1.19 Many factors can play a part in determining the size of the refinancing gain such as whether the size of the debt within the project has increased, the length of time remaining in the PFI project and the conditions in the financing markets (Appendix 6).
Refinancing without increased termination liabilities is likely to reduce the refinancing gain to the public sector
1.20 Treasury guidance expects that if the private sector proposes increases to the authority's termination liabilities, then the authority should also obtain an alternative refinancing proposal involving no increase to termination liabilities. This is expected to be part of the value for money assessment process. However, there is no requirement for the private sector to proceed with this alternative proposal. If the private sector is unwilling to refinance on terms which the public sector assesses as value for money, then this may reduce the extent of refinancing activity and this appears to have contributed to the low refinancing activity in 2005.
The size of gains will be affected by the timing of a refinancing and conditions in the financing markets
1.21 A PFI contract is of finite length - usually between 25 to 35 years - with the debt remaining within the project reducing over time. Hence, the potential gains to be made from refinancing the debt will diminish (other things being equal) the longer the delay in undertaking a refinancing. If lending rates on future new deals should become higher than they now are, there might, however, be a case to defer refinancing until lending rates reduce.
1.22 Although financing terms for PFI projects have generally been improving as the market matures, there could be fluctuations which either increase or decrease the scope for refinancing gains depending on financing conditions at the time of the refinancing. For example, in recent times there has been a high degree of liquidity in the bank and bond credit markets. This has created a competitive market with historically low risk margins - the part of the interest cost reflecting credit default risk (Figure 7 overleaf). It is uncertain though whether these favourable conditions will continue. The Treasury note that investment decisions are long term decisions, not driven by potentially short term market phenomena.
1.23 Whilst many new deals are now bond financed where, as with all bond finance, significant penalties for early repayment of the bonds mean that refinancings may not be a feasible option, there may still be opportunities to reduce the risk margin on some other bank financed PFI deals.16 The potential for refinancing gains needs to be weighed against the costs of ending any fixed interest arrangements.
1.24 Furthermore, the cost of finance could increase if new opportunities emerge which attract funds which would otherwise have been invested in PFI projects. For example, the current growth of new overseas markets in PFI and PPP projects, or the 2012 London Olympics projects, may create attractive opportunities for investors as an alternative to investing in what is now a relatively mature UK PFI market where returns are expected to decline or remain tight. The Treasury does not expect these factors to have a significant effect on the PFI sector. It also notes that the cost of finance will be driven primarily by matters beyond lenders' choice of whether to invest in the United Kingdom - credit margins being currently very low due to global liquidity in financial markets, the interest of pension funds in making long term investments as a hedge against long term pension liabilities and banking regulation changes. Nevertheless, whether an investor will remain motivated to undertake a PFI refinancing given the time and costs involved will always be influenced by the opportunity costs of other possible transactions.
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16 Bonds can be an attractive source of finance for a refinancing since they have a longer term to maturity which suits a 30 year PFI project, and they tend to be cheaper than bank debt. There may be costs involved in switching from one form of bank finance to another.