In the space of two weeks in late April, the Italian PPP market turned a corner with the close of three eagerly awaited projects across different sectors: the Salerno-Reggio-Calabria highway phase I; the Florence light rail project; and Mestre hospital.

But the upbeat outlook is still marred by a number of issues unique to the Italian PPP sector: Impregilo's financial woes highlight the relative weakness of Italian contractor balance sheets; long-anticipated financing have been frustratingly protracted; and although there is a legislative push for fleshing out the specifics of the general contractor (GC) provision, this could now be stymied by a vote of no confidence in the government and resultant general election.

Rethinking the GC scheme

The biggest problem with the workability of current GC schemes is the relative weakness of Italian contractors – as demonstrated in the provisions of the recent Salerno-Reggio-Calabria (SRC I and II) deals.

The Impregilo– (51%) and Condotte– (49%) sponsored SRC phase II closed first at the end of last year, backed by Depfa and ISPA. The CMC-sponsored SRC I followed last month (phase I had been delayed by land permitting issues) with mandated lead arrangers Banca OPI and Dexia bringing in Banca Popolare di Milano and MCC in a club deal for CMC. It is expected that another one or two banks will come in, with BBVA hotly tipped as a participant.

In both SRC deals, because of the way the GC scheme works, a bankruptcy-remote special purpose vehicle (SPV) does not prevent recourse to the contractors in the event of problems during construction – a fact not lost on CMC which did not employ an SPV for SRC I. This makes such schemes difficult for lenders – especially when one of the sponsors is troubled Impregilo and the other, CMC, is only the fifth largest Italian contractor.

Under the current general contractor provisions, set down as a framework in the Legge Obiettivo, the lenders to the contractor are not recognised until successful completion of construction. Consequently, interim credits from the project awarding bodies, due at specified project milestones, are not legally recognized and are not guaranteed by the state to the lenders. Effectively, lenders to GC projects are taking corporate rather than project risk until after construction.

This would be fine for the relatively low-risk road construction schemes, but the weak financial position of most Italian constructors is demonstrated by Impregilo's troubles, which have sent a shiver through the market.

The fallout from Impregilo's problems has already slowed what was an accelerating market. Depfa is now waiting for Impregilo's successful re-capitalisation and restructuring before syndicating the SRC II debt and progressing with the same sponsors for phase III.

In addition, Stretto di Messina SpA, the specially formed public concession-awarding company for the Messina Straits bridge project, has extended the final bidding period to 25 May from 20 April, despite initially adamantly refusing to consider such a move. This is to enable Impregilo, one of three qualifying bidders, to get its house in order.

The GC problem is being addressed. More specific legislation fleshing out the GC provisions is anticipated later in the year. A committee arranged by the Ministry of Infrastructure and featuring all the major players – ANAS, RFI, HATAC, TAV, Stretto di Messina and contractors' and bankers' associations – has suggested that the GC scheme be put firmly on a non-recourse basis by the use of a performance bond put up by a third party, rather than putting constructors' balance sheets on the line.

The banks are arguing that they, the receivables assignees, are put in a similar position to the assignor, so that the banks do not bear the claw-back risk of the concession awarder (usually ANAS) in the event of a project failure. If these changes are effected the banks will take little project risk.

ISPA's impetus

ISPA – a quasi-governmental agency established in early 2003 to finance infrastructure projects in Italy – is likely to play an increasing role in Italy's infrastructure rollout.

In addition to co-lending on SRC I and the ongoing high-speed rail TAV bond programme, ISPA will launch its maiden Eu2 billion syndicated loan (for more details search 'ISPA' on www.projectfinancemagazine.com) in the coming weeks. ISPA also has a lending role in the recently closed Eu300 million Florence light rail project, for which the main sponsor is French metro operator RATP, supported by Banca Monte dei Paschi di Siena and Calyon.

ISPA's impetus, and its complimentary role to bank lending, is welcomed by the PPP sector, and the Eu750 million Mestre bypass toll highway is an example of that complimentary role. Like SRC, the Mestre highway is progressing under the GC scheme, but on this project ISPA 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 ISPA is the only financial institution involved on ANAS' side and is looking to bring in mandated lead arrangers (MLAs), with its underwriting stake dependant on commercial bank appetite. ISPA had been asked to participate to back the GC but declined for fears of conflicts of interest – Intesa and BBVA currently back the GC. The project is waiting on due diligence and a green light for the toll tariffs. Funding competitions for both could begin by the end of May.

ISPA's activity has not gone unnoticed by the EU. Eurostat is currently investigating whether the TAV capital markets financing should be categorised, as is currently the case, off-balance sheet. At present the distinction rests with such technicalities as the difference between a direct state guarantee (on balance sheet), with a hair-trigger prompt payment by the state on a default, or a contingent guarantee – currently off-balance sheet – that involves a lagged payment (search 'TAV' for more on www.projectfinancemagazine.com).

Although the investigation, which will yield a report by June, is focused on TAV, it could have wider implications for the future of ISPA – for example should all Ispa activities be considered on balance sheet? If the remit of the report remains narrow, but TAV is deemed on-balance sheet, ISPA, which is only at the beginning of its infrastructure roll out, may consider itself lucky to have lost a battle and won a war.

Metros back in market

Beyond the Florence light rail scheme and TAV, two signature metro projects have recently come a long way in a relatively short time. Both Line 5 in Milan and Line C in Rome had seemingly gone dormant for most of 2004, but now they are moving again.

The Milan Line 5 metro project now looks odds-on to be the first significant concession-based metro project in Italy to close. The project was put out to open tender by the Municipality of Milan on 13 April, but has a protracted history. 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 is now agreed 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.

Also, as a constituent of the priority list of the Legge Obiettivo, the Rome Metro Line C project has been put out to tender by the Municipality of Rome – but as a GC scheme rather than under a concession. The project has a total value of about Eu2.9 billion and is split into two portions largely because only the first portion has been allocated public funds. The first portion is worth about Eu1.2 billion and has been allocated funds by CIPE. The second is slightly larger at Eu1.3 billion and has been approved by CIPE with public funding to be settled later.

Roads take to the shadows?

While the Metro projects, particularly Rome, will have to grapple with archaeological risks as well as nuances of financial structuring, the most active sector continues to be roads.

As well as progress on the outstanding lots of SRC, the BreBeMi project should close by the end of the year, as should the Mestre Bypass and Pedemontana Veneta highway. The Asti-Cuneo highway project has also recently been awarded under the rarely-used Article 19 provisions.

The Eu1 billion Asti-Cuneo motorway was awarded to SIAS (Società Iniziative Autostadali e Servizi) of Grupo Gavio which beat Cintra and Astaldi with Vianini. The 23.5-year concession grants the right to build and manage a 90km toll road. The contractor is advised by Mediobanca and RBS, which are expected to take the lead on the financing.

It is worth noting that SIAS may be the exception to the rule for Italian constructors. Although small, it has one of the best balance sheets and forward order books relative to its size compared to most other road builders across Europe. Such is the company's outlook, CSFB's equity desk recently rated the stock a buy.

Beyond specific projects, public bodies, and their advisers are flirting with the idea of road concessions predicated on a new form of revenue. Although to date the concept of shadow tolls has not appeared in an Italian concession, there is much talk of shadowing future projects.

In the Budget Law 2005 the idea was raised that ISPA could purchase the entire major road network from ANAS and run them under a vignette shadow toll system – under the current regime ANAS is responsible for the major road network, and the municipalities and regions for the minor roads.

This does not appear likely in the short term, but such a scheme would be more favorable than piecemeal shadow tolls paid to various concessionaires. And in the event that the tolls were set too high – a nod to Portugal – the government would only have to reach agreement with one party.

Whilst a ISPA-owned network would appear to favour the GC route for new roads (build and transfer), and would at one swoop alleviate ANAS' budgetary mire, ISPA is likely to be unwilling because of the sheer scale of the transfer. Political hackles would be raised on both a domestic and particularly EU level as it would appear that a huge financial burden is shifted from the state to a quasi-state off-balance-sheet entity. As well as denting ISPA's capital, the political fallout could further undermine ISPA's future.

Thin water margin

Outside transport, projects are moving in the water sector in the wake of the Nuove Acque financing which closed at the end of the last year – the first to close since the inception of the Galli law ten years earlier. Despite the probable upturn in deal flow, the margins for both equity and banks are thin because of the stringent regulatory regime.

The dearth of deals following Galli's inception is largely down to three reasons: firstly, Galli is a complex framework law that required a raft of implementation rules; secondly, the many disparate and incumbent operators provided substantial political resistance to change; and thirdly, the capital expenditure on these projects are high and the margins relatively low.

The next project to follow will likely be the Terni water concession, in the Umbria region, awarded by ATP Terni. The project company is part sponsored by UK utility Severn Trent. MPS Banca per l'Impresa and Banca Intesa are the mandated lead arrangers of about Eu45 million of debt that should close imminently. Eu200 million Acea Acqua in Pisa, lead arranged by Depfa, should close by year-end, and a much larger deal Depfa is working on with Banca OPI and Merrill Lynch – the Eu700 million Acquedotto Lucano in Basilicata – should be in the market in 2006.

UK-style health

Also likely to get PPP bankers' pulses racing is the health sector. Last month the first UK-style hospital concession in Italy – Mestre hospital – reached financial close. (For details on Mestre hospital see deal analysis, page 14.) Mestre hospital highlights the difficulty in coordinating different cultures – particularly obtaining long term contracts from service providers – nevertheless the deal should make future PPP deals in healthcare easier and quicker.

In the pipeline is the Eu400 million Brescia II hospital – Brescia I was technically the first PPP hospital project in Italy to close, but did not contain any performance risk. A project to restore and extend two hospitals near Asolo should also come to the market this year: MCC is backing a consortium called Asolo Hospital Services SpA for the Eu120 million upgrade of Castelfranco Veneto and Montebelluna hospitals. And the financing of the Eu190 million Naples hospital could close before 2006 – an Astaldi-led consortium is sponsoring backed by RBS and MCC, and the concession agreement has just been restated on more favorable terms to the concessionaire.

Much of the lead times for these projects are spent connecting public expectation with commercial viability. So far all the GC schemes, and to a large extent Mestre hospital, which required major participation of the EIB, and the Florence light rail project that required ISPA's assistance, have been projects formed through compromises by the lenders.

Regionalism will remain

The market is waiting to see if these first projects in healthcare, water, rail and the corpus of road concessions are enough to drive a strong deal flow comprising projects with shortening lead times that do not require such a leap of lender faith. But agreement with the public procurement agencies will be key, and, excepting ANAS and RFI, those agencies are fragmented by region, both in terms of PPP expertise and credit quality.

One banker active in the Italian project market is particularly damning of public-side expertise, describing a "general level of weakness" with many tendering processes run through without adequate scope, planning or drafting. Others are more optimistic, despite the recent regional elections that were a landside victory for Berlusconi's chief opponents the centre-left.

But if potential lenders to Italian PPP are waiting for a centralisation of procurement processes and a one-stop shop authorisation procedure, or enabling legislation, they may be waiting for a long time.