Behind all the furore and noise over the high-profile, flagship PFI deals, there has been far less attention focused on the hundreds of mid- and small-sized PFI deals that continue to progress to conclusion. It is difficult to gauge the effect that the negative publicity surrounding projects like the Tube has had on other less visible PFI schemes. There is no doubt that the considerable amount of negative press coverage that has been awarded to the PFI has not gone unnoticed in local government, and there are certainly points to be scored by local government officials conscious of public disquiet over the programme. ?It is very frustrating when people refer to the Tube in a debate about PFI,? comments Stephen Matthew, partner at law firm Eversheds in Nottingham, which has advised on a raft of local authority PFI deals. ?There is no comparison at all. It is a completely different situation.? This may be the case, but has there been a marked effect on sponsor and lender appetite for smaller scale PFI projects as a result of such high profile debacles?

Sponsor appetite

The huge problems and widespread criticism of the Railtrack and London Underground projects have come to the fore at a time when the PFI market itself is maturing. The fact that the number of bidders for new deals has fallen dramatically can be seized upon by PFI's critics as evidence of a waning appetite for the programme. But what it does indicate is the increasing specialisation of sponsors ? most of whom have now targeted one sector in which to specialise. ?People are being far more selective about what they are getting involved in,? notes Jo Elliot, chief executive at Edinburgh-based Quayle Munro, which runs a dedicated PFI fund. As evidence he points to Renfrewshire Council's recent bundled schools project. The council approved plans for a £142 million school building and renovation building programme this August. ?This involved a considerable number of schools and until recently we would have expected to see the number of bidders for the scheme in double figures,? says Elliot. ?In fact there were only two.? And this is being seen across the spectrum: The sizeable £300 million North Staffordshire hospital scheme also attracted just two bids.

Not surprisingly, those active in the market see the reduction the number of bidders for schemes as a natural byproduct of an evolving market. ?People are recognising bid costs,? says Elliot. ?They look at what bidding costs can do to a sound company like Amey. But the process will be self-correcting,? he predicts. ?People will come in when the price is right.? Charles Barrington, project director for the Colchester Barracks PFI scheme at RMPA (the consortium consisting of Sir Robert McAlpine, WS Atkins and Sodexho), agrees. The £1 billion Colchester scheme has encountered several setbacks and is now significantly behind schedule. ?The Tube, several major health and defence schemes and Colchester itself have all caused people to think very hard about the costs involved in bidding for PFI work,? Barrington tells Project Finance. ?Smaller projects will increasingly be bid by established consortia and for larger projects people will be much choosier about who they team up with and more prescriptive on the original bid costs.? Sir Robert McAlpine has been one of the most active sponsors in the PFI market from the largest deals to the smallest. While it is lead sponsor on the huge Colchester deal it was also awarded a £7.2 million contract for a cancer research building at the University of Newcastle upon Tyne in November.

But as the number of bidders dwindles there is no doubt that the same names will crop up with increasing regularity as sponsors concentrate their efforts on particular markets. But will the inevitable consequence of this process be the development small sponsor oligopolies in which all the expertise and experience in a sector is held by just one or two companies? Could you eventually have the situation where one sponsor has been involved in every deal in a certain sector for the last five years? ?I don't see any evidence that this is happening,? states Barrington at Sir Robert McAlpine.

An important side effect of a reduced pool of sponsors is a far greater emphasis on the timing of particular projects. ?You have got to get your timing of sectors right if you want to have three or four good bids as opposed to two,? explains Tony Poulter, global head of Infrstructure, Government and Utilities at PricewaterhouseCoopers in London. ?If, for example, there are two or three large schemes in a sector well into procurement and a couple more coming along then it would probably be difficult to get more than a couple of bids for a project and it is a question of whether that is enough.? The question of how many bidders is sufficient to ensure sufficient competition is one that can be debated ad nauseum, but one person who is well qualified to comment on the issue is Chris Wilson, executive director of the Public Private Partnerships Programme (4Ps), the local government project procurement agency. ?Our experience shows that having three or so bidders at the Invitation to Negotiate stage is optimal to ensure a rigorous competitive process ? and three is what we usually see,? he tells Project Finance.

Concerns about the number of sponsors bidding for deals may, however, be unfounded if the market is as ?self-correcting? as claimed. There is no doubt that bid costs have come down considerably ? by as much as 40% since the introduction of standard form contracts ? and the likelihood is, therefore, that new players may consider PFI deals which were previously put off by bidding costs. There is far less legal work involved and bidding should, given the number of transactions that have taken place, now be a fairly straightforward process. ?Standardised contracts means that the legal documentation is now fixed,? says Stephen Matthew at Eversheds.

But project specific problems are not to be sniffed at ?housing refurbishment PFI projects have seen huge delays to potential deals due to the amount of work involved in assessing the state of housing stock. But uniform documentation has meant that the whole process can be much faster. ?People say that these deals take two or three years to do ? they don't,? says Matthew. Eversheds has recently been involved in two transactions in Sunderland and Derbyshire that were completed in less than one year. ?It is still not cheap to bid,? he warns, however. ?If you lose three in a row you are still in a hole.?

Bank appetite

The number of banks in the market has also fallen sharply, but there is little fretting about whether or not there are enough players involved on this side of the equation. ?We have seen a period which has been very favourable to borrowers with some lenders chasing market share,? reckons Pouter at PwC. ?That has finished now. There is still enough capacity in the market but lenders ? like sponsors ? are likely to be more careful and more selective.? Graham Beazley-Long, director in Capital Markets Origination at Dresdner Kleinwort Wasserstein, agrees that capacity in the market is now about right. ?Although the number of banks involved in PFI transactions may now have peaked there is still significant capacity in the market to fund new deals.? DrKW has been an active lender to PFI deals and has recently closed the £90 million Manchester police station deal sponsored by Equion.

DrKW is lender to the Tubelines consortium and Beazley-Long distinguishes between its involvement at the different ends of the market. ?Where we are the sole bank on a transaction we will do everything possible to get the deal done,? he says. The bank signed two Metropolitan police service deals last year at around the £100 million mark but is also looking at far smaller projects such as county police station deals in Wiltshire and Gloucestershire now under consideration at around £20 million. Where the bank is just a participant in a large consortium the amount of work required is far less but it can also do little to influence the deal. ?We would rather be a sole underwriter on a £150 million to £200 million deal as it is something over which we can guarantee to provide a high standard of service to the client,? says Beazley-Long.

There is clearly a size threshold below which PFI deals may become inefficient for project finance. However, the market still seems prepared to finance relatively small deals. ?There are a few people who will not look at deals [of less than £50 million] as they are too small ? but only a few,? says Jo Elliot at Quayle Munro. Towards the larger end of the scale the appetite is also still there ? but it tends to be confined to banks that can cover the bank lending versus bond finance stand-off that has been seen in the market over the last two to three years. This has been particularly prevalent in the NHS sector, where NHS trusts have been directed to use financing based on index-linked payment streams. This has resulted in most recent NHS deals involving index-linked bond rather than bank finance. ?Understandably many banks became frustrated at having followed a deal for some time only to lose out in a bank/bond trade-off at a very late stage,? observes Beazley-Long at DrKW. Bidding banks have therefore learned to be prepared to offer a range of financing solutions. ?It is important to have a broad financing package in place as that way there is less risk of a head-to-head competition with the monolines,? agrees Mike Smith in the infrstructure finance group at HBoS in London, one of the lead banks in the Tubelines transaction.

Given that there is still healthy bank interest in the PFI process, are there any signs that banks are being put off the larger deals and maybe focussing their attention on smaller, less controversial (and therefore more likely to get done) projects? Observers dismiss this across the board. ?There is no evidence of the giants starting to muscle in on the smaller end of the market,? states Jo Elliot at Quayle Munro. Smith at HBoS explains that the bank looks at all projects from about £20 million in size upwards but that ?we are a volume player with a large underwriting capacity.? But Smith is all too aware of the hurdles that a larger deal can present. ?The issue for banks in PFI is lead time and this is often worse in the larger transactions,? he admits.

One very straightforward deterrent in smaller transactions is the fee. ?The conventional view is that the smaller transactions are simply not worth it,? states Smith. But many don't see it that way. ?There is clearly a size threshold below which PFI deals require a different approach,? says Poulter at PwC. ?Several sponsors are focusing on schemes of less than £20 million or £30 million which ? with the right structure ? can be profitable for them and less exposed to political risks than some larger schemes.?

This seems to be the crucial decision for sponsors to make: stay small and keep off the media and central government's radar screens or go for the more lucrative larger schemes and risk getting sucked into a political bunfight. Elliot at Quayle Munro emphasises his view that the high-profile central government deals are best steered clear of. ?The advisers on these [regional] transactions are now so experienced that it solves the problem of local authority inexperience,? he says. ?Central government involvement in these deals can be a negative: I would rather pay the price of a little local inexperience than be constantly under the Treasury spotlight.?