Tube Lines has tapped the capital markets for £2.081 billion ($3.83 billion) to refinance an original £1.934 billion bank and mezzanine debt package put in place 18 months previously. The deal has many new and peculiar facets: the £1 billion plus pre-sale of a project bond to one taker; a bond of this size unwrapped and AA-rated passing direct project risk to the lender; the variation bond template used for the majority of the financing for notes in excess of £1 billion. Throw into the mix a politically charged renegotiation of a state guarantee, and there exists a highly complex and an ultimately successful high profile refinancing.

Goldman Sachs and SG were mandated to pull together the refinancing within months of the signing of the original deal. "It was always envisaged we would refinance when there was certainty with regard to the concession - refinancing formed part of the value for money tests when the PPP contract was signed in December 2002," says George Hutchinson, director of external affairs, Tube Lines. "The cash benefit demonstrates that the government recognised the need to refinance and provide a benefit to Transport for London (TfL) and shareholders," added Hutchinson.

The total cash benefit of the deal is £84 million, 70% of which will go to Transport for London and 30% to Tube Lines. The benefit represents a partial monetisation of future interest cost savings - the remainder of the interest savings will be received by Transport for London as they accrue.

The refinancing pares down the cost of lending by concentrating TfL's 95% guarantee of approved debt and isolating it to effectively 100% guarantee the A1 notes, the EIB facility, and standby facility, leaving three uncovered tranches.

"The deal was segregated into two distinct pools of security assets," said Aedan Macgreevy, executive director, structured debt syndicate at Goldman Sachs. "One pool was created to meet the market for unwrapped 20% BIS rated municipal risk, and the second, to meet the demand of those institutions willing to undertake the credit work and take on operating risk."

The £1.1 billion A1 notes were pre-placed in their entirety with DEPFA Bank. Although the B tranche is more expensive than its original counterparty, the remaining tranches are better priced and there is a significant overall gain. Pricing on the TfL-guaranteed tranches was not disclosed, but the A1 notes are thought to pay 15bp to 25bp. The TfL-underpinned tranches pass on structured project risk direct to the lender rather than being wrapped, as was the route in Metronet. The ratings agencies required the see-through to the TfL guarantee, and Secretary of State comfort letter to be sufficiently transparent to award an AA rating. The lawyers were busy reworking the underpinning arrangements to satisfy the agencies' demands of nearing zero documentation risk and zero counterparty risk.

"As the largest unwrapped corporate infrastructure risk in sterling, this is an unusual transaction, without any close comparators," added Macgreevy. "Whereas Metronet could be compared with other long, fixed-interest, wrapped project risk, this deal has no obvious pricing reference. There is no similar deal - should it be seen as an asset-backed security, or project-type security" In the end it was marketed as a corporate infrastructure deal."

With DEPFA purchasing the £1.146 billion A1 notes, £95.26 million A2C notes, and £273 million bank facilities, and EIB swallowing a £300 million wrapped facility only £248.7 million uncovered debt was left for the wider market. The roadshow included over 50 investment meetings. Around 30 institutions participated, of which a large proportion are familiar corporates and pension funds. UK-based institutions took 89% of the uncovered tranches with lenders from Switzerland, the Netherlands, Spain and Portugal taking 11%. To reject claims that the underlying complexity of deal could affect the take-up of debt and its tradability, the index-eligible C tranche, which was priced on issue at 387bp over Gilts, is now trading 10bp tighter in the secondary market.

One legal hurdle was the need to document the interface between the refinancing and the PPP project documentation. Whilst the original documentation clearly contemplated the prospect of the refinancing, the way in which the underpinning worked was necessary to make the project bond palatable to the capital markets. At all times, this had to be set against the government's desire not to take on more risk, which in turn was set against the tangible refinancing gain accruing to the public sector. "The public sector interface proved a challenge," said Andrew Briggs, partner at Lovells, which advised Tube Lines. "The pre-consent didn't quite fit with the new structure. A square hole was originally carved into the documentation, through which we had to make fit the round peg of the refinancing structure."

The intercreditor agreements, and the structuring of the variation bonds technology for the A1 tranche, are complex and are best explained by the difference in the standing of creditors in the refinancing as opposed the original structure. In the first deal all lenders taking approved debt were on equal footing: in the event of a debtor failure each lender stood to lose 5 pence in the £1, because they were each covered by a 95% TfL guarantee. Under the refinancing, DEPFA benefits from a 100% guarantee, so has nothing to lose to push for precipitous action if Tube Lines lapses into default. Therefore the intercreditor agreement is carefully drafted to ensure that the important decisions are made by the parties with something to lose, such as Ambac, which wrapped the EIB's £300 million tranche.

The variation bonds technology applied to the £1.15 billion A1 tranche is exceptional - normally the technique is used on 2-5% of bonds on any one project. Under the draw down schedule equal six-monthly instalments are made over 6.5 years, until 2010; effectively the bond facility becomes more like a bank facility. As a result there is some exposure to DEPFA and Goldman Sachs under the forward note-purchase agreement borne by the takers of the uncovered tranches, B, C and D.

Tube Lines also departs from the traditional in its method of procurement under the PPP contract. Tube Lines' sole income is a four-weekly payment made by TfL in consideration for its obligations under a service contract that includes maintaining and upgrading the Jubilee, Northern and Piccadilly lines. The service contract structure is different from that used in Metronet and by the majority of PFI/PPP projects. Conventionally most requirements are sourced, then subject to long contracts at the start of the concession; Tube Lines, however, relies on continual tender procedures and entering into a number of rolling contracts over time. Lenders will therefore take a keen interest in the day-to-day running of Tube Lines.

Tube Lines Refinancing

Description: A £2.1 billion capital markets refinancing, partially covered by a guarantee from Transport for London, Ambac wrapping EIB's tranche, and the remainder uncovered and directly open to operational risk.

Financial close: 12 May 2004

Borrower: Tube Line Ltd

Equity: Amey, Jarvis, and Bechtel

Lead managers: Goldman Sachs (bookrunner), Societe Generale (intercreditor agent)

Legal counsel to Tube Lines: Lovells

Legal counsel to lead managers: Allen & Overy

Legal counsel to Transport for London: Herbert Smith

Legal counsel to EIB: Norton Rose

Technical adviser: Scott Wilson Kirkpatrick & Co.

Issuer facilities providers: Depfa Bank

Note trustee: Law Debenture Intermediary Ltd