Last month's pounds 91m financing of Greenwich hospital, using 30-year bonds, is just one of several similar deals. Interest rates on the Greenwich project have been held down partly by inflation-linking interest rates, and by a letter of support from the Health Minister Frank Dobson, which has made clear that the Government would not walk away from future problems, even though it does strictly represent a financial guarantee. Seven other recent PFI agreements have involved bond issues, including a Carlisle hospital, the M6 extension in Scotland, and a local authority's waste- to-energy incineration plant.
The emerging view is that while bonds are important to the PFI, they are generally less suitable than bank-brokered loans. "The PFI unit in the NHS is pushing consideration of the bond market, because the term is longer, the pricing is finer, and so the deals are more affordable," suggests Nick Salisbury, director of Barclays Bank's PFI unit. Despite the terms and price advantage of bonds, Mr Salisbury argues that the flexibility offered by bank loans makes them generally a better deal. "If the specification changes, then you may have to go back to your bond investors as soon as you have signed," he warns.
This view is endorsed by Jeff Thornton, head of public sector finance at the Royal Bank of Scotland. "We have seen a slow but steady development of the technology in PFI bonds," he says. "But, because the debt market has responded to the bond market, and offers a more flexible structure and length, we are now in a position where each project can look at either debt or bonds, whichever is best for their project. There is no hard- and-fast rule that debt or bond will always be better. Bonds don't look appropriate, for example, for schools, where they will be drawing small amounts over an extended period of time."
Bonds may, however, be a way of attracting pension funds into PFI investment. Will Hay, head of bonds at Standard Life, remains cautious about investing in PFI bonds, but says that the Government's reduced borrowing requirement means that institutions are looking to replace gilts with new bond issues. "PFI deals will take up the slack, as the Government's finances are so strong," he says. "There is not much in the way of gilt issues coming in the next year, so there will be some demand for bonds, and the PFI will go some way to satisfy that. There are a lot of potential PFI deals out there, maybe as much as pounds 20bn. We will continue to ask, does the yield justify the risk?"
David Gould, manager of investment services with the National Association of Pension Funds, says that smaller funds will probably invest only through a PFI venture fund, rather than as direct investors, as the risk attached to PFI deals is still considered too great.
Innisfree operates the main venture capital fund investing in PFI deals, on behalf of its clients Norwich Union, Australian Mutual Provident and Hermes' BT pension fund. It has already taken up several bond issues, but says that high risk projects may be best suited to loans arranged by the banks. "Things will go wrong with some of these deals," predicts Matthew Webber, the director of Innisfree. "When they do, it is as well to go to a bank to sort out, which they will be able to do. The bond holders are distant institutions which will find it difficult to deal with problems as they arise on very long term projects."
Changes in the European capital market could be an important factor for future PFI bond issues. David Gould suggests that uncertainty over the euro will encourage managers of larger, mature funds to reduce their shareholdings, to be replaced by bond investments. Will Hay of Standard Life, though, believes that the opposite may happen. As more workers across Europe build up pension funds, there will be a greater emphasis in central Europe on share-buying, he believes. This will help to reverse the traditional approach in Germany, in particular, where corporate financing has mostly been achieved by bonds rather than by share issues. The London Stock Exchange points out that privatisation issues in Germany are also helping to develop a wider share culture there.
Jeff Thornton, of the Royal Bank of Scotland, points out that British corporations now, conversely, are beginning to copy German practice, relying on bonds for new capital, rather than share issues. This indicates, he believes, that the European capital markets are moving together, to choose particular investment routes on merit.
Robert Rees, a director of Barclays Capital, which put together the Greenwich bonds issue, believes that we can look at the European capital markets as becoming more integrated. "With the approach of the euro, people are looking further afield," he says. "There are new opportunities elsewhere in Europe for projects financed through the capital markets. The PFI is largely UK, but Portugal is taking it up, and so are Finland, Sweden and eastern Europe. I think PFI-type deals have to get going in many places, because governments won't be able to afford to finance projects themselves because of the heavy strictures on borrowing from the Central European Bank. That will have some effect, and then all the central European institutions will get involved."
This change will offer, he believes, some strong opportunities for British PFI experts to sell their expertise in new markets.
The bad news for the PFI in the UK, then, is that while the number of potential investors is rising, the competition for the available funds is also increasing.