A private finance initiative project to build a new hospital for Maidstone and Tunbridge Wells NHS Trust in Kent has been forced to abandon its plans to issue insured bonds to fund the project, the Financial Times has learnt. It will instead turn to banks to provide the £225m ($446m) needed.

The U-turn is an example of how uncertainty over the future of bond insurers is changing the face of the PFI market, removing the cheapest funding option for big projects and potentially pushing up costs to the tax payer.

In recent years, bond insurers such as Ambac and MBIA have “wrapped” almost all PFI bonds by lending them their top-notch credit ratings, making them safer and so cheaper to issue.

For larger private finance deals of more than £100m, bond insurers undercut traditional competition, offering cheaper funding than bank loans.

An example of the scale of bond insurers’ involvement in PFI projects is Ambac UK, which has insured £5.7bn of PFI deals, including £1.7bn of PFI hospitals. Specific deals include:
£200m Northern batch PFI hospitals project closed last September.
£498mRoyal London and Barts PFI hospitals project – the largest PFI hospital project to date.
£730m Allenby & Connaught PFI military housing project – largest PFI accommodation project.

But as bond insurers, also known as monolines, have run into trouble over their involvement with US subprime debt, the situation has reversed dramatically. Investors’ confidence in “wraps” collapsed as rating agencies downgraded some bond insurers and put others on negative watch.

Tunbridge’s new hospital was to be funded with wrapped bonds, until the bond insurer was downgraded. David Hardy, director of John Laing Investments Limited, which leads the consortium running the project, said this ruled out the bond option.

“As a sponsor you have to ask three questions. First: will they be able to continue supporting the paper with their downgrades? Even if they could, would we be able to get sufficient investors interested in it? And if we could get people interested, at what cost?”

Under pressure to close the deal before delays caused mounting costs, the consortium and the NHS trust decided bank loans would provide the best value for money.

This is a pattern being repeated across the PFI market for big projects. Last month the UK’s largest PFI – to provide the RAF with a fleet of refuelling tankers – also switched from wrapped bonds to bank debt.

The £1bn scheme to provide a military flying training system for the British army may also be facing Tunbridge Wells’ dilemma. The Ministry of Defence said it was still working on a financial arrangement.

Market participants say other projects are going the same way, resulting in potentially higher funding costs for big PFI deals.

This could also be exacerbated by banks’ unwillingness to lend as cheaply as before in a time of tightening credit conditions.

“The bank markets have had a choppy period since the credit crunch, and for the more challenging or bigger deals obviously there’s a pricing consequence,” said Bruce B. White, head of Linklaters’ PFI team, who advises on bringing PFI deals to financial close.

Mike Chappell, who heads Lloyds TSB’s PFI team, said banks’ own exposure to the bond insurers as well as general tough credit conditions were affecting their appetite to buy syndicated debt – small parcels of PFI debt.

This may leave some bigger PFI deals stymied, unable to find sufficiently cheap financing to go ahead.

From:
http://www.ft.com/cms/s/0/15bc5a92-e8ac-11dc-913a-0000779fd2ac.html