Project Funding

Sources of Funding

The SPC will finance the majority of the cost of any PFI project through senior debt borrowed from either banks or the capital markets (bonds).  The shareholders are required to provide some investment in the form of equity and usually also loan stock or subordinated debt (a form of loan from the shareholders to the SPC).

Senior Debt

Bank debt can be a flexible source of funding, and is often structured such that refinancing is more readily achievable than with other funding options, should that occur. However, bonds are likely to be a cheaper option for large projects. (Not all PFI schemes are suitable candidates for bond financing.)The bond market tends to have more capacity, but the timing of fund raising in relation to that capacity and other projects in the market can be an issue. There may be insufficient liquidity in the banking market to procure attractive margins for the most substantial projects, and PFI bidders therefore are increasingly seeking long-term debt from the bond market. The types of bond available are ‘fixed’ (interest) and ‘indexed linked’ (interest).

The cost of debt will vary case by case, depending mainly on the associated risk, but also to some extent on the size of debt required and the maturity, and the level of interest rate margins and cover ratio requirements in each market. The costs of PFI bonds can be reduced by insuring the debt payments (“wrapping”), where the total cost of the “wrapped” debt will include the insurance premium.  The UK Government also introduced the Credit Guarantee Finance (CGF) scheme in 2004. In this, the Government provides the debt while a bank or insurer guarantees its repayment. The benefits are the lower cost of financing, and that the guarantor takes the repayment risk rather than the Government.

Exposure to variable interest rates can be minimised by hedging the debt via a fixed rate “swap”, essentially ensuring the interest paid on the debt is fixed for a known length of time. The debt can be “swapped” with the senior lender or with an alternative provider.

Construction costs represent a significant proportion of the concession costs, and are mainly funded by senior debt, repaid over the length of the concession. The lender(s)  will require a reserve account to be established whereby debt repayment is covered in the event of any difficulties or even termination of the project. In the unlikely case of termination, the bank always has priority over investors to recover its debt.

Equity is invested as a form of risk capital, i.e. the shareholders share the risks of the project with the senior lenders by having a financial interest. If the project has problems and is terminated, the equity investment can be lost or eroded.

The two types of equity are shares and loan stock or subordinated (sub-) debt. Share equity is paid at the beginning of the project, and is repaid with no interest at the end of the project. However, dividends are received a number of years after the construction period is over, with the timing dependent on available earnings and cashflows.

Loan stock or sub-debt is a form of loan, supplied by shareholders. It is typically injected at the end of the construction period, but there may be further investments during the course of the project. Shareholders are often repaid during the operational stage, as the project cashflows allow. In addition, interest is earned on the loan and paid with the capital. Alternatively, shareholders might receive interest payments only, with the capital returned in one sum at the concession end.