The £1.3 billion ($2.1 billion) M25 financing – a flagship deal for the UK PFI market – came in with remarkably low pricing (starting at 250bp over Libor) and a long tenor (27 years). The deal is testimony to the resilience and adaptability of the bank market and set a Europe-wide benchmark for transport and PPP projects at a time of intense pricing uncertainty and hence lending stasis.

The 30-year DBFO contract involves the widening of most of the remaining three-lane sections of the London orbital motorway (around 63 kilometres in total) to four lanes in each direction. The operation and maintenance of the M25 network will be undertaken by Connect Plus Services, a joint venture comprising Balfour Beatty (52.5%), Atkins (32.5%) and Egis (15%).

In its early days, the financing was being worked out at a time when counterparty risk was a concern to all potential lenders. Banks were concerned about the creditworthiness of other banks, hedging counterparties, insurers and bond providers, and the documentation had to be drafted to minimise these counterparty risks. A general worry for the procurers was whether there would be enough active banks left in the market to close the deal, so it was decided that every effort should be made to keep all of the 21 banks pre-committed to the deal. Four coordinating banks were given key roles to guide the wider bank group to financial close – Lloyds (documentation), SMBC (technical), WestLB (modelling) and BBVA (insurance).

The majority of the commercial banks believed that the project would require 90-95% direct government backing, as in the London Underground concessions, Metronet and Tubelines. However, the DfT was keen to avoid such a liability, particularly given the fallout from the Metronet default. The DfT argued for keeping a long-term deal and a 60% floor on termination liabilities. Both the tenor and non-SOCP4 termination conditions, under which in default the project is retendered, were sufficiently stringent to scare five banks away from the deal (although some withdrew due to internal capital constraints).

In return, and given the concerns over counterparty risk, banks demanded concessions over project risks. The initial package proposed a debt to equity ratio of 92/8 with an LLCR of around 1.2x. The negotiation process took the structure a long way from that, though – at close the project was levered 85/15 and with an ADSCR of 1.4x and an LLCR of 1.5x.

The increase in equity, as well as an increase in the availability fees, made the conservative cover ratios possible. The DfT and Highways Agency were keen to avoid paying more in availability payments while boosting the sponsors' rate of return, so the structuring featured a novel rebate mechanism whereby excess cash is diverted back to the procurer before being distributed to shareholders.

Banks also moved for cash sweeps to bring down the average tenor and dropped a planned equity bridge. The sponsors injected £200 million of equity, a mixture of upfront equity plus pro rata letters of credit from corporate relationship banks. As late as January, a £200 million equity bridge was to be bundled with the project financing, but was dropped due to concerns about its impact on liquidity for the senior tranche.

The DfT told banks in December 2008 that it could come in as a direct lender because there was the worry that there would be enough banks at financial close. Despite banks' concerns over the potential conflict of interest between having the DfT as procurer and lender, the intercreditor agreements and changes to voting rights were negotiated, but in the end the DfT loan was not required. Better than that, the deal closed oversubscribed.

The £1.3 billion financing comprises a £710 million 27-year commercial tranche priced at 250bp until year seven, stepping up to 300bp, and then 350bp at year 11. Upfront fees are 250bp. There are two cash sweeps. The first – a 50% cash sweep – happens at year 8, followed by a full sweep at 20 years. Given the reluctance of banks to place long-dated swaps, the inflation and interest rate swap fees are relatively high, at 45bp and 35bp respectively. The swaps were shared among 15 of the 16 commercial banks, after pre-hedging from Lloyds, HSBC and Barclays Capital.

The banks covered on a pro rata basis a £215 million EIB counter-guarantee facility, and the EIB is providing a £185 million direct loan. Unusually, the EIB facilities feature step-ups in margin broadly following the commercial bank debt.

The sponsors went out to their corporate relationship banks to secure letters of credit after the equity bridge was dropped by the project banks. Together with upfront contributions, these totalled £200 million in equity.

The successful close of the M25 financing had strong implications for the rest of the market. As a banker at BBVA says of the deal: "The fact that it closed at such a difficult moment, with no need for public money, sent a very positive message to the market – not just to UK PFI, but to the broader European market. Many banks were simply waiting for it to close before fully committing to what they were looking at."

M25 Widening Project
Status: Financial close 21 May 2009
Description: £1.3 billion (85/15 debt-equity) financing for 30-year, £6.2 billion road widening PPP concession
Sponsors: Skanska (40%); Balfour Beatty (40%); WS Atkins (10%); Egis Projects (10%)
Mandated lead arrangers: Lloyds (documentation); SMBC (technical); WestLB (modelling); BBVA (insurance); HSBC; Barclays Capital; RBS; Dexia; SG; Calyon; Natixis; BayernLB; Helaba; KfW; NAB; BTM
Multilateral: EIB
Financial adviser to the Highways Agency: PricewaterhouseCoopers
Financial adviser to sponsors: HSBC
Legal adviser to sponsors: Ashurst
Legal adviser to the Highways Agency: Denton Wilde Sapte
Legal adviser to commercial lenders: Linklaters
Legal adviser to EIB: Slaughter & May