Germany is inefficient – if ever a statement needed qualifying it is that. But it is.

There is always an element of value-added private sector efficiency spin to public-private-partnership (PPP) in Europe. The sugar coating on the bitter sweet state budgetary medicine of more expensive off balance sheet public procurement offset by the NPV benefit to the economy of modern infrastructure.

But that reality is only just beginning to be acknowledged in Germany. The focus of German PPP has been on getting up to 20% private sector efficiency gains through PPP rather than off-balance sheet cash – despite the fact that Germany has again failed to meet the 3% deficit Maastricht criteria.

According to the Deutsches Institut fur Urbanistik (Difu) Germany needs to invest around Eu690 billion ($872 billion) over the next decade in social infrastructure maintenance, upgrades and newbuild across all sectors. The federal government is unlikely to have the cash, even with a radical turnaround in Germany's economic fortunes.

But still the concentration is on efficiency gains rather than efficient use of financial engineering to make existing budgets go further. And there is no real agreement, at least not among bankers, on how those gains are measured, despite a number of well argued academic reports – notably that of Professor Alfen at Weimar University on valuation gains.

Efficiency – or perhaps over-efficiency to the point of inefficiency – has held up development of the German PPP market at both federal and regional government levels. Despite the rebirth of the A-model roads scheme and the announcement of 100-plus prospective PPP projects last month by head of the federal PPP Taskforce Jorg Christensen, German PPP tendering processes still need to speed up – longstanding PPP deals for the Bundeswehr and centralised emergency services for example.

Simply put – the German awarding authorities are spending too long road testing PPP and not enough time stamping TUV (Technischer Ueberwachungsverein, or control standard) on models that have been proven to function efficiently in other markets.

German PPP also suffers from too many political cooks. Only four out of 16 German Lander are run by the same political party as the federal government. And, unlike the UK, central government does not have much leverage over local budgets. The likelihood of local governments being able to agree and co-ordinate umbrella-type financings for portfolios of smaller projects looks remote at best.

Forfaiting

To some extent that does not matter because the German PPP market is two-tier with its own unique Hochbau forfaiting mechanism at local level. The forfaiting model is based on the credit quality of the public offtaker, which although often unrated cannot go bankrupt, and has been used in the majority of schools deals to date (for more details search 'Offenbach' on www.projectfinancemagazine.com).

The scheme involves a bank purchasing, at a discount, the receivables of the project company that are to be paid by the local authority. Thus the project company can pre-finance the construction phase, and debt will be retired over the long term using the regular payments from the authority.

As far as the banks are concerned the only risk is during the construction phase because once built local government payments are guaranteed. And the funding provided is therefore very cheap. But the whole concept undermines the normal concept of PPP by transferring all the risk back to the public sector.

It is also unclear what margins the landesbanks – the lenders to these types of deals – will be able to continue to offer on these kinds of deals, irrespective of the fact that the deals are public sector backed.

Landesbank status change

The landesbanks have long been raising and on-lending debt at unrealistic levels. The German bank market and local borrowing has been distorted by the Anstaltslast (maintenance obligation) and Gewahrtragerhaftung (owners obligation) mechanisms that have provided German landesbanks with the support of their regional state owners. In July that system ends and the landesbanks are going to have to become more margin aware.

The system functioned by enabling the landesbanks to retain high credit ratings that were no reflection of their standalone credit quality. A more accurate gauge of that quality (or lack of it) has historically been the unflattering financial strength ratings (FSRs) published by the ratings agencies.

In the late 1990s, for instance, Moody's was assigning FSRs of C and C+, respectively, to the Aaa-rated Bayerische Landesbank and Helaba, and an ignominious D to WestLB, which had a senior rating of Aa1. By contrast, Aa3-rated Deutsche Bank and Dresdner Kleinwort Wasserstein both had FSRs of B.

With the guarantees slipping away, the landesbanks will no longer be able to borrow in the capital markets at razor-thin levels as triple-A rated institutions, and on-lend the funds to their customers.

Despite the change in landesbank status the forfaiting system will always be around 60bp cheaper on average than traditional project debt. But there have been some local deals deal done as true project finance PPP – the Eu20 million Unna Kreishaus deal last year and the HVB-financed Eu15 million Erftkreis handicap school in 2003 for example.

Bilfinger Berger put up Eu2.2 million in equity for the more recent Unna project, while the balance of the funding was a non-recourse loan from mandated arranger KfW IPEX Bank, the newly-established commercial unit of KfW Bankengruppe.

Some true project financings may still get done in the local sector because they do not require the public sector authority to get permission from their supervisory authorities, unlike in forfaiting-type deals, where the local authority has agreed to pay out over the life of the deal. Thus in Lander that are less supportive of PPP, the project finance structure will be more likely to get a deal off the ground.

Local roll-out

Local programmes are now beginning to roll out in a number of Lander. Nordrhein-Westfalen has been at the cutting edge of PPP development, but Hessen will now be coming to market with four pilot project in the coming two years and Schleswig Holstein, Hessen, Baden Wurttemburg and Saxony are setting up PPP units.

And at federal level the Bundeswehr Helicopter Training Centre finance – arranged by BayernLB – signed in December and will sell down in June.

Another positive signal for the development of the market is that the federal Ministry of Finance in Berlin is holding a round of discussions with private sector participants on a planned PPP Acceleration Act. This will facilitate PPP by amending various laws on issues such as procurement and taxes, which are currently holding up market development.

But the main area of focus for German PPP in the coming years will be roads. Last month the City of Hamburg held a meeting to discuss a potential Eu475 million new port link road public-private-partnership (PPP) – the Hamburg Hafenquerspange project. And the A-Model programme was reborn at the beginning of this year after a year of delays.

To date the German road sector has proved difficult and drawn out. The F-Model programme – for bridges and tunnels – has not proved a success. The Rostock/Warnow and Lubeck F-Models (for more details search www.projectfinancemagazine.com) proved both drawn out – three years between financing and signing the toll ordinance for Rostock – and inflexible in terms of regulation and determination of tolls.

The Rostock toll income only came in at about half that predicted and the sponsors, MIG and Bouygues, got hit. Both sponsors should have known better – but that does not detract from the inflexibility of the F-Model, which is unlikely to reappear again as was.

The A-Model

With the new federal system of electronic toll collection (ETC) across Germany up and running after many delays – and functioning efficiently – the A-Model roads, which are part funded by ETC tolls, are coming to tender.

ETC seems to be proving worth the wait. The tolls are purely on trucks. Trucks weighing more than 12 tonnes pay an average of 12.4 cents per kilometre, depending on vehicle size and exhaust emission standards. This system makes it relatively easy to introduce shadow tolls, and earmark certain revenues for a given stretch of autobahn.

The concessionaire will receive a share of the tolls paid by trucks using this particular stretch of road, so there is some traffic risk, but these projects are widenings of existing motorways, and so cashflow analysis can be based on many years of traffic data on a particular road.

Another factor that makes the new A-Model road projects very bankable is that 50% of the construction cost will be paid out of conventional Federal funds earmarked for transport infrastructure. Since tolls, thus far, apply to trucks and not private passenger vehicles, the federal government is willing to pay partially for road widenings.

The construction companies will likely be interested in these tenders, and with 50% Federal financing will be looking at traffic risk involving the flow of heavy trucks on only the remaining 50%.

The Ministry of Transport has 12 projects (Eu4 billion in total) planned for the first wave of A-Model deals, and the first five pilot projects will be solicited this year. The A8 in Bayern will be the first out, and although there is some urgency to get the deals done the first financial close is unlikely to happen before 2006.

The German tender process is very slow and the A-Models have already been delayed – with that in mind bankers question why the government did not go ahead with the tender in 2004 whilst continuing to rejig the programme, so that there would be something to sign in late 2005.

The A8 will be followed by the A4 in Thuringen-Neuland and a number of banks have already tied up with sponsors for bidding. HSH-Nordbank has been linked with the Strabag-led consortium Konfam; Macquarie with Bilfinger Berger; HVB with the PMB consortium comprising small- medium-size construction companies; KfW has been approached by two consortia but has yet to commit; Hochtief along with Eurovia is being advised by Deutsche Bank.

The German PPP market will eventually be a winner, if not a big earner, for the German banks. Margins look set to be tight despite the change in landesbank status, and even given an equal playing field, German private banks can find more lucrative PPP margins abroad along with better profits in other sectors of German banking: All the major German banks – KfW, HVB, WestLB, BayernLB, Depfa, and DrKW – are active in overseas PPP markets.

Furthermore, it may only be 18 months since PwC and Freshfields provided expert option to the federal Transport Minister on whether PPP was legal in Germany – but the German PPP market, although picking up, is still at least two years away from being vigorous.

The two-tier PPP system looks set to continue with the savings banks and landesbanks servicing small public sector projects. But there could yet be another twist to German PPP. Life insurance companies and pension funds are forced to invest very conservatively under German law. Traditionally they have invested in muni bonds but a change in law could allow them to look at PPP and its inherent cashflows.