2.5 One of the primary risks for the private sector in undertaking a PFI project is the construction of new assets required to deliver the specified service. Once the construction or implementation phase has been completed successfully, and the private sector has established a track record in the delivery of the service, the perceived risk of the project is lower.
2.6 A lending margin is added to the banks' own cost of providing a loan for a project, and serves both to provide the banks with a profit and to compensate them against the risk of non-payment. Once the service is up and running and the service provider has proved its ability to deliver the service, there is a reduction in project risk. As a result, the project company may be able to obtain a reduced lending margin either from its existing lenders, or by moving its debt to other lenders. This has the effect of lowering the total level of interest charged to the project company, leaving more free cash with which to pay dividends.
2.7 In the case of Fazakerley prison, one of the existing banks agreed as part of the refinancing to underwrite the full amount of the loan whilst reducing its lending margin from 1.5 per cent to 0.7 per cent (rising to 0.9 per cent in June 2005). Part of this reduction may be attributed to the lender's perception of reduced project risk, and the balance to the general downwards market trend in lending margins for PFI projects. The additional value created for FPSL's shareholders as a result is £2.6 million.