2.29 At the submission of Revised and Confirmed Tenders in December 1998 Modus submitted two bids, one being a bond-financed solution, and the other using bank finance.4 In MOD's detailed evaluation of Modus' two bids at this stage, the bond-financed model bid offered the better value for money. Modus' calculations suggested that bond finance would be approximately £25 million cheaper than bank finance at that time.
2.30 Both Modus and MOD and its advisers continued to evaluate both bank and bond options during the preferred bidder stage and interviewed the bank and bond providers before a decision was reached on the method of financing. During the period from selection of preferred bidder to June 1999 the differential between bank and bond financing was diminishing. In June 1999 MOD reached a view, following discussions with Modus, that the deal would be completed within four months by October 1999. Modus and its funders had wanted the method of financing to be agreed for some time and MOD decided that, based on the expected four-month timetable for closing the deal, it was not practical, for both cost and programme reasons, to attempt to continue to pursue both bank and bond finance solutions. There was evidence from the bank and bond funders that they would not commence their final reviews of the deal until the decision on method of financing had been made.
2.31 At this decision point, in June 1999, Modus proposed that bank finance should be used. Although bond finance had clearly appeared cheaper when Modus submitted its revised bid in December 1998 movements in the financing markets meant that by June 1999 the difference in cost between bank and bond finance had become marginal and Modus suggested qualitative factors favoured bank finance. MOD and its advisers reviewed these proposals and agreed that bank finance should be adopted. MOD noted that future changes in the financing markets could, however, mean that the bond solution would be cheaper at financial close. But it considered the volatility of the financial markets made it impossible to forecast how the markets for bank and bond finance would move before the deal was completed.
2.32 In agreeing to Modus' proposal that bank finance should be used MOD identified qualitative factors that supported using bank finance. These included: greater flexibility to cope with any contract variations which would require changes to the financing; lower costs to MOD in the event of a premature termination of the contract, because the amount of bank borrowings outstanding, to which termination liabilities are related, declines over the contract period; concerns about how security issues would be dealt with under the public disclosure requirements of a bond issue; and, concerns that the underwriters of a bond issue might not accept Modus being exposed to the same level of financial penalties for poor performance that could be applied in a bank-financed deal. Additionally, MOD and its advisers were concerned that there might be difficulties in arranging a bond issue as they considered the market for PFI project bond issues immature and MOD's financing requirement of around £550 million would have been the largest PFI financing that had been brought to the bond market.
2.33 Bank financing allows for the possibility of private sector gains from future refinancings. Such gains are not normally possible in a bond-financed solution where the initial terms of the finance remain in place for the life of the bond and cannot be improved upon during this period. MOD says it was aware that Modus' proposal for bank finance created the potential for it to benefit from refinancing benefits. MOD sought, therefore, to obtain from Modus a share of future refinancing gains but, for the reasons noted in paragraph 1.32 (c), Modus resisted this.
2.34 In deciding to adopt Modus' proposals for bank finance, MOD benchmarked the bank terms Modus were proposing to ensure that these were the best the market could offer. At the request of MOD, Modus had sought two rounds of competitive bids for the provision of bank finance and MOD was satisfied, as a result of this and the benchmarking exercise, that competitive terms had been achieved. Modus' capital structure, and terms of finance, are set out in Figure 8.
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4 The characteristics of bank and bond finance are explained in Appendix 4.