A £274 million two-tranche bond issue backing the PFI deal for the new headquarters of the UK's Home Office closed on 26 March 2002. The notes have been a long time coming but bankers say they have been worth the wait. Described as receiving a positive response from the markets, the deal marks the first significant PFI bond issue since the Dudley Hospital financing in May 2001 and the largest since GCHQ in 2000. It also boasts the tightest spreads the market has seen in five years. The notes have been rated AAA by Standard and Poor's and Aaa by Moody's.

Annes Gate Property PLC (AGP), a special purpose vehicle owned by HSBC Infrastructure Limited and Byhome Limited, a subsidiary of Bouygues Construction, secured preferred bidder status in July 2000. The contract entails demolition of three existing towers in Marsham Street that previously housed the Department of Environment, Transport and the Regions and construction of new office accommodation for Home Office employees. Following the 34-month stipulated construction period, AGP must also provide facilities management services over a 26-year operating concession.

Royal Bank of Canada Europe Ltd. and Barclays Capital underwrote and led the Ambac-wrapped notes, which were launched to the capital markets on 20 March. A £174 million amortising index-linked tranche has a final maturity of March 2030 and an average life of 15.5 years. Pricing came in with a 3.237% coupon and spread was 65bp over the 2.5%, 2016 index linked gilt.

A fixed rate bullet tranche of £100 million was issued in tandem, featuring a coupon of 5.661% and launch spread of 70bp over the 4.25%, 2032 fixed rate gilt with an issue price of 100.01%.

This dual structure is a first for PFI projects, which usually opt solely for RPI notes. It has been adopted to keep the government's debt service coverage down. The Home Office will pay a monthly fee to AGP on condition that the stipulated services are provided. This amount covers the project's ongoing costs, interest and principal on the RPI linked issue and interest on the fixed tranche.

The principal on the latter, however, is repaid in a bullet towards the end of the project life. Almost three years before the end of the notes' life, the Home Office must elect either to purchase the property or give it to AGP to sell. If it opts for the former it pays whichever is less, the market value or an agreed residual value of £137.5 million.

The nature of this arrangement exposes the deal to a fall in the value of the property, but mitigating structures have been put in place. From the bondholder's point of view, Ambac has borne the brunt by extending its normal insurance policy to cover property value risk. In a move indicative of its typically conservative approach, Ambac is itself guarded against any real loss from this eventuality through a cash trapping mechanism.

Starting from 2022, an annual evaluation is to be carried out on the property. If it comes in above an agreed cushion, then AGP collect profits as normal. If the building is valued at less than the stipulated amount, however, the mechanism kicks in and an agreed level of revenue is siphoned off. Further comfort is drawn from the fact that the project will be typically cash rich towards the end of the tenor, once the RPI-linked tranche has started amortising.

Other risks typically associated with accommodation PFI deals are not widely seen as a great threat for this project. The facilities management called for is fairly standard, with no complex IT demands.

?The underlying project has several key strengths including strong project participants, especially Bouygues (UK) Ltd, whose parent company Bouygues Construction S.A. (A-/Stable/A-2) has guaranteed its operations,? says Bram Cartmell, analyst at Standard and Poors. ?In addition, the project has relatively limited building risk and, as an office project, contains low operational risk.?

AGP has contracted the entire construction and facilities management obligations to Byhome, a wholly owned subsidiary of Bouuygues. Byhome in turn has passed on construction work to Bouygues (UK) Ltd., whose obligations enjoy a parental guarantee. Facilities management will be taken on Ecovert FM, which is a subsidiary of the Bouygues' SAUR group. The two sponsors have put in £30 million between them, giving the deal a standard PFI gearing of 90%.

The deal appeared to reap the benefits of clear contractual terms when it hit the markets. Rumours had suggested that recent troubles experienced by Railtrack meant that investors were steering clear of UK government deals. But this does not seem to have been the case. An investor group led by UK insurance and pension funds snapped up the full amount.

The deal's robust nature is also reflected in tight pricing. Peter Macfarlane, director of global structured finance at RBC draws attention to this point. ?The tight pricing achieved is good news for the deal, but also good news for the market.? The market is certainly active at the moment, with considerable appetite for AAA wrapped transactions.

This will be good news for PFI deals in the pipeline. After a year's drought we are likely to see an increasing number choosing the bond route. AGP's notes were preceded by a smaller issue from Ellenbrook Developments. The joint venture between Royal Bank Investments and Carillion Private Finance raised £60 million in the capital markets in Febuary backing a DBFO contract for the University of Hertfordshire. Wrapped by FSA, these came in at 85bp over the 2020 gilt. Looking forward, it is well documented that a number of hospital PFI deals are planning to look to the bond markets.

Annes Gate Property

Status: closed 26 March 2002

Size: £304 million

Location: London, UK

Description: £274 million bond issue backing construction of new headquarter buildings for the UK Home Office

Sponsors: HSBC Infrastructure Limited and Byhome Limited

Debt: £174 million amortising index linked issue with a final maturity in 2030 and a £100 million fixed-rate tranche maturing in 2031

Bookrunners: Royal Bank of Canada and Barclays Capital

Insurer: Ambac

Financial adviser to consortium: CIBC Capital

Legal adviser to consortium: Norton Rose

Legal adviser to banks: Allen & Overy

Legal adviser to government: Berwin Leighton Paisner