Birmingham City Council's ambitious programme to improve the city's highways network finally became a reality in 2010 and stands as a pivotal deal for the sector.

The £2.7 billion pathfinder transaction faced a wide range of challenges, but in spite of its complexity and scale has set a precedent for future highways maintenance deals.

Birmingham Highways [Transactions Database] is a deal that had every challenge conceivable thrown at it:

• political change
• affordability issues
• industrial action
• the full impact of the credit crisis

Despite the number of hurdles it had to surpass along the way, the impact of this landmark deal is huge for the PF market and will provide a substantial economic boost for the Midlands region.

The deal is significant not only because Birmingham is the first metropolitan authority to implement a Highways Maintenance PPP, but it also stands out as the largest local government highways sector PFI.

Background

In March 2001 - following an Audit Commission that identified a quarter of Birmingham's highway network as being sub-standard - early discussions got underway about forming a new partnership between the city council and the private sector to implement a road repairs programme.

By October 2003 the UK government gave the ambitious scheme the go-ahead and granted the city council PFI credits of £379 million - at that time the biggest PFI credit granted to any local authority. This was subsequently increased by a further £229 million up to £608 million.

In February 2004, the PFI was voted through as part of the city's Corporate Plan - its policy outline for that year - by 57 votes to 55 and the contract was initially set to commence in autumn 2006.
The authority engaged the following advisers for the procurement process:

• DLA Piper - legal
• Mott MacDonald - technical
• Deloitte - financial adviser
• Aon - insurance
• Hewitt Freeborn Associates - assisted project team

The council published a contract notice in May 2004, but by July that year the scheme was thrown into doubt after city council leaders refused to reaffirm support. This was sparked by the Tory-Lib Dem coalition running the local authority - having ousted their Labour opponents in the elections - and promptly announced it would conduct a review of the project.

By September 2004 some changes were made to some of the principal elements of the project and the scheme was back on track.

In February 2005 the council selected four bidders to move forward from a list of eight consortia. The teams were:

• Amey
• Atkins and EDF Energy
• Balfour Beatty, Mouchel Parkman and Birmingham Street Services
• Vinci, AMEC and Laing Roads

By October 2005 the Balfour Beatty-led group withdrew its bid after Mouchel Parkman - a 20 per cent equity partner - left the consortium.

This was followed by growing concerns that the deal would face even longer delays with the possibility of trade union opposition to the proposed scheme, as well as the council's direct labour organisation (DLO) claiming to have come up with a 'cost effective' alternative proposal.

In spite of this, the three remaining teams submitted bids by the end of the year. However, by March 2006 the Atkins and EDF Energy JV had dropped out of the running over concerns about the high levels of risk associated with the project.

This once again brought into the equation by the viability of bundling two complicated road and streetlighting PFI schemes into one deal.

On 30 June 2006 the two teams entered the best and final offer (BAFO) negotiation stage amid the threat of ongoing Trade Union strike action as well as local and central government issues going into 2007 and the impending global financial crisis.

In May 2008 the two teams finally submitted BAFOs and as the full impact of the GFC was unfolding. And then Lehman Brothers was allowed to collapse in September and debt funding became a scarce commodity. In early 2009 the council asked for further assurances that the credit and finance arrangements were in place for each bid.

By 4 August 2009 the city council finally selected Amey as its preferred bidder after a troubled five-year procurement process.

Wragge & Co acted as legal counsel to Amey, PwC was financial adviser, while JLT provided insurance advice.

Following a nine-month financing phase, financial close was then achieved on 6 May 2010. There was an urgency to get the deal across the line over fears that the election results could put the project in jeopardy.

In the second week of June 2010, Amey started the upgrade and maintenance of the city's infrastructure network for the next 25 years.

The Project

The 25-year PFI scheme includes the making good and management of more than 2,500km of highway, 96,000 streetlights, 1,000 traffic signals and more than 850 bridges, tunnels and other structures across the city.

Amey - in partnership with Birmingham City Council's Highways Service - will deliver a step change of improvements to the city's road network over the first five years to remove any backlog of work and raise standards; it will also maintain the infrastructure at this improved standard for a further 20 years.

The firm will also be conducting detailed inspections and surveys of the city's road network, including structures such as bridges and tunnels to help determine the future programme of works and identify priority areas in need of repair.

Amey will support the development of the council's overall traffic management strategy, which looks to reduce congestion and improve road safety on the city's road network through its work at the council's urban traffic control centre.

There will be a significant investment in the first five years (2010-2015) - the core investment period - to remove any backlog of work and improve standards, as well as maintaining street scenery such as safety barriers, seats and trees.

Amey will invest £350 million in repairing roads and pavements and providing thousands of new streetlights in the first five years, while the DfT and Birmingham City Council will fund the remainder of the project.

Work got underway in the second week of June 2010.

Mel Ewell, chief executive of Amey, said: "This significant project will not only deliver an enhanced level of service to Birmingham but will improve the city's highway infrastructure for the travelling public in the region."

Councillor Timothy Huxtable, cabinet member for Transport and Regeneration at Birmingham City Council, also said: "This project is on a scale that has never been undertaken before in any part of the country. We will pride ourselves on the quality of our streets, roads and lighting and make Birmingham a much better place to live."

Financing

By August 2009 a number of lending institutions that were active in the PFI market had been engaged in discussions for the oversubscribed deal, and by November the initial bank group had taken shape.

The original commercial lenders were:

• Bank of Ireland
• Dexia Group
• Fortis
• National Australia Bank (NAB)
• Nationwide
• Natixis
• NIBC
• WestLB

The UK Treasury Infrastructure Finance Unit shadowed bank meetings throughout the financing stage and by January 2010 three lenders in the bank group had been deselected - after the sponsor lost confidence that all eight banks would get to a clearing position to drive forward financial close - and Lloyds Banking Group stepped in.

In addition to a £70 million ticket - £20 million more than the rest of the club - Lloyds also committed to £23 million in equity on top of Amey's £47 million stake.

After some further gestation the deal finally reached financial close on the day of the UK general election - 6 May 2010.

The final commercial bank line-up included:

• Lloyds Banking Group - £70 million
• Dexia Group £55 million
• Bank of Ireland - £52.5 million
• Nationwide - £47 million
• Natixis - £47 million
• NIBC Bank - £47 million

The six commercial lenders provided debt facilities of £318.5 million including a £250 million term loan and an equity bridge loan of £68.5 million.

Senior debt priced at Libor +250bp rising to +275bp after the first 10 years of operation.

The debt to equity ratio is 80:20 and the debt service cover ratio (DSCR) averages out at 1.44 due to the operational leverage. This cover ratio is stronger than the M25 Widening deal (1.40) that closed last year and will likely set a precedent for future highways maintenance deals.

It should be noted that the greater cover ratio on the M25 was not caused by the volume of finance, but more due to the maintenance of a large network over a small capital structure.

Birmingham and the DfT had been aiming for a DSCR on Birmingham a lot closer to 1.25. However, the cover ratio is higher to reflect the leveraged O&M risk on a highways maintenance project in relation to a greenfield project.

Following the five-year core investment period, Lloyds and Amey will retire the £68.5 million EBL as follows:

• Lloyds Banking Group - £22 million
• Amey - £46 million

PFI credits for the deal total £608 million and the total cost of the project over the 25-year concession period is £2.7 billion.

Denton Wilde Sapte acted as legal adviser to the lenders, Halcrow provided technical advice, while JLT was insurance adviser. Operis carried out the model audit.

Conclusion

The Birmingham Highways deal was a long and complex learning process - taking five years in the planning and nine months between preferred bidder and financial close.

The scheme benefited from the experience of Portsmouth's £500 million pathfinder highway deal - a much smaller project that struggled to secure PFI support from the DfT.

Although the Portsmouth PFI reached financial close in August 2004, it was not at all a smooth deal and in some ways allowed the Birmingham deal to better handle how risk is packaged and shared for this kind of deal.

While more manageable deals like Portsmouth are clearly easier to get over the line - from debt requirement to complexity - it's not as simple as that.

Portsmouth conceded differential inflation indices on the availability escalator - meaning the availability payment goes up in relation to a mixture of inflations - not simply CPI which rises in line with construction inflation and energy price inflation.

As a result, the operational risk of Portsmouth was considerably lower than Birmingham - impacting on the cover ratios on the Birmingham deal.

With Sheffield, Isle of Wight and Hounslow highways maintenance PFIs working through the procurement process, Birmingham demonstrated there is strong investor appetite for this kind of deal.

Despite the myriad of challenges the city council and Amey had to contend with over the last six years, the deal received strong political and market support, and is an example of a true pathfinder that overcame the kind of obstacles that would have derailed most projects.