Some of the best innovations in project finance are born out of necessity, and Derby hospital in the UK shows that nimble participants can change the shape of a market. This PFI hospital bond, while building on the work of the Walsgrave hospital financing, set its own first in the PFI market. It tapped the fixed-rate market on competitive terms - something that the UK's National Health Service has rarely allowed.

Project company Derby Healthcare has (like Walsgrave) Skanska and Innisfree as sponsors. The two won the concession in September 2002, with South Derbyshire Acute Hospitals Trust as its client. The hospital, which has a total capital cost of £333 million ($612 million), replaces the existing Derbyshire Royal Infirmary, although not some outlying facilities.

According to the trust, the new hospital is to be completed by the end of 2008. Construction started in August 2003. The new hospital will house more beds and more operating theatres. It is the largest third-wave PFI hospital to be financed.

Derby shares many features with other third-wave hospitals, which benefit from standardised documentation. Moreover, operationally Derby benefits from the refinement of the retention of employment model pioneered at Walsgrave. It should be noted, however, that for Derby the secondment of NHS staff begins before, not after, the project is complete.

But the most innovative element of the project was the fact that the bookrunner BNP Paribas and co-manager Barclays, faced with extremely limited available funding in the index-linked bond market, went back to the client and persuaded it to reprice the contract to accommodate a fixed-rate bond.

Such was the demand for the deal that it achieved a good price for the trust. The monoline, MBIA, also proved that there was demand for its paper, despite the fact that it had wrapped paper for NATS, Southern Water and the BBC beforehand

The £446.5 million fixed-rate bond was priced on 3 September 2003 paying a semi-annual coupon of 5.564%. The maturity on the notes is 30 June 2041 and the pricing at issue was 75bp over the reference Gilt (the 4.25% June 2032 Gilt). The deal carries an underlying BBB rating by Fitch and a Baa3 rating by Moody's. The issue includes £35 million in variation bonds.

Traders and bookrunners will continue to debate whether the index-linked market was as shallow as it appeared, but Derby stands out as a useful innovation in financing. Moreover it adds a useful new alternative for the cost-conscious NHS manager.

It also, along with Blackburn pioneered the so-called 'Deed of Safeguard', designed to deal with the potential conversion of the hospital to foundation status - a conversion Derby recently announced.

erby Healthcare

Status: closed 9 September 2003

Location: Derby, UK

Description: PFI bond financing of NHS hospital

Concession awarder: South Derbyshire Acute Hospitals NHS Trust

Sponsors: Skanska and Innisfree

Debt: £446.5 million bond

Bookrunner: BNP Paribas

Maturity: June 2041

Coupon: 5.564%

Lawyers to the sponsors: Clifford Chance

Lawyers to the awarder: Pinsent Curtis Biddle

Lawyers to the lenders: Ashurst Morris Crisp

Sponsor's financial advisor: Investec

Government's financial advisor: PricewaterhouseCoopers

Architect: Capita Property Consultancy