The Private Finance Initiative has come of age ? for project sponsors. Margins have narrowed, bank tenors increased to match bonds and new financiers have emerged. Even the ever-evolving PFI Taskforce, the government body set up to manage the process of the initiative ? seems destined for a new role under the banner of Partnerships UK.

But while PFI may have lost its initial lustre, the competition for projects ? even in the transport sector ? remains strong.

It is not surprising that banks are still attracted by the prospect of doing what largely remain government contract deals in a investment grade rated country. PFI projects offer safer returns in a safe environment. And even the prospect of financing a transport deal is not seen as unattractive.

But then this is not Hungary where new toll motorway projects were initially blighted by low traffic levels and inadequate tolls revenue ? the two key risks in any transport project.

More importantly most of the design, build, finance and operate (DBFO) road contracts that have been offered in the UK have been for existing roads and a shadow toll payment has been collected. In only a few cases, the Docklands Light Railway and Croydon Tramlink included, have the transport schemes carried any high degree toll or technical risk.

Under the steering of Adrian Montague at the Treasury Taskforce the aim has been to encourage standard contracts and more formulaic templates, where the only real issue is that of price.

?The fact is that since the early PFI deals, the market has become very aggressive,? says Mark Wells, vice-president in the power and infrastructure department at ABN Amro in London. ?A lot of them have been driven as far as they can go, so that in many cases the public sector is getting the best possible deal.?

With some deals fine-tuned down to the last possible basis points, some banks are being very selective about deals that they choose to finance, preferring to steer their attention to exporting their skills to countries where PFI is still relatively new ? Japan, Taiwan, Portugal, South Africa and Canada, for example.

And further government tinkering may be adding to the lack of bank interest.

Alan Douglas, vice-president in the EMEA project finance group at Bank of America in London, says that while the government realised that the private sector were averse to taking on traffic risk for some of the recent road deals, the availability payment structure that has taken its place could be as onerous.

Furthermore, one of the key challenges for the PFI road deals ? which until recently have mainly involved shadow tolls ? is the interface with utility companies. The upgrade of road, and particularly an urban scheme, could involve dealings with all the major gas, electricity and water suppliers all of whom will be inconvenienced by the road works.

Avoiding road rage

At the end of April the Highways Agency and Road Management Services consortium ? which comprises Amec Investments, Alfred McAlpine, Brown & Root and Dragados ? raised £200 million for the A13 DBFO road through a bond issue. Bond issues have been used to finance roads before for deals such as the M6 in Scotland, but the A13 is unusual because it is one of the first urban roads to be financed by the private sector. ?The project has a unique availability based payment,? says Mike Wilkins of Standard & Poor's in London.

Spurred on by an increasingly hostile public reception to road closures in the UK, the government was eager that the A13, which is one of the main arteries into London, was not shut during its renovation. So under the terms of the A13 deal, Road Management Services is rewarded for keeping some lanes open at all times. Around 70% of the contract is based on the consortium maintaining a certain level of flow. Failure to keep lanes open will be counted with a penalty point system, which in the worst case could mean termination of the contract. ?As long as they keep those lanes open they get their money,? says Wilkins, although he adds that there are some provisos.

Some of the revenue, for example, comes from the amount of heavy traffic that travels on the road. And Road Management Services is also required to maintain a CCV camera system on the road which is designed, among other things, to track accidents which can then be dealt with, so preventing congestion and saving money.

?The deal is not exposed to traffic risk in anyway ? that is the single most important factor,? says Wilkins

It is not a structure that all bankers favour. One banker claims that the project could produce perverse results. For example, CCV systems are notoriously open to faults and that the cost of maintaining the system could almost be more than not allowing the accidents to go unnoticed.

Other risks include a level of uncertainty over the long-term traffic projections, especially in the first five years, and weak creditor projection thresholds under the bond indenture.

However, Wilkins counters that argument saying that while the project contract may be quite prescriptive in what it demands ? that the road is properly maintained ? all those involved will be following the spirit of the contract. ?This means that it can be assumed that the Highways Agency will implement the contract in a reasonable way and will not be overly zealous,? he says. He highlights the importance of the A13 as an arterial road into the centre of London. Road Management Services has been involved in other PFI projects including the A1(M) and the A419.

The index linked bond structure also fits in well with the structure of the deal which is partially linked to RPI. ?This provides a natural hedge,? says Peter McFarlane, head of project bonds at Greenwich NatWest in London. The involvement of the EIB on a bond issue also helped keep costs low as the EIB provides very cheap money.

The institutional investors, meanwhile, take some availability payment risk but the involvement of MBIA, which satisfied institutional investors buying into the deal ? all of whom were UK investors. The fundamental pull in such projects, however, is the implicit guarantee from the UK government.

Such guarantees may not prove enough for the £500 million Birmingham Northern Relief Road. The project, which is in the middle of selecting a banking group to finance it, will be the first real toll road financed under PFI. Banks bidding for the project include WestLB, ABN Amro, Lloyds TSB, Abbey National, Bank of America, Halifax and Royal Bank of Scotland.

Developing a good financing structure for the Birmingham road means dabbling in the highly tricky art of projecting traffic volumes and toll assessment. Hungary and Mexico aside, toll road project have hit problems even in places such as Washington where tolls on a new road were deemed too high and traffic levels dived.

On top of that Birmingham has been hit by environmental and political protests.

According to Mark Elsey, partner at Ashurst Morris Crisp in London, while real toll roads carry more obvious risks, projects based on availability payments carry other kinds of challenges: ?On the Birmingham Northern Relief road the issue is how much will people pay. On a shadow toll road it is generally a traffic risk which is closely linked to growth in GDP. Moving to an availability structure in some ways is better because companies are not taking GDP risk but conversely they may be taking other risks.

?One of the big risks that is often overlooked is the long-term maintenance cost. No one has done a study over 25 years to see how much it costs to maintain a road and financiers appear happy for these risks to remain in the project company. Conversely on accommodation projects such as hospitals one of the key issues in recent negotiations has been the allocation of long-term maintenance risk.?

If predicting traffic on a road is hard, the problem is compounded for light rail projects. In recent years, several projects have been harnessed under the PFI scheme. The Docklands Light Railway, the Croydon Tramlink, the extension to the Manchester Metro and the Nottingham Express Transit have all attracted private financing.

According to Bank of America's Douglas: ?The Manchester metro project was unique in that it involved extending an existing line which had been built using public money. This meant we had a proven revenue stream. We knew we had good usage so that there were no acceptance issues and we had a solid base of revenue to lend against.?

But passenger levels, toll revenue, technical issues and public considerations have arisen in other deals.

The Croydon Tramlink, a tram project based in south London which will use existing roads and rail lines to connect Croydon to a number of other key south London locations, has had its launch delayed while the project operators resolve a number of traffic management issues. The £170 million Nottingham transit project, meanwhile, to be financed by ABN Amro, Dresdner and BG Bank, only recently gained the final go-ahead from the Department of the Environment, Transport and the Regions.

But public concern is really stirred when the project involves a central rail system such as the London Underground. The underground, which is still under the supervision of the local government, is in need of modernisation. PFI contracts have already been awarded to teams willing to take charge of the undergrounds power supply and ticketing system, but the upgrades of the line remain at the centre of a political dispute.

As Londoners go to vote for the first elected mayor of London at the beginning of May, a core issue for many will be how refurbishment and upgrading of the underground will be paid for. The role the private sector has to play in that project will be a highly contentious issue.

With plans for further road development curtailed by the existing UK labour government ? which favours greater use of public transport ? and local transport projects emerging on an ad hoc basis, the next few projects to come to market are likely to be refinancings of existing road deals or one of a number of tram projects planned.

Earlier in the year, the UK government outlined plans to develop four new tram projects in London ? all of which will be financed under the government's public-private partnership scheme. The trams would run from Camden to Stockwell; from Ilford to Barking and Romford; from Greenwich to Woolwich and beyond; and from Uxbridge to Ealing and White City. Plans are also being drawn up for similar schemes in Nottingham, Leeds and Portsmouth.Whether these deals or the road refinancings choose to tap the bond or bank market is still largely dependent on market conditions but some are predicting a fresh batch of participants. Says one source: ?In the battle of bank versus bond, it is still largely dependent on who offers the best terms. But there are a lot of untraditional lenders offering very attractive money. In the next few months, expect to see a new type of lender emerge who is neither bank, nor building society nor the traditional bond investor.?