That elusive perfect finance deal is rarely found. If you want cheap money, you have to accept the risks that this entails
One of my strategies for surviving dull meetings is to make lists. Today I reviewed my life to date and discovered I have owned 17 cars, moved house eight times, visited 24 countries and had ‘significant’ relationships with four women. This has made me realise three other things: I still don’t know how a gearbox works, have needlessly spent thousands of pounds on estate agent fees and will never understand the motivations and emotions of half of the people on the planet.
It has also made me realise that I have wasted a lot of time and money trying to improve on what were perfectly satisfactory situations just because I thought something a little bit better could be obtained. I live in a house much like all the other houses I used to live in, I swapped a comfortable BMW for a very uncomfortable Porsche and I have paid for the ski chalets of two divorce lawyers.
However, I am not alone in thinking the grass is always a slightly nicer shade of green somewhere else and this thinking is particularly prevalent when it comes to finance. Over the last 15 years, I have completed over 100 deals involving clients in both the public and private sector involving over £1bn of external finance. I have also worked on a smaller number of deals that have failed to attract any finance at all, and a common theme to all these has been the belief that there is always a slightly better deal to be had.
This mistaken belief is built on the wobbly foundation of a more fundamental misunderstanding about the relationship between the price of money and risk. Money becomes more expensive and less available the more risk your funder is taking. This is an absolute and universal law of finance, albeit one that some banks forgot in the run up to the credit crisis. I have a friend in LA who says he should have realised that the banks were probably losing sight of this rule when his Mexican maid bought the house next door to him with a $1m mortgage.
Sanity has since prevailed and, with the zeal of the newly converted, the banks are applying this rule more strictly than ever. This is why payday loans are very expensive compared to mortgages. If you need to borrow £200 in a pressing hurry you are unlikely to be a prudent investor and hence the bank will regard you with fairly jaundiced eyes. Put your house on the line and, hey presto, everything becomes much cheaper.
So repeat after me. The price of money and the price of risk are two sides of the same coin. If you want cheap money, you take the risk not the bank.
This sounds blindingly obvious but the current hoo-ha over funding of infrastructure and the future of the Private Finance Initiative shows once again that this universal law is not universally understood. We have gone over this ground many times but let’s take it from the top once again; the public sector can only borrow more cheaply than the private sector because it has a better credit rating and hence the bank is taking less risk.
The absolute level of risk remains the same so this simply means that the public sector is taking more risk and the bank less. You cannot magically make risk disappear you can only allocate it between the parties.
We can easily illustrate this by comparing the history of the Scottish Parliament building to that of Wembley Stadium. The Scottish Parliament is basically a big fancy shed to house 129 MSPs and 1,000 civil servants. Wembley Stadium is of course a much bigger building to house 90,000 drunken football fans.
The Scottish Parliament was meant to cost £40m but eventually came in at an eye-watering £414m. Yes that’s right, £400m for a building designed to hold about 1,000 people from 10am to 4pm most days. This unbelievable but true cost fell squarely on to the Scottish taxpayers who no doubt grinned and bore it with the generosity for which they are renowned. Wembley Stadium was meant to cost £500m and came in at £715m, but critically because the Football Association had skilfully negotiated a non-recourse arrangement, this extra cost was borne by the builder and their bank.
The risk inherent in both projects didn’t go away just because they were financed differently, it just got paid for by the different parties. So risk is real and when you don’t transfer it to the private sector, it may come back and bite you with a vengeance. For critics of PFI who scoff at the notion of risk transfer, the Scottish Parliament building is not just an elephant in the corner of the room, it is a whole herd of snorting mammoths sitting on the sofa, hogging the remote and eating your Pringles.
So you can always get cheaper money but only if you are prepared to take the chance of paying more further down the road. Non-recourse bank debt is currently trading at about 7% for projects and you wont get it any cheaper unless you put your existing assets at risk. If you don’t want to do this and cannot make your project work at these rates then it wont work. If you can make it work and get an offer of funding then bite their hand off.
Because my friend’s maid unsurprisingly didn’t keep up with her mortgage, we are living in a world that is short of credit and likely to remain so for at least a couple of years. So take what you can while it is available.
On a macro scale, the UK is at a bit of a crossroads here. We can either get on with building £30bn of infrastructure using pension fund money at 7% or we can keep rehearsing stale arguments about PFI and waste a lot of time in the process. From the banks point of view, the UK is just a cold gloomy island somewhere off the coast of Europe and the same rules of finance apply here as everywhere else.
So in conclusion, eating what is on your plate is a good rule for toddlers and getting funding. You can spend a lot of time trying to improve your funding structure while closing your eyes to the concept of risk or you can accept the way the world is and get with actually building your project.
If I had my life again, I would have purchased fewer cars, fewer houses and married my third wife first. If the Scots had their time again, they would have made their MPs work in the same bog standard offices the rest of us do. You can learn from both of these mistakes and fund your project with the money that is available to you today not the cheaper deal that exists in theory in some academic’s head.
Michael Ware is corporate finance partner at BDO
