A turf war is brewing in Italy. The power sector has seen two non-recourse CCGT financings in 2005 so far – Calenia and Voghera. And the year is likely to witness three more – Energia's Modugno, and EGL's Rizziconi and Salerno plants. But despite the increase in the number of deals, there are unlikely to be many bumper bonuses for Italian energy project financiers this Christmas.

Why? Because advisory fees and margins have been pruned to an all time low. New entrants to the market are taking on the more established players. A battle is being played out, much to the advantage of sponsors, between the likes of RBS, MCC and other established banks that can woo a sponsor with a back-catalogue of past deals, and newer entrants which have smaller teams offering ultra-competitive terms. Law firms face a similar situation, with the more established firms competing with much smaller and less experienced teams.

Among the banks, the new entrants are not restricted to smaller local institutions. Most notably both BBVA and SG have made a concerted push for more business in Italy, and have been using their wider brands to win favour with sponsors.

Sponsor paradise

Margins on a standard combined cycle gas turbine (CCGT) tolling deal with a strong credit as an offtaker are coming in as low as just over 100bp. But not just margins are under pressure, since some firms are offering their advisory services for free, hoping to make a few basis points on arranging, while others are making large concessions with regards to the standard corpus of project terms and conditions.

This structural pressure is manifested through such changes to the package of risk mitigants available to lenders as the abolition of the need for lender consent to refinancing and associated terms, a loosening of restrictions on dividend distributions, the removal of prepayment penalties, and the shrinking of debt service and maintenance reserve accounts.

Energia's first merchant deal, Termoli, was successfully syndicated among local banks but was shunned by the international community. Lead arranged in MPS' corporate division, the deal had a covenant package more akin to an acquisition financing than a project financing. In particular, the standard covenant of lender consent to a refinancing was omitted. This has an important consequence if the project company is in trouble: under Italian insolvency law there is a two-year automatic clawback of monies disbursed by an insolvent company – payments made on senior debt along a standard amortization profile are generally safe from clawback, but an early payment on a refinancing is at risk without an explicit provision to the contrary.

Sponsors are asking for better terms, and in some instances are getting lenders to release security on projects. Savvy sponsors are fully aware that banks are so willing to get a slice of the energy project debt market that they will accept derivations from the norm.

One banker says that "sponsors behind project companies with more than one asset are likely to push for a cessation of dividend locks as early as during drawdown – say, where one plant is online and one is up and running." This is not believed to have happened yet in the energy sector, but that the market is countenancing such a revision gives some indication how good sponsors have it at the moment.

As well as major structural amendments and tight pricing, sponsors are saving on transaction costs as general syndications become redundant. Such is the appetite for assets that it is now usual for sponsors – inundated with bank enquiries – to introduce potential participants to the original lead arrangers, with all the recent deals booked and held as clubs.

The old guard stands firm

It would be too simplistic to say that all deals are being done on such favourable terms. Sponsors want different things. Some sponsors want a quick closing and reasonable terms; others want debt to be as cheap as possible with a speedy close a lower priority.

Some of the more established players are holding their own in the face of stiff competition, by playing the experience card. Notably, RBS and MCC appear to have a steady stream of mandates. Although they are subject to the same squeeze on pricing as everyone else, early indications are that they have resisted tampering with the standard package of project covenants on EGL's forthcoming Rizziconi deal (also lead arranged by MecFin).

As a general rule of thumb, the longer the lead time, the more likely that the documentation deviates from normal practice, while banks negotiate and try to justify the risks to their credit committees. This is without reckoning, however, with the scourge of the Italian generation market – permitting.

EGL Italia (Elektizitaets-Gesellschaft Laufenburg) plans to have four generation plants operating in Italy. Calenia was financed earlier this year. The financing for Rizziconi is expected to be signed by December, but EGL's fourth 780-800MW CCGT plant in Salerno is thought to be delayed because of a permitting snag. The lead arrangers on Rizziconi have the mandate to arrange the Salerno deal – but the two will be separate financings, with each tolling agreement-driven deal to seek roughly Eu450 million in project debt.

The terms are likely to be very similar, if not tighter, than the Calenia deal, with the deals again underwritten as a club. The financing documents for 800MW Calenia Energia combined-cycle gas turbine project at Sparanise in Campania were signed on 18 February. A club of ten banks lead arranged the Eu453.2 million deal: BTM, BayernLB, Fortis, HVB, RBS, SG, WestLB, Mediocredito Centrale, Banca Mediocredito, and BNL; BBVA came in later as a co-arranger. The tenor on the debt includes a 2.5-year construction period and 15 years operation, backed by a 15-year tolling agreement from the sponsor. The margin is believed to range from 100bp to a long-term ceiling of 150bp.

More conventional Modugno

As well as Rizziconi, financing for Energia's 760MW Modugno plant in Bari should be in place by the end of the year. As with Termoli, Modugno will be a merchant credit with a 65/35 debt-equity split – but unlike its predecessor the financing package is likely to contain conventional project covenants. The fact that BNL and WestLB – which both have experienced project teams – are also mandated lead arrangers (MLAs) on the deal indicates that the project terms will return to norms. MPS, which lead arranged on Termoli, is also an MLA on Modugno.

The financing was scheduled to be closed in late August, but has slipped and is likely to be wrapped up in November. The delay is centered on negotiations between Energia and the lenders on the amortization profile, drawdown timetable and other structural issues. Also differing from Termoli, the Modugno payment profile is anticipated to be more forgiving on the DSCRs by adopting a bullet.

Beyond EGL and Energia, there are few firm CCGT financings in the pipeline. Atel is rumoured to favour non-recourse financings but is still mired in permitting delays for its prospective plants. Swiss utility Rezia is thought to be choosing between a project deal and an on-balance sheet financing for a plant and has mandated MCC.

Withering dealflow ahead

While a number of generation plants will be built on-balance sheet by ENEL and Edison and their peers, the cash-rich utilities, 2006 is likely to witness more portfolio refinancings. The API and Eurogen deals have paved the way for sponsors to take advantage of a highly competitive bank market.

The Eu470 million refinancing of the API Energia gas-fired power facility closed on 15 June 2005. The 14-year loan was 65% oversubscribed, and priced at 100bp over Euribor for the first five years, 110bp for years six to nine and 130bp to term.

MLAs RBS, Calyon and Banca Intesa ran the book, and BNL, Centrobanca and MCC joined as additional MLAs. The syndicate is made up of a total of 18 Italian and large international banks, some of which are new to the project, slimmed down from 30 on the last deal. This was not a concerted effort to reduce the lending group by the sponsor or its advisers, but rather the result of some banks withdrawing from project financings, given the low margins and intense competition.

The plant is located in the API refinery at Falconara, close to Ancona, Italy. This is the only refinery on the Adriatic coast. API Energia, the sponsor, is a subsidiary of API. The refinancing has allowed cash to be returned to the sponsor and the tenor extended. The original financing closed in 1996 and the first refinancing took place in 2000, while sources close to the deal say that this will likely not be the last. The market risk overall on the project is low because the electricity price is set under grandfathered and protected CIP6 tariffs.

Eurogen, the 7,000MW portfolio genco carved out of incumbent ENEL, has also witnessed two refinancings. The $2.3 billion deal signed in February lead arranged by Barclays, Banca Intesa, BNP Paribas, Calyon, Commerzbank, Mediobanca, MCC, SG, Unicredit and WestLB, takes out the original refinancing package put together in September 2003. The latest deal is not a refinancing in the proper sense of the word because no new money went through credit, rather the existing banks agreed to amendments in the existing documentation.

The first Eu2.3 billion deal refinanced Eu3.8 billion in acquisition debt. The portfolio's support consists of tolling agreements that initially covered 6,000MW of capacity, which will rise to 8,000MW over an eight-year period as new plants come on line. As an indication of how much the bank market has warmed, the first deal had margins that stepped up incrementally from 150bp over Euribor to 195bp, while the second refinancing starts at 75bp.

Next year bankers have predicting more of the same. The third genco, Tirreno, is a likely candidate for a refinancing. The Tirreno Power (formerly Interpower) financing was the first for a merchant portfolio in Italy. The Eu1.9 billion in debt signed in January 2003 with the seven-year debt priced at 125bp over Euribor years one to two, 130bp years three to four, 140bp years five to six, and 170bp thereafter.

And the ISAB and Sarlux deals have been tipped to come to market again. ISAB is a 512MW IGCC (Integrated Gasification Combined Cycle) power plant in Priolo, Sicily, 51% owned by ERG Petroli, and 49% by the Mitsui/International Power joint venture IPM Eagle. The 548MW Sarlux IGCC is sponsored by Saras (and formerly Enron) and is located at Sarroc. Both deals benefit from the legacy of the CIP6 regime, and would weigh-in at about Eu1 billion each if they were to come to market.

The field narrows

If banks are unable to compete, whether on the handful of greenfield generation plants or on the mooted refinancings, they could be in for a hard time ahead. Either manpower could be diverted internally to where the margins are slightly fatter (to, say, trade or export finance, as one banker suggests) or they must prepare themselves for a battle of attrition – with the larger teams, with more overheads, relying on their experience and their contact books against the smaller domestic teams that are offering their services for less.

If banks and law firms do adopt a wait-and-see attitude, they will be hoping to see the end of the constellation of events that have colluded to give sponsors probably the best lending environment they are likely to see. Either the credit cycle will reach an inflection point divorced from what energy is doing; a project default will instantly fatten margins; competitors will leave the market; or the window for Italian generation capacity will pass.

An alternative strategy could be to participate in the large portfolio deals where possible, but make margins by avoiding the vanilla single-plant tolling deals that are ultra-competitive and going for more bespoke financings. The French banks appear to be deploying this strategy with BNP Paribas MLA on the Eu120 million Elettra deal, with project sponsors PE house Oxenbridge & Co and Hutton Collins, and SG thought to be working on a French-lease structure – the first in Italy – for a renewables project.

But renewables is not a panacea either – the economics are tight and have been made tighter by the decision to replace the 488 development grants in the South with a soft loan regime.