PFI: AirTanker decision fuels bond market gloom

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By:
Louise Bowman
Published on:

UK PFI deal taps loan market for entire £2.2 billion.

Capital markets make a U-turn for AirTanker

Capital markets make a U-turn for AirTanker

At £2.5 billion ($4.98 billion), the AirTanker deal (which will fund new aircraft for the Royal Air Force) is a very big transaction by public finance initiative standards, and not to tap the bond and bank markets would have been unthinkable this time last year. But it seems that a rethink on the size of the bond tranche was on the cards as early as August 2007, when the crisis in the credit market first began to bite. By the New Year, as it became very clear that the monoline guarantors faced serious difficulties, plans to include both bond and loan tranches in the deal were abruptly scrapped by sponsors Cobham, EADS, Rolls-Royce, Thales UK and VT Group. A group of seven banks was then swiftly assembled to arrange a £2.2 billion loan.

This is an understandable if comprehensive U-turn from the sponsors, which were planning to finance the majority of the deal in the bond market, with a smaller portion funded in the loan market via HBOS. The decision was a blow for RBS, RBC and Deutsche Bank which had all been working on a capital markets financing for the deal for a long time – of those three, just RBC is involved in underwriting the loan. Deutsche Bank is, however, advising on the deal.

Flagship

Given that the AirTanker deal is such a PFI flagship for 2008, it is not unreasonable to assume that a similar approach will be taken with the rest of the pipeline this year. (There is usually about £10 billion of PFI business a year in the UK.) Does this mean that there is no monoline appetite for infrastructure risk any more?

That is not quite the case, if the recent Belfast Gas Transmission Financing deal is anything to go by. The £119 million index linked bonds were wrapped to triple-A by monoline guarantor FSA. But FSA and Assured Guaranty are really the only two monolines in Europe in a position to wrap bonds at the moment – largely because they are probably the only two names that would be palatable to investors.

The bond tranche of the AirTanker deal was to have been wrapped by Ambac – one of the monolines worst affected by the problems in the ABS CDO market. The sponsors’ decision to pull it is a stark reflection of how the name is now perceived in the market – regardless of Ambac’s actual ability to absorb and appetite for the risk itself.

Mike Chappell managing director and head of project finance at Lloyds TSB, which is co-underwriting the AirTanker loan, says that "there is limited liquidity at present." And that liquidity seems to be limited to the loan market. But if the entire PFI programme opts to finance in this market the implications for that liquidity – and pricing – are obvious. "I think that it is a fairly high risk strategy to fund a deal of this size entirely in the bank market," observes one PFI expert.

The AirTanker consortium has raised £2.5 billion in a mix of senior and subordinated debt and equity. There is a £200 million mezzanine loan and £100 million equity tranche. The six banks that have underwritten the £2.2 billion senior loan – Lloyds TSB, HBOS, RBC, Fortis Bank, Calyon, Bayerische Landesbank and BBVA – have taken on £400 million of underwriting risk apiece. In this market that could be quite a challenge. The initial margin is 100 basis points over Libor.

Sources close to the deal believe, however, that there could have been monoline appetite for about £500 million of the AirTanker debt. While investors might not have been keen to take direct exposure to a monoline such as Ambac because of headline risk, other firms have capacity – which could be enhanced by, say, Ambac itself reinsuring the primary monoline’s exposure behind the scenes. But the sponsors were clearly not prepared to take the risk of attempting and failing to raise funds in the bond markets. The cost of the capital markets option would also probably have been around 30 basis points wider than bank funding anyway.

On the table

The fact that a deal of Air Tanker’s size has eschewed the bond market is a stark indication of the problems that the capital markets face in financing infrastructure while the monoline guarantors are out of the picture. "For deals of around £100 million the bank market is the obvious place to go," says a PFI expert. "But for the large deals you need to keep all your options on the table." There are growing signs of mid-sized PFI deals also going to the bank market: for example, the recent £225 million fundraising for the Maidstone and Tunbridge Wells NHS Trust in Kent has been rethought – changing from wrapped bonds to bank debt. Comments by the sponsor, John Laing Investments, indicated that the decision had been made because of uncertainty over whether monolines could continue to support paper following downgrades, uncertainty over investor appetite and uncertainty over cost.

But will the loan market prove to be the cheapest and most available option for the entire PFI sector? And if so, for how long?

"The banks will support sponsors on the basis of their existing corporate relationships," says Chappell at Lloyds TSB. "If capital is restricted they will support sponsors that have stuck with them." Indeed, the question of cost is no longer paramount in this market – what sponsors want is guaranteed execution.

Wider M25

"The smaller hospital and school deals will get done but the absence of liquidity (as a result of issues with the monolines) may affect the bigger deals," Chappell predicts. If the AirTanker deal is anything to go by, it already has. So all eyes are on the next bumper PFI trade – the widening of the M25 motorway – which is due this year. That £5 billion project is expected to need about £1 billion in debt financing, and if conditions in the capital markets do not change markedly it looks as if arrangers will be heading to the loan market to find it.

The PFI market is not the only one to be feeling the absence of the guarantors. Across the whole of infrastructure finance, deals are having to be rethought as their capacity to wrap this risk evaporates. BAA’s £10 billion acquisition refinancing – already long overdue when the credit crunch hit – has had to be restructured in light of changed market conditions. The lion’s share of the deal was expected to take the form of a ring-fenced securitization, but a source close to the deal has confirmed that the bond element of the deal will be "smaller than anticipated". And the prospect of selling unwrapped bonds now seems to be on the agenda. This is a punchy call given the unstable nature of BAA’s ratings: Standard & Poor’s downgraded its guaranteed nonconvertible bonds from triple-B plus to triple-B minus on April 16, blaming not only the refinancing delay but also BAA’s "weakened business profile".

The BAA refinancing will inevitably look to the loan markets to for funds it cannot raise in the bond market. A £1.2 billion club loan deal has already been inked to refinance the unregulated airport portion of the acquisition.