"Things are moving gradually forward," is a typical refrain from seasoned financiers about the Italian PPP market. At least the market is moving. In the past 10 months the market has withstood a number of body blows, from ill-conceived legislative changes to the partial victory of a new Leftist government in the general election.

Demise of the GC scheme?

Since the Italian Banking Association got its way with a change to the general contractor (GC) provisions at the end of 2005, not one significant GC deal has closed. The Italian banking fraternity pushed for the change because of a slim possibility that banks, as buyers of invoices in a general contractor scheme, could be sued if there was a major contractor default. But the uncertainty surrounding the legal status of the pre-financing payments has increased with the revision. "Things were fairly unclear to begin with," says one banker, "and in my opinion they've now become less clear."

But the relegation of the general contractor provisions as the procurement method of choice is likely to be more about public budgets than legislative change. The GC scheme is effectively construction finance based on factoring. Unlike thoroughbred PPP schemes there is no concession period, so the awarding public authority must make interim payments along the life of the construction, and are obliged to pay fully on completion.

Some market participants – contractors, bankers and lawyers – are shunning some GC schemes out to tender at the moment, for fear that the deal will never complete or take so long to come to fruition that a capped advisory fee would be too punitive.

Messina-Straits

The Messina Straits bridge mega project, the highest profile GC scheme, appears to be moving inexorably, if slowly, toward financing and completion. But all is not as it seems. Several market participants rate its chances of ever-being financed as slim. This, despite the Impregilo-led consortium being named preferred bidder in October last year.

The preferred bidder came in with a tender price of Eu3.88 billion ($4.5 billion) and has Banca Intesa, Banca Popolare Italiana and Banca Carige in place to fund a Eu582 million pre-financing commitment – around 15% of the total price. Also, Royal Bank of Scotland (RBS) and Mediocredito Centrale (MCC) are working on a preliminary information memo for parastatal project company Stretto di Messina for around Eu1.5 billion in project debt to supplement the project company's Eu2.4 billion in capital. Construction on the project is scheduled to start at the end of 2006 and be complete in 2012.

Recently the Word Wildlife Fund (WWF) contacted the EU to ask for details of how the bridge will affect neighbouring nature reserves. At stake is the EU's share of up to 20% of the overall funding for the project. But even excepting the environmental doubts, the project still has the twin high hurdles of bankability and affordability to surmount.

In total the bridge is likely to cost the government (albeit mostly off balance sheet) some Eu7 billion – a figure that probably seems too high for a new government that doesn't deem the bridge of high importance. The new government's antipathy was spelled out when transport minister Alessandro Bianchi said to journalists before his inauguration speech: "the planned Messina bridge is the most useless and damaging project in Italy in the last 100 years and must be kept far away from this government's program". Yet, there is unlikely to be an easy contractual route out for the government.

Also, it is unclear how the two financing packages – the GC financing and the project financing capitalizing the project company Stretto di Messina – will work in practice. "To my mind," says one market participant, "the GC scheme layered beneath a project financing will be almost impossible to bank because both groups of lenders will be after the same security."

Some cynics argue that interested parties are going through the motions collecting their design and advisory fees with little prospect of the bridge ever being constructed. Not only has the political impetus evaporated along with Silvio Berlusconi's tenure as Prime Minister, but it appears the public road authority ANAS is not convinced either – it has recently asked the contractors for leg 2 of the Salerno-Reggio-Calabria motorway project to link the motorway back into the mainland road network rather than link to the Messina Bridge as originally planned.

New government, new direction

Market participants are waiting to see the position the new government takes, but most accept that it will almost certainly remap the projects specified on the Legge Obiettivo. "There are signals that the government wishes to change the prioritization of the projects of high importance under the Legge Obiettivo," says one lawyer, "The feeling is that urgent projects will be concentrated in the North."

As well as inheriting a change to the general contractor provisions and the Messina-Straits Bridge saga, the government also inherits the mess made over the legislation governing water and waste-to-energy concessions by the previous administration.

There is an unwritten convention in the Italian constitution that government will not pass any new law in the 45 days preceding a general election. Yet six days before the general election, a motion was passed for a new law that supersedes the provisions governing water and waste-to-energy concessions – the Galli law.

Despite fierce lobbying through February and March by market participants the old Right administration decided to push ahead with the legislation to fully privatise the water sector, to disallow any concession fees in the sector, and to terminate any operating concession by December 2006. The new law was published just days after the election on 14 April and enacted 29 April. Needless to say the legitimacy of the decree rings hollow, both because of its timing and its punitive retrospective effect.

The galling aspect of this legislation for market participants is that the Galli law was beginning to witness a number of deals having in place for over ten years and witnessing none (search "Nuove Acque" for details of the first Galli law project at www.projectfinancemagazine.com). The previous administration's motive was obviously to get more private capital into the water sector more quickly. Because of the unconscionable nature of legislation it is likely it will get repealed directly or through a challenge in the courts.

Incredibly, despite this the water sector is arguably the most encouraging of Italy's PPP sectors. The majority of local water authorities (that usually comprise a local consortia made up of municipalities and provinces called ATOs) are looking to bring in private concessionaires. Tuscany, in particular is a hot bed of activity with Depfa on the cusp of closing a Eu100 million to Eu200 million ATO deal in Pisa within the next three to four months. Depfa is also believed to be working on a similar sized deal in Florence due to close by the end of the year.

Also due to close by year-end are water concessions in Termoli, Umbria backed by BNL, in Naples which BancaOPI is working on, and MCC is working on a deal in Sicily. The Naples scheme is the largest by some margin, with capex at roughly Eu700 million. It is likely to be the most difficult to bank not because of its size but because the water tariffs for end users in the ATO region are low – too low to support a concession. It is very difficult under the present law to revise the tariff.

To improve dealflow, the way forward should be pragmatic and incremental amendments to the Galli law, which make private investment more hospitable and projects more bankable. A simpler authorisation procedure for tariff reviews would be a welcome step, and amendments to the provisions governing termination liabilities and water-manager guarantees should also help the dealflow.

Presently, under the Galli law the water-manger must give a five to 10 year guarantee to the public entity for planned works which roughly translates to a third of the average value of the concession. This, along with onerous termination liabilities, makes water projects difficult to bank.

Beyond water

Despite these difficulties, there is a gathering flow of concession awards among the ATOs. The other PPP market rivalling the water sector is the hospital sector.

The template for future hospital financings was firmly set down at the end of last year when financing closed for the Eu120 million Castelfranco and Montebelluna hospital, in the Veneto region, Italy – the first hospital PPP to be structured solely under Italian law. Banca Mediocredito and Monte dei Paschi di Siena (MPS) joint lead arranged the Eu85 million project debt, with Banca OPI and Venetobanca joining syndication.

The 30-year concession is managed by a consortium led by Guerrato SpA. The debt comprises a 19.5-year Eu70 million term loan, a Eu7.9 million VAT facility and a Eu5 million cost overrun facility. Pricing on the debt begins at around 120bp over Euribor, rising after completion of the three-year construction phase.

The Castelfranco and Montebelluna hospital followed the Mestre hospital financing, also in the Veneto region. Mestre was the first true hospital-PPP financing in Italy, but unlike the newer deal, was banked under UK law.

The Mestre hospital financing comprised a main tranche of Eu110 million with a tenor of construction-plus 23 years. The public contribution totaled Eu100 million, and the sponsors' equity was Eu28 million, giving an 80/20 debt-equity split and structured to give an ADSCR of 1.44x. The senior debt was lead arranged by ABN Amro, Banca Intesa and InterBanca, with Banco Antonveneto – the retail arm in the same group as InterBanca – coming in as a lead underwriter (search "Mestre" for more details).

There are a number of small schemes in the offing. Banco Mediocredito closed a Eu20 million deal for a rehabilitation unit at the Torino Sanita hospital in Turin at the beginning of the year. The project is sponsored by Cofathec under a 27-year concession.

Dexia is working on a Eu60 million – Eu70 million hospital in Legnano, Lombardia that should close in September or October. A similarly sized deal for a hospital in Livorno should also close by the end of the year.

On a larger scale, Italy's largest hospital PPP is likely to take the form of the St Anna Hospital in Como. The Pirelli lender group has been named preferred bidder for the Eu450 million project and Mediobanca is the financial adviser. The consortium is currently in the market for lead arranging banks.

Despite the Como Hospital, there is likely to be a glut of small healthcare deals under Eu60 million spread throughout the regions. Italy still lacks a centralist direction, and this is clearly evident in the healthcare sector. In the UK, for example, the Treasury has stipulated that PPP will not be value for money due to the high transaction costs on deals below £25 million (Eu36.3 million). Many of the schemes in Italy would fall on the UK Treasury's model. In Italy they have no real equivalent to the public sector comparator or PFI credits – most healthcare infrastructure is funded through investment grants – so where regional budgets are tight it is more a question of whether a hospital gets built using PPP or not at all.

The other issue that regionalisation brings, which the Mestre financing appears to have partially solved, is the creditworthiness of the regional health authorities, the ASLs. In the UK this is overcome by the Residual Liability Act whereby the government effectively guarantees an agency acting as an arm of the state. In the Mestre hospital financing it was concluded that although there was no explicit provision or contract, such is the importance of the hospital to the local population that the Veneto regional authority was a de facto guarantor of the ASL with regards to its payments to the project. But the limiting factor here, of course, is the creditworthiness of the region, for Mestre and the Castelfranco and Montebelluna hospitals the Veneto region is AA rated by S&P. Many of the Southern regions have lower ratings.

Tricky transport

The dealflow for transport deals has stalled slightly while market participants wait to see what approach the new government takes – as well as re-prioritising projects they also have a strong environmental agenda. Road projects, perhaps more than any other sector, has suffered from delays due to the elections because most concessions are tendered through the central body ANAS, rather than a regional body. Nevertheless, the market should be buoyed by the input of foreign contractors.

At the beginning of the year the Spanish giant Cintra was appointed preferred bidder to design, build, finance and operate the 60km Cremona-Mantua toll motorway. The selection of Cintra to carry out the Eu943.8 million ($1.1 billion) project was the first time a non-Italian sponsor has been awarded a major PPP contract. Autostrade Centro Padane had been favourite to win the 55-year concession. Cintra holds a 68% equity interest in the project company; Merloni Finanziaria is the other partner in the consortium. Cintra's part parent Ferrovial will carry out the Eu600 million construction contract.

Santander and one other bank advised Cintra through the bidding process, and are likely to become MLAs, with perhaps two more banks joining them. With commercial close not contingent on the financing structure, the concession is likely to be signed early in 2006.

Another notable aspect of the deal is that it is the first Italian road concession to be awarded by a regional administration, in this instance Infrastructture Lombarde – widely regarded as the most expert PPP regional body – instead of ANAS. Autostrade had been the favourite to win the concession because it already operates another toll road connected to the Cremona-Mantua motorway, creating opportunities for cost savings.

However, the project has been delayed because of the elections, and because one of the losing bidders wishes to challenge the appointment through the courts. The lead arranging banks are expected to be awarded once the dispute has cleared. Under Italian tendering rules, bidders are not required to provide underwriting commitments. Also delayed by the elections are: the Bologna bypass project whose promotore is Eiffage; the Cartagena bypass, Tuscany promoted by Autostrade, and the Mestre bypass. The Mestre bypass project is an unusual financing because it incorporates two elements – in many respects it is similar to the financing of the Messina Straits Bridge, so it should provide a useful guide as to whether the Bridge can be banked.

On the Eu750 million Mestre bypass project ISPA (now subsumed within Cassa Depositi e Prestiti) is financing ANAS, the awarding company, rather than the general contractor – in this case another Impregilo-led consortium.

Under a complex transfer, ANAS will repay the loan using revenues from tolls of the existing ring road currently operated by three private concessionaires. Once the bypass is built the ring road will revert back to ANAS and the bypass is transferred to the concessionaires.

At present Cassa is the only financial institution involved on ANAS' side and is looking to bring in mandated lead arrangers (MLAs), with its underwriting stake reserved at 30%. Intesa and BBVA currently back the GC.

Milan Metro is go

One transport project that is progressing well is the Milan Metro line 5 project. Total project costs are just under Eu505 million, with a maximum public contribution of about Eu300 million toward construction costs.

The 30-year concession has progressed under the promotore provisions. At the beginning of 2002 an Alstom-led consortium presented proposals and another Astaldi-led consortium presented a competing bid. The municipality could not decide between the two, and instead chose a traditional public works contract.

At the end of June 2003, the two consortia merged and presented a new proposal and in January 2004 the municipality appointed the consortium backed by Dexia, Mediobanca and WestLB as preferred bidder. The project was delayed while the public contribution was settled. It was agreed a year ago that the Municipality of Milan will contribute Eu54 million; an Eu81 million loan will be provided through article 211/92; and CIPE will provide Eu175 million under the Legge Obiettivo.

The concession agreement is to sign any time now, and the financing is expected to be in place in September or October. The three financial advisers are likely to form the lead arranging group.

The much larger Rome Lines C and D projects are also progressing, but execution of the concession agreement is unlikely until 2009.