The week the bank list for the M25 was scheduled to be named in mid-September 2008, Lehman's Brothers collapsed. As a large high profile UK PPP, the deal was expected to be engineered along the same lines as the £2.2 billion ($3.62 billion) FSTA Ministry of Defence transaction that closed in the midst of the credit crunch after the demise of the monolines in March 2008. However, because competition among banks had completely evaporated it was not possible, as with FSTA, to go out to market with a fully formed term sheet and ask lenders to compete on price.

That the £1.3 billion M25 financing closed within nine months of Lehman's collapse with a starting margin of 250bp and a headline tenor of 27 years is testimony to the resilience and adaptability of the bank market. Not that it was plain sailing – the procurers, the Highways Agency and the Department for Transport (DfT), and the Connect Plus project company and their advisers had to make huge changes to the initially proposed financing package to get the deal done.

The 30-year DBFO contract consists of 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 the formative stages at the end of 2009, the financing was worked along when counterparty risk was a huge concern to all potential lenders – banks were concerned about the creditworthiness of other banks, hedging counterparties, insurers and bond providers. The documentation had to be painstakingly drafted to minimize these counterparty risks. An overarching concern for the procurers was whether there would be a sufficient number of active banks left in the market to close the deal, so it was decided that a concerted effort should be made to keep all of the 21 banks pre-committed to the deal.

Four coordinating banks were given key roles to shepherd the wider bank group to financial close – Lloyds (documentation), SMBC (technical), WestLB (modelling) and BBVA (insurance).

Most commercial banks took the view that the project would require 90-95% direct government backing as featured 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 staunchly 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 equity ratio of 92/8 with a loan life cover ratio similar to a UK PPP accommodation project at around 1.2x. The negotiations took the structure a long way from those beginnings: at close the project was levered 85/15 and with an ADSCR of 1.4x and a LLCR of 1.5x. Such generous ratios helped the banks expedite their due diligence of the minutiae of the concession agreement and performance grid for the availability payments.

The conservative cover ratios were achieved by the increase in equity, but also by increasing the availability fees. 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. It is only the second time this rebate mechanism has featured in UK PPP, the first being the Ministry of Defence's Allenby/Connaught accommodation project which raised £1.8 billion in the capital markets in April 2006. The mechanism allows the procurer to boost cover ratios to make lenders more comfortable without benefiting sponsors – a feature that could be used to stimulate bank competition in future PPP deals.

As well as improved ratios, banks also moved for cash sweeps to bring down the average tenor and dropped a planned equity bridge. The sponsors are injecting £200 million of equity, which is 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 the liquidity for the senior tranche.

In December 2008 the DfT told banks that it could come in as a direct lender because there was ebbing confidence that there would be a sufficient number of banks at financial close. Despite banks' concerns over the potential conflict of interest between having the DfT as procurer and lender, all intercreditor agreements and changes to voting rights were negotiated, but in the end the trigger was not pulled and a government loan was not required. Given worries about whether there was still a bank market the deal closed surprisingly oversubscribed.

The Treasury Infrastructure Finance Unit (TIFU) was formed on the back of the M25 experience, but was not conceived in time to have a role on the M25. For future deals, the TIFU's existence as the government's lending vehicle should soothe banks concerns about a separation from the procuring arm of government. The TIFU has so far a provided a £120 million loan for the Greater Manchester Waste scheme.

The £1.3 billion M25 financing includes a £710 million 27-year commercial tranche priced at 250bp until year seven and then steps up to 300bp, and then 350bp at year 11. Upfront fees are 250bp. There are two cash sweeps to, the first – a 50% cash sweep – happens at year 8 with 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 are covering pro rata 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 margins broadly following the commercial bank debt.

After the equity bridge was dropped by the project banks, the sponsors went out to their corporate relationship banks to secure letters of credits, which together with upfront contributions totals £200 million in equity.

Most of the banks in the club have come in with £75 million tickets and had to be scaled back (Helaba, NAB and Natixis took smaller tickets), so there is little pressure for syndication, with all banks comfortable to take and hold their commitments. The syndication is therefore to test the secondary market and hopefully kick start distribution for future deals.

Does the financing have implications for future PPP deals? Given the high profile nature of the M25 – the value of the contract is £6.2 billion and as the orbital road around London is probably the best known motorway in the UK – and the kudos attached to lending to the project, the deal is probably misrepresentative of current bank liquidity for small and mid-sized PPP deals. Already the 250bp starting margin looks too low for the current market, and the £75 million tickets are probably too large.

The M25 deal does set precedents for how future deals will be structured, with coordinating banks putting together term sheets for a pre-syndication. The question remains whether those banks most active at the sub-£300 million end of the UK market such as SMBC and Lloyds are too competitive on margin for the rest of market, or whether the market has fallen away for smaller and mid-sized vanilla PPP deals. If the market is still there, the formation of the TIFU may have been – in retrospect – a hasty, reactionary step whose participation risks crowding out commercial banks.

The next chunky UK PPP deals are Thameslink and Intercity Express; hopefully neither will have to contend with a Lehman's-style incident, and both have the TIFU to fall back on if banks cut their exposure to the UK PPP market.

M25 widening project
Status: Financial close 20 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: PwC
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