An update report by the NAO identifies that the government has secured gains of £137 million from PFI debt refinancings under new arrangements introduced by the Treasury in 2002. These new arrangements followed previous reports by the NAO and the Public Accounts Committee that highlighted the opportunities for the private sector to benefit from refinancing early PFI deals. There has, however, been a decline in recent refinancing activity following two NAO reports in 2005 on hospital refinancings which drew attention to the risks to the public sector from refinancings involving increased debt, following which the Treasury re-emphasised to departments the need to rigorously evaluate the value for money of all refinancing proposals. The NAO update report also describes the emergence of the PFI secondary market which is enabling equity investors in PFI projects to sell their shares on to new investors.
Of the £137 million government gains from PFI debt refinancings, £102 million relates to four large refinancings (one of the London Underground contracts and three hospital projects: Norfolk & Norwich, Darent Valley and Bromley). £72 million of the gains arose through a voluntary code whereby private sector companies have given the public sector 30 per cent of refinancing gains on early PFI deals which did not have contractual arrangements to share these gains.
The NAO found that the new sharing arrangements appear to be generally working well but there have been exceptions: in three road projects the public sector missed out on at least £1.7 million because gains were not shared in accordance with the voluntary code.
Information disclosed to the NAO showed that the profitability of projects following refinancing has varied. Most early PFI contracts were let on the expectation of an internal rate of return (IRR) to investors of 15 to 17 per cent. The IRRs following refinancing disclosed to the NAO ranged from less than 10 per cent to over 70 per cent. Around half of the projects showed little change from expectations when the contracts were entered into but in four deals (a fifth of the projects providing information) the IRR including the refinancing gain had risen to over 50 per cent. On deals closing now, the improved debt financing terms should be available to government during the procurement thus reducing the likelihood of significant later refinancing gains.
The report warns that PFI refinancing may bring risks as well as benefits. The NAO’s reports in 2005 on the Norfolk & Norwich and Darent Valley refinancings identified risks where, as part of these early refinancings, the NHS Trusts had accepted a longer contract period and the possibility of increased termination liabilities. Those organisations that accepted the share of the gain over the life time of the project could face uncertainty in collecting the gains if the project is terminated early. It is too early to judge whether investors taking accelerated gains from PFI projects will impact on service delivery in the longer term although there should still be incentives on contractors to perform after a refinancing.
There is an emerging secondary market, where investors sell on their shares in PFI projects, and the report finds that there has been a change of investors in 40% of projects. Half of the projects where there has been a change of investors have also undergone a refinancing. Where share sales have not taken place only 25% have been refinanced.
The Treasury considers that as the supply of PFI equity increases this should reduce the cost of equity and improve the pricing of future PFI deals. The NAO recommends that the Treasury should report annually on the trends in PFI financing costs. The report also recommends that, to provide transparency and a better understanding of the dynamics of PFI equity investment, further information is required on the full range of costs and benefits which investors experience from participating in the PFI market.