Is PFI going to waste in credit-crunched times?

The Government recently baled out key PFI projects amid fears they might collapse. But what does this mean for PFI as a funding tool? Dean Stiles investigates

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The bank credit crisis has exposed the inherent weakness of the Private Finance Initiative (PFI) with the Government locked into private sector financing at a moment when the private sector cannot find the money. Given the economic crisis, the Government has little option but to bale out key projects, and it will provide finance of between £1-2B in the next financial year on the same commercial terms as banks.

The Treasury is to administer funding at arm's length through a specially created company. Yvette Cooper, chief secretary to the Treasury, said that although it expected most projects would also be funded by commercial lenders or the European Investment Bank (EIB), the Treasury would "provide the full amount required if necessary".

According to Simon Foy, partner of projects at law firm Pannone LLP, the possible collapse of projects like the Greater Manchester Waste Disposal Authority project for want of funding at such a late stage in the procurement process "would have caused shockwaves throughout the entire PFI sector" so government intervention has, at least in the short term, partly assuaged the fears of bidders and local authorities.

In it for the long term
Foy says the establishment of the Treasury's Infrastructure Bank suggests that the Government sees itself not simply as a funder of last resort for all projects, but as a medium to long-term partner with the EIB and commercial lending sector on key schemes. But he believes it likely the Treasury will lend only to the larger, more complex schemes. "PFI has historically been, and will remain, a very effective tool for procuring services and managing risk, particularly complex schemes with a significant funding requirement," he says.

Recent figures from Defra suggest that up to £7.3B of investment in waste infrastructure will be required over the next three years. According to Foy, that is far more than UK plc can afford to lend directly. "PFI credits have already been committed to many projects, and are an essential source of funding for procuring authorities," he maintains.

Whatever political doubts are expressed about PFI, Britain's contractors still see a healthy future for the initiative, which has provided a key financial prop for many facing a severe downturn in construction activity with the collapse of the housing market. The civil engineering contractor, Carillion, set up a specialist private finance business in 1996 to invest in PFI projects.

About 80% of Carillion's UK revenue is from government contracts and public private partnership projects, and it has closed, financially, 49 projects to date, 36 of which are in
operation. Richard Adam, Carillion's finance director, believes the Treasury's action "will help because the UK has lost some of the funding previously provided by foreign banks".

Costain chief executive Andrew Wyllie is equally sanguine. "PFI remains a strategically important activity given its prominence as a procurement route for major public projects," he says. "We continued with our policy of trading our PFI equity portfolio to reinvest in bidding for new projects, and disposed of two equity stakes in the year."

Wyllie adds: "Despite the more difficult market conditions, we were successful in securing more than £1.4B of quality new orders during the year from a range of blue-chip customers. We also ended the year with more than £1B preferred bidder positions, including preferred contractor for the SPV on the Greater Manchester Waste Disposal Authority's PFI contract."

Still a healthy appetite for projects
There remains a healthy appetite among sponsors and commercial lenders for PFI and PPP infrastructure projects and these will continue to attract equity and commercial debt, even in these straightened times. Foy says that while current debt pricing is undoubtedly reflective of the availability of credit, there is evidence that longer tenors are becoming available again for waste projects, albeit with earlier cash sweeps.

"The requirement for direct funding by local authorities using either prudential borrowing for direct capital contributions or debt funding from the EIB and the new Treasury Bank will increase over the next few years," he maintains. "Club deals are unlikely to comprise more than five banks, and any deal that requires funding in excess of, say, £150-200M will almost certainly need this additional funding, which will generate its own project-specific issues."

Foy points out that waste schemes take a long time to come to market, and that while the competitive dialogue process has its critics, its flexibility also enables authorities to reduce or alter the scope of their technical requirements during the process where funding constraints are an issue.

"There is little evidence to suggest that direct funding would deliver a better outcome for the public sector in the available time-frame without competitive pressure. PFI still has a long-term future, deals will close, but are likely to take longer to reach financial close, and the largest projects will require top-up funding in addition to, but not in substitution for, commercial lending."

PFI is a politically, not economically, motivated funding tool designed to make it look as if the Government is spending less than it does, at least in the short term. Its future will be determined less by its economic merits and more by its compatibility with broader government policy.

Dean Stiles is a freelance journalist

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