Select Committee on Public Accounts Thirty-Fifth Report


CONCLUSIONS AND RECOMMENDATIONS

1.Octagon's investors' internal rate of return more than trebled following the refinancing. The total cash which investors expect to receive from the project reduced from £464 million to £335 million following the refinancing, but they have now got a large part of it much earlier. As a result, their internal rate of return, reflecting the value of getting benefits sooner rather than later, soared from 19% when the contract was let to 60%.
  
2.This refinancing produced a balance of risks and rewards between the public and private sectors which, even for an early PFI deal, is unacceptable. Octagon was able to optimise its refinancing gain by reducing its interest costs and extending the period of its borrowings. It was then able to increase its debt from £200 million to £306 million, thus accelerating the benefits to its investors.
  
3.The Trust secured the right to receive only £34 million (29%) of the resulting £116 million gain. This was despite the gain arising just two years after the hospital opened and the Trust being exposed to significantly increased risks. Contracts are now expected to include provisions to share refinancing gains with the public sector on a 50:50 basis.
  
4.The possible impact of refinancing gains to the private sector was not considered before the Trust awarded this PFI contract. Although the Department was aware of the potential for refinancing when entering this contract, there was no contractual arrangement to share in refinancing gains and no assessment of the effect of refinancing on the investors' returns. As a result, the Trust's liabilities could now also include all the additional borrowings Octagon took on to accelerate the benefits to its investors.
  
5.Following the refinancing, the Trust could have to pay up to £257 million more if it needs to end this PFI contract early. It is wholly inappropriate that, in the event of termination, the Trust's liabilities could now include not just the cost of the hospital, but all the additional borrowings Octagon took on to boost its investors' returns. It is unacceptable that, in the event of termination, the Trust could be left with liabilities incurred simply to make it easier for the investors to achieve high returns.
  
6.To maximise the refinancing gains, the Trust agreed to extend the minimum period of its PFI contract by five years to 2037. There can be no certainty that a hospital will be needed in its current form in over thirty years time, and the Trust need not have incurred the risks of extending the contract.
  
7.The investors took their benefits from the refinancing immediately whereas the Trust is receiving its share over 35 years. On advice from the Department, the Trust is receiving its share of the refinancing gains as a reduction to the annual PFI contract charge it pays to Octagon. If the contract is terminated early, the Trust may find it difficult to recover the outstanding balance of its share of the refinancing gain.
  
8.This project again shows an authority too readily agreeing with refinancing proposals when more robust negotiations could have produced a better outcome. Staff managing PFI projects should be trained to understand refinancing issues and should appoint experienced advisers to assist in robustly negotiating refinancings.
  
9.The Trust incurred additional financing costs by entering into an early contract in the emerging PFI hospital market. Financing costs were higher on early PFI hospital deals than current deals reflecting the risks of a new market, and the Trust should not be expected to bear the additional cost unaided. The Department argues that the Trust avoided subsequent construction cost inflation, but this is a different issue which does not relieve the Trust of the higher financial costs.
  
10.  There is no central data on PFI construction cost inflation or the impact of government building programmes on public sector building costs. In order to manage better the future PFI programme, the Treasury should provide an annual assessment of the effect of construction cost inflation on public building projects, including the effect on PFI projects and a comparison with private sector experience.




 
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