Northern Batched Hospitals: Alternative PFI

Northern Batched Hospitals was the first major scheme to progress under the Department of Health pathfinder batching process. The deal was also notable for securing competitive all-in debt pricing during a turbulent time in the credit markets.

The rationale for the batched process, formulated while Geoffrey Spence (now at HBOS) was seconded from Deutsche Bank to the UK Treasury, is to provide cost savings during both the bidding phase and the operational phase. Cost efficiencies were made by the two Trusts acting as a single negotiating team throughout the entire process, allowing a common 'deal' to be agreed for the two schemes: The Trusts benefit from lower public-side bid costs because two projects can share the same advisers. On the private side bid costs should be reduced because most UK PFI sponsors win around one in every three of the projects on which they bid, and adjust their bids to accommodate these sunk costs.

Under the batched scheme, bids are compared on a fully-priced initial project with a complex client pricing schedule also entered at bid stage for future projects. There is a fully open pricing protocol in place which provides for a transparent unit cost for each component of future projects based on components of the fully-priced project, with the unit costs categorised as identical, similar or different to the first project.

Operational synergies between the two schemes are made as a result of shared management personnel and efficiencies of scale in the procurement of services. These cost-savings are passed to the Trusts with a mechanism to protect the sponsors against higher costs in the event that the second scheme does not close and the associated efficiencies lost.

Fortunately this mechanism was not called and both schemes closed within two weeks of each other as the Ambac-wrapped bonds were distributed despite the turbulent market conditions.

Consort Healthcare reached close on the £159 million ($318 million) bond issue for Salford Royal NHS Foundation Trust's 36,000m2 new build hospital on the existing Salford Hope Hospital site on 3 September. Consort Healthcare is a 50/50 joint venture between Balfour Beatty and HSBC Infrastructure Fund. The second part of the scheme, Tameside and Glossop Acute Services NHS Trust's 21,000m2 new build hospital on the existing Tameside hospital site Tameside Hospital, reached financial close 14 September.

RBC acted as financial adviser to Consort and also as joint bookrunner with HSBC. The £159 million floating rate bond due 2041 for Salford hospital had a coupon of 2.0677%. It is wrapped to AAA by Ambac. Ambac won the fixed-fee funding competition over other monolines before the summer, so its fees were unaffected by recent market events.

The spread over government gilts was 80bp significantly wider than the spread before the credit tumult on comparable UK healthcare bonds such as St Barts and St Helens at 50bp. However, given the rush to safety the yield on government gilts had fallen to around 1.2%, so the all-in cost is comparable to the situation before the outbreak of the sub-prime contagion.

One bonus of the choppy market conditions was that there was positive carry on the bonds given that the short term rates were higher than the long term guilt rates.

For Tameside Hospital, the £79 million ($158 million) index-linked bonds due 2041 had a coupon of 1.98%, just under 9bp below the coupon on the first batch, the £159 million Salford Hospital bond. The spread over Gilts on Tameside was 79bp versus 80bp for Salford, with the fluctuation in Gilts accounting for around 8bp of the difference between the coupons.

The two deals closed while the shadow of capital inadequacy was first moving over the monolines. Fortunately the deals got away before the most serious runs on monoline stock and the rating downgrades, with the Ambac wrapped bonds sold to a mixture of real money and asset swap investors.

While other projects around September switched from bond solutions to the bank route, the sponsor with its financial adviser, RBC, tested the market and found that there was still a significant gap between the pricing of the monoline-bond solution compared with the bank market. Anecdotal evidence suggests that a swing of around 20bp was necessary for the project to drop the bond and go the bank route.

There is an option for the Salford Trust to press ahead with another batched scheme for the Salford Cancer centre, which is expected in 2009. But this is now likely to be funded in the bank market or via the public purse.

It is uncertain whether the UK market will see another batched scheme. Most of the innovation in UK PFI has centred on lowering bid costs through the introduction of strategic partnership agreements such as LIFT and BSF – the batched hospitals scheme is a variation on this theme.

The challenge of the batched scheme is keeping bid costs low in light of the need to work through complex pricing formulas, and these burdens have the potential to be too onerous and costly for any really sizeable cost savings. Furthermore, given the head of steam LIFT has built up, batched health schemes may remain just a pathfinder method of procurement rather than offering any long-term deal flow.

Nevertheless, the Northern Batched Hospitals scheme achieved competitive pricing in uncertain times, and while the project could be the last batched scheme in the UK for some time, and mark the end of the monoline-backed model for 2008 and possibly beyond, the deal is a tenable PFI procurement alternative in a market where traditional cost savings on debt and EPCs are going to be harder to find. In short, small savings may take on greater significance in the PFI future.

Northern Batched Hospitals
Status: Financial close Salford – 3 September 2007; Tameside – 14th September 2007
Description: The first procurement under the Department of Health pathfinder batching process.
Sponsor: Consort Healthcare (Balfour Beatty and HSBC)
Mandated lead arrangers: RBC Capital Markets; HSBC
Monoline: Ambac
Financial adviser: RBC Capital Markets
Financial adviser to government: Deloitte
Legal adviser to sponsors: Ashurst
Legal adviser to lenders: Allen & Overy
EPC contractor: Balfour Beatty Northern
Technical consultancy: Gleeds