Mark Dennison 07 July 2015

Refinancing PFI debt

Refinancing PFI debt image

Local authorities across the UK are currently looking at the possibility of refinancing the debt in their Private Finance Initiative (PFI) projects. By utilising borrowing from the Public Works Loan Board (PWLB), local authorities are, subject to the wider regime of applicable legislation and regulation, able to lend into these projects and retain the difference between the PWLB borrowing and the PFI project lending.

Approximately £220bn remains payable by local authorities under the approximately 700 PFI projects in the UK. A significant part of this relates to the repayment of project finance debt, much of it currently advanced by conventional bank lenders. Given the margin to be retained by local authorities, local authorities who commit to refinancing that debt could be set to make a very substantial gain. On some projects, this could be in the tens of millions of pounds.

To the extent relevant PFI projects are already on balance sheet and subject to accounting advice, such refinancings may not adversely affect the relevant local authority's balance sheet or public sector net cash requirement.

Northumbria Healthcare Foundation Trust (NHFT) was the first to replace its project finance debt. It did so in 2014 with a loan from Northumberland County Council. This in turn was advanced by PWLB. In this case, the refinancing was the result of NHFT exercising a contractual right – a feature not commonly found in PFI.

It is more usually case for the range of refinancing options to turn on the legal detail of the transaction in question and the nature and the commercial intentions of the organisations which are involved in the delivery of that project.

Considerations of a legal and commercial nature

The simplest approach for a local authority will usually be to purchase the debt under the transfer mechanisms contained in the relevant project finance loan and ancillary finance agreements. However, it will only be that these can be exercised if the existing lenders are minded to dispose of their debt. As interest rates have fallen since many PFI projects were written, it tends to be the case that bank swaps teams are making a very good return, and accordingly the bank as a whole is not minded to dispose of the debt.

An option which might be more realistic in practice, which is for the project finance borrower to exercise its voluntary prepayment rights. Prepayments of this type are conventionally applied pari passu between the lenders. Without commercial agreement disapplying this, a project finance borrower would therefore not be entitled to prepay selected lenders alone.

For certain projects, this will be particularly noteworthy: where an organisation such as the European Investment Bank (EIB) has provided part of the debt at below conventional market rates, it is likely to be preferable for that debt to be retained. This presents challenges relating to the local authority contributing debt alongside an existing entity with its ongoing (though then potentially partially repaid) debt.

For example, the roles of agent, security agent and account bank would need to continue but neither EIB nor the local authority may be willing or indeed able to provide those services.

For some projects, there will be advantages in retaining existing swaps. A possible way of addressing this would be for new back-to-back swaps to be entered into between with the relevant local authority and the (potentially new) security agent.

The role of the project finance borrower

As the lenders’ relationship is with the project finance borrower alone, it will usually be necessary for that borrower to be involved in all negotiations between the local authority and the lenders.

Many PFI project agreements provide that the relevant local authority is entitled to request the borrower to undertake prescribed actions relating to refinancing where that local authority believes the market offers more favourable debt terms.

A consequence of the local authority triggering these mechanics is that considerations would then arise as to the application of any framework for the sharing of ‘refinancing gain’. It is possible that the project finance borrower considers these mechanics relevant regardless of the fact that it would be the local authority providing the new debt rather than a new private bank which that project finance borrower has sourced. The sharing mechanics would need to be considered in detail to determine the extent to which this is an issue.

Alternative routes

Looking at other options, the local authority might consider purchasing the project finance borrower outright. This would enable it to enjoy full flexibility in relation to new debt arrangements. However, this is unlikely to be viable in many cases by reason that the existing shareholders could be reluctant to dispose of the interests where there is a prospect of a share in any 'refinancing gain' (as mentioned above) – or command a purchase price which factors in a potential gain.

Further, it is possible that the local authority might not find the prospect of owing a project finance borrower appropriate (or indeed be willing to undertake a potentially significant amount of due diligence prior to purchasing such an entity).

A further option would be the existing lenders to lend on revised terms which are more favourable to the project finance borrower. It is difficult to see how this could be achieved in the current financial climate. However, if it is possible, the local authority could still benefit by choosing to pay a lower ongoing charge under the applicable concession or project agreement.

Wider considerations

Structures for PFI debt refinancing by local authorities are likely to require close scrutiny in state aid terms. There is a risk that an outgoing lender might challenge the relevant local authority’s decision to proceed on the basis that it amounts to state aid. This underlines the need for rigorous market testing prior to a transaction going live.

Another overriding requirement is that there is no impact on the effectiveness of the payment streams from the applicable local authority under the PFI project agreement.

Mark Dennison of counsel at Norton Rose Fulbright

This feature first appeared in Local Government News magazine. Register for your free copy here.

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