Health and social care

The Refinancing of the Norfolk and Norwich PFI Hospital: How the deal can be viewed in the light of the refinancing

“I have decided to produce a report for Parliament as the issues raised by this case have wider interest in considering how the pricing of PFI deals may change over time. In this case, the Trust continues to pay a premium on its financing costs for being an early entrant into the PFI market whilst benefiting from the early use of the new hospital and lower construction costs. But other factors may affect price comparisons over time and further analysis of price movements would be valuable.”

Report cover showing Norfolk and Norwich hospital

    “I have decided to produce a report for Parliament as the issues raised by this case have wider interest in considering how the pricing of PFI deals may change over time. In this case, the Trust continues to pay a premium on its financing costs for being an early entrant into the PFI market whilst benefiting from the early use of the new hospital and lower construction costs. But other factors may affect price comparisons over time and further analysis of price movements would be valuable.”

    Sir John Bourn, 10 June 2005


    Sir John Bourn, head of the NAO, today reported that, following improvements in PFI financing terms, the Norfolk and Norwich University Hospital NHS Trust has shared in the gains from a refinancing of its early PFI hospital contract, but it continues to pay a premium in respect of the financing costs compared to current deals. Sir John also reported that the Trust has received the benefits of a new hospital earlier than many other communities and avoided the high rate of recent construction cost inflation.

    Sir John noted, however, that other factors, some of which have yet to be fully analysed by the Department of Health, could also affect comparisons between the prices of early PFI deals and those being entered into today. The NAO recommends that the Department should carry out further analysis to identify how the pricing of all elements of PFI deals has changed over time – taking account of changes to the deals being entered into, general economic factors and other factors specific to the PFI market such as whether the private sector is delivering cost efficiencies from their increasing experience of delivering PFI projects.

    The NAO also concluded that it might have been possible for the Trust to have improved the original deal with greater competition and better defined requirements in the closing stages but the Trust is not convinced it could have obtained any added benefits in what was then an immature market as it sought to close a pathfinder deal which had already been assessed as value for money.

    The Trust currently pays £37.8 million a year to Octagon. The original contract was a pathfinder deal which helped the Department of Health to establish a new market in PFI hospital procurement. Sir John decided to report to Parliament following the refinancing which generated gains, in net present value terms, of £115 million. £34 million of the gains were shared with the Trust. The internal rate of return to the shareholders of Octagon increased from 16 per cent to 60 per cent following the refinancing. The increased rate following the refinancing reflects the high value of receiving large returns early in the contract period.

    Octagon’s refinancing in 2003, nearly six years after the letting of the contract and two years after the opening of the new hospital, generated large gains for Octagon mainly because they were able to significantly increase their external borrowings (from £200 million to £306 million). Because these additional funds were not immediately needed to operate the project, this created cash resources which could be used to enable Octagon’s shareholders to draw immediate benefits from the project, with the increased borrowings to be repaid out of planned profits later in the contract period. The £115 million refinancing gain, based on the increased borrowings, was a reflection of the better financing terms Octagon were able to secure, not available in 1998 when the contract was entered into, as a result of: the maturing PFI market (there is more competition in the funding market and funders see PFI as less risky than in its early years); the successful delivery of the hospital and demonstration that the operational phase of the hospital is going to plan; and the general reduction in borrowing rates.

    In this early PFI hospital deal the contractual arrangements had placed no obligation on Octagon to share any refinancing gains arising from the original deal. Octagon shared, however, approximately 30 per cent (£34 million) of its total refinancing gain with the Trust. This was in accordance with the voluntary code for sharing refinancing gains on early PFI deals which the Treasury had negotiated with the private sector in 2002. The cost of additional work which the Trust commissioned from Octagon in 2001 has been fully offset by the contract price reduction arising from the Trust’s share of the refinancing gains.

    The NAO found that the terms of the bank finance for the original deal appear competitive for a bank financed deal at that time. But the NAO considered that it might have been possible to improve the original deal. Alternative financing solutions were not seriously explored to ensure the financing terms remained competitive during a two year deal closure, the Trust considering that it did not wish to further delay the project and that it was not convinced that the overall terms of the deal could be improved bearing in mind the relatively undeveloped state of the PFI financing market at that time. The annual charge increased by a fifth in a non-competitive situation due to specification changes.

    By entering into this deal in early 1998 the Trust has avoided construction cost inflation which has been in excess of general inflation in recent years. The cost of government building work has, on average, increased by 49 per cent since 1998. The Department has demonstrated that, if today’s financing rates were applied to Octagon’s original financing, then the additional building costs arising from construction cost inflation probably offset the benefit of the lower financing costs which are now available, assuming no other savings are priced into a current bid.


    Publication details:

    ISBN: 0102933057 [Buy from TSO]

    HC: 78 2005-2006

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