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There seems to be little that is unusual about the£122m plan to redevelop South Cleveland Hospital at South Tees trust. It will be funded through the private finance initiative, but this scheme is now so entrenched that few will give it a second thought. What is notable is how the private sector money will be raised.

The South Tees scheme is the fourth and biggest PFI project to be funded almost entirely through a bond issue.

Most health service PFI deals have been funded through mortgage-style bank borrowing, although money can be raised through the sale and redevelopment of land and the sale of shares in the consortium.

But more bond issues are likely to be added to the projects at Carlisle, Greenwich and North Durham, drawing the NHS, the City, pension funds and insurers together for 30-year periods.

These are bonds that tie, and as with practically every other area of PFI, there is a debate on whether the public sector is getting value for money.

A bond is basically an IOU. In the case of an NHS private finance deal, the private sector consortium, not the trust or the government, issues bonds which are bought by investors. In return, the consortium makes an interest payment - normally twice a year. At the end of the 30-year issue period the original investment is paid back.

An underwriter, a bank that agrees to buy any unsold bonds, will also usually be involved. Barclays Capital acted as underwriter for the South Tees and Greenwich deals.

Bonds can be guaranteed or unguaranteed. A guaranteed bond is one where an insurance policy has been taken out which will cover payments to investors if the bond issuer defaults.

Robert Rees, a Barclays Capital director, says the decision to take insurance is based on cost. A guarantee may reduce payments to investors, but this saving could be swallowed up by the insurance premium.

Steve Anderson, finance director of South Tees trust, says its private sector partner's decision to raise funds through a bond issue has advantages for the NHS.

'The first is the ability to borrow over a longer term,' he says. 'In our case it is 30 years, but in the early negotiations we had about more conventional borrowing it would have been 25 years. Bonds cost less compared to conventional mortgage-type funding, though this may not always hold good in the future.'

This is because long-term interest rates stand at around 2 per cent at the moment, compared with the short-term lending rates offered by banks, which are much higher.

In South Tees and North Durham the repayment is index-linked, so it will increase each year by the rate of inflation. Mr Anderson says index-linking gives the trust some certainty about the price it will pay.

'Index-linking is attractive to investors because it is inflation-proof. Several schemes have gone down the bond route and a clear process has been established. We have benefited from that.'

But do investors have the appetite for NHS private finance deals? Maurice Fitzpatrick, head of economics at city accountants Chantrey Vellacott DFK, says money is out there waiting to invest in relatively low-risk projects, such as PFI.

Insurance companies and pension funds often hedge their riskier investments by putting money into government bonds, known as gilts.

But Labour's drive to reduce public borrowing means the Treasury is now only issuing four to five billion gilts a year, he says. In 1993-94 it was issuing a similar number every month.

The shortage of gilts, combined with greater demand for low-risk investments, has made PFI bond issues more attractive.

But bonds may only provide value for money in relatively stable trusts with a good financial record.

Before bonds are issued, they are given an investment rating by an agency such as Standard & Poor's or Moody's. A good rating is immensely important. If it is poor, they are known as junk bonds and bond-holders will see their investment as a greater risk. In return for taking this risk they demand higher interest payments.

Gilts enjoy the highest rating (AAA). If a trust's investment rating is low, public sector funding of a capital scheme may offer better value for money, as the Treasury can borrow more cheaply.

This was not a problem for South Tees because its scheme was awarded an AAA rating by Moody's. Mr Anderson says this helped increase the value for money offered by the deal.

But getting a good rating can be hard work.

Agencies are not only interested in the financial position of the trust; they will also rate the investment on issues such as management culture. They take into account anything that could threaten the investment.

There are other criticisms of bond issues. They have higher start-up costs because of the need for greater legal advice and the cost of ratings agency fees.

But this may be balanced by savings made over the lifetime of the deal.

The South Tees project has a capital cost of£122m, but the bond issue is for£137.4m. Mr Rees says around£7m of the difference can be accounted for by professional fees and start-up costs.

During the four-year building period the consortium will not receive any revenue from the trust yet it will have to pay interest on the bonds. The extra cash will finance this spending. The additional money also includes around£8.5m of variation bonds. These have not yet been sold but will be if, during the construction period, the trust decides it needs more accommodation. In the meantime the trust's payments are based on the£122m capital cost of the redevelopment.

Trusts whose PFIs are financed through index-linked bonds are at the mercy of trends in inflation, though Mr Rees contends that increases will be matched by the allowance for inflation in NHS funding.

Bonds may not be appropriate for all PFI schemes and their use is controversial.

But in PFI, competition is a watchword and the NHS Executive is keen that private finance projects at least examine bond issues as an alternative source of funding.

That way, it believes, trusts can be sure they are getting the best value for money possible out of their PFI deal.