We do not consider there to be an opportunity currently to realise savings to refinance the senior debt in existing PPP projects, given that the margins1 applying to debt have increased since most of the projects reached financial close. For many years, commercial lenders were prepared to lend long term finance to infrastructure projects at a margin of 1% and below. The credit crisis has seen a re-pricing of this finance to at least double the margins previously charged. Therefore the opportunity for operational projects to take on cheaper debt does not currently exist. For those (relatively few) projects that have reached financial close since the credit crisis and have therefore had to incur these higher margins charges from the start, there may be an opportunity to refinance the debt once they have reached the operational period. This will not occur before mid 2011 and should be considered at this time.
We have also considered whether the partial repayment of debt directly by the public sector could provide value for money for the public purse. Specifically we have reviewed the funding of a capital contribution from the public works loan board (PWLB) to repay a minority of the outstanding debt within a local authority PPP project. This review has not demonstrated value for money as the borrowing rate from PWLB (which since the Comprehensive Spending Review on October 20th has increased to 1% above the relevant gilt rate) in general exceeds the interest rate on the project debt it would be replacing. This is illustrated in Box 2 as a worked example.
| Box 2 - Project Example In one project we have reviewed, £74.3m of senior debt was outstanding, with an interest rate swap rate of 5.23% and a margin of 0.66%. The senior debt was repayable over the remaining 23 years of the project with an average life of just over 11 years. The LIBOR and PWLB rate for this duration were 3.3% and 4.5%. Therefore any borrowing of funds from PWLB to repay debt would incur interest at 4.5% and would make a saving of interest of 3.96% (LIBOR rate of 3.3% plus the margin 0.66%). The saving is not greater than this as the interest rate swap remains in place, which means that the project company has to pay to the swap counterparty the difference between LIBOR (3.3%) and the swap rate (5.23%). The swap can only be broken by paying an upfront charge equivalent to the stream of expected payments to the swap counterparty. Therefore replacing existing senior debt with PWLB funds does not provide a saving but would add a cost. Pre PWLB cost increase, when the cost of PWLB funds was nearly 1% less, then PWLB at a cost of approximately 3.5% could have replaced existing senior debt at a cost of 3.96% realising a saving. This would have meant some transfer of risk back to the public sector but this was not examined further as the PWLB shift made this irrelevant. |
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1 While margins have increased the underlying interest rate at which debt is available has decreased. However in most cases the underlying interest rate movement was hedged at the time of financial close and cannot therefore provide a gain in a refinancing.