Leeds: Leading CGF

The Leeds oncology financing illustrates the elegance of how credit guarantee finance (CGF) can be applied. Leeds sets precedents as Europe's largest cancer treatment centre and for being the first CGF scheme to close.

The project is a stand-alone, new-build cancer unit at St James's University Hospital in Leeds. Catalyst Healthcare, a 50-50 joint venture between HBoS and Bovis Lend Lease, won the 33-year concession. The concession includes a ring-fenced contract for medical equipment provision with a capital cost of £15 million to £20 million, the majority of which will pay for 10 linear accelerators. HTI is responsible for the medical equipment management.

Total financing comprises a £200.3 million ($373.9 million) main tranche with a 31-year tenor; £18 million equity bridge facility with a tenor of 37 months (the length of construction) that will be repaid by junior loans from the shareholders; variation facilities of £9 million over 37 months; and a £5.4 million change of law facility over 31 years.

The sponsors had worked through most of the financing details when the Treasury approached them to make the project its second designated pilot for CGF ? the first, Portsmouth Hospital, has been delayed due to planning issues.

The aim of CGF ? the legacy of Geoffrey Spence's tenure at the Treasury ? is for the government to save money by providing the debt at market value by issuing gilts. The gain is made because gilts can be effectively raised at zero cost unlike the spread paid by commercial banks to arrange bank debt or bonds. The traditional bank role is restricted to bearing the project risk in a similar role to that of monoline.

As guarantors, lending banks will remain exposed to the same project risk, so the margins should remain about the same. A downside for commercial banks is the sidelining of swaps under CGF because the Treasury lends at a fixed rate, CGF effectively negates the need for swaps and saves a spread of 10bp-15bp ? normally a lucrative addition for project financiers. Because Leeds was approached late in the day for CGF, the banks' requirements for the upside of the swap were factored into the margin payable to HBoS through negotiation with the Treasury.

Margin on the long-term debt is just over 100bp over Libor during construction, dropping to 100bp at start of operations, then down to 90bp. The guarantors receive their payment as they would under a loan agreement, here through a 6-monthly amortization schedule. HBoS has brought in Bank of Ireland, Dexia and Barclays in a club deal, with final signatures expected at the end of January.

A large part of the negotiations between the Treasury and banks centred on the nature of the guarantee; the Treasury initially pushed for joint and several liability. However, such a structure would require each guarantor to run a credit check on the other participants, pushing up transaction costs. Instead they agreed upon a bilateral guarantee where each institution is liable for a set portion if the project is in default.

The quick and successful closing of Leeds will help the widespread adoption of CGF across UK PFI. However, the first pilot, Portsmouth Hospital, has been delayed ? on paper Portsmouth appears easier to transact because the project is being financed via a bond so the government's credit guarantee will be from a monoline. Admittedly, Portsmouth has been held up due to project-specific reasons, but it is understood that that relations between the Treasury and Portsmouth project members are more adversarial than Leeds.

If, as they should be, margins are comparable to commercially placed lending, banks have little to fear from CGF. CGF will, on average, pare down the cost of lending by some 10%, a significant saving, defined as the overall cost of lending taken by the government, rather than the cost of borrowing, since the government lends at market rates. In the short term, at least, fees for participating banks are likely to be slightly higher because of the lost revenues for arranging swaps and to sweeten deals in sell down because CGF is a new quantity. Lead arranging fees are currently about 100bp, sub-underwriting 60-65bp, and general syndication 30-40bp. Under CGF about 10bp may be added to each tier.

Whilst banks do have to ring fence a portion of capital to service their guarantees, under CGF they will still receive a similar margin as if they had provided a direct loan but without needing to extend the capital. CGF could therefore encourage arbitrage plays by institutions, particularly investment banks, with restricted deposits. However, only banks with a rating equal to A+ or greater can participate as a guarantor. Banks participating in a CGF scheme can transfer their liabilities to another bank as long as it is rated A+ and above. Banks with a lower rating, such as some Japanese institutions and the Landesbanks cannot participate in CGF.

When Project Finance looked at CGF last year, many institutions were sceptical and even hostile to the idea. Sentiment may have warmed through indifference but there has also been acceptance from some quarters, and Leeds plays no small part in that change. (see Project Finance April 2004 issue, or search CGF at www.projectfinancemagazine.com)

Leeds Oncology Unit
Status: Closed 15 October, signatures expected by the end of January on club guarantee
Size: £232.7 million
Description: Financing for Europe largest cancer treatment unit at St James's University Hospital in Leeds
Concession awarder: Leeds Teaching Hospitals NHS Trust
Financial adviser to the trust: Grant Thornton
Sponsors: Catalyst Healthcare (Bovis Lend Lease; HBoS 50/50)
Mandated lead arrangers: HBoS, Bank of Ireland, Dexia, Barclays
Legal counsel to the trust: Dickinson Dees
Legal counsel to sponsor: DLA
Legal counsel to guarantors: Clifford Chance
Design and construct contractors: Bovis
Facilities management: Lend Lease FM
Medical equipment management: HTI