Last week the Treasury announced plans to boost recession hit PFI schemes with public cash, which could leave the NHS billions of pounds out of pocket. Sally Gainsbury explains the impact on health projects

The Treasury’s announcement last week that it will lend to recession hit private finance initiative schemes might have been good news for some. But for the NHS, it could at best make little difference and at worst see the Treasury claw back billions of pounds of unspent capital funds.

In a typical PFI scheme, equity providers such as construction firm Carillion invest up to 10 per cent of the capital value in the form of an equity stake - like a mortgage deposit - with the remaining 90 per cent funded through various forms of bank borrowing.

Treasury head of PFI policy Gordon McKechnie insists there is currently no problem in finding equity investors for schemes, although speaking in London last week he said the Treasury had not ruled out expanding its newly formed lending business into equity bridging loans if such “products” became necessary.

The problem now is with banks’ reluctance to lend at all, or to lend only at huge marks-ups (around 2.5 per cent above the inter-bank lending rate).

To plug that gap, the Treasury now anticipates that its new arm’s length - and unregulated - lending company will lend£1bn-£2bn to schemes in 2009-10, with more available if necessary in the years after that. But with£8bn worth of schemes looking to secure up to£7.2bn of lending by March 2010, the majority will be disappointed.

The Treasury has not yet stated the detailed criteria it will use to select which of the 110 potentially eligible schemes across the UK it will lend to. But despite continued references in national newspapers to new hospitals, it is noteworthy that the Treasury’s official statements on its most recent PFI announcement make almost no reference to this vote-winning end of public policy.

Projects in the pipeline

Outlining the scheme, Mr McKechnie said: “The objective is to ensure that PFI projects already planned and in the pipeline go ahead, that construction begins and jobs are preserved, new schools open and recycling targets are met.”

In practice, the focus could be on roads and waste, which together make up over half of all remaining approved but unsigned PFI schemes.

Reading between the lines of what Treasury officials say publicly and privately, it might be wise to note that roads help keep workers, imports and exports moving. Meanwhile delays on waste and environmental schemes will expose the UK to millions of pounds of fines if it misses its 2013 EU landfill reduction targets - something the government will be loath to stomach given its current budget deficit.

So where does this leave health PFI schemes?

Last week, the Department of Health confirmed that of the 22 NHS PFI schemes planned in England in 2007, only 11 were still being pursued.

While the halving of plans was seized on by the Liberal Democrats as an example of the global recession hitting health policy, many of the cancellations predate the credit crunch and were more related to concerns that PFI projects lock hospitals into decades of fixed overheads, just as policy requires a shift towards care outside hospital buildings. In addition, new accountancy rules mean the schemes will add billions to the government’s net debt.

The list of cancelled projects includes a£600m children’s hospital in Leeds, which has now been replaced with a far more modest£25m reconfiguration programme.

Only four of the 11 surviving schemes have developed business cases and of those only North Bristol trust has placed its formal tender for bidders in the Official Journal of the European Union.

There was talk in the autumn of bringing PFI schemes forward as part of the Treasury’s “fiscal stimulus” to keep the construction industry ticking over through the recession. Some NHS organisations - including Sandwell and West Birmingham Hospitals trust, which has plans for a£368m scheme - considered doing that.

But chief executive John Adler said that in practice the prospect of tweaking the timing on a£368m scheme tied into a huge local regeneration project was “very limited”. Mr Adler now does not expect to approach lenders until the end of 2011. Few economists, let alone NHS managers, are prepared to stick their neck out to predict the shape of the money market by then.

That makes North Bristol trust’s£475m project the only realistic English contender for a Treasury loan - although the Victoria Hospital in Fife will also be eligible as the Treasury scheme is UK wide.

Although he would not rule out applying to the Treasury, North Bristol’s head of capital projects David Powell said there was “every chance” they would not need to borrow from the Treasury.

“We think we may be OK because we are not looking to go to the market yet,” Mr Powell said. The trust has already had positive signals from the European Investment Bank, which has indicated it may be prepared to lend it half of the necessary debt and they will not need to approach banks for the other half until autumn.

If things are still not better by then, the scheme’s equity providers, Carillion, are also thought to be considering upping their stake from the usual 10 per cent to 20 per cent.

Mr Powell said: “It’s nice to know there is some kind of safety net from the Treasury. But there would be no affordability advantage in going to them as they will be lending at commercial rates.”

The Treasury plans to sell its debts when the financial markets recover, so any loans will need to be structured and priced with that in mind.

Treasury sources do hope, however, that the ministry’s entry into the lending market will at least stem the upward pressure on lending rates demanded by other borrowers, so even schemes not directly funded by Treasury loans could benefit.

The small print

Announcing the plans last week, chief secretary to the Treasury Yvette Cooper said: “Funding will be provided from across government, including initially from unallocated funds and departmental underspends on previous projects.”

That means clawbacks. And crucially, the Treasury is clear
that departmental clawbacks will not be earmarked for lending within each respective department’s boundary.

The DH has run up substantial capital underspends over recent years - partly due to slow progress on the national IT programme - and has generally seen that funding claimed back by the Treasury. In 2005-06 and 2006-07, 40 per cent of the capital budgets were not spent. Spending picked up in 2007-08, but£521m still went unspent - the equivalent of 22 per cent of the budget.

If the DH continues to underspend at the same rate over the next three years, the Treasury could claim some£3.3bn out of its total£15.1bn budget to recycle to other departments.

But NHS finance, performance and operations director general David Flory told HSJ he expects the underspending this year to be “significantly lower”.

Finance directors hope that is because Mr Flory is gearing up for a rapid end of year capital giveaway: to spend it all quickly before the Treasury claws it back.

One logical solution would be for the DH to use any unallocated funds to provide bridging loans to organisations whose plans to generate capital investment funds through the sale of parts of their estate have been hit by the property market slump.

But the “bridging” bit implies the trusts would pay the DH back once they managed to sell those properties - so the department may still need to wrangle with the Treasury to make such funds immune from clawbacks.

Whether the department manages that will become clear when the Treasury finally publishes its 2009-10 Budget on 22 April - as will the implications for the national IT programme, which could be the main target for any clawback.

Once that is sorted, the DH will come under pressure to renew its efforts to reform the capital funding regime for NHS organisations, as few doubt the list of 11 outstanding PFI schemes will be added to.

The payment by results tariff assumes that hospitals spend an average of 8 per cent of their income on capital, but hospitals with significant new developments can see themselves spending up to 15 per cent, leaving them with an increasingly uncomfortable funding gap as NHS funding is further squeezed.