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CDO world takes an interest in U.K. PFI paper

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Fitch Ratings expects that CDOs may become a funding source in the U.K. private finance initiative (PFI) sector and said it is currently working on a number of proposed CDO transactions that would purchase PFI assets.

As the 10-year PFI program in the U.K. settles into a more mature phase, a new class of investors is giving mezzanine paper an increasing role in PFI refinancings.

PFI contractors have made little use of the capital market to date. However, according to market reports, the use of bonds has increased to GBP3 billion (US$5.34 billion) from GBP700 million (US$1.2 billion) in 2002. The trend is likely to continue in particular because many of these projects have passed the completion stage, opening a number of the deals up for refinancing.

According to Fitch analysts, the key issue with how to split the financial benefits of refinancing between the private and the public sectors is now resolved, with a mandatory 50/50 profit split on all new transactions and a 70/30 voluntary split on the existing ones. This could pave the way for secondary market appetite.

Construction companies have historically played a key role in this market: they are both the primary contractors and the initial equity providers on the projects. According to Fitch, these investments have historically been profitable but funding constraints are increasing.

Over the past few years, the reference to a floor covering all of the senior debt in case of termination has all but disappeared, said Fitch. It only remains an issue for those transactions with significant construction and operating risks such as those

associated with the companies managing the infrastructure for the London Underground through the Tubeline and Metronet trans-actions.

Without this floor, the difference between senior debt, equity and subordinated debt is less defined.

This makes the transactions now better suited for securitizations-type financing.

“Combined with revised accounting standards, these constraints put pressure on

traditional sponsors to sell their existing investments and to limit future equity participation in this market,” said Fitch analysts.

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