By Joti Mangat
Like many capital markets inventions, it’s a great idea in principle. The UK’s public finance initiative, a way of funding public expenditure with private capital, can finance complex and risky public interest projects at competitive rates while providing a liability-matched, retail price indexed home for pension fund money.
But now a crisis of confidence threatens to undermine the steady growth of the market. Doubts focus on the arrival of the largest non-defence PFI financing ever arranged in the UK, the redevelopment of St Bartholomew’s Hospital (Barts) and the Royal London Hospital. Arranged by Deutsche Bank and Morgan Stanley, the deal will supply around £1.5 billion ($2.6 billion) of long-dated RPI-linked paper, insured by monolines Ambac and FSA, into a tight market.
Recent reports suggest that the government is considering abandoning the project in favour of a more suitable and cheaper location for the new facilities. The Barts and The London NHS Trust, the body set up to administer the scheme, has tried to allay these concerns. “The cancer and cardiac element of the new hospitals programme is appropriately sized and meets the needs of east London’s growing population, and there is no appropriate capacity elsewhere in London,” it says. “The Trust hopes that ministers now have the evidence they need to approve the new hospitals programme.”
Ian Dixon, head of European infrastructure finance at Ambac, can understand the frustration. “We have been working on Barts for more than four years now and it’s very disappointing for the private sector that the public sector can’t get its act together just as the deal is about to close,” he says. “It is anticipated that Barts will proceed after the project has been adjusted to meet the new Department of Health current requirements,” he says.
Rumours persist, though, that central government’s commitment is shaky at best and that it might yet cancel the £15 billion pipeline of future projects. PFI service providers meanwhile, are losing faith in the government’s approach to the scheme.
History
“History has shown that when the private sector has completed a PFI, it tends to deliver the asset on time, on budget,” Dixon says. “Where the public sector has attempted to go it alone, without the same level of financial control, consequently budgets and deadlines have been broken.” He cites the example of the Scottish Parliament building, whose final cost was £400 million after an initial government estimate of £40 million.
From an investor’s perspective, the decision to back or not back a PFI is a simple one: ‘Can the body being funded meet the debt service? If not, then how soon do I get my money back?’ John Keane, securitization specialist at Barclays Capital Research, argues that contemporary PFI structures can deliver attractively priced funding when the risk transfer and market disciplines achieved are considered.
“PFI structures have improved as the asset class has matured,” Keane says. “Performance requirements, while not extremely onerous, are tougher than they were. Where earlier deals were structured more in favour of bondholders, recent transactions have typically seen a greater balance of interest between funder, trust and government, with greater risk transfer achieved,” he suggests.
There have been situations where projects have failed to deliver. Newarthill reported in its financial accounts that its construction arm, McAlpine, suffered in excess of £100 million of cost overruns in completion of the complex hospital build for the Dudley Group of Hospitals NHS Trust’s PFI project.
McAlpine had underestimated the cost of the build, but under the terms of the deal stood behind the project and took the hit.
Investors are becoming increasingly comfortable with PFI risk. Keane argues that the hunger of the four monoline insurers – Ambac, MBIA, FGIC and FSA – to be involved with these transactions can only improve liquidity and investor comfort, and widen the appeal of the asset class.
The shortage of long-dated assets with better yields than UK government paper means that an Ambac-wrapped PFI triple A pricing 40 to 50 basis points back of gilts is increasingly compelling value for fund managers.
The growing number of investors looking at these transaction means PFI contract holders could access incrementally cheaper financing as UK pension funds and banks do battle with the German public sector banks for allocations.
“Landesbanken benefit from low-cost funds, so they can afford to be aggressive on spreads,” Keane says. “But if UK pension funds decide that PFI-backed linkers are a key investment for their funds, especially in the light of the very low government linker spreads at present, they could start to be competitive when bidding for new PFI issuance,” he asserts.
Keane argues that central government has all the performance metrics it needs to justify continued commitment to PFI. “Through National Audit Office case studies, various White Papers and the Lyons report on PFI, the government is constantly monitoring the financial and managerial efficiency of PFI,” he says. “My understanding of the Barts delay is that it is as much a question of whether the government wants this project to be undertaken as how it is financed.”
| Building the public sector |
| Issuance of infrastructure securitizations in Europe (€bn) |
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| Source: Barclays Capital |