2.35 Financial close four months after June 1999 proved unattainable, however, because of substantial outstanding, and additional, survey and technical work, and the sale of the property development arm of Kvaerner (part of the Modus consortium) in Autumn 1999. The initial surveys revealed in Spring 1999 that the buildings were in a poorer condition than had been anticipated. MOD was keen to transfer full latent defect risk to Modus which Modus accepted, provided they could complete an extensive programme of further surveys. Failure to complete the surveys may have resulted in Modus having to increase its price or, at worst, made the deal unfinanceable. Given the importance of surveys to the pricing of PFI redevelopment projects, departments should give careful consideration to the risk to the early completion of a deal that the outcome of surveys present. In this deal, MOD was guided by Modus' previous statement that financial close was achievable by October 1999.
8 |
| Capital structure of Modus | |||
|
| Funding type | Capital (£'000) | Term (Years) | Interest rate |
|
| Pure Equity | 100 | n/a | Note 2 |
|
| Subordinated debt | 53,000 | 29 | Note 2 |
|
| Senior debt tranche 1 | 298,700 | 25 | 7.61-7.86% |
|
| Senior debt tranche 2 | 200,000 | 27 | 7.61-8.11% |
|
| Total | 551,800 |
|
|
|
| NOTES 1. The senior debt was provided by Halifax PLC and others. 2. The forecast rate for the equity and subordinated debt taken together is 17.63 per cent in real terms. 3. The senior debt interest rates are given as a range as they vary over the loan period. The rates exclude upfront fees and commitment fees. 4. The overall project rate of return is anticipated to be 7.05 per cent in real terms. | |||
|
| Source: Modus | |||
2.36 Following the delays caused by the further survey work most of the outstanding matters were resolved in late 1999. But MOD and Modus were still not able to close the deal, as they had planned, by their revised target of commercial close by Christmas 1999, with financial close in February 2000, reflecting concerns at the lack of liquidity in the financial markets around the millennium period, and given the large amount of finance required for the Main Building project. Agreement was reached on all major technical and commercial issues and contract price in March 2000. After obtaining necessary MOD approvals, financial close was achieved in May 2000.
2.37 Closing the deal in May 2000 was seven months later than MOD's expectation when it chose the financing method in June 1999 that the deal would be closed in October 1999. Deal closure was thus 11 months after the MOD's decision on the method of financing. As a result, MOD was exposed to changes in financing costs (both relative to other forms of finance and in absolute terms) for a longer period than originally envisaged.
2.38 During these closing stages financing rates were increasing including a £10 million cost increase due to the adverse and unexpected impact on bank financing rates of the auction for 3G communication licences in Spring 2000. This contributed to the outcome, noted in paragraph 2.24, that increased financing costs accounted for the main part of the price increase after Modus became preferred bidder.
2.39 MOD did not, however, accept all of the movement in interest rates. Bank rates increased on the day of the financial close because the market knew that the MOD deal was coming but as part of the closing negotiations (see paragraph 2.26) MOD negotiated a cap on interest rates with the banks and members of the Modus consortium taking a reduction in their returns in order to close the deal. MOD did not, therefore, take the full interest rate increase and saved £4 million as a result of this negotiation.