Initiative (PFI) or other
orms o Public Private Partnership (PPP). Sectors o economic and social
inrastructure provided in this way include, or example, new hospitals and
some roads.
PFI projects are long-term contractual arrangements between public authorities3
and private sector companies with project nancing raised by private companies.
Project nance means that the nancing is provided or a sole project, through a special
company set up or the purpose. Departments generally conclude that the contract
oers value or money when the benets associated with the transer o project risk
outweigh any additional PFI nancing cost.
PFI projects typically use around 90 per cent debt nance and 10 per cent equity4
nance. The debt portion o this nancing can be provided by bank loans and/or bonds.
The banks and bond holders receive interest on their loans related to risks. Interest
charged on a bank loan is usually a combination o two parts, the reerence rate (usually
the interbank rate) and the loan margin (Fgr 1). The interbank rate refects general
market risks, while the loan margin refects project specic risks. Variable rate bank loans
are swapped to xed rates to provide stable monthly payments over the project lie.
-
8/4/2019 Pfi Credit Crisis
7/37
Financing PFI projects in the credit crisis and the Treasurys response Smmr 5
Bond nance is where a loan is split up into many identical bonds which saving5
institutions can trade in public markets known as capital markets. Credit Rating
Agencies analyse individual project and nance structure risks and publish a rating as
a guide to investors. Beore the credit crisis, the purchase o credit insurance could
improve the rating o the bond, thus making the risks acceptable to non-specialised
lenders such as pension unds.
In late 2007, market condence in the providers o this credit insurance collapsed,6
leaving PFI projects in the United Kingdom without access to capital markets.
The bank loan market, however, continued to unction. Banks can make loans7
while they have sucient reserve capital (see Glossary) to allocate against them. To keep
making new loans banks must ree up reserve capital by selling existing loans, in whole
or in part, to other banks or raise new capital. This process is known as syndication.
The collapse o Lehman Brothers in September 2008 led to a halt in loan syndication,continuing throughout 2009. This limited the ability o banks to make new PFI loans.
The equity nance is provided by a projects contractors and nancial institutions.8
It typically comprises a mixture o shares and shareholder loans. Equity nance is known
as risk capital because, generally, the equity will be lost rst i the project company
ails. The shareholder loans are higher risk as their repayment in a ailure is junior to the
external debt, known as senior debt, which is repaid rst.
Figure 1
This shows how a variable rate loan is converted to a fixed rate and the
composition of loan interest costs
NOTES
1 LIBOR means the London Inter Bank Offered Rate (see Glossary) which is similar to base rate, but usually higher to
reflect risk of bank failure.
2 A swap fee is payable to convert a variable rate loan to a fixed rate loan. Short-term rates can often exceed long-term
rates during the life of a project.
Source: National Audit Office
Reflects
Project Risks
Reflects
Market Risks
Cushion for changes
in Market Risks
Swap Fee
Margin
Index Rate
(LIBOR) Variable
Swapped Rate
(LIBOR)
Fixed Long Term
Margin
-
8/4/2019 Pfi Credit Crisis
8/37
6 Smmr Financing PFI projects in the credit crisis and the Treasurys response
Sc
This report examines the eects o the credit crisis on privately nanced9
government inrastructure projects and the Treasurys response. Although unable
to control conditions in the nancial markets, the Treasury sets guidance on how
departments assess value or money and approves signicant projects. It thereore
was responsible or coordinating the Governments response to the nancial crisis and
mitigating its impact on inrastructure procurement. In particular, the report sets out:
how the Treasury responded to the impact o the credit crisis on the availability
and terms o nance or PFI contracts;
the impact o the credit crisis on the cost o nance or PFI contracts; and
the challenges ahead.
The report does not consider the value or money o individual projects, nor does it
address the remit o Inrastructure UK, the new body established to coordinate the
Governments approach to the inrastructure challenge. The report does, however, make
recommendations on issues that Inrastructure UK should address.
Figure 2
Average international project finance loan margins compared to PFI
Margin (%)Credit Crisis
Year
No of PFI deals
NOTES
1 The margins are averages based on monthly data.
2 Numbers in bold are the number of PFI projects financed in that year.
Source: National Audit Office and project finance chart based on data from the Infrastructure Project Finance Benchmarking Report 1995-2009 further
description at http://infrastructureeconomics.org/2010/02/09/project-finance-benchmarking-report/
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
1998 1999 2000 2001 2002 20031995
1 15 24 46 54 68 52 54 51 61 50 57 57 31 35
1996 1997 2004 2005 2006 2007 2008 2009
All PFI
-
8/4/2019 Pfi Credit Crisis
9/37
Financing PFI projects in the credit crisis and the Treasurys response Smmr 7
K fgs
The Treasurys response to lower availability o nance
The Treasurys role in establishing the PFI market contributed to reductions10
in the risk margin o private debt nance between 1999 and 2007. Over this period,
the establishment o the PFI market and the availability o bank nance lowered nancing
costs as bank competition increased. Departments took advantage by letting around
300 contracts with relatively low nancing charges. The part o the interest cost relating
to project risk, the PFI loan margin, averaged around one per cent, or less. These rates
were lower than intern ational project loan margins which averaged 1.7 per cent rom
1994 to 2008 (Fgr 2).
As the credit crisis took hold in autumn 2008, debt nance became11
increasingly unavailable. As a result o market conditions, largely outside the
Treasurys control, rst bond nance, and then bank nance, became severely restricted.
But as the UK economy entered recession, the Government had a signicant pipeline o
inrastructure projects, with an investment value exceeding 13 billion (Fgr 3).
Figure 3
The investment value of UK infrastructure projects notified in the Official Journal of the European
Union as at March 2009
billion
NOTES
1 Building Schools for the Future (BSF) is a secondary schools investment programme.
2 Local Improvement Finance Trusts (LIFT) finance primary medical care projects.
Source: HM Treasury
Capital value of pipeline by sector
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
Housing Health Street
lighting
Emergency
Services
Libraries Education
(other)
Waste Educat ion
(BSF)
Transport Leisure Prisons NHS
LIFT
Joint-service
centres
Courts
-
8/4/2019 Pfi Credit Crisis
10/37
8 Smmr Financing PFI projects in the credit crisis and the Treasurys response
The Treasury was concerned about the macroeconomic impact o the12withdrawal o debt nance. With debt nance increasingly unavailable, individual
contracts became harder to nalise. The Treasury eared that, as a result o this potential
slowdown in new PFI contracts, the opportunity to stimulate the economy through
new inrastructure would be lost. In addition, important benets, or example, improved
school acilities and dealing with road congestion, depended on the completion o
planned PFI projects.
The Treasury thereore sought to maintain a fow o signed PFI contracts.13
The overarching Government policy in late 2008 was that the pipeline o PFI deals
should reach nancial close promptly, to stimulate national and local economies, and
create jobs. The Treasury ollowed this policy whilst continuing to apply standard PFIvalue or money tests.
Bank lending was so restricted in late 2008 that, despite Treasury14
encouragement, no sizeable contracts could be let. In September 2008, the
Treasury asked the European Investment Bank to step up its lending to inrastructure
projects which the Bank did. The Treasury, however, did not set PFI lending targets or
UK banks when they received government support during that winter. The Treasury
initiated internal discussions about such targets but did not pursue them because the
banks concerned were a sub-set o the PFI lending market and because PFI lending
was only a small part o the issues acing the Treasury in relation to its banking support.
In early 2009, there continued to be insucient bank debt or larger projects becausebanks did not resume lending as expected.
The Treasury helped to reactivate the lending market or inrastructure15
projects by setting up its own nance unit. In March 2009, the Government rapidly
set up The Inrastructure Finance Unit to address the scarcity o debt nance. The
units role was to be available to provide government loans to inrastructure projects, on
commercial terms, so shortalls in the amount o available bank nance could be met.
In April 2009, The Inrastructure Finance Unit helped to nalise a large waste16
treatment and power generation project. The unit provided a 120 million loan to
complete a 582 million nancing package or a waste treatment and power generation
project in Greater Manchester. The Treasurys participation in this loan, on the same
terms as commercial banks, is intended to be temporary and reversible.
The Treasurys willingness to lend improved market condence and17
subsequently around 35 government inrastructure projects have been agreed
without any urther public lending. The Inrastructure Finance Unit has not made any
urther loans. But since its establishment, around 35 projects have been agreed. There
is thereore some evidence that the unit improved market condence. In addition, the
availability o government loans provided some competitive tension to the banks in a
market which, since 2008, had lacked competition on loan nancing terms.
-
8/4/2019 Pfi Credit Crisis
11/37
Financing PFI projects in the credit crisis and the Treasurys response Smmr 9
Th cst fc
We ound that as a result o the credit crisis, the total interest cost o bank18
nance increased by one-th to one-third. In the 35 projects agreed ater the
establishment o The Inrastructure Finance Unit, we ound that the part o the cost
relating to loan margins on PFI deals, which had been 1 per cent or less, widened
signicantly to around 2.5 per cent on average (Fgr 4). Some, or example, the
complex Greater Manchester Waste project, will rise to more than 3 per cent in stages
over the project lie. The increased loan margins resulted in substantial increases to the
cost o nance (Figure 4).
These increases occurred despite the all in short-term borrowing rates and19
little change in the intrinsic risk prole o projects. The all in the underlying short-
term bank lending rate (the base rate) to 0.5 per cent only had a slight impact on PFI
deals. This is because the private sector xes the interest cost on their long-term PFI
borrowings. This xed interest rate, currently around 4 per cent, refects the risk o uture
changes in interest rates and is a market actor that is not specic to PFI.
In line with policy on acting to stimulate the economy, the Treasury gave20
priority to closing deals at the prevailing market rates, even i this meant paying
more and banks carrying less risk. In addition to charging higher margins, the
banks have sought to de-risk their lending to projects ollowing the credit crisis. They
renegotiated their lending terms with preerred bidders, through: lowering the proportion
o debt in projects; increasing cover ratios (see Glossary); requiring the private sector
to inject risk capital earlier; and placing more onerous conditions on when the private
investors can withdraw cash rom the project.
Figure 4
Comparison o interest costs on PFI projects
Str ds lrg ds
pr crss pst crss pr crss pst crss
K csts Sm rcts(2007)
Sch sm(2009)
FSTa(Mrch 2008)
GMW(ar 2009)
M25(M 2009)
Level o project risk Various Low High/medium High Medium
Interest rate margin (%) 0.79 2.51 1-1.15 3.25-4.50 2.5-3.5
Total interest cost (%) 5.9 6.9 5.9-6.1 7.7-8.91 6.9-7.9
Increase post crisis
(minimum) (%)
+18 +31 +17
noTeS
1 The indicative level o project risk shown above illustrates the act that the projects are not directly comparable. The change in interest margin
percentages partly reflects this.
2 The Future Strategic Tanker Aircrat (FSTA) project raised unding o 2.5 billion. Greater Manchester Waste (GMW) borrowed 582 million.
3 The increase post crisis will rise with stepped increases in the interest rate margin i refnancing (see Glossary) does not take place.
Source: KPMG and National Audit Office
-
8/4/2019 Pfi Credit Crisis
12/37
10 Smmr Financing PFI projects in the credit crisis and the Treasurys response
Our analysis shows that the higher nancing costs increased the annual21charge o typical PFI projects by 6 to 7 per cent (Appendix Two). Riskier PFI
projects experienced a larger increase. For example, we estimate that the increase in
the nancing charges o the Greater Manchester Waste project added 12 per cent to
its annual contract price (Figure 11 on page 25). To address this, in October 2008 the
Treasury increased the public sector share o any uture reductions in debt costs rom
50 per cent to 70 per cent.
We estimate that between 500 million and 1 billion o higher cost has been22
locked in, partly oset by the increased public sector share o renancing gains.
The higher end o this range refects the dierence between current PFI bank rates and
low rates prior to the credit crisis. Although departments can now press investors torenance, any renancing requires careul judgement and will depend on uture market
conditions. We doubt whether more than hal o the current higher nancing costs might
be recovered.
Higher nancing costs eroded the value or money advantage that23
departments attribute to PFI. Departments initially seek assurance on the value
or money o PFI procurement by comparing alternative ways o providing the same
results. Although we have oten expressed concern about these calculations, the
typical estimate o the PFI cost advantage lay in the range o 5 to 10 per cent (and
some cases we have audited showed smaller savings). We estimate that nancing rate
changes increased the annual contract charge by around 6 to 7 per cent. This ndingsuggests an increased risk to value or money resulting rom the credit crisis. Given the
Governments policy objectives or stimulating the economy, we accept, however, that
delays rom resubmission o individual business cases might have put the policy at risk.
Although the Treasury and departments took steps to assess the impact24
on the value or money o projects, there were limitations to their assessment.
Despite the higher nancing costs the Treasury and departments considered that all
35 contracts let in 2009 continued to represent value or money. The Treasury relied
on the normal review processes or PFI projects and a review by Partnerships UK o
the expected eect o higher bank risk margins on a sample o projects. There were,
however, limitations to this approach, as:
although the Partnerships UK review, commissioned by the Treasury, was useul
analysis, it did not cover all projects let or all aspects o nancing costs. In addition,
the Treasury monitored actual nancing terms, but did not have a ull analysis o the
impact o the higher rates on the cost o projects that closed in 2009;
some schools projects did not ully reassess their business cases, using out o date
guidance which had said an updated quantitative analysis was only necessary i
costs increased by 25 per cent; and
the value or money assessments or the M25 and Greater Manchester Waste
projects continued to rely on assumptions, rom earlier business cases,that high savings in uture whole lie costs would not be available under
conventional procurement.
-
8/4/2019 Pfi Credit Crisis
13/37
Financing PFI projects in the credit crisis and the Treasurys response Smmr 11
Challenges
The Treasury, through Inrastructure UK, aces a number o challenges to25
identiy the best unding models or projects now being developed. The Treasury
has ormed Inrastructure UK to oversee inrastructure investment in the UK, including
aspects o Government capital spending. It will ace important challenges regarding the
prioritisation o projects and procurement methods given the large decit in the public
nances and the increased cost o using private nance.
There are alternative nancing options to PFI.26 Projects such as the Olympics
and Crossrail have relied on, or will be using, a greater input o public money. There were
other nancing options, and although these would not have been likely to achieve the
Governments policy objectives in 2009, they could be relevant in uture:
The French government guarantees 80 per cent o the debt, once a project
is operating successully, to reduce the use o bank risk capital and thereore
nancing costs. The disadvantage is that this approach is not a temporary or
reversible intervention and retains some operating project risk or the public sector.
The not-or-prot European Investment Bank (EIB) is generally able to make unding
available on more avourable terms (such as margins and ees) than commercial
banks. Some European countries have used public loans in a similar manner.
Ccs v r m
We have assessed how the Treasury managed the risks to value or money,27
rather than examining individual projects. Departments ability to nance the existing
programme was in doubt until the Treasury set up The Inrastructure Finance Unit and
reactivated the lending market. Our value or money conclusion relates to projects
actually nanced in 2009. However, we accompany that conclusion with a warning on
value or money or subsequent projects.
On projects nanced in 2009:28 It is our opinion that in the circumstances the extra
nance costs o projects nanced during 2009 were value or money. We take this view
because the overarching policy priority to provide economic stimulus severely limited thescope or the Treasury to do more than they did to protect public value while ensuring
that the programme o PFI projects was moved orward. In reaching this view we
considered the act that the nancing margin being paid had widened signicantly, and
that banks renegotiated lending terms which resulted in an increased cost o risk or the
public sector. We regard this as having been oset to some extent, and as ar as was
reasonably achievable in all the circumstances, by the increased renancing gain share
terms obtained by the Treasury.
-
8/4/2019 Pfi Credit Crisis
14/37
12 Smmr Financing PFI projects in the credit crisis and the Treasurys response
We also considered whether the PFI deals could have been required to29submit individual revised business cases, which might have led to some o the least
advantageous projects being postponed or discontinued with the eect o improving
overall value or money. We concluded that this requirement would have imposed urther
delay that might have put the policy objectives at risk, and would not thereore be a
reasonable yardstick to assess the protection o value or money in the programme.
However, having concluded thus positively on projects nanced at the height o the
crisis, we would expect more exacting criteria to be applied subsequently.
On projects which have yet to be ully developed:30 There should be no
presumption, based on earlier business case analysis, that continuing the use o private
nance at current rates will be value or money. We now expect a thorough projectby project review o the orward programme to apply more exacting and narrower
criteria than applied to projects nanced at the height o the crisis. PFI is less likely to
be value or money unless there are substantial and credible savings to oset higher
nancing costs. The Treasurys ormation o Inrastructure UK gives a platorm or wider
consideration o risks, other unding options and alternative procurement models.
Rcmmts
To the Treasury
Market disruption, causing a lower availability o nance, has interrupted
the Governments inrastructure programme.The Treasury should analyse
the lessons rom the past two years. It should use these lessons to prepare a
contingency plan or how departments should handle uture market disruption
aecting procurement plans.
There is limited evidence that projects undamentally re-evaluated their
business cases in light o the credit crisis. Where there are material changes,
such as project costs increasing by 15 per cent, the Treasury should require that
the department re-evaluate the project. This re-evaluation should assess all the
benets, and potential loss o benets, o continuing the project in its current orm,
compared to other available options, including other orms o procurement.
Increased reliance on a single type o nance, with reduced competition,c
promotes ineciency. The Treasury should continue to consider how a greater
mix o nance sources, with less emphasis on the use o commercial bank loans,
can be used to nance inrastructure projects.
-
8/4/2019 Pfi Credit Crisis
15/37
Financing PFI projects in the credit crisis and the Treasurys response Smmr 13
To the Treasury and departments
Allowing individual projects to negotiate renancing will lead to variable and
overall sub-optimal outcomes. The Treasury should adopt a portolio approach
to renancing, with input rom the relevant departmental team, so that individual
authorities do not exercise any right to a renancing on a piecemeal basis. During
the operating phase o a number o projects, taking a portolio approach will
enhance the public sector bargaining position, reduce transaction costs and
increase potential gains. The Treasury should also consider whether the returns to
equity investors are aligned with the changed risk allocation in deals that has arisen
ollowing the credit crisis.
The increase in nance costs, including some reduction in risk borne by
banks, makes PFI less likely to be a value or money solution. In line with
Treasury guidance, departments should not presume that a wholly privately
nanced project oers a solution likely to secure good value or money. During
procurement, and in drating notices or the Ocial Journal o the European Union,
departments should assess a range o nancing options, including all public
nance or part public and part private nance.
The public sector gave greater priority to securing agreed contracts than
to negotiating better outcomes. In such situations, departments should
nevertheless make greater use o sensitivity analysis to inorm decision-making
over negotiation on possible small changes in nancing rates and on each request
to take on additional project risk.
-
8/4/2019 Pfi Credit Crisis
16/37
14 prt o Financing PFI projects in the credit crisis and the Treasurys response
Part One
The Treasurys response to the eect o the creditcrisis on privately nanced inrastructure projects
During 2008, the market capacity or providing bank nance decreased, pricing1.1
increased and other terms tightened. Fgr 5 shows the main changes aecting the
nancing market and the eect on inrastructure projects.
Th Trsrs t rss t th mct pFi ctrcts
The Treasurys initial response was to evaluate the extent o the impact o nancial1.2
market disruption on PFI projects. From June 2008, it analysed increasing evidence that
the disruption to the credit markets was aecting unding or the PFI market, in terms
o both the pricing and availability o project debt. In particular, it concluded that market
changes had increased project costs, leading to delays, and putting the overarching
policy o stimulating the economy at risk. In addition, i cheaper nance were to become
available in the uture, the private sector would then gain more benet rom renancing
(see Glossary). Departments were, thereore, already being advised to seek a right to
bring about a renancing and obtain an increased share o any gains. In October 2008,
this was made a ormal amendment to standard contract terms.
Banks put up their ees and interest charges to borrowers generally, including1.3
PFI borrowers, but most were unwilling to provide long-term loans in greater amounts
than about 25 million per project. As a result many PFI borrowers had to take time to
assemble a club o ve or six banks to do a large deal. Such a deal would previously
have involved only one negotiating bank and later syndication on pre-agreed terms at
the risk o that lead bank.
All-in interest charges and other lending terms worsened or PFI deals during 2008,1.4
and most notably during 2009. Complex deals, like the M25 project and the Greater
Manchester Waste project struggled to orm bank clubs or the substantial amounts
they needed.
-
8/4/2019 Pfi Credit Crisis
17/37
Financing PFI projects in the credit crisis and the Treasurys response prt o 15
Figure 5
Key events and Treasury response
pr/dt K vts Trsr
rss
ect rstrctr rcts
December 2007 Last bond issue: Northern
Ireland Road II project raises
146 million
Projects, such as the Ministry o Deences Future
Strategic Tanker Aircrat project, change rom bond
to bank inance
March 2008 Future Strategic Tanker
Aircrat inancing raises
2,200 million
Bank group ormed with eight arranging banks and
15 participants. Interest cost about 6 per cent, up to
1.15 per cent above the then bank cost o unds
September 2008 Lehman collapse Some banks withdraw, others charge more than
1.5 per cent above cost o unds (some as high as
2.2 per cent) compared with 1 per cent previously.
This makes it diicult to procure debt inance to
complete contracts. Major projects such as the
Greater Manchester Waste project and the M25
are delayed
October 2008 Government provides banks
with inancial support
Treasury notes unding
gaps or large or more
complex projects
Projects compete with corporate borrowers or
scarce bank capacity. Finance cost increases are
partially oset by alling underlying interest rates.
Government support to the banking sector does not
trigger a rapid resumption in lending
November 2008 Treasury proposes a range o
possible solutions, including
greater EIB involvement
Increased Authority capital contributions
Authority loans on commercial bank terms
Working Group on medium-term solutions
January 2009 Treasury proposes direct
lending accepted
30 January 2009
Advice leaves open any decision on the lending
body, although Department or Transport may act
as lender on the M25
March 2009 Ministerial Statement on The
Inrastructure Finance Unit
Treasury lends 120 million to the Greater
Manchester Waste project which, in April 2009, is
the irst contract to be let ollowing the credit crisis.
Treasury places letter with lending criteria on websitein May. The market realises that it is now possible to
complete PFI deals in the current market conditions.
The M25 contract is let in May 2009 without the
need or a departmental loan
August 2009 Treasury Application Note
provides new guidance
or taking orward private
inance projects
No signiicant change is made in the way that projects
are assessed ater the Outline Business Case. The
intent is to avoid excessive reliance on uncertain
inancing proposals early in procurements, the low o
new deals is now becoming more established
Source: National Audit Office
-
8/4/2019 Pfi Credit Crisis
18/37
16 prt o Financing PFI projects in the credit crisis and the Treasurys response
The Treasury approached the European Investment Bank in September 2008, to1.5step up its lending activity to help ease the situation. The Treasury, however, did not
set PFI lending targets or UK banks when they received government support during
that winter. The Treasury initiated internal discussions about such targets but did not
pursue them because the banks concerned were a sub-set o the PFI lending market
and because PFI lending was only a small part o the issues acing the Treasury in
relation to its banking support. Banks did not resume lending as expected and, between
October 2008 and March 2009, only our smaller PFI projects were nanced, including
two school projects.
Th mct v r m ssssmts
The Treasury-chaired Project Review Group was responsible or the scrutiny o1.6
business cases or major PFI contracts. Partnerships or Schools undertakes the same
role or schools contracts. Both require projects to rework the economic assumptions
behind the choice o procurement route, made at the Outline Business Case stage, i
there has been market ailure or a major change. Current guidance does not contain
an actual number to dene what constitutes a major change, relying instead on overall
judgement. Some projects such as schools, however, took guidance rom August 2004
exempliying major change as an increased cost, in real terms, o 25 per cent.
In our audits, previous business cases oten indicated that PFI projects were1.7
expected to deliver savings in the range o 5 to 10 per cent. We have also reported in thepast that there were faws in these comparisons between the PFI price and conventional
procurement.1 An increase in the cost o nance thereore represented an increased
risk to value or money, and could have led to reappraisals o the value or money o
individual projects. A review o a sample o Outline Business Cases by Partnerships UK
estimated, however, that all cases remained value or money at higher bank risk margins
o 3 per cent.
Given the Governments policy objectives or stimulating the economy, we accept1.8
that delays rom resubmission o individual business cases might have put the policy at
risk. We also generally accept the case or absorbing higher nancing costs or projects
at an advanced stage in 2009, but would still have expected some supplementaryanalysis o the impact at the project level. In particular, where projects had yet to be ully
developed, we would have expected departments to have presented wider value or
money assessments to the Treasury on the benets and disadvantages o proceeding
with their PFI projects.2 Where applicable, this should have included the eect o the
public sector taking on greater project risks, where the banks made this a condition o
their nancing, balanced against lost service benets rom delaying the projects. Such
analysis would have improved the Treasurys understanding o the trade-os involved in
accepting higher nancing costs, as well as inorming uture decisions on the use o PFI.
1 See, or example, Private Finance Projects, A Paper or the Lords Economic Aairs Committee, October 2009,
paragraph 4.9, pages 46-47.
2 An example o this orm o analysis is in Appendix Five o this report and can be ound at www.nao.org.uk/
inrastructure-fnancing-2010.
-
8/4/2019 Pfi Credit Crisis
19/37
Financing PFI projects in the credit crisis and the Treasurys response prt o 17
Delayed projects were vulnerable to the credit crisis. The M25 case study, or1.9example, shows a cost increase o over 600 million on a contract which had originally
been due to close in February 2008 (Appendix Three).
One school case, however, illustrates how innovation mitigated the disruptive eect1.10
that the credit crisis had on certain projects reaching contract closure. In this project, to
build a new school in the London Borough o Newham, the bank supporting the winning
bidder withdrew a month beore the planned nancial close. Partnerships or Schools
proposed a solution based on the Local Education Partnership contracting a Design &
Build contract, without committed private nance.3 On an exception basis, the Treasury
allowed the London Borough o Newham to conclude this school project on condition
that interim grant unding would be replaced by private nance within six months, whichwas achieved.
The establishment o The Inrastructure Finance Unit
Following the worsening o the credit crisis in autumn 2008, it became clear that1.11
sucient debt nance, whether bank loans or bonds, was no longer available to privately
nance larger government inrastructure projects. The Treasury wished to close the
contracts in the pipeline to re-establish the market or government inrastructure projects
as part o the broader scal stimulus package. The Treasury thereore considered
options and developed a contingency plan to establish a lending unit. This unit obtained
Government approval at the end o January 2009.
In March 2009, the Government implemented its plan or the lending unit to ensure1.12
that some 110 privately nanced inrastructure projects (exceeding 13 billion) would go
orward, despite diculties in raising debt nance. The unit, known as The Inrastructure
Finance Unit, was created with the purpose o unding any shortalls in bank nance
on privately nanced inrastructure projects. The lending terms would be on the same
commercial terms as the banks.
Ater ten months o negotiation, with almost all o the available banks, the Greater1.13
Manchester Waste project had remained unable to raise the last 120 million to
complete its nancing. In March 2009, the Treasury agreed to make up this shortallthrough a 120 million loan. The Inrastructure Finance Unit subsequently monitored and
provided support to a number o other projects but no urther loans have been required.
The Treasury intervention on the Greater Manchester Waste project was timely1.14
and helped to reactivate the market. The Treasury chose this project because it clearly
met its lending criteria. Raising enough bank nance had proved dicult because the
project carried more risk than the average PFI project (see Part Two). The possibility o
Treasury loans was not needed on the other large complex deal, the M25 project, as
the Department or Transport had already developed a contingency plan to be ready
to act as a co-lender to the project. Other projects were smaller and did not appear to
have nancing gaps or could be grant-unded on a temporary basis, as permitted in theexceptional case o the Newham school.
3 See National Audit Ofce The Building Schools for the Future Programme Renewing the secondary school estate,
February 2009 or an explanation o the Local Education Partnership role.
-
8/4/2019 Pfi Credit Crisis
20/37
18 prt o Financing PFI projects in the credit crisis and the Treasurys response
Although helpul in moving projects in the pipeline towards contract closure,1.15Treasury lending created increased risks or the public sector parties. Public sector
lending also caused some concerns or the private sector about inormation sharing
(Fgr 6).
During the onset o the credit crisis rom autumn 2008 through to summer 2009,1.16
the Treasury amended renancing provisions and continued to apply existing guidance
to departments on how they were to consider value or money issues on PFI contracts.
Rather than issue additional guidance, the Treasury ocused on getting procurements
moving again and later on the ormation o its lending unit. A guidance note on eligibility
or Treasury loans was issued in May 2009, and an Application Note on PPP projects in
current market conditions was issued in August 2009. The latter did not make materialchanges to the tests that should determine value or money in the nancing conditions
that had arisen ollowing the credit crisis because the Treasury believed its value or
money guidance remained sound.
Figure 6
The main risks and concerns related to Treasury lending
I the project ailed then the Treasury might lose part or all o the money it had lent. As the economy
was in recession there was a higher risk o project ailure due to service deliverers running into
inancial diiculties than beore the credit crisis. This risk was mitigated by hiring sta with appropriate
proessional experience.
There was the potential or conlicts o interest within government over decision-making i a project ran
into diiculties. The procuring department would be seek ing to protect service delivery, and i the project
had to be terminated it would expect the banks to share in any losses that would arise. The Treasury, as
lender, would be motivated in the opposite direction to ensure that it recovered as much as possible o
the money it had lent. This risk was mitigated by a governance structure including a credit committee and
a steering group with some independent members.
The commercial banks lending to the project would be concerned that the Treasury, as lender, might
receive inormation about the departments intentions or the project which had not been communicated
to the banks. The Inrastructure Finance Unit is, however, treated in the same way as any commercial
lender in terms o access to inormation.
Source: National Audit Office
-
8/4/2019 Pfi Credit Crisis
21/37
Financing PFI projects in the credit crisis and the Treasurys response prt o 19
othr ts r mtg rct csts
There were other nancing options, and although these would not have been likely1.17
to achieve the Governments policy objectives in 2009, they could be relevant in uture.
The French government guarantees 80 per cent o the debt, once a project is
operating successully. Although this can reduce nancing costs by several million
pounds, it increases public sector exposure to operating risks. Large projects in
France have struggled to reach conclusion on this basis since 2008, and none
closed in 2009.
The not-or-prot European Investment Bank (EIB) is generally able to make unding
available on more avourable terms (such as margins and ees) than commercial
banks. Some European countries have publicly owned banks playing a similar
role. Lending at similar rates was not pursued because the Treasury considered
government lending should be temporary and reversible. In a uture renancing, it
would be dicult to sell such loans to other parties to recover the original unding.
-
8/4/2019 Pfi Credit Crisis
22/37
20 Part Two Financing PFI projects in the credit crisis and the Treasurys response Financing PFI projects in the credit crisis and the Treasurys response Part Two 21
During 2008, the market capacity or providing bank nance decreased, pricing2.1
increased and other terms tightened. Figure 7 shows the main changes in the nancing
market and their eect o n the timing o the inrastructure projects we reviewed.
Helped by the Treasurys establishment o its lending unit, condence improved,2.2
market activity resumed and 35 delayed projects closed between March and
December 2009 (Figure 8 overlea).
Where private nance has been used since the credit crisis, however, the cost was2.3
always more expensive than beore, generally by around one per cent. The act that the
base rate is currently at an all time low has not ully oset the higher loan margins that
banks are charging. This is because the cost o a xed interest loan, as with government
borrowing over 20-30 years, refects uture interest rate expectations. These rates are lower
than two years ago but the reduction has not been sucient to oset the signicantly wider
loan margins now charged by the banks (Figure 9 overlea).
Part Two
The eect o the new nancing terms on
contracts let since the credit crisis
1 Jun
2009
1 May
2009
1 Apr
2009
1 Mar
2009
1 Feb
2009
1 Dec
2008
1 Nov
2008
1 Oct
2008
1 Sept
2008
1 Aug
2008
1 Jul
2008
1 Jun
2008
1 May
2008
1 Jan
2009
8 Apr 2009
Financial close
December 2008
Department for Transports
willing-to-lend letter
20 May 2009
Financial close
16 Sept 2008
Lehman Brothers
filed for bankruptcy
27 Mar 2008
FSTA project reached
financial close
8 Oct 2008
Banking support
measures announced
by the Treasury
19 Jan 2009
Further support
measures announced
5 Mar 2009
Bank of England started
Quantitative Easing
3 Mar 2009
Treasury
announced
lending unit
3 Apr 2009
EIB increased capital by
67bn (or 40%) to expand
lending during crisis
16 Jan 2009
Contract signed for design and build
aspects with a Laing ORourke consortium
23 Jun 2009
Financial close
13 Nov 2008
BP4L consortium
selected as
preferred partner
7 Jul 2009
Financial close
8 May 2008
Connect Plus selected
as preferred bidder
Figure 7
Timeline of key events affecting case examples after notice in Official Journal of the European Union (OJEU)
PFI project/capital value
Source: National Audit Office
Barnsley
schools 111m
Newham
schools 69m
M25 1,073m
Greater Manchester
Waste 795m
1 Apr
2008
1 Mar
2008
1 Feb
2008
1 Jan
2007
1 Jan
2006
1 Jan
2005
1 Jan
2008
22 Feb 2005
OJEU issue
1 Oct 2005
Pre-qualification/bidder invitation
to submit outline solution
29 Jan 2007
Viridon/Laing selected
as preferred bidder
Change in
timeline scale
Major events
during credit crisis
Continuous delays in achieving financial close
23 Mar 2005
OJEU issue
13 Oct 2006
Flow, Connect Plus, Amey/Laing,
ORourke/Ferrovial shortlisted
19 Dec 2007
Downgraded credit ratings of a
number of credit insurers
13 Sept 2007
Run on deposits
in Northern Rock
Further downgrades by credit
rating agencies on credit
insurers during first half of 2008
26 May 2006
OJEU issue
7 Aug 2006
Invitation to tender
11 Apr 2008
Preferred
bidder selected
16 Mar 2007
OJEU issue
17 May 2007
Bidder
longlist
selected
23 Jan 2008
Number of
bidders
reduced to two
21 Jun 2007
Bidder
shortlist
selected
-
8/4/2019 Pfi Credit Crisis
23/37
22 prt Tw Financing PFI projects in the credit crisis and the Treasurys response
The increased nancing costs since the credit crisis have come ater a period in2.4
which around 300 PFI contracts were let at relatively low nancing rates when compared
to other types o project nancing, as shown earlier (Figure 2 on page 6). The low rates
refected the successul establishment o the PFI market and availability o bank lendingwhich encouraged competition in the nancing terms.
Th mct hghr t fc csts c sctr
srvc mts
The increased cost o nance has generally been passed through by the private2.5
sector service provider to the public authority in the orm o an increased monthly
payment, known as the unitary charge. In Appendix Two, Figure 15 sets out the impact
in real terms, compared to projects that were nanced in 2007, and suggests that, on
an all-in basis, the extra cost increased by around 5.6 per cent to 7.4 per cent. The
nancing costs o schools projects, which are airly typical, moved up sharply at the starto 2009 (Fgr 10).
Figure 9
Increase in loan margins applied by the banks
2007 2009 j 2010
Borrowing rate (%) 5.1 4.46 4.18
Schools margin (%) 0.6 2.55 2.23
annual interest cost or a typical 20 million 1.1m 1.4m 1.3m
school project
Waste project margin (%) 1.2 Above 3
annual interest cost or a typical 190 million 10.8m 14m
waste project
noTe
1 Project values shown above relate to the amount o senior debt and the annual interest cost reduces as loan
repayments are made.
Source: National Audit Office analysis
Figure 8
PFI deals concluded April to December 2009
ds Ct V (m)
Greater Manchester Waste PFI 631
M25 project (whole lie present cost 3,360 million) 1,073
20 PFI school projects 1,396
12 other PFI/PPP deals 1,795
Total 4,895
Source: National Audit Office
-
8/4/2019 Pfi Credit Crisis
24/37
Financing PFI projects in the credit crisis and the Treasurys response prt Tw 23
Figure 10
Typical changes, after December 2008, in loan margins and total interest
rates, exemplified by Building Schools for the Future (BSF) projects
Percentage
BSF PFI deals bank average margins
0.00
0.50
1.00
1.50
2.00
2.50
3.00
Percentage
14 Dec
2005
2 Jul
2006
18 Jan
2007
6 Aug
2007
22 Feb
2008
9 Sept
2008
28 Mar
2009
14 Oct
2009
2 May
2010
14 Dec
2005
2 Jul
2006
18 Jan
2007
6 Aug
2007
22 Feb
2008
9 Sept
2008
28 Mar
2009
14 Oct
2009
2 May
2010
NOTES
1 The first chart shows the effect on bank margins. The second chart shows the effect on total interest costs. The charts
show two main points:
a There was a dramatic increase in bank margins between July 2008 and June 2009. There has been a very slight
easing in the margins, moving into 2010.
b The total increase in interest costs (i.e. bank margins + swap rates) is not as great as the increase in bank margins.
This is due to the fall in swap rates, by about one per cent, over the same period.
Source: Partnerships for Schools
BSF PFI deals total interest rates
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
PFI school deal interest rates Bank base rate 25-year gilt rate
-
8/4/2019 Pfi Credit Crisis
25/37
24 prt Tw Financing PFI projects in the credit crisis and the Treasurys response
The Treasurys approval o the nal nancing terms or contracts, such as the2.6Greater Manchester Waste project and the M25, demonstrates that it gave priority
to agreeing contracts, and that it believed that it aced a lenders market. In such a
lenders market, it was not possible to resist price increases, particularly ater the Future
Strategic Tanker Aircrat (FSTA) nancing in March 2008, as shown in Fgr 11.4
A similar trend was starting to be visible in other countries. The nearest comparator or
the M25, a toll road in Germany obtained project nancing in March 2009. That projects
total interest cost was about 6.5 per cent, including debt margins o over 2 per cent
during construction (M25 2.5 per cent) and early operating years (over 3 per cent
ater 10 years M25: 3.0-3.5 per cent).
On large deals it was dicult, costly and time consuming to arrange bank nance.2.7A very large deal, such as the M25 described in Appendix Three, also resulted in a club
o 16 banks eventually taking shares o around 25 million to 65 million each.
Margin increases have not been the sole impact o any reduced competition2.8
resulting rom club deals. Based on analysis o projects concluded in 2007 and 2009
(see Appendix Two), banks have also sought to reduce their project risk by lowering the
proportion o debt in projects and increasing cover ratios (see Glossary). This increases
the risk to investors, who have passed the corresponding cost to the public sector
by increasing the unitary charge. The M25 cover ratio originally required cash, at a
minimum, exceeding 1.23 times the amount needed in each period to service the debt.
The banks increased this coverage requirement to 1.4 times the amount needed tocover the debt. The nal M25 contract also resulted in some additional risks being borne
by the Highways Agency. The Agency negotiated concessions in return.
In all types o lending, banks are seeking shorter periods or the repayment o2.9
their loans. In the case o PFI, or example, at the time o selecting the Preerred Bidder
(July 2008), the planned nal repayment o the M25 loans was six months beore the end
o the concession and it was subsequently increased by three years.
In the Greater Manchester Waste project, there are progressive step-ups in loan2.10
margins ater the ninth year (see Appendix Three). The banks chose this structure to
increase the likelihood o the private borrower and/or the public authority seeking a
renancing at lower margins. This is preerable to imposing an obligation to renance the
loans at a specied uture date.
Ftr rfcg
Based on a survey we commissioned with market participants, the consensus view2.11
was that they expected margins in three to ve years time to be in the range o 1.25 per cent
to 1.75 per cent. As such, we have assumed the new debt margin on the renanced debt to
be 1.5 per cent. The potential eect on a typical project is set out in Fgr 12.
4 National Audit Ofce Delivering multi-role tanker aircraft capability, March 2010, reported in paragraph 18 that the
selection o a PFI solution was made without a sound evaluation o alternative procurement routes to justiy why
the PFI route oered the best value or money.
-
8/4/2019 Pfi Credit Crisis
26/37
Financing PFI projects in the credit crisis and the Treasurys response prt Tw 25
Renancings will only occur i market conditions improve and i the private sector2.12can be motivated to renance the projects with revised arrangements that now give
most o the renancing benet (70 per cent o typical renancings) to the public sector.
Since October 2008, the public authority has a contract right to request a renancing,
which is exercisable once in any two year period.5 Until that time is judged to be right,
the Government is locked into substantially higher nancing costs that we estimate to be
between 500 million and around 1 billion.
Taking the illustrated level o renancing gain, at the our year stage, an aggregate2.13
recovery o 400 million might be obtained across the basket o deals concluded in 2009.
Although there are some technical actors that could increase the renancing gain, these
are likely to be oset by the private sectors share o the gain and by transaction costs.
5 Refnancing gains are shared on a sliding scale basis: Up to 1 million 50 per cent; between 1-3 million 60 per cent
and greater than 3 million 70 per cent. Both Greater Manchester Waste and the M25 achieved higher shares.
Figure 11
Change in notional unitary charge on large, complex projects
Trm FSTa
Mrch
2008
GMW
ar
2009
M25
M
2009
Level o project risk High/
medium
High Medium
Total interest cost (%) 5.9 - 6.1 7.7 - 8.9 6.9 - 7.9
Final repayment (months beore end o concession) 24 months 18 months 42 months
Debt inance proportion (%) 86.2 85.2 84.7
Unitary charge increase compared to FSTA (%) 12 6
noTe
1 Although the projects dier, and each has dierent proportions o operating costs, the unitary charge has been
re-scaled, or comparison with the typical 190 million base case in Appendix Two.
Source: KPMG and National Audit Office
Figure 12
Potential renancing gains on a project with 190 million senior debt andan estimated locked-in cost o 8.6 million
Rcg dt ptt G
(rs tr strt orts) (nt rst v m)
Three years 3.52
Four years 3.45
Five years 3.37
noTe
1 The gain is calculated gross (beore sharing) on an original capital investment o 170 million.
Source: National Audit Office
-
8/4/2019 Pfi Credit Crisis
27/37
26 prt Thr Financing PFI projects in the credit crisis and the Treasurys response
Part Three
The inrastructure challenges in the currenteconomic environment
Th chgs t th Gvrmt
The Government aces challenges in planning inrastructure investment in3.1
the current economic environment. Inrastructure UK, the new coordinating body
established within the Treasury, estimates that the Government needs to continue
to encourage substantial investment in new inrastructure, possibly 40-50 billion
per annum until 2030.6 But government departments need to reduce annual spending
to assist the public nances; and the cost o using private nance has increased
signicantly compared with beore the credit crisis.
Th cst sg rvt fc
Our analysis in Part Two has shown the increase in the cost o using private nance3.2
compared with beore the credit crisis. This increased cost may not be a temporary
phenomenon, because one o the primary eects o the credit crisis may have been to
change the attitudes to corporate and project risk within banks. As a result, there may
have been a long-term increase in the cost o using private nance.
In addition, a signicant problem or banks at the peak o the credit crisis was the3.3
mismatch between long-term loans (their assets) unded by short-term borrowing (their
liabilities). So although PFI projects are underpinned by revenue rom public unds, the
combination o long-term loans and remaining risk transer may have permanently increasednance costs and reduced the number o participants willing to lend in this market.
Th stshmt irstrctr uK
Inrastructure UK was established ater the 2009 Pre-Budget Report to coordinate3.4
the long-term inrastructure needs o the UK. Inrastructure UK is a unit inside the Treasury
incorporating a number o policy, nancing, and delivery bodies to lead work within the
Treasury to enable greater private sector investment in inrastructure, and improve the
Governments long-term planning and delivery. In the autumn, the Government will publish
a national inrastructure plan that will set out priorities or UK inrastructure on a cross-
sector basis. Inrastructure UK will also carry out an investigation into how to reduce thecost o delivery o civil engineering works or major inrastructure projects.
6 HM Treasury Strategy or national inrastructure March 2010.
-
8/4/2019 Pfi Credit Crisis
28/37
Financing PFI projects in the credit crisis and the Treasurys response prt Thr 27
By consulting stakeholders, Inrastructure UK has identied that there is a3.5signicant risk o a gap emerging in the provision o equity capital to large complex
inrastructure projects, particularly in the energy sector, within the next ew years.
This issue compounds the challenges posed by the reduction in availability and increase
in cost o debt nance highlighted in this report. Inrastructure UK has also set out to
identiy the critical interdependencies that impact on economic inrastructure investment
needs (Fgr 13) and will publish an action plan, setting out how the risks and
interdependencies will be managed, by spring 2011.
As a result o the interaction o these issues, there is a need to re-evaluate3.6
unding mechanisms across the whole range o public and private inrastructure
investment. Some unders may be repaid rom public sector payments or services,mostly originating in taxation, and others out o payments by users or consumers
(see Fgr 14 overlea).
Inrastructure UK recognises that it needs to nd ways to maximise unding sources,3.7
and in particular to nd new ways or inrastructure projects to obtain unding rom the
capital markets. The main obstacle is that institutions, such as pension unds, do not have
the internal credit approval processes and skills to assess the risk and return or investing
in project bonds, typically issued with a lower credit rating than BBB.7 Such investors
will only develop this new line o business i they believe that there is a substantial uture
pipeline o inrastructure projects that carry relatively low repayment risk.
7 Investments are graded according to methodologies produced by credit rating agencies such as Standard and
Poors (Range: AA A to D). Triple B (BBB) is the lowest investment grade rating and indicates a 0.32 per cent
probability o deault.
Figure 13
Economic inrastructure
Sctr Sgct ssts
Water Water resources (rivers, reservoirs and dams), drink ing water distr ibution (pipes
and pumping stations), waste water treatment, sewerage systems, lood and
coastal deences.
Waste Landill, recycling acilities, waste collection and processing, hazardous waste
treatment, energy recovery.
Transport Roads (strategic and local), heavy rai l, l ight rai l, a irports, ports, metro systems.
Energy Gas storage, transmission and distribution, electr icit y generation (renewable and
non-renewable), transmission and distribution.
Communications Fixed voice and data networks, mobile voice and data networks, satellite
networks, television and radio broadcast networks and radio spectrum.
Source: Strategy for National Infrastructure
-
8/4/2019 Pfi Credit Crisis
29/37
28 prt Thr Financing PFI projects in the credit crisis and the Treasurys response
Renancing and secondary market equity sales
The risk proles o PFI projects vary considerably during the construction phase3.8
making it dicult to renance a number o projects on a pooled basis. Once in
operation, many dierences all away making possible an approach that coordinates
the right to renance by a number o public authorities. This aligns with the interest o
lenders in selling loans to ree up reserve capital and then support new projects.
In March 2010, the House o Lords Select Committee on Economic Aairs,3.9
in its report Private Finance Projects and off-balance sheet debt8 called or urther
investigation o any impact on service delivery that may result rom the sale o shares by
the original private sector investors, known as secondary market sales (See Glossary).
Treasury guidance currently permits such equity sales without the sharing o resulting
gains with the public sector. The Treasury has yet to publish research on the contribution
made by equity investment at various stages in the lie o a public private partnership.
8 Published 17 March 2010 (HL Paper 63-I and 63-II).
Figure 14
Methods o inrastructure unding by sector, with examples
WtrWstTrsrtTcmserg
Source: Strategy for National Infrastructure
pc ct
User
unding
Public
industry
commercial
waste
operations
by Local
Authorities
Scottish
water
Taxpayer
unding
Conventional
capital
procurement
most
roads
municipal
waste
acilities
lood and
coastal
deences
prvt c
Taxpayer
unding
PPP/PFI M25
widening
municipal
waste
treatment
Northern
Ireland
water PFIs
User
unding
Economically
regulated
private industry
National
Grid
BT
Openreach
some
airports
England and
Wales water
supply and
sewerage
Other private
industry
electricity
generation
cable
networks
ports commercial
waste
disposal
-
8/4/2019 Pfi Credit Crisis
30/37
Financing PFI projects in the credit crisis and the Treasurys response ax o 29
Appendix One
Methodology
This report examined whether the Government has put in place an economic, ecient
and eective strategy or nancing public services projects ollowing the banking crisis.The main elements o our eldwork, which took place between November 2009 and
April 2010, were:
Mth prs
Banks survey
We commissioned KPMG to survey 40 banks and
inancial institutions, incorporating all the main PFI
lenders, on an anonymous basis.
To understand:
Views o market participants on current PFI
issues, in particular:
The appetite or PFI lending.
Credit terms and conditions.
Role o The Inrastructure Finance Unit.
Approaches and lessons learned on major
recent transactions.
Future expectations.
Interviews
We also held semi-structured interviews with
other key stakeholders, including HM Treasury,
Partnerships UK, Department or Environment,
Food and Rural Aairs (DEFRA), and Partnerships
or Schools (PFS), and inancial institutions including
the Bank o Ireland and the European InvestmentBank (EIB).
To identiy:
Views o stakeholders.
Benchmarking and modelling o results
Using market data provided by KPMG, DEFRA
and PFS, we analysed the changes in loan terms
between 2007 and 2009.
We also commissioned KPMG to analyse the
aordability impact o change in inancing terms.
Using a generic PFI inancial model, KPMGs
sensitivity analysis illustrates how the change in
each variable has led to changes in unitary charge
and returns to sponsors.
To identiy:
The trends in banks PFI margins and other
terms beore and during the banking crisis.
Using sensitivity analysis and the inancial
model, the relative weight o each driver and
the extent o any recoverable costs.
-
8/4/2019 Pfi Credit Crisis
31/37
30ax o Financing PFI projects in the credit crisis and the Treasurys response
Mth prs
Case studies o changes in scope and bank
pricing and impact on VFM
We identiied our case studies which represent
signiicant developments in the PFI market during
the credit crisis:
Greater Manchester Waste the only project in
which the Treasury made a loan.
M25 Design Build Finance Operate project.
Newham School.
Barnsley School.
To identiy:
Comparison o terms at Outline Business Case
stage and Final Business Case.
Whether costs and beneits had been checked
or adjusted.
The involvement o The Inrastructure Finance
Unit as a lender.
The role o the European Investment Bank as
a lender.
Documents Review
We reviewed relevant documents including:
Documents, emails and minutes relating to
inancing inrastructure projects held by the
Treasury in the period leading up to setting up
The Inrastructure Finance Unit.
To understand:
The rationale or setting up The Inrastructure
Finance Unit.
Changes in guidance.
Overseas comparison
We also reviewed documents rom the
European PPP Expertise Centre (EPEC)
on how other countries are undinginrastructure projects.
EPEC/EIB documents.
To understand:
How other countries have responded to
the crisis.
Potential savings i the UK were to adopt the
French guarantee scheme.
Expert Panel
We established an expert panel who, together,
had expert knowledge o the banking and
inrastructure/project inance sector, to provide
challenge and assurance or the study.
The members o the panel were:
Dr Harry Bush, CB, Board Member and Group
Director, Civil Aviation Authority
Jeremy Barker, Director, KPMG
Corporate Finance
John Layton, CPA
Proessor Roger Strange, Proessor o
International Business at the University
o Sussex
To identiy:
Challenges to study indings.
-
8/4/2019 Pfi Credit Crisis
32/37
Financing PFI projects in the credit crisis and the Treasurys response ax Tw 31
Appendix Two
PFI Benchmarking
As part o the eldwork, and under our direction, KPMG have benchmarked1
changes in the cost o PFI nance. The table at Fgr 15 below sets out the eects ona base case model o a variety o changes, drawing on data taken rom a broad sample
o actual projects.
Figure 15
Impact on aordability o changes in nancing terms rom 2007 to 2009
Ctgr assmt
2007
assmt
2009
a
utr
Chrg
()
Chg
2009
(%)
Base Case model (2007) 33,392
Debt amount as a percentage 89.7% 87.7% 33,790 1.19
Swap Rate (variable to ixed) 5.1% 4.3% 32,315 -3.23
Loan margin 0.79% 2.39%-2.59% 36,145 8.24
Arrangement Fee 1.1% 1.57% 33,530 0.41
Commitment Fee 0.38% 1% 33,575 0.55
Interval ater inal repayment 11 months 15 months 33,487 0.28
Minimum ADSCR/LLCR 1.17x/1.22x 1.19x/1.23x 33,500 0.32
Swap Credit Spread 0.11% 0.25% 33,662 0.81
2009 model (rom range o results) 25th Percentile 35,295 5.7
75th Percentile 35,870 7.4
noTeS
(see Glossary or ADSCR and LLCR under Cover ratios)
1 The unitary charge shown above is based on separately applying the terms & conditions to a typical size deal with
a capital cost o 170 million and debt o about 190 million and a rate o return to equity o 12.5 per cent.
2 The sum o the price impacts o each change individually, totalling 8.57 per cent, would be incorrect and greater
than the price impact rom the base case to the current climate. The reason or a lower result is that increasing the
unitary charge, to fx a par ticular variable, mitigates the impact o other changes.
3 I the unitary charge is held constant, the rate o return to equity alls to 6.55 per cent.
Source: KPMG
-
8/4/2019 Pfi Credit Crisis
33/37
32ax Thr Financing PFI projects in the credit crisis and the Treasurys response
Appendix Three
Case Studies
bchmrkg th M25 dsg b Fc ort prct
The single Design Build Finance Operate project or the M25 will widen1
two sections (38 miles). The 30-year cost includes maintaining the Dartord crossings
and operating 250 miles o existing motorway. This cost increased by 23 per cent rom a
net present value o 2,756 million beore the banking crisis, to 3,400 million by the time
the nancing was complete in May 2009.
We estimate that the largest component o the increase aced by the Highways2
Agency was an increase, arising rom debt nance costs, o around 15 per cent compared
to market terms available in 2007. This nding is extrapolated rom our benchmarking
model or typical cost changes on smaller transactions (see Appendix Two).
Larger and more complex projects were already acing higher bank costs in3
March 2008 when the Future Strategic Tanker Aircrat (FSTA) project closed early in
the credit crisis (see timeline in Figure 7). The M25 nancing terms, when applied to
the KPMG model, show a cost 6 per cent greater than that derived when applying the
FSTA nancing terms. This is similar to the lower end o increases experienced since
October 2008 on other PFI projects.
We will be reporting separately on the value or money o the M25 project.4
l mrgs r th Grtr Mchstr Wst rct
The Greater Manchester Waste Authority is the largest waste authority in England,5
covering 5 per cent o national waste. The 25 year recycling and waste management
project includes 36 recycling acilities, across 23 sites, and a waste-red thermal power
station. The project will reduce local waste diverted to landll by 75 per cent.
In addition to 184 million rom the European Investment Bank, the banks6
supporting the project set market pricing or 280 million o lending, leaving a gap o
120 million. The Inrastructure Finance Unit provided this balance on the same terms as
the banks.
-
8/4/2019 Pfi Credit Crisis
34/37
Financing PFI projects in the credit crisis and the Treasurys response ax Thr 33
It is dicult to benchmark this pricing, in order to be satised that lenders did not7behave in an opportunistic manner. Unlike a schools project, primarily providing lower
risk accommodation, waste projects involve complex industrial processes which rely
on the nancial and technical ability o companies to perorm inter-related contracts.
These higher risks result in higher margins and the most similar deal, which had closed
in 2008, had a provisional margin o 2 per cent that was increased to 2.75 per cent in
January 2009 at the launch o syndication. Subsequently, at least one bank told Bank o
Ireland that it could not expect an approval rom its credit committee unless the margin
was set at more than 3 per cent.
Greater Manchester Waste closed with margins on the ollowing sliding scale:8
Construction 3.25%
Completion to Year 9 3.35%
Years 9 to 15 3.70%
Years 15 to 21 3.95%
Years 21+ 4.50%
The amount o department credit support accorded to this project, as a result o9
the banking crisis, was increased rom 109.5 million to 124.5 million. In January 2007,
the second stage review by Partnerships UK commented It is also apparent romthe bids received, that the Authoritys original cost assumptions were excessively
conservative, hence the considerable aordability headroom.
Additional Appendices Four and Five are at www.nao.org.uk/inrastructure-
nancing-2010.
-
8/4/2019 Pfi Credit Crisis
35/37
34 Gssr Financing PFI projects in the credit crisis and the Treasurys response
Glossary
Trm dft
Cover Ratios Ratios that measure the extent to which current and uture
liabilities to lenders are covered by available cash fows.
There is a minimum Annual Debt Service Cover Ratio
(ADSCR) and a Loan Lie Cover Ratio (LLCR).
Debt service costs The periodic instalments o loan principal and interest, and
associated ees, due rom a consortium to its lending banks.
Floating/variable
interest rate
A rate o interest which varies periodically, in accordance
with a stated market reerence, usually the London
Interbank Oered Rate (LIBOR).
Interest/lending margin An additional amount that a bank charges on a commercial
loan over and above its own cost o providing the loan. The
margin compensates the risk o not having the loan repaid,
potentially providing a prot.
LIBOR London Interbank Oered Rate. The interest rate at which
banks will lend to each other, which became dicult to
determine at times during the banking crisis.
Renancing The process by which the unding terms, put in place at
the outset o a PFI contract, are later changed, usually
with the aim o creating benets or renancing gains.
Renancing may be benecial where project risk has
reduced, or example, ater the completion o construction.
Reserve Capital The amount o capital regulators require a bank to hold
in relation to its lending based on international guidance
produced by the Basel Committee on Banking Supervision.
Secondary market The market or buying and selling shares in project
companies that, usually, have commenced trading.
Swap An arrangement whereby a loan which has a variable rate
o interest (which continually changes in relation to market
rates o interest) is exchanged or a loan which has a xed
rate o interest.
Unitary Charge The amount that the public body contracts to pay
each month or the service being delivered. It will cover
operations and maintenance, on a whole-lie basis as well
as the ully nanced construction cost.
-
8/4/2019 Pfi Credit Crisis
36/37
Design and Production by
NAO Communications
DP Re: 009310-001
This report has been printed on Consort
155 and contains material sourced rom
responsibly managed and sustainable
orests certiied in accordance with FSC
(Forest Stewardship Council).
The wood pulp is totally recyclable and
acid-ree. Our printers also have ull ISO
14001 environmental accreditation
which ensures that they have eective
procedures in place to manage waste and
practices that may aect the environment.
002825
-
8/4/2019 Pfi Credit Crisis
37/37
Published by TSO (The Stationery Oice) and available rom:
o
www.tsoshop.co.uk
M, Th, Fx & em
TSO
PO Box 29, Norwich, NR3 1GN
Telephone orders/General enquiries: 0870 600 5522
Order through the Parliamentary Hotline
Lo-Call 0845 7 023474Fax orders: 0870 600 5533
Email: [email protected]
Textphone: 0870 240 3701
The Parliamentary Bookshop
12 Bridge Street, Parliament Square,
London SW1A 2JX
Telephone orders/General enquiries 020 7219 3890
Fax orders: 020 7219 3866
Email: [email protected]
Internet: http//www.bookshop.parliament.uk
TSo@bckw thr accrt agts
Customers can also order publications rom:
ISBN 978-0-10-296546-9
14.75