Press Release - The Refinancing of the Norfolk
& Norwich PFI Hospital: How the deal can be viewed in the light
of the refinancing
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.
Sir John Bourn said:
“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.”
Notes to editors
- The Trust’s 1998 contract required Octagon to
build the new hospital, then to maintain it and provide facilities
management service for a minimum period of 30 years. The current
contract also reflects additional building work that the Trust
commissioned from Octagon in 2001. The total minimum contract
period, including the construction phase, was extended from 34 to
39 years at the time of the refinancing.
- The internal rate of return is the standard
measure which the public sector has used to compare returns
expected by shareholders of consortia bidding for PFI contracts. It
is not an indication of the future rate of annual returns which
Octagon anticipate realizing from the project but reflects, and is
sensitive to, the time value of when benefits are received. The
rate of 60 per cent following the refinancing reflects the high
value of receiving large returns early in the contract
period.
- The increase of 49 per cent in the cost of
government building work is from the Median Index of Public Sector
Building Tender Prices (MIPS) published by NHS Estates based on
information compiled by the Department of Trade and Industry
relating to all government building work of varying complexity.
Compared to the cost of building work on the Norfolk & Norwich
hospital, the Department currently expects to pay PFI building
costs today which are 57-89 per cent higher.
- Press notices and reports are available from
the date of publication on the NAO website, which is at
www.nao.org.uk. Hard copies can be obtained from
The Stationery Office on 0845 702 3474.
- The Comptroller and Auditor General, Sir John
Bourn, is the head of the National Audit Office which employs some
800 staff. He and the NAO are totally independent of Government. He
certifies the accounts of all Government departments and a wide
range of other public sector bodies; and he has statutory authority
to report to Parliament on the economy, efficiency and
effectiveness with which departments and other bodies have used
their resources.
Press Notice 39/05
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