The turmoil in credit markets has dealt a big blow to the UK government’s defence procurement programme, putting in jeopardy plans to help fund a new fleet of Airbus tankers for the Royal Air Force with a bond issue.
The £13bn project over 27 years, the largest private finance initiative, is now expected to be financed by bank debt.
The government and a consortium led by EADS, the aerospace and defence group, had been planning to raise £2.5bn in the City through a combination of bank debt and a bond issue. These bonds were expected to be supported by guarantees provided by troubled bond insurer Ambac.
However, Ambac and other bonds insurers have been hit hard by losses on bonds they have insured. The credit rating of Ambac was cut below AAA by Fitch Ratings and further downgrades are thought likely, sharply reducing the value of their guarantees.
For the past 10 years, PFI deals have been using bond insurers to support their bonds when raising initial capital for the projects. The insurers, or “monolines”, give their triple-A creditworthiness to the bond, making them cheaper to sell and so cheaper for the government to raise money.
But as the credit turmoil has spread, the spreads on monoline-wrapped bonds have shot up as the market worries about the ability of the insurers to stand behind their commitments.
“The investment banks didn’t think they could place any Ambac paper in today’s markets efficiently,” said somebody close to the deal.
The other monolines the government was considering working with – including triple-A rated MBIA – were similarly struck by a collapse in market confidence.
“Although other monolines have not been as hard hit, there is scepticism generally around the monoline market,” said Anthony Forshaw, managing director at Deutsche Bank, the consortium’s financial adviser.
Instead, the government and the AirTanker consortium are likely to revert to their earlier plan to finance the deal solely through bank debt. They had sought to raise some money through bonds after the banks demanded a high rate of interest during the summer credit-crunch.
Last night, Phill Blundell, the chief executive of the AirTanker consortium, said: “It is fair to say a more bank-driven solution is now likely. We still expect to achieve the affordability targets we agreed with the government.”
HBOS will lead the group of banks lending the money. Lloyds TSB are also involved, and the consortium expects to get the deal away by the end of March.
The shift could be the death-knell for the monolines’ involvement with PFI, because unless the market’s confidence in them returns, their “wraps” will be virtually worthless. “Unless the cost of capital arbitrage returns …it’s going to be very difficult for the monolines to recover market share,” Mr Forshaw said.
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