European Investment Bank - SPRUCE evaluation: final report

3. Value for Money

3.1 Introduction

In accordance with the brief, we have considered the value for money offered by SPRUCE and the investment led approach compared to traditional non-repayable grant and also against a longer-term structured financing arrangement of 10 years.

We also considered alternative intervention models available to support infrastructure investment in Scotland such as the Growth Accelerator Model and Tax Incremental Financing, albeit these were not subject to a full financial appraisal.

We also considered the do-nothing option but rejected this on the basis that funding intervention is required to address long running and continuing market failure in Scotland regarding access to capital for urban development and regeneration projects. A do-nothing approach would therefore undermine delivery of the Government's Economic Strategy including the original ERDF Priority 3 requirements.

3.2 Value for money assessment

The results of our comparison are summarized in Appendix II. It details the value for money offered by SPRUCE compared to non-repayable grant and a 10-year structured finance facility over the following time frames:

• At the end of the current investment period (28 November 2021). As set out previously, SPRUCE funds were partially reinvested with some £135M invested in 18 projects, some of which are still in receipt of SPRUCE funding at this point.

And for comparison purposes, the assessment considers as also set out in the interim valuation, the VFM offered by further recycling/a longer term investment period for SPRUCE:

• To 2032 at which point the fund would be expected to have been fully recycled twice
• To 2042 at which point the fund would be expected to have fully recycled three times.

The comparison assumes the same profile of projects supported, timing of investment and repayment periods, and benefits achieved to date with the current SPRUCE. The VFM assessment is provided for illustrative purposes only.

The structured finance arrangement could be a social finance instrument like the charitable bond delivered on behalf of Scottish Government by Allia or commercial finance like SPRUCE and involving senior debt, mezzanine or equity finance. The key difference is the longer-term nature of the finance at 10 years on average compared to the shorter terms on average with SPRUCE.

In summary, the VFM assessment confirms:

• SPRUCE offers considerable value for money to the public purse when compared against alternative pricing interventions including non-repayable grant and/or other structured financing alternatives. Based on the alternatives assessed, it represents the most economically advantageous option for achieving a set of desired impacts compared to these other options in the short, medium, and longer term.
• The additional value created by SPRUCE is powered by the combination of the investment led approach and the recycling of funds. Both the investment led approach and the recycling aspects improve VFM for the public pound compared to traditional grant, but the maximum value is created when they are combined.
• The financial performance of the current SPRUCE fund has been supported by the relatively short payback period on the business space projects which repaid on average within 3 .5 years for the offices and 4.25 years on average for the industrial units with most of the offices sold on since completion. The post completion sale remains a key part of the private developer strategy. They do not wish to hold the asset long term but are keen to develop out, sell and move on. This has worked well for SPRUCE in the initial tranche for both the office and industrial unit projects. The energy projects involve longer term loans.
• SPRUCE has financially outperformed the forecast in the interim evaluation partially as a result of the early repayment of some of the loans and also due to the concentration of office projects supported in the recycling phase. This strong financial performance has to be balanced against the broader outputs delivered.

We set out in earlier sections of the report the strong leverage (almost 3 times) achieved by SPRUCE investment of £135M supporting total development activity of £0.5BN and £425M from third parties funding the rest. Tables 4 and 5 provide a simple illustration of the potential value from SPRUCE, the potential leverage and impacts from a fully recycled fund to 2032 and 2042 respectively.

This shows significant increase in the leverage gained from recycling the initial investment (increasing from £2.82 to £8.47) and is very significant compared to other options.

Table 5 illustrates the benefit of recycling the original capital. Each time the capital is recycled that offers direct benefits over and above the non-repayable grant alternative and so an original £94M investment by the Scottish Government delivering almost £1.1BN infrastructure activity by 2042.

The VFM assessment details the potential additional benefits available from the recycling phase(s) are so considerable that the Scottish Government should consider the broader application of SPRUCE funding techniques across other mainstream programmes.

Our analysis has also confirmed:

• A portfolio that tends towards shorter term lending will maximise the financial performance of the fund, but as the investment strategy makes clear the overarching policy aim of SPRUCE is to achieve wider social, economic and environmental impacts and so it is important to note that SPRUCE may not necessarily seek to maximize financial return. This will have to be balanced with the requirements of individual projects to be funded. Feedback also suggests a need for longer term money in some cases; and therefore,
• The increasing importance of the targets in the recycling investment phases so that an appropriate balance of financial performance and impacts can be achieved rather than over achievement in some and no progress in others. This balance increases in importance relative to the size of the fund available.

Whilst currently delivering significant additional value compared to traditional grant our analysis concluded that the fund is not currently reaching its potential due to the above and that the following constraints have been noted.

• The fund was insufficient in scale relative to the infrastructure needs of Scotland when considered in light of the domestic policy agenda for a just economic transition.
• The 10-year term may be satisfactory in commissioning terms but is insufficient in policy imperative terms as it provides insufficient time for all initial funding to be fully reinvested (as has been borne out in practice with a recycling rate of 1.4 times rather than full reinvestment and a recycling rate of at least 2);
• The 10-year term also appears to have impacted on the likely selection of projects for SPRUCE funding. Investments to date have been focussed on refurbishment and/or shovel ready projects. An extended time would allow an opportunity to invest in longer term initiatives with stronger strategic alignment of SPRUCE to support specific aspects of the economic and regeneration strategies of the Scottish Government. including:

(1) Transition to net zero and retrofitting of existing assets. The lack of energy efficiency in Scotland's property sector and the ability to meet government ambitions for a carbon neutral/net zero economy. Around 200m sq ft of industrial space and 60m sq ft of office space is not energy efficient and the market is moving out of it. These properties could be renovated and reoccupied if there was funding to support it.

(2) Assembly of strategic sites is limited in Scotland beyond Clyde Gateway. This is a long run concern as the inability to bring forward key sites now (in the short/medium term) will put a brake on economic growth/transition arrangements over the longer term. The concern here recognises we are now competing in a global market and, in that sense, Scotland's competitiveness/attractiveness for inward investment relative to other destinations must also be global;

(3) Ability to undertake more comprehensive placed based interventions – either creating new places to live and or regenerating deprived areas. Without major public sector intervention, there will be insufficient supply and some areas are most likely to continue suffering economic decline which in turn impacts on wider wellbeing and the prosperity of residents who live and work in the area and ultimately on Scotland economic aspirations. Feedback was also made here relative to wider City Centre and wider place/town perspectives rather than individual pepper potted projects.

3.3 Other infrastructure interventions

We looked briefly at the Growth Accelerator Models and Tax Incremental Financing alternatives and whilst these were not subject to a full financial appraisal, we found that SPRUCE is likely to outperform both the Growth Accelerator model and TIF approaches in a number of situations including where access to capital is the primary market failure, for otherwise viable projects.

Both the growth accelerator and TIF approaches are very long-term variants on PPP and PFI structures which require ongoing annual revenue (and/or grant) subsidy payments from the Scottish Government and which are not features of SPRUCE. That said, for some major infrastructure works, with multiple market failures to address, SPRUCE could be part of, but not a whole solution. Nevertheless, our analysis suggests the VFM case for SPRUCE is strong and should be considered on a bigger and broader scale as a mainstream tool for intervention to support infrastructure investment in areas of market failure.

Progress in thinking around sustainability and circular economy models which could usefully also be considered in the context of a SPRUCE or similar fund in future.

3.4 VFM methodology

We conducted the VFM assessment using the net present value (NPV) methodology at a real discount factor of 3.5% which is in line with UK's HM Treasury Green Book appraisal. The sensitivity of the appraisal to movements in the discount rate was also examined and these results are also set out in Appendix II.

The NPV appraisal of the SPRUCE fund includes the fees charged by Amber and EIB to the fund and so it outperforms the traditional grant routes even with the higher cost as this is offset by interest earned on the fund.