There is a certain irony in the fact that after months of skirmishing between UK supporters and detractors of the private finance initiative, the golden bullet might have been fired from one of the countries clinging on to the eurozone. Yet exactly that is the fear now rippling through project finance circles as the financial chaos emanating from the eurozone rapidly erodes appetite for long-term bank lending to UK construction projects.
Mervyn King, the governor of the Bank of England, referred last month to “the most serious financial crisis we have seen at least since the thirties, if not ever”. The consequences of this crisis are undeniable. The rates of credit default swaps (which oblige the seller of the CDS to compensate the buyer in the event of loan default) are already responding to the exposure of banks to sovereign debt in Greece and Italy in particular and anticipate the scenario in which default is claimed to be averted by writing off some of the debt. Meanwhile negotiations to close UK project finance deals are becoming increasingly difficult - each day increasingly feels like wading through porridge. It’s 2008 all over again.
At the beginning of the year there was great optimism that the bank lending markets would improve through the year to a sub 200 basis point margin by the year end. But since Easter that optimism has gradually dissipated and in the last two months the bank market has moved from stable to chaotic.
Lending terms for long-cooked deals are being reopened by banks at the last moment. No deals have fallen over, but only because of the concerted efforts of all concerned and the large contingencies for financing terms that have wisely been a product of project finance models since the near-death experience of project finance in late 2008. Margins are going up - 50 basis point jumps are being seen on individual transactions. Underwriting, tentatively coming back onto the table, has evaporated again like a genie. Hold levels are falling back down, though mercifully not yet to the £35m territory which last brought the market to its knees as funding compilation replaced funding competition.
But the real fear is not another interlude of low liquidities and high margins, but that this nail drives through to connect with Basel III (the global regulatory standard on bank capital adequacy and liquidity) and drives banks out of long-term project lending altogether.
And this is no idle worry; one prominent lender has already decided that henceforth it will only lend short term. There is a widespread expectation that by 2012 the whole market will have followed suit. Quite right say some; banks and long-term holds always looked like a strange couple. But the trouble for construction project finance is that despite this scenario having been discussed in earnest for the last three years in government and industry circles, no alternative has yet been implemented.
Time is rapidly running out. EU plans to support project lending, a similar private initiative called Hadrian’s Wall and the Green Investment Bank are all admirable concepts but at the moment none have been implemented.
The government has just announced a consultation on PFI. The trauma in the bank market should become the main focus of that review.. The trauma in the bank market should change the focus of that review. The prime minister has made the link between growth in the UK economy and investment in UK infrastructure. The national infrastructure plan says £200bn needs to be invested, 70% privately. If it is now inevitable that banks will only lend short term, then the real and immediate question for the government is how can it intervene to ensure that the huge sums of long-term money in UK pension funds are invested in our future, whether by underwriting risk in the construction phase or supporting refinancing post construction. Answers on the back of a 10 euro note please.
Richard Threlfall is UK head, infrastructure, building and construction at KPMG
18 November 2011
18 November 2011