NHS Tayside
NPD Workshop 10 Oct 2007
Mikko AJ Ramstedt - FPU
Edward Yescombe - PUK
Paul Moseley - FPU
Agenda – am
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Policy context
NPD vs Equity Model
Bidding process
Evaluation methodology
Preparation & Resources
What is NPD about?
• Securing Expertise
• Maximising VfM
• Stakeholder Transparency
SG experience of NPD
• 5 projects to date
• Concept & principle deliverable
• Contractual structures bankable
Context for NPD development
• SFT =
– Cheaper funding
– Recycling of profits
– Stakeholder participation
• Starting point - > NPD
NPD development
Objectives:
– Optimum funding structures
– Transparent incentivisation
– Increased economies & efficiencies
– Potential for more defined surplus stream
SFT development
• Framework
• Scope
• Timetable
NPD - Next Steps
• NHS Tayside Adult Mental Heath
Developments Project
• Review of other sectors
• SFT:
– Scoping -> Development -> Implementation
1. NPD v. Equity Model
What are the are the areas that it is thought can be
improved in the PFI equity model?
What is an NPD?
• Non-profit distributing organisation
• Providing economic or social infrastructure
• Funded by debt only
• No equity dividends → capped rate of return
for investors
• Enhanced corporate governance
1. NPD v. Equity Model
How could an NPD help to solve the equity model issues?
SG basic criteria for an NPD:
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At least as good value for money (VfM) as available under the
equity-based model
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Minimal disturbance to PFI standard documentation (e.g. same
risk transfer)
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Surplus revenues applied for VfM benefit of the Authority[1]
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NPD’s assets remain off the balance sheet of the Authority (under
FRS5)
[1]
N.B.: This is a generic term used for the public-sector body which
signs the Project Agreement.
1. NPD v. Equity Model
Most of an NPD’s “building blocks” are the
same as the equity model:
• Project company (SPV)
• Project Agreement with the Authority
• Construction and FM sub-contractors
• Limited-recourse finance (i.e. no
corporate finance option available)
1. NPD v. Equity Model
But:
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Wholly debt-funded, instead of (say) 90% senior debt and 10%
equity (NPD debt funding likely to be 90% senior debt and 10%
[higher-risk] junior debt)
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Surplus cash flow paid to a Charity (e.g. to benefit healthcare in
Tayside)
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Project Company controlled by junior lenders (using a nominal
shareholding which does not pay dividends—N.B.: could be
CLG)—principle of private-sector management and control. (N.B.
Junior debt is “stapled” to shares.)
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Greater transparency and influence over day-to-day operation for
the public sector through the presence and activities of the
Independent and Stakeholder Directors
2. The Bidding Process
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Substantially similar in both models.
But the NPD model is unfamiliar and
needs careful explanation to bidders at
all stages of the procurement, including
pre-OJEU.
Financing issues for OJEU:
– Funding / hedging competition
– Refinancing / SFT issues
3. Evaluation Methodology
Financing:
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To get the best terms for financing, the basic principles for any
project financing must be observed, e.g.:
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Basic familiarity of the model: banks or bondholders do not like too
much innovation
Risk limitation (“A banker is a man who lends you an umbrella when it
is not raining”)
Cash-flow surplus → debt cover ratio
Therefore most of the debt likely to be senior debt on terms
substantially similar to those for standard PFI equity-based
projects.
Roughly 10% of the debt likely to be “junior”—higher-risk and
more expensive than senior debt—new type of financing.
3. Evaluation Methodology
Two possible models of junior debt:
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Mezzanine debt:
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“Debt-like” structure
Total debt cover ratio (e.g. 1.05x)
Priced in mezzanine debt market
Subordinated debt
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“Equity-like” structure
No TDCR (i.e. cover 1:1)
Priced akin to equity—but return is capped, unlike equity investment
Used on all deals so far
N.B.: Not the only possibilities, e.g.
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preference shares
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one tranche of debt (“blended” structure).
3. Evaluation Methodology
Comparison between models / types of junior debt:
Mezzanine Debt
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Lower WACC, but cover ratio requirement may make Unitary
Charge higher
Payment of surplus revenues to Charity more important
Direct mezzanine lenders’ controls over Project Company
Subordinated debt
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Higher WACC, but no cover ratio may mean Unitary Charge is
lower
No surplus paid to charity in Base Case until “tail” period
“Thin capitalisation” issue
Indirect controls though board membership
Junior debt rate
Equity IRR
Unitary charge
Mezzanine Debt
10.5%
n/a
84.5
Subordinated Debt
12.5%
n/a
81.9
Equity Model
n/a
12.5%
81.8
Senior Debt Cover Ratio
Senior debt proportion
Total Debt Cover Ratio
1.18
92%
1.05
1.15
92%
1.00
1.15
92%
n/a
NPV of Unitary Charge
NPV of Surplus
Net NPV Cost
1,107
52
1,055
1,073
7
1,066
1,071
n/a
1,071
6.7%
6.8%
1,001
6.4%
n/a
n/a
981
5.9%
n/a
n/a
WACC
6.3%
(taking payments to the Charity into Account)
Post-Refinancing
Net NPV Cost
WACC
80% Senior Debt from PWLB
Net NPV Cost
WACC
3. Evaluation Methodology
– Evaluating the surplus
– Effect on risk transfer
– Balance-sheet treatment
4. Resources, early preparation
and market awareness
– Templates and experience from Argyll &
Bute and Falkirk schools projects
– Need to prepare detailed NPD structure and
documentation (including corporate
constitutional documentation) to be issued to
bidders as part of ITCD. It is important to
realise this is not just about a few changes
to the Project Agreement (which the NPD is
designed to disturb as little as possible).
Agenda – pm
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Reference case
Corporate governance
Charity
Project Agreement
Pre OJEU & ITPD review requirements
5. Reference Case
– Purpose and structure
– Rights and responsibilities of junior lenders:
» Board control
» Management of the NPD
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Subject to checks where there are conflicts
of interest
N.B.: Too much Authority influence can lead to
public-sector classification.
5. Reference Case
Refinancing
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Basic SoPC principle of 50:50 sharing
But
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Lenders have little incentive to refinance
If junior loan has prepayment penalties could wipe out any
gain
Independent Director controls refinancing
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Protection for junior lenders against a “fake” refinancing
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Agreed tendering and evaluation procedures (“Refinancing
Protocol”)
No further refinancing within a year
6. Corporate Governance
– Corporate v. Project Agreement (“nuclear
bomb”) controls
– Appointment and rôles of Stakeholder and
Independent Directors / size of board
– Conflicts of interest
– Management incentives (possibly different
approaches during construction and
operation)
7. Charity
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Existing or specially-formed?
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Cash flow to charity—annual or at the
end?
8. Project Agreement - NPD variant
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Process & timetable
Key changes
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Protection of NPD structure
Unitary Charge adjustments
Compensation on termination
Refinancing protocols
9. Pre OJEU / ITCD requirements
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SG review procedure
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Timetable