104. I am afraid I am going to ask more questions about the financing. It strikes me that the project itself is round about £550 million, the building costs, running costs, operating costs subsequently. Is that about right?
(Sir Kevin Tebbit) Yes, that is about right.
105. If the overall project is £750 million, am I right in saying that the costs of financing the £550 million amount to £200 million to use a round figure?
(Sir Kevin Tebbit) That must be about right.
106. So the £62 million difference is very easy to calculate: it is one third, an error of one third was made in the original estimate, or there was a change in the interest rates, because £62 million is one third of £200 million which was the eventual cost.
(Sir Kevin Tebbit) I think that must be right over that 18-month period, yes.
107. I do not think it was too difficult for somebody behind you to have calculated that. It came to me in an instant and I am sure it did to somebody behind you.
(Sir Kevin Tebbit) You probably find it a lot easier up here than I do.
108. Perhaps it is easier sitting where I am than where you are. The fact of the matter is that the financing of this scheme is not only conceptually distinct, it is also a totally different process in practice. This is why we are particularly interested in how this was financed and the £200 million costs of financing a £550 million scheme was obviously a very large proportion, probably about 40%. It is a huge proportion. I was intrigued about the public sector comparator. I passed a note to the Treasury, but they are unable to answer me. Perhaps somebody might be able to answer. The difference in cost had the money been provided through the Public Works Loan Board. What we have done, by the sound of it, is gone onto the market and borrowed the whole £550 million at a fixed rate of interest for 30 years, which must be about the most expensive way of borrowing money that one could devise. I do not know who made that decision, but the public sector comparator presumably, although I cannot see the figures here easily, must have calculated the difference in borrowing money from the Public Works Loan Board.
(Sir Kevin Tebbit) The point is that it is the company which was borrowing the money and the proposition which we accept is that it is the company which is putting its own money at risk, therefore it is the private sector partner who has the incentive to use the money that it has raised more efficiently.
109. With due respect, I am talking about the public sector comparator. I am predisposed to go with the public sector. I think that civil servants and the Government are predisposed to go with the private sector, so there may be an ideological difference between us. I accept eventually it is decided by the facts of the case. The facts of the case which we have been told are that the public sector comparator was £100,000 more out of £750 million than the private sector. An intriguing difference. What I am asking is this: of the £750 million £200 million were financing costs. If we had said to the builder, you get on with the building and running the building and we are going to finance it through the Public Works Loan Board, what would be the difference in cost? What would be the difference in cost? I know for a fact that there is a huge divergence between long-term borrowing, everybody round the table must know, and Public Works Loan Board. What is the difference? Can anybody tell me?
(Sir Kevin Tebbit) I am afraid I am not informed about the Public Works Loan Board. It is not a source of finance which is available to the Ministry of Defence. I do not know whether it is to anybody else.7
110. I just want to know how the public sector comparator was constructed? Do we assume the same financing costs?
(Sir Kevin Tebbit) 6% is the figure which is used in all cases for calculating the public sector comparator. That is the Treasury discount rate.
(Sir John Bourn) Perhaps we can help here.
(Mr Colman) This is a frightfully technical issue.
111. And huge amounts of money are involved.
(Mr Colman) Indeed there are. The fact is that the methodology which Treasury prescribe for the public sector comparator does not explicitly include the public sector borrowing costs. You might think the purpose of the calculation is to show whether the benefits of the PFI approach exceed the extra financing costs; you might think that is the purpose of the calculation. It is not in fact what that calculation does. The calculation uses a standardised discount rate of 6% which is not directly related to borrowing costs. To answer your question: the calculation could be done of the impact of financing this at a lower rate, but that is not what emerges from the public sector comparator.
112. Just so I understand. What is the finance cost which was eventually fixed at 6% then? What did you borrow on, Mr Webber?
(Mr Webber) We borrowed at an average of 7.8% or something like that.
113. You borrowed at 7.8%. You say it was an average but you fixed the price on day one. Who decided it should be fixed over a 30-year period? Why did you borrow long term on a fixed rate?
(Mr Webber) We were raising long-term funds for which we wanted to fix our risk on the interest rate.
114. You decided to borrow fixed over the long term.
(Mr Webber) We did and that is common practice.
115. It is also common practice to take advantage of market changes in the costs of borrowing money. Seven point 8% strikes me as quite high.
(Mr Webber) As we were discussing earlier, over the 16 months beforehand rates had gone up and that was precisely the problem.
116. What could you borrow it at today?
(Mr Webber) I suspect the rates have come down again slightly, but I do not know what the precise rate will be. This is the point: they are volatile and therefore with a long-term asset and long-term income it is best for companies such as ourselves with a high amount of debt in them, therefore quite fragile, to lock into the known cost of interest.
117. Just coming back to the Comptroller and Auditor General for a minute, the difference between 7.8% over 30 years on £550 million and 6% is an enormous amount of money. I am trying to understand where I can identify the difference in financing costs and whether we might well have done better from the public sector even though this Government may well be ideologically predisposed not to do such a thing.
(Sir John Bourn) That calculation could certainly be made.
118. Where would I find that calculation in this document?
(Sir John Bourn) The document is done by the Treasury rules for calculating the public sector comparator. The document brings out "Don't rely on the public sector comparator to determine your judgement", but if the Committee would find it helpful, we could certainly make the hypothetical calculation.8
119. We are talking about huge amounts of money, absolutely huge amounts of money. Whatever anybody else's ideological position round the table is, at the end of the day one's decisions are based on the facts rather than simply an ideological predisposition. I personally should be very interested to see how that calculation is done and what the difference in price might be. I want to move on to one other sub-set of questions around the same kinds of issues to do with the costing of risk. No, I shall come back to that. I shall change tack for a minute. Were the contractors aware of the public sector comparator prices, the £750-ish million?
(Sir Kevin Tebbit) No, no.
120. At no stage were they made aware of it?
(Sir Kevin Tebbit) No, not at all. That is why I said it was an accidental coincidence. They get the base costs but not the other. I think what you are actually arguing is that we should have raised this money by gilts at the price the Government can offer money rather than in the market. That is the basic proposition.
121. I am not arguing anything. I am predisposed to believe that would be the cheapest way of borrowing money.
(Sir Kevin Tebbit) What I am saying is that the company raising money in the market therefore took on the risk. The proposition is that the private sector partner, as a result of that risk, has to deliver efficiencies which more than offset the increased cost of borrowing by the route they take. That is the argument about better value for money.
122. With all due respect, I understand the argument that the public sector does not know how to build as efficiently as the private sector or to project manage, but this company took no risk at all with financing this debt because on day one they went to the market, borrowed the whole amount of money, affected the interest rate being charged in the spot market on that day by operating in a way which I regard as inept and secured the whole of the debt for the whole of the period. So the private sector took no risk at all. The price was fixed.
(Sir Kevin Tebbit) But the ability to repay depends upon the stream of cash from the Ministry of Defence and if that does not come they will be -
123. The public sector took a hit of £60-odd million as a consequence of that decision. I should be interested to see how the figures we have asked for turn out. I want to move on to one other thing which is this business of risk taking by going to the public sector. You talked about the Monte Carlo simulation, but I rather think the reference to risk is in this Table 9, where we are adding millions of pounds to the public sector price to rig it effectively to put the job out to the private sector. In paragraph 2.50 it says that you were working to guidance partly laid down by The Cabinet Office Efficiency Unit, but in fact barely any data was available on which to base the risk calculations. There were only two MOD refurbishment projects on which to base any kind of estimate and there was a huge difference in the cost overruns between the two. It actually says, and you have agreed to this, that there was a lack of comparative data on redevelopments. So these figures here, which add up to £102 million loading the dice against the public sector, are based on inadequate information. Would you comment on that assertion of mine?
(Sir Kevin Tebbit) We did obviously look at whatever other comparators we had; certainly within the Ministry of Defence we had relatively few. We did use information from other Government Departments. As I have already explained, we did not use risk factors which were weighted heavily according to the Treasury Green Book. We were using pretty competitive risk factors, if you like. We did sample many projects, but one can always wish for more. At the bottom of all this, there is this basic issue of saying that if every project were done using Government finance we would end up essentially renationalising or nationalising the whole economy.
124. That sounds like a good idea to me, but that is another subject. It used to be in clause 4 of our Party at one time but somebody moved it. On reflection, I regret the fact that we took clause 4 out. The penultimate sentence in this paragraph talks about two MOD refurbishment projects, "... these had been subject to very different degrees of cost overruns". I think you said the Treasury were saying you should use a 35% overrun, which is really loading the dice against the public sector. You have gone for figures lower than that.
(Sir Kevin Tebbit) Lower than that.
125. Could you tell us what the variations were in the two projects which you were able to use?
(Sir Kevin Tebbit) I am not sure that I can. One was the Old War Office building which substantially overran. We have to be frank about this. The history of conventionally procured building projects in Government has not been marked with success. There was a large overrun in the Old War Office project which was finished in about 1992; several hundred %, I have to tell you. In the good old days of public finance we were not necessarily that brilliant at this. I come back to the proposition here. The contractor does have his money at risk. He depends on the payments coming from the Ministry of Defence which will only happen if he performs well. He is incentivised in order to do it on time, so he gets the money when he needs it and he is fixed with all sorts of other performance criteria. Therefore he really does need to deliver efficiencies in order to make money on his contract. The proposition of going for the private finance route is that the efficiencies which flow from these incentives and risks on the private sector outweigh such additional cost of borrowing that might arise. Those additional costs of borrowing are often going to be there anyway, even if we use conventional procurement because you go to a contractor, you ask him to build you a building, he will still be borrowing money in the market and you will not know exactly how he has built that into his price.
Jon Trickett: I do accept some of the points you are making. Just reflecting on the debate about financing costs, it strikes me that there are three separate rates of interest: one is long-term fixed, which would be the highest, most expensive money you could borrow from the banks; one is the bank rate itself which is less; then-I was using the Public Works Loan Board simply because I am aware that is a publicly available figure-any way in which money might be available to the Department from the Treasury in the conventional way. It would be interesting if we could be shown the differences in the savings which might be made by using each method of borrowing, if we may?
Chairman: Perhaps the National Audit Office might advise us.
Jon Trickett: Building on the points we have already agreed.
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7 Note by witness: The total financing costs, calculated relative to the Treasury discount rate of 6% in real terms, amount to approximately £185 million of the total project cash flow. This figure reflects both the equity return and the interest cost that Modus pay to their third party funders and excludes the impact of interest paid on cash balances and the repayment of outstanding principal.