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Infrastructure Financing

Author: Adrian D Eakin | Date Added : 13-Apr-05

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Infrastructure Financing

With the capital value of Northern Ireland's next PPPs set to break the £100m mark, Adrian Eakin discusses the prospect of Northern Ireland's first bond-funded Project.

Infrastructure Financing

The last few years have seen an increasing use of bond financing for large-scale Public Private Partnership schemes (PPPs), largely due to the growing maturity of the financing market and familiarity with standard contract terms. Whilst no PPP in Northern Ireland has yet been financed through the bond markets, it may be that for some of the £100m+ projects coming through the pipeline (particularly in the roads and water sectors) bonds could be the best option.

Structure

The usual funding package for a PPP will include a small portion of equity (provided by the PPP company's shareholders) alongside a much larger tranche of senior debt (provided by the company's banks). When considering whether to use bonds instead of bank debt, it is for this largest tranche of capital. If a bidder can optimise the effect of the cost of finance on the ultimate cost of the scheme in a way that is deliverable in a reasonable time frame, its chances of success can be greatly improved. Indeed, Mary Dunne, a senior adviser at the Strategic Investment Board, confirmed to us that "innovative provisions in relation to financing can and should be considered along with all other aspects of bids".

Why use bonds?

Bonds are generally regarded as having the following advantages:

Cost - since the potential number of investors is far greater than banks offering commercial loans, this wide investor base allows the PPP company's debt (and risk) to be spread among numerous investors. In addition, the regulatory costs of being a bank do not apply to capital market investors and as a result the cost of raising finance on the capital markets is reduced.
Tenor - banks tend to be reluctant to lend for 30 years or more yet some PPPs can run to 30-40 years; this can have a detrimental effect on the net present value of a project.
Guaranteed - bonds often use insurance programmes (with "monoline insurers") designed to pay out if the bonds themselves have failed.
Flexibility - the rigid structure seen in initial bond issues appears to have disappeared; it is now possible to drawdown in tranches and use variation bonds to deal with changes to the project as matters develop. Also, bonds can be structured to tailor products to the specific requirements of the project, for example, the yield on a bond can be linked to an index of inflation to off-set inflation-related risk.
Drawbacks

Fees - bonds are not suited to every project and the high start-up costs can make bonds inappropriate to use on deals below £100m. There are more parties at the table (insurers, rating agencies and underwriters) and lots more paper (and of course lawyers..). In the South Tees NHS PPP scheme, around £7m of the £137m issue is believed to have related to start-up costs (albeit balanced by cost savings over the project term).
Renegotiation - if a project gets into trouble, it is much easier for the borrower to deal with a few banks than with hundreds of bond holders. Whilst bond trustees obviously play an important administrative role, any final decisions on renegotiating debt would be up to the bond holders themselves.
Refinancing - bond structured deals can be more difficult to refinance than those financed by senior debt. However, the less scope for refinancing, the less this will be a material concern - it is now very unusual for a PPP company to have complete freedom to refinance.
Effect

The use of bonds for a Northern Irish PPP could raise a number of issues. First, it will be interesting to see how the banks react to the increased competition; there is evidence to suggest than some banks have been lowering cover ratios, pushing out tenors and reducing margins to compete. Secondly, if bonds are effectively used in such a project, it may also lead to greater bundling of smaller schemes under umbrella contracts to bring the capital value/debt requirement up to a level which justifies further bond financings. Finally, bond issues are normally governed by English law and PPPs in Northern Ireland by Northern Irish law. However, the new insolvency regime in the rest of the UK has not yet been implemented in Northern Ireland and the mis-match between the two will require careful scrutiny in the context of a PPP company's default.

Adrian Eakin is a Partner in the firm's Corporate Department specialising in projects and financing work. Adrian can be contacted at adrian.eakin@lestrangeandbrett.com

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