Vol 2 (2005) - Issue 5

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PFI - What Problems Lie Ahead?

Philip Davidson (Partner) and Neill Morgan (Senior Manager) from KPMG’s Restructuring team have recently concluded an assignment advising a lender group to a complex PFI deal. After two and a half years of analysis and negotiation, a way forward was finally agreed, to the satisfaction of the lenders, the government and the contractor. In this article, Neill draws on recent experience, identifies the current issues in the PFI market place and speculates on the likelihood of future problems with PFI deals.

Background

The Private Finance Initiative (‘PFI’) was set up by the Conservative government in 1992. Its objectives were to bring private sector skills and efficiencies to improve service delivery in the public sector; to allow some risk to be transferred to the private sector; and to bring in private capital to the public sector.

Under a PFI scheme, a capital project, such as a school or hospital, is designed, built, financed and operated by a private sector consortium, under a contract that typically lasts for 30 years. The consortium is paid a unitary fee from public money when the capital project is completed and put into operation. If the consortium misses performance targets in the operating phase, it is paid less.

PFI was slow to start but has been very widely used since the Labour Party came to government in 1997. PFI covers a wide variety of sectors including transport, health, defence, schools and prisons. It is estimated that PFI contracts worth c.GBP 42 billion have been signed. In recent years the PFI has accounted for 9% of public spending annually.

Key players in the sector include many large and listed construction and support services groups such as WSAtkins, Balfour Beatty, John Laing, Mowlem, Si Robert Mc Alpine and Serco. Financial institutions active in the sector include Barclays, Royal Bank of Scotland, Deutsche Bank, HBOS and Lloyds TSB. A significant number of advisers have large and strong PFI foccussed teams.
PFI is not exclusive to the UK. PFI or public private partnerships exist in many other countries (for example Australia, Singapore, France, Germany and Chile). However, each country has adapted the model to its own particular circumstances. France has supported its transport infrastructure over many years and does not face the same issues as the UK has, for instance with the London Underground (the biggest single PFI project in the UK, worth GBP 15.5 billion over 30 years).

Problem PFI deals

Many PFI deals have faced problems, including a schools project in Huddersfield and West Yorkshire, Croydon Tramlink (and other tram ventures in Sheffield, Manchester, Nottingham and the West Midlands), Dudley NHS Hospital, Ballast Wiltshire’s three schools PFI projects in Tower Hamlets, Dudley and East Lothian; and the Skye Toll Bridge. Other examples of stressed or distressed PFI situations include Jarvis selling out of its PFI portfolio as it restructured its business and Amey’s problems with Croydon Tramlink (amongst other corporate problems) before it was taken over by Ferrovial in 2003.
Some companies undoubtedly overstretched themselves. Amey now consider that they bid for too many PFI contracts. It is possible that Jarvis acted similarly. However, the main reason for these problems was the public and private sector experimenting with the level of risk the other could bear. Over the typical PFI lifecycle of 25-30 years these issues can still be categorized as ‘early stage’ problems. This painful process is now behind participants in the market and
lessons have been learned.
For example, Croydon Tramlink was deemed to be a transport success, with considerable success in reducing the number of car journeys in its area. Financially, the Special Purpose Vehicle (‘SPV’) was in serious difficulty. It was reported that the SPV had only seven weeks of cash remaining and a rescue refinancing was necessary. The main reason for this was that the viability of the project was heavily dependent on receipts from passengers. Passenger numbers were 80% of projected levels and the shortfall led to a GBP 10 million operating loss in one year alone.