30. On this question of paragraph 1.42, you referred to how it could have been seen as a state aid if you had financed it through gilts. I take it you are saying it could have been seen as a state aid under EU rules, given that you had this Exchequer Partnership project?
(Sir Andrew Turnbull) We would be lending to a private sector body at something other than the normal cost of capital.
31. Nonetheless, this is a Treasury building. The thing that interests me about paragraph 1.42 is there is a spread of 163 basis points over gilts to accommodate the risks inherent in the project but why could not the Treasury have financed the development and refurbishment of its own building, which was a state building, using gilts?
(Sir Andrew Turnbull) This is the first time this has been done in 90 to 100 years. The Treasury has never engaged in a major property transaction before. The idea of becoming our own developer would have taken us into completely new territory, asking us to do something we have never done before and probably will never do again.
32. Who built the Treasury building in the first place?
(Sir Andrew Turnbull) Probably the Ministry of Public Building and Works.
33. Are you saying there was 100 years ago but there is not now expertise within government on managing this sort of project?
(Sir Andrew Turnbull) The responsibility for buildings is devolved to departments. The legacy of that was Property Holdings which disappeared some years ago. That is the route that produces the Marsham Street building, if you do it yourself.
34. There is quite a lot in the report on pages 16 and 17 about the bonds and issue of the bonds. Can you say how much money was raised by issuing the bond?
(Sir Andrew Turnbull) £125 million.
35. Was the 2.6 million for advisers' fees on top of that or were your net proceeds 122.4?
(Sir Andrew Turnbull) The £2.6 million includes lawyers, quantity surveyors and so on.
36. On top of?
(Sir Andrew Turnbull) Yes.
37. Was it 127.6 or was it 122.4?
(Sir Andrew Turnbull) I think the £2.6 million is what the Treasury has incurred for itself.
38. Is it not normal that if a company is trying to raise money it issues a bond and all the fees associated with raising the money are slapped on the bond?
(Sir Andrew Turnbull) All the fees on the EP side would have been, yes.
39. You raised 125 million.
(Sir Andrew Turnbull) We did not. EP raised it.
40. 125, excluding the facilities, management and the ongoing costs over the years ahead. Is it right to say that £125 million is the cost of refurbishing the building?
(Sir Andrew Turnbull) Yes, more or less.1
41. You are paying out £14 million per year for the next 35 years?
(Sir Andrew Turnbull) Yes.
42. Which adds up to 490 million?
(Sir Andrew Turnbull) With a net present value of £169 million.
43. Could you explain in layman's terms the sentence: "The total net present cost of the unitary payments is £170 million"?
(Sir Andrew Turnbull) If you take £14 million and, for 35 years, discount back at six per cent I think you get to £169 million.
44. Nonetheless, it is cash out of the door. You are paying 14 million a year?
(Sir Andrew Turnbull) Yes.
45. You are, cash out the door, paying £490 million over those 35 years?
(Sir Andrew Turnbull) Yes. You have to compare it with what we would have been paying had we done nothing.
46. Forgetting construction costs, what are now the annual maintenance costs of the Treasury building and the running costs, including maintenance where necessary.
(Sir Andrew Turnbull) We are paying something like nine but some of that includes a property charge. For the facilities bit, I am not sure I know the figure.
47. £9 million a year?
(Sir Andrew Turnbull) Yes.
48. That is in its 'undone-up' state?
(Sir Andrew Turnbull) We pay £9 million for an old slum and we will pay £14 million for a nice, new building.
49. You say you have a discount rate of six per cent. What were real interest rates when you came up with the six per cent?
(Sir Andrew Turnbull) Probably about three to three and a half.
50. Do you think it is a fair figure or is it too high?
(Sir Andrew Turnbull) It is an issue we have to look at.
51. Does that not fundamentally affect the project, the discount rate that you use?
(Sir Andrew Turnbull) It could do.
52. Are you saying that there are circumstances in which the discount rate that you use would not fundamentally affect the viability of the project?
(Sir Andrew Turnbull) The discount rate would apply both to this project and to the public sector comparator.
53. The discount rate is always going to be important, is it not?
(Sir Andrew Turnbull) Yes.
54. It is always going to determine whether it is viable and whether it makes sense to do it.
(Sir Andrew Turnbull) Yes. What I do not have in my head is whether we would have concluded that we would not have done it because this was a project that we had to do. The one thing we were absolutely sure of was that spending about 50 or 60 million simply to stop the water ingress into the basement, to stop lorries falling through the pavement into the basement, cabling maintenance-we were beginning to get a number of cable fires-and ending up with a building no better than what we have at present was an extraordinarily bad deal.
The Committee suspended from 4.35pm to 4.45pm for a division in the House.
55. Returning to the discount rate, you said you did not have it in your head whether it would have made much of a difference because you would have had to do something anyway. I paraphrase. I am right, am I not, that real interest rates were quite a lot higher than when you came up with the six per cent discount rate than real interest rates are now?
(Sir Andrew Turnbull) The six per cent is not-
56. That was not my question. Are real interest rates now a lot lower than they were when you originally came up with the six per cent discount rate? Yes or no?
(Sir Andrew Turnbull) Yes.
57. If you were to do it now, you would come up with a discount rate quite a lot lower, would you not?
(Sir Andrew Turnbull) Not necessarily because the discount rate is encapsulating probably three different functions.
58. Including risk?
(Sir Andrew Turnbull) It is encapsulating the pure time preference, risk and the fact that, when you raise money for a project, you have to do it through taxation and there is a welfare cost.
59. Nonetheless, are you looking for future projects at having a lower discount rate?
(Sir Andrew Turnbull) We are looking at the Green Book but there are no decisions or proposals as yet to change it.
60. Could you talk about the question of risk? What are the risks associated with the project?
(Sir Andrew Turnbull) One of the risks that we have is if it exceeds it costs. That makes no difference to us. We still pay 14 million. If they are late, they do not start getting the 14 million until we move in. Next are latent defects. EP and its architects surveyed this building extensively. If it turned out once they started knocking it apart that it was a lot more difficult to deal with or there was a lot more asbestos, for example, and they had to spend more money correcting that and it took them longer to correct that, that was their risk. There was a risk of listing and planning consents. There was broad agreement on the nature of the refurbishment with the planning authority, Westminister, but if it turned out that English Heritage were more fussy about this piece of stucco and that bit of panelling, that was EP's risk. There is the tenancy risk at the other end of the building. If there is a delay in finding a tenant, that is a risk that is transferred. They have to provide a set of facilities and management services to a particular standard. They have made an estimate as to how much it is going to cost them. If it turns out that it cost them a lot more than they estimate, that is again their risk. A risk that we have transferred is a pre-committed level of maintenance. As the tenant, we know that we will get this building maintained. We are not at risk of another part of the Treasury denying us the money in some future spending round to maintain it. That is a very comfortable position to be in. In the process, we have protected the residual value of this building. Summing that up, basically we only pay for what we get. There is quite an extensive risk transfer going on.
61. It says on the Office of Government Commerce website that the net present cost should include an estimate of the risk that would be retained by the public sector compared to the PFI
option. Is there a number for that and if so what is it? (Sir Andrew Turnbull) I do not have a number in my head for that.
62. You do not know how much risk would have been retained by the public sector? How can you begin to make a decision about whether to do this or not if you do not have a figure in your head?
(Sir Andrew Turnbull) In doing the public sector comparator, we made allowances for some of these risks, latent defects, cost over-runs and so on, and they were factored into that alternative calculation.
63. How much risk overall is retained by the public sector compared to the PFI option? That is one of the key things we need to know in order to decide to go the PFI
route or not, is it not? Am I wrong?
(Sir Andrew Turnbull) The risks we retain are probably common to both.
64. This is the definition of net present cost: "This is the net cost (taking into account any project revenues) estimated by the public sector of undertaking a project itself and producing the same or similar outputs under conventional procurement. The NPC should include an estimate of the risk that would be retained by the public sector compared to the PFI
option . . ." (Sir Andrew Turnbull) This is telling you what you should put into the public sector comparator. We did put an element of risk into the public sector comparator. We assumed, for example, that the cost over-run could be one of three figures, 10 per cent, 15 per cent or 20 per cent.
65. Forgetting the refurbishment costs for the moment, is the building going to cost less to run and maintain in the future than it does now?
(Sir Andrew Turnbull) It will cost more. That is because it is a hell of a sight better building. The relevant comparison is will it cost more or less than what we would otherwise have been forced to do with it.
66. £9 million a year sounds quite a lot of money for one building. Over 35 years, that is £315 million. If you add on 125 million, the cost of the refurbishment, that comes to 440.
(Sir Andrew Turnbull) What is not in that nine million is the 50 or 60 million that we would have to spend in the next three or four years to rectify the serious defects in this building.
67. Are you saying that the 50 or 60 and the 125 are separate numbers?
(Sir Andrew Turnbull) The £125 million was my ball park figure for the value of the bond. Actually, it was £127.8 million. There is then the mezzanine debt and the equity making the capital cost £141 million.
68. It is still only 16 million more than 125?
(Sir Andrew Turnbull) Yes.
69. The 60 million that you have talked about that you would have had to spend in the next three or four years and the 141 are completely separate figures?
(Sir Andrew Turnbull) One is the cost of patching up: the other the cost of a major refurbishment.
70. Which will mean that you do not have to spend the 50 or 60 million. So I am right. Forget the 50 or 60 million. If you add the 141 and add the existing cost, nine million a year, you come to 315 million, which is the current maintenance cost over 35 years, plus 141. That comes to 456 but you are paying out 490 over the 35 years, are you not?
(Sir Andrew Turnbull) We have done the calculation differently.2 The net present value of the public sector comparator, allowing for the additional risk that would involve, would have been £189 million. The project we are going ahead with has a net present cost of £169 million. In discounted terms, we think this project is £20 million cheaper than going ahead with a similar modernisation project carried out as a public sector project.
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1 Note by witness: The total sum raised for the refurbishment was £140.985 million, comprising £127.790 from the indexed bond, £6.925 million of equity and £6.25 million of mezzanine debt. Ref answer to Q186.
2 Note by witness: The calculation by Mr Bacon ignores the interest cost on the £141 million of capital raised. Ref answer to Q188.