In December 2003, the NNUH project was refinanced through lower-interest-rate debt by Octagon Healthcare45 and the contract with Octagon Healthcare which was initially 34 years was extended to 39 years. The break point of the contract then became the year 2037 instead of the year 2032. According to a report of the Public Accounts Committee of the House of Commons, the gain from refinancing amounted to £129 mn of which the immediate cash gain to Octagon Healthcare's investors was £95 mn (PAC 2006, 7). The gain to the NNUH Trust was £34 mn. but this was spread over the rest of the contract period. So the NNUH Trust's share of the gain was £34 mn out of £129 mn or about 26% of the total.
How did the refinancing arise? It arose for two reasons. Firstly confidence by investors in PFI deals had grown between 1998 when Octagon signed the contract and 2003 when the refinancing took place. Secondly, between 1998 and 2003 interest rates in the UK had dropped (NAO June 2005, 10). These two factors made it profitable for Octagon to switch from bank financing to cheaper bond financing and the longer borrowing period and lower interest rates enabled Octagon to increase its borrowings from £200 mn. to £306 mn (PAC 2006, 7).
Did Octagon gain from the refinancing? Yes, hugely. As stated above, the immediate cash gain to Octagon's investors was £95 mn. and the PAC reported that the annual rate of profit to Octagon's investors rose from an expected 16% before the refinancing to 60% after the refinancing (PAC 2006,
9). Not surprisingly, Richard Jewson46 (the Octagon Healthcare Chair at the time of the refinancing) was reported as saying;
"We are pleased that the refinancing has been signed. Both parties have worked together to implement the refinancing in complete accordance with the Government's guidelines and both of us will now benefit accordingly" (NNUH Trust website)
The PAC reported that "The high rate of return to Octagon's investors following the refinancing is in line with the Darent Valley Hospital refinancing…" (PAC 2006, 9). However it is worth noting that the PAC's reported figure of 60% per annum could be an understatement of the rate of return since nowhere in its report does the PAC set out the year-by-year cash flows from and to Octagon's investors from the time of the first investment. The rate of return was said by the PAC to be derived from Octagon's financial records relating to the refinancing held by the Trust's financial advisers, Royal Bank of Canada (PAC 2006, 9). How much detail was given to the National Audit Office and the Public Accounts Committee is not clear. I come back to this issue of the rate of return to Octagon Healthcare in the next and last section of this Appendix.
Was the PFI deal a good one for the NNUH Trust? No, it was a poor deal. The PAC reported that; "This refinancing produced a balance of risks and rewards between the public and private sectors which, even for an early PFI deal, is unacceptable" (PAC 2006, 4) and its summary stated that "we would not expect to see another Accounting Officer appearing before this Committee defending what we believe to be the unacceptable face of capitalism in the consortium's dealings with the public sector" (PAC 2006, 3).
It is worth noting that as with other early PFI deals, this PFI hospital contract had placed no obligation on Octagon to share any refinancing gains47. The 26% of the refinancing gain accruing to the NNUH 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 200248.
The gain for the Trust is a reduction in the annual payments to Octagon of £3.5 mn a year in March 2005 prices (Annual Accounts 2006/07, 35)49.
This gain is a small one in two senses as the PAC report emphasised. Firstly it is small compared to the huge rate-of-return gain to Octagon Healthcare. Secondly, under the terms of refinancing of the contract, the Trust will find it more expensive to terminate the contract. As the PAC put it; "The Trust further contributed to the inappropriate outcome by accepting that, should it wish to end this contract early, its liabilities could now include all the additional borrowings Octagon used to boost its investors' returns" (PAC 2006, 3). These additional amounts are not small. If, in 2008, the Trust wished to end the new contract, it would have to pay £300 mn instead of £150 mn under the old contract. If, it wanted to wait until 2018 to end the contract, the Trust would have to pay £257 mn in liabilities whereas there would have been no liabilities to pay in 2018 under the old contract (PAC 2006, 11). The PC reported that "The Trust thought that objecting to the higher termination liabilities would have limited the amount of the refinancing gain but this belief was untested" (PAC 2006,13).
It its 2005 report on the refinancing, the National Audit Office tried to justify the deal by comparison with later PFI deals by saying that "the benefits of a new hospital have been received earlier than in many other communities and the high rates of recent construction cost inflation have been avoided" (NAO June 2005, 3). The latter is a strange argument since the choice should have been not just about the timing of a PFI deal but about whether the hospital should have been financed by the private sector at all. It can be argued that if public sector finance had been used, not only would the construction cost inflation have been avoided but the hospital would have been financed at a much lower interest rate.
This is what the argument should have been about, namely a comparison between private sector and public sector finance. Unfortunately as we have seen, there was little option for the NNUH Trust but to use private finance if it was to go ahead with the hospital. The NAO report states that the Trust was satisfied that the net benefits from a PFI procurement were at least as good as what might have been obtained from conventional procurement. However, on the same page, the NAO report implies that the Trust was in a hurry to close the deal with Octagon and as a result did not pressurise Octagon to seriously consider (cheaper) bond finance (NAO June 2005, 20). The NAO report goes on to say that;
"Decisions at that time [1998] were influenced by a wish to close this pathfinder deal which had already been significantly delayed, without further delay so as to promote the development of the market for PFI hospitals. The market was then in its formative stages and needed completed deals to create confidence in this new form of procurement" (NAO June 2005, 21)
Thus it seems that the NNUH project was entered into as a pathfinder PFI project and as such was an outrageously expensive deal. A reasonable interpretation is that the NNUH Trust was told that if it wanted a new hospital then it would have to go down the PFI road, a road which was inherently expensive but one which was doubly so in the early stages of PFI.
45. The Supplemental Agreement, following the re-financing, was signed by two directors of the Trust (Ann Osborn and Anna Dugdale) and by two directors of Octagon Healthcare (Moira Black and Nigel Middleton).
46 . At the time of the refinancing, Richard Jewson was also chair of Archant (the newspaper publishing company) and of Savills (estate agents) as well as being Pro-Chancellor of the University of East Anglia. In addition he is or has been deputy chair of Anglian Water Services, chair of East Port Great Yarmouth and chair of the East Anglia Art Foundation Executive Committee. Also Managing Director of Jewson (the building material company) and then chair of its parent company (Meyer International) from which he retired in 1993. In September 2004, he took over from Timothy Colman as Lord Lieutenant of Norfolk . In August 2004, Richard Jewson set up a company (the PFI Infrastructure Company) based in the Isle of Man to deal in PFI projects (Private Eye 23/7-5/8/04, page 11). On 1 August 2006, he resigned as Chair of Octagon Healthcare. In 2007 he was non-executive chairman of PFI Infrastructure.
47 . In 2004, on a BBC File on 4 programme, Anna Dugdale (the then Director of Resources at the NNUH) said that; "I think that what's really important to remember is we had nothing written in the contract, but at the end of this negotiation, we had a significant benefit which we didn't have at the beginning" (BBC Tuesday July 6, 2004, p.7, transcript)
48 . "The first NHS scheme where outstanding loans were successfully refinanced was at Calderdale in May 2002. Under the original terms of the contract the Trust would have been eligible for 10% of such savings; this was successful negotiated up to 30% … Under a new code of conduct published in October 2002 by the OGC the public sector will benefit from a 30% share of any refinancing gains in all similarly signed schemes. OGC produced guidance at the same time providing for a 50% share of refinancing gains in all new contracts" (Department of Health February 2004, page 1). The Office of Government Commerce (OGC) was formed after a review in 1999 by Peter Gershon who was then Chief Operating Officer in BAE Systems and a member of British Aerospace plc. His review into civil procurement in central government recommended the creation of OGC. His review was accepted by the then Chief Secretary of the Treasury, Alan Milburn. The OGC is an independent office of the Treasury reporting to the Chief Secretary (www.ogc.gov.uk). It seems that the splitting of the profits in the first place resulted from pressure from the National Audit Office "which embarrassed PFI companies and the government into making the compromise agreement to share the proceeds of refinancing windfalls" (BBC Tuesday July 6 2004, 11). Note that from 2004, all PFI contracts were required to share refinancing gains on a 50:50 basis in accordance with the 2004 OGC guidance (Department of Health 2007, 214) and in 2008, the Government increased to 70% the share of receipts that it can claw back when projects are refinanced (Observer, 19 October 2008).
49. Roughly half of this £3.5 m consists of a reduction in the rent due to the extension of the contract, and the other half consists of a reduction in the rent as a share of the refinancing gain (see NAO June 2005, 11).