Patrick Sweeney sets out some of the key considerations for local authorities that are looking to refinance their PFI or PPP deals.
As the wider public sector adjusts to another round of funding settlements, the pressure to find real, quantifiable value in existing contracts grows.
An area of increasing interest to the public sector is the opportunity to refinance an existing PFI/PPP project - particularly those projects that achieved financial close at the height of the banking crisis commencing in 2008.
Treasury rules introduced in November 2008 allow the public sector to:
- trigger a refinancing; and
- keep a greater proportion of the refinancing gain.
At the time, HM Treasury presented these changes as necessary to protect the public sector and offset the increased costs incurred by the public sector in achieving financial close.
In other words, the public sector was not responsible for the banking crisis and yet it was paying a premium to achieve financial close in testing circumstances. HM Treasury wanted to ensure that as the cost of money in the financial markets fell back from the peak of the banking crisis, the public sector would stand to gain most from any subsequent refinancing.
A refinancing gain from an existing contract could be realised in two ways:
1. Lower unitary charge payments – in other words, the amount payable by the local authority on a monthly basis; or
2. Payment of a lump-sum financial gain. This would be payable to the authority on completion of the refinancing transaction and would mean that the existing unitary charge payments would not be reduced.
It is clear that either option could make a real difference to public sector bodies seeking to protect frontline services.
There are number of important issues for local authorities to keep in mind when considering a refinancing including:
- What is the purpose behind refinancing? Is the refinancing designed to improve the affordability of an existing contract by reducing the unitary charge or to release a lump sum to assist service delivery in other areas?
- What resource does the local authority have to deliver the refinancing process? Identifying a client team to manage the process will be essential to ensuring a smooth process through to financial close.
- What does your Project Agreement allow you to claim on a refinancing? HM Treasury updated its guidance in November 2008. So if your Project Agreement pre-dates November 2008, you may still find a refinancing attractive but care would need to be taken over the level of any refinancing gain share;
- How strong is the relationship with the Project Company? A fractious relationship may unsettle a potential new funder, who will be concerned that they could be inheriting a dysfunctional arrangement;
- How is the project performing? Linked to the previous point, funders will want to see low risk projects. Evidence of a high level of deductions to the unitary charge may require a funder to undertake further due diligence to understand why deductions are being levied;
- What work has been undertaken on testing lender interest? Timing is crucial. Some funders will be hungrier than others, depending on their own appetite to invest at a given moment. It is also crucial to find out how long a funder's approval process will take;
- What is the timetable? A refinancing can be a relatively simple process but it does require a lot of planning. The local authority will also be dependent on the capacity of the Project Company to deliver a refinancing and manage the funders (existing and incoming) more generally. If your Project Company is managing a number of refinancing deals, this may result in a delay to completing your refinancing.
- Would a prudential borrowing solution be appropriate? A local authority may be able to borrow via the Public Works Loan Board and act as the incoming funder on a PFI project for another public sector body. There are a number of challenges with this approach not least appetite from the Project Company, compliance with the Prudential Code and the potential impact on any Affordable Borrowing Limits; and
- Are there additional issues which need to be tidied up within the Deed of Variation to the Project Agreement? A refinancing represents an opportunity to 'tweak' the Project Agreement. It is important not to over engineer the Deed of Variation but, equally, there may be issues, which have arisen during the Project to-date that could usefully be formalised as part of the amendments to the Project Agreement.
Refinancing will not, on its own, address the funding shortfalls facing many public sector organisations. That said, a refinancing may unlock real value for the public sector and be one solution in continuing to identify efficiencies and protect crucial front line services.