HM Tresury Finncing PFI projects in the credit crisis nd the Tresury s response Appendices Four nd Five JULY 2010
Contents Appendix Four Cse studies 3 Appendix Five Modelling the costs nd enefits of strting over 7 Design nd Production y NAO Communictions DP Ref: 009310-002
Finncing PFI projects in the credit crisis nd the Tresury s response 3 Appendix Four Cse studies Cse A London & Home Counties Authority Highwys Agency Investor Connect Plus Contrctors Construction JV: Blfour Betty 50 per cent nd Sknsk 50 per cent; Operting & Mintennce JV Blfour Betty 52.5 per cent, Atkins 32.5 per cent & Egis 15 per cent Sector nd rtionle A single Design Build Finnce Operte project in the rod trnsport sector The project opertes nd mintins the M25 nd plns to widen two sections of the M25 (sections 1 nd 4) efore the 2012 Olympics. Section 1 covers the North West etween the A40 (junction 16) nd the A1 (junction 23). Section 4 covers the North Est etween the M11 (junction 27) nd the A13 (junction 30). The originl usiness cse included two further sections, which form optionl dditions to the finl contrct. 30 yer cost 3.4 illion (present vlue, up from 2.7 illion efore the nking crisis) Amount of cpitl investment 1.1 illion Amount of Equity 200 million s shreholder lons (nd 1,000 shreholder equity) Amount of Senior Det (Funders) 1,108.7 million ( 708.7 million of senior nk lons nd 400 million Europen Investment Bnk lon). The lons cover cpitl investment, working cpitl nd provision towrds interest pyments. Interest Rte Mrgins 2.5 3.5 per cent Other significnt terms ffecting the rising of finnce nd/ or risk trnsfer to senior lenders Lenders required unitry chrge tht, suject to performnce, would provide the orrower in ech period with csh flow t the level of 1.4 times the mount of lon interest nd principl pyle. The lons were scheduled to e pid off in full 42 months efore the end of the concession (incresed from six months). The Highwys Agency s dvisers estimted tht the overll impct of this chnge ws n extr 55 million. Lenders, cting on technicl dvice, lso required tht dditionl contingency e dded to the estimted price in vrious wys tht dded further 123 million (Mrch 2009 estimte). Extent of chnge The results set out t i) elow were clculted using model sed on PFI project with senior det of 190 million nd other terms nd conditions tken from the smple of projects descried in Appendix One. i) Previous project The unitry chrge would e 6 per cent higher thn for the Future Strtegic Tnker Aircrft project (which hd closed when underlying interest rtes were out one per cent higher). ii) Preferred Bidder Stge The M25 unitry chrge, mostly ttriutle to finncing, incresed y etween 0.6 illion (excluding de-risking mesures) to 0.7 illion (including incresed lour infltion nd reserve ccounts). iii) Other enchmrking Privte sector regulted utilities The difference etween verge mrket prices for det issued y utilities nd UK Government det (gilts) peked t 3.2 per cent in Decemer 2008, ut y Septemer 2009 this det ws eing priced t 1.8 per cent more thn gilts. Trget Finncil Close Ferury 2008 Actul Finncil Close 20 My 2009
4 Finncing PFI projects in the credit crisis nd the Tresury s response Cse B London Authority London Borough of Newhm Investor Newhm Lerning Prtnership Contrctors Ling O Rourke Sector nd rtionle The uilding of two PFI finnced nd two trditionlly finnced secondry schools In 2003, the Deprtment for Children Schools nd Fmilies nnounced the Building Schools for the Future (BSF) progrmme. BSF ims to renew ll 3,500 English secondry schools over the 15 yer period 2005 2020, suject to future pulic spending decisions. BSF provides eductionl nd lso recretionl socil environments tht support modern teching nd lerning methods nd the locl community. This is the first of six Newhm project phses. 30 yer cost 193 million ( 80 million present vlue) Amount of cpitl investment 69 million Amount of Equity 5.9 million (in vrious forms) 12.7 per cent lended internl rte of return Amount of Senior Det (Funder) The Aviv funding structure ( 55 million) for this project ws kin to ond type funding solution rther thn the long-term senior det structure of other schools dels. Interest Rte Mrgins 1.8 per cent Other significnt terms ffecting the rising of finnce nd/ or risk trnsfer to senior lenders Funding for the Newhm project ws originlly to e provided y Dexi, the French Belgin nk which withdrew in erly Decemer 2008. No replcement nk lender cme forwrd. The Authority considered short term switch from PFI to Design nd Build with n option to move ck (or flip ). For udgetry resons, Newhm ws the only such rrngement tht went hed, lthough some schools projects, scheduled for Spring 2009, did not close until the summer s result of this. Grnt funded finncil close took plce in Jnury 2009, with PFI close tking plce five months lter in June 2009 fter the life ssurnce compny, Aviv, hd stepped in. The extr costs for Newhm involved oth direct costs nd dvisory nd legl fees, though the lower interest rte more thn compensted for this. Extent of chnge The scope of the project ws lrgely unchnged t Finncil Close from tht proposed t Outline Business Cse. i) Previous project At the Finl Business Cse stge Newhm estimted tht the PFI procurement sved 38.5 million compred to it s estimte of shdow id. However the timing of PFI funding to the project chnged. ii) Preferred Bidder Stge An Erly Works Agreement provided flexiility nd enled the Authority to meet the school opening timetle. iii) Other enchmrking The Authority commissioned Rthones, the investment dviser, to provide the pproprite gilt ginst which pricing would tke plce. The enchmrk gilt used ws the Tresury 4.25 per cent 2027 gilt. A rte of 4.26 per cent ws included within the Commercil Close Finncil Model, eing the ctul gilt rte t tht dte. The fixed funding rte of 6.2 per cent cme in elow commercil nk rtes. Mny schools dels re refinnced once construction work is completed, ut Aviv s del is unlikely to e refinnced ecuse compensting the fund mnger would offset ny reduction in finncing costs. Trget Finncil Close Summer 2008 Actul Finncil Close June 2009
Finncing PFI projects in the credit crisis nd the Tresury s response 5 Cse C Brnsley Authority Brnsley Metropolitn Council Investor Brnsley Prtnership for Lerning Contrctors Ling O Rourke Sector nd rtionle The uilding of three PFI finnced nd two trditionlly finnced secondry schools The Brnsley schools project forms the first phse of three BSF phses in Brnsley. This phse plns to provide 10 schools in the Brnsley re, s prt of the BSF progrmme. 30 yer cost 304 million ( 130 million present vlue) Amount of cpitl investment 111 million Amount of Equity 9.4 million (in vrious forms) 13 per cent lended internl rte of return Amount of Senior Det (Funders) The senior det finncing ( 78 million) is provided y Ntionwide Building Society, Nord/LB Bnk ( 39.5 million) nd Europen Investment Bnk (EIB) ( 38.5 million). Interest Rte Mrgins Commercil lon mrgin 2.55 per cent, EIB lon mrgin 0.4 per cent Other significnt terms ffecting the rising of finnce nd/or risk trnsfer to senior lenders Prtnerships for Schools pproched EIB, s potentil source of finnce for schools projects struggling to complete dels, in lte 2008. EIB hd previously jointly provided senior det for BSF project in Newcstle, s one-off del, which closed in July 2007. EIB pproved funding of 300 million for BSF projects from Mrch 2009 enough finnce to cover round 25 to 30 individul schools. This funding covers hlf the det required nd is imed t lrger dels with cut-off set t round 70 million (from ll sources of funds). EIB fces competing clls on its resources, thus setting minimum del size which ffects the rte of closing dels. EIB hs susequently provided joint finnce to three schools projects reching finncil close, of which Brnsley ws the first. Extent of chnge i) Previous project At Finl Business Cse stge, 16 Mrch 2009, Brnsley estimted tht the procurement sved 68.6 million compred to its estimte of shdow id. The Council confirmed tht there hd een no mteril chnges in the scope of works from tht set out in the Outline Business Cse which might hve led to n increse in cost of 25 per cent or more, over nd ove the originl cost, including estimtes of optimism is. ii) Preferred Bidder Stge There hd lso een no significnt dely (i.e. in the order of nine to twelve months) or mrket filure (e.g. competition reduced to one idder) nd the Council therefore confirmed tht in its view further quntittive nlysis exercise is not necessry. iii) Other enchmrking The ll-in rte of 7.32 per cent for Brnsley ws representtive of other school projects reching finncil close in summer 2009. Refer to Figure 10 on pge 23 of the pulished report. Brnsley s Averge Det Service Cover Rtio ws competitive eing 1.17 per cent. Trget Finncil Close Autumn 2008 Actul Finncil Close July 2009 NOTE 1 Technicl terms used ove, such s Averge Det Service Cover Rtio, re explined in the Glossry on pge 34 of the pulished report.
6 Finncing PFI projects in the credit crisis nd the Tresury s response Cse D Greter Mnchester Authority Greter Mnchester Wste Disposl Authority Investors 1 Viridor Ling (Greter Mnchester) Limited: Viridor Wste Mngement Limited 50 per cent John Ling Infrstructure Limited 50 per cent 2 Ineos Runcorn (TPS) Limited: Ineos Chlor Ltd 60 per cent Viridor Wste Mngement Limited 20 per cent John Ling Infrstructure Limited 20 per cent Sector nd rtionle Wste collection nd recycling, including providing feedstock to generte electricity The Authority is the lrgest wste uthority in Englnd, ccounting for 5 per cent of ntionl wste. The Contrct is 25 yer Recycling nd Wste Mngement Contrct with 631 million construction progrmme, creting wste-fired therml power sttion nd network of 36 recycling fcilities cross 23 sites. The contrct is worth 3.8 illion to Viridor over its term. All fcilities will e completed y 2012 nd will reduce locl wste diverted to lndfill y 75 per cent. 30 yer cost 5.1 illion (nominl) Other fctors ffecting the Authority s risk The Authority is oliged y mesures originting from the EU Lndfill Directive to reduce the mount of wste going into lndfill, to 50 per cent of 1995 levels, y 2013 or fce, yet to e specified, penlty regime under the directive. In ddition the remining wste must e pre-sorted into vrious ctegories. Extent of chnge The mount of credit support the Deprtment for Environment, Food nd Rurl Affirs ccorded to this project, s result of the nking crisis, ws incresed from 109.5 million to 124.5 million. In Jnury 2007, the second stge review y Prtnerships UK commented It is lso pprent from the ids received, tht the Authority s originl cost ssumptions were excessively conservtive, hence the considerle ffordility hedroom. Other enchmrking Riverside Wste: A 22 yer pre crisis del originlly priced with mrgin of 2 per cent. Despite flexing mrgins to 2.75 per cent nd csh sweep 1 t yer 10 this del ws not successfully syndicted t the sme time s Greter Mnchester ws reching finncil close. Bores: A 325 million project finncing closed in Octoer 2009 with 15 yer lon hving mrgins strting t 3 per cent to yer five rising to 3.25 per cent to yer 8 nd 3.75 per cent therefter. There is csh sweep t yer nine. Trget Finncil Close Spring 2008 Actul Finncil Close 8 April 2009 Amount of cpitl investment 1.1 illion Amount of Equity 584 million Interest Rte Mrgins Construction: Completion to Yer 9: Yers 9 to 15: Yers 15 to 21: Yer 21+ 3.25 per cent 3.35 per cent 3.70 per cent 3.95 per cent 4.50 per cent NOTE 1 A csh sweep prioritises immedite repyment to lenders over distriutions to shreholders.
Finncing PFI projects in the credit crisis nd the Tresury s response 7 Appendix Five Modelling the costs nd enefits of strting over 1 This is n illustrtive pproch to modelling the costs of ndoning PFI procurement in order to find the tipping point t which the enefits of strting over could outweigh the costs involved. The stge reched in the procurement process will e key vrile, s costs rise fter the notice in the Officil Journl of the Europen Union (OJEU notice). 2 A preliminry identifiction of costs follows for two distinct cses: Cse (A) A lrge PFI project with one-off chrcteristics Cse (B) A project in progrmme or series of projects (e.g. Locl Eduction Prtnership or Locl Improvement Finnce Trust schemes) 3 Benefits tht modify/mitigte the pprent extr cost of finnce when continuing with PFI projects common to Cse (A) nd (B) 4 c The 70 per cent or pplicle shre of the pulic sector of refinncing gins (to e modelled t vrious time intervls). The mcroeconomic enefits from strting shovel redy projects s soon s possile. The Tresury guidnce issued in August 2009 trets relevnt projects tht hve issued n OJEU notice s hving selected the PFI delivery mechnism, suject to Finl Business Cse tests of vlue for money. Costs of strting over tht re common to Cse (A) nd (B) Any contrctully committed reimursement of idders costs, excluding overhed nd profit. Cost of dely in re-idding (scertinle costs only) fter pplying ny mitignts, such s pying for enling works during the re-idding period. Risk of higher finncing chrges from shrinking the PFI nking mrket, during wht my susequently prove to hve een temporry crisis. This cost could e estimted y nlogy to the impct on finncing chrges of regultory risk. This cost my e mitigted y short mrket memory nd possile trend to lower mrgins s competition increses fter the UK emerges from the recession.
8 Finncing PFI projects in the credit crisis nd the Tresury s response 5 c d e f g Vrile strting over costs tht differ etween Cse (A) nd Cse (B) Out of pocket costs of holding new competition. In-house stff costs of holding new competition. Bidders costs of new competition (if ville within id udgets). Cost of project specific finncil penlties, such s EU penlties for continuing wste disposl using lndfill sites. Cost of extending current operting nd mintennce rrngements. Cost, including dely cost (if dditionl) in renewing plnning pprovls. Cost of chnges in mrket conditions, such s the ernings index nd indices relevnt to specilised or long led procurement items. 6 Soft costs, in the sense of hrd to quntify strting over costs tht re likely to differ etween Cse (A) nd Cse (B) c d 7 Loss of key project personnel, their corporte knowledge nd expertise nd the more generl loss of stff cused y timing nd uncertinty over some employment terms, for exmple pension rights, when trnsferring to the privte sector. Cost of dely in re-idding, such s loss of enefits for dely period which might extend to full cdemic yer in the cse of school. For detiled exmple of enefits foregone nd cncelltion costs incurred clcultion see Figure 19, The Chnnel Tunnel Ril Link HC 302 pulished Mrch 2001. Dely would require proportionte clcultion. The emerging preferred idder hs secured n informtion dvntge nd my not e chllenged y losing idders (loss of competitive tension) especilly in Cse (A). Reduced risk trnsfer from chnging the form of procurement my not e fully compensted y idders lowering the risk premium. Benefits from strting over tht my modify/mitigte the cost findings Most of the due diligence enefits my e retined, reducing the rel impct of reimursing ll the costs incurred t 4. ove. In Cse (B), the Locl Eduction Prtnership or other joint venture my lredy hve pid for nd s consequence own the preliminry nd detiled design work.