2.35 We have noted above that the debt that does not count as part of the equity investment benefits from a form of guarantee. In the event of the financial failure of the limited liability company set up to implement a PFI transaction, lenders are protected by the value of the asset under construction. One way of realising this value is to re-let the service contract to a replacement provider. Re-letting contracts in this way posed problems in the case of the Tube, partly because ownership of the assets remained with LUL. The protection afforded to the lenders was increased in autumn 2000 before the BAFO bids were due for submission. This was done by providing clarity that LUL would pay lenders a sum (known as the 'underpinned amount') set at a minimum of 90 per cent in the event of a default leading to termination. This was backed up by Government letters, known as comfort letters (see glossary), which recognise the amounts of Infraco borrowing and the circumstances that the Secretary of State would consider in setting the transport grant for Transport for London. One bidder told us, however, that based on supplier support, his group had arranged indicative financing without requiring that the minimum underpinned amount be made explicit. This is indicative of what might be possible on smaller scale transactions, rather than being achievable from the lending market as a whole.
2.36 The placing of Railtrack in administration in October 2001 had an impact on market sentiment in part by illustrating the risks of costing maintenance and renewal of assets when their condition is not well known. Market sentiment can also be expected to have been affected by the ongoing political opposition to the PPP. The PPP preferred bidders persuaded London Underground that increasing the underpinned amount to 95 per cent in the run up to Committed Finance Offers (CFO) was essential to raise the total amount of finance required from the bank and bond markets for all three deals. Even with this support, financial institutions consider the Infraco borrowers a riskier proposition than the Government and this is reflected in their lower investment grade credit rating BBB+/Baa3 partly based on unique aspects that carry uncertainty, for example the periodic review arrangements. Although they ultimately carry risk reduced to 5 per cent or less, lenders are charging about £450 million more than they would charge on some £3,800 million of direct Government loans that would enjoy the highest credit rating (AAA).
2.37 The Tube Lines financing structure, in May 2004 refinanced in the bond market, had been developed earlier in the bidding process. Tube Lines had always planned to refinance at least £600 million of their debt at an early stage after project risk had reduced and after allowing time for market capacity to increase. The full potential impact of re-structuring most of the financing, say £1,800 million, in the light of the 95 per cent guarantee became clear when an investment bank made proposals to switch the main source of funding to the bond market between May and December 2002. London Underground and Tube Lines have both told us that at this late stage they made a conscious decision not to switch over to an unproven bond market structure because the bank deal was ready to close and they feared that any further delay could have prevented the PPP from reaching close at all. As is normal in PFI deals, the whole amount of any savings before close would have gone to London Underground, but this decision meant sharing the potential savings in financing costs with Tube Lines. As a result of commercial negotiations, the normal 50 per cent public sector share was increased to an initial 60 per cent rising, Tube Lines told us, to a 70 per cent share (undiscounted) over time out of a net gain of £84 million. This leaves a share of at least 30 per cent that Tube Lines was able to earn in the first sixteen months of the project.
2.38 Alongside delivering economic and efficient investment and services the key risk being passed to Tube Lines, and Metronet, was that of project managing multi-trade work packages and ensuring that the commissioning interfaces are dealt with efficiently. Part of the early refinancing gain arises from managing this risk with Tube Lines placing sub-contracts to the value of £620 million between Financial Close and October 2003. Political risk reduced when the Department and the London Mayor finally reached agreement on a funding statement in January 2003 setting out the grant for the period to 2009-10, fixed for the first three years and with scope to adjust the grant in the event of major unforeseen expenditure pressures. If they had been able to reach agreement earlier, for example before agreeing to guarantee 95 per cent of the senior loans, public money might have been saved through more competitive bank or bond financing terms.