When asked to describe the state of their domestic PPP and infrastructure market, Spain's project finance bankers keep using the same word: parado, or "stationary". While the dramatic turnaround in what was once Europe's most active PPP market outside the UK is mostly due to the credit crunch and subsequent recession, the exposure of structural flaws in some of the country's early road concessions have also played their part in reducing sponsor and banker appetite for risk.

Dealflow in Spain began to drop before the credit crunch, largely because Spain had already put so much new infrastructure in place. According to law firm DLA Piper, the value of new PPP projects in Spain dropped by 71% between 2004/05 and 2005/06, from Eu10.3 billion ($14 billion) to Eu2.9 billion. However, over the past couple of years the credit crunch and subsequent recession have put a halt on a upturn in the sector that began in 2007.

The parlous state of the country's public finances – which have gone from surplus in 2007 to a deficit of around 10% – means that government promises made in 2009 to make infrastructure spending an integral part of stimulus measures to lift the economy out of its recession could ring hollow. If "stimulus spending" was the hot phrase of 2009, it has been replaced in 2010 by "budget cuts", and Spain's political discourse at the start of 2010 has been dominated by the issue of deficit cutting, as elsewhere.

On the other hand, the heightened desire to tap private finance could eventually provide fresh impetus to a market where sponsors were once prepared to accept equity internal rates of return of 6% or below, and banks were lending at margins of less than 100bp, but where failed gambles have made these participants much more risk averse. Nominally, Spain's potential dealflow is big; but it would take a big reallocation of risks to turn this nominal flow into a real one, a risk reallocation the government has been passing measures to help make happen.

As one of the first standard bearers for the diffusion of PPP throughout Europe, Spanish PPP is arguably the future for some developing PPP markets, particulalrly now that mini-perms are so fashionable throughout European PPP. But the fact that the mini-perms from early Spanish projects now lie behind many of its market's difficulties now is an ominous sign. Real toll projects that were struggling with lower-than-expected traffic volume before the credit crunch have been hit by further reductions in traffic as the recession started to bite. Some of these projects now face refinancing in incredibly tough conditions, forcing the government to take measures to keep them afloat.

An important test of the market's resilience will be how much movement there is on a programme to renovate 1,521km of four motorways running out of Madrid to the rest of the country – known as the first generation motorways because they were the first to be built, in the 1980s. Parcelled up into 16 shadow toll projects mostly in the region of Eu300 million each, this programme has been in the pipeline since 2006, and was supposed to be completed by 2009. It was then to be followed by a second phase for a further 610km of motorway by 2012. Though 10 of the 16 projects – with a total capex of Eu3.35 billion – were awarded in 2007, the remaining six projects, costing an estimated Eu1.5 billion, have yet to be tendered.

Plans to get the programme moving once more involve state-owned land transport investment corporation SEITT coming into the projects to share the equity burden with project sponsors. Under the planned restructuring, the combined public and private equity would account for one third of the financing for the projects, with commercial banks also providing a third of the financing and the remainder coming from the European Investment Bank. The plan still needs EIB's approval before it can be implemented, but it would begin with two Eu300 million projects, covering a stretch of the A-3, between Madrid and Cuenca, and a stretch of the A-4.

Extraordinary plans

The first generation road programme stimulus forms part of the government's Extraordinary Infrastructure Development Plan, which envisions an investment of Eu15 billion in infrastructure over the remainder of the current Spanish parliament.

Around half of this is expected to be for new projects and the remainder for maintenance of older infrastructure – possibly including financial assistance to the struggling real toll projects – with the bulk to be spent on rail projects. The EIB will be heavily involved, as will publicly-owned development bank, the Instituto de Credito Oficial (ICO). Once sponsor equity is also taken out of the equation, one experienced project finance banker estimates this will leave roughly Eu2 billion worth of financing to come from the bank sector, in projects mostly ranging between Eu100 million and Eu400 million in size.

However, turning the Extraordinary Plan into reality, if it happens, is likely to be a slog. While the minister for public works seems determined that part of these funds should be directed towards the bailout of the real toll concessionaires – one mooted solution involves the setting up of a balancing account with guarantees that the state will clear it after 10 or 20 years – the Treasury is equally keen to avoid taking on public liability for real toll projects at a time when it is committed to slashing Eu50 billion from the public deficit. Yet without state guarantees, private sector players are unhappy with the risks they are taking on, and the government's plan to tap them for further private finance could prove to be just wishful thinking.

Meanwhile, the Ministry of Transport last year announced plans to tender Eu6 billion in infrastructure projects, breaking down to Eu4.4 billion for rail projects including high-speed rail; Eu1.1 billion for road projects, of which Eu510 million was to be for the first generation roads; Eu368 million for airports; and Eu188 million for port projects.

But these plans are still in their conception phase, and as long as there remains a lack of follow-through, private sector participants will remain sceptical. "The projects are there, but the problem is that the budgets aren't." says one banker. "We're going through a very slow period while the authorities change their plans, decide what projects they will do and prioritise."

So far it looks like rail is the priority, but this is a domain where PPP traditionally has not played a prominent role in Spain. Some will hope that the planned rail expansion will herald an opening up of Spain's high speed rail network to PPP, but so far PPP activity in this sector has mostly been confined to urban light rail projects. In December the Spanish railway infrastructure company, ADIF, raised a Eu200 million public finance loan from Deutsche Pfandbriefbank, indicating that public finance remains the preferred option. There is a precedent, however, for Spanish rail project financings in the Eu1.1 billion Perpignan-Figueras high-speed rail link financing of 2005. Though a cross-border project, it was largely a product of the Spanish market, though from an era when Spanish banks were hungry for traffic risk.

El pipeline regional

Further complications come from the fact that at the moment most PPPs are not tendered by the national government but by Spain's devolved autonomous regions. Most of the real toll projects were tendered under the previous Partido Popular, and since Jose Luis Zapatero's Socialist government, which opposed real tolls in principle, came to power, the only nationally tendered PPPs have been the first generation roads.

However, the regions face their own budgetary constraints, and S&P cited an "inflexible expenditure base", including PPP commitments, among its reasons for giving a "negative outlook" to the Madrid Autonomous Communities region in a credit rating report last year, though the overall credit rating remained unchanged at AA+.

For transport infrastructure PPPs, the two regions that are most active are Catalonia and neighbouring Aragon, with road and light rail projects.

In Aragon the Eu340 million Zaragoza tram PPP is expected to close imminently, once the group of around six lead arrangers have concluded the due diligence and some final details of the concession agreement have been concluded. The 35-year project, sponsored by an FCC/Acciona-led consortium, will see Eu130 million of the project cost provided by the Zaragoza municipal and Aragon regional governments.

In Catalonia, the Barcelona Metro Line 9 needs to close imminently, though it is still not certain that in its final form it will be project financed. FCC and Dragados, the project's sponsors, took out a Eu1.16 billion one-year bridge loan with Santander, BBVA, Caja Madrid and La Caixa in December 2008, but this had to be extended by three months after the long-term financing still wasn't in place by the end of 2009.

In Catalonia, the 33-year Vic-Ripoll shadow toll road reached financial close in late 2009 after Banesto, BBVA, Caja Madrid, La Caixa and ICO signed on a five-year Eu225 million loan with a flat margin of 250bp over Euribor. Santander was also looking at the FCC-sponsored deal but pulled out of the financing, despite the Catalonian government providing a guarantee on the refinancing at maturity.

FCC's Cedinsa consortium is also the concessionaire on another Catalonian shadow toll: the 35-year Eix Transversal concession. But the Eu708 million project, awarded to Cedinsa in 2007, is currently stalled. A third Catalonian shadow toll project, the ACS-sponsored Eje Diagonal concession, was reported to be close to securing a Eu250 million eight-year mini-perm loan, though it was also reported that the concessionaire was renegotiating the terms of the concession to secure further guarantees from the Catalonian government that it will cover the refinancing risk.

The Navarre regional authorities tendered two sections of the A-21 Pyrenees Highway in 2009, and in December awarded the Eu36 million stretch between Sigues and the A-1601 to Corsan-Corviam. SEITT has provided some of the equity for that deal, as it did on a Eu24 million stretch of A-21 in neighbouring Aragon. That stretch resumed construction in January with a new sponsor, Mariano Lopez Navarro, three months after the original concessionaire, Teconsa, filed for insolvency.

Other projects include the Eu105 million Autovia del IV Centenario highway and the M-61 Madrid Ring Road project, which involves the construction of a 10km tunnel between Majadahonda and Alcobendas and 33km of road. The regional authorities of Castile-La Mancha tendered the 30-year greenfield Autovia del IV concession last year. It will involve the construction, maintenance and operation of a 28km stretch of road connecting Granatula de Calatravo and Valdepenas.

In February the EIB granted a Eu100 million loan to the government of Extremadura to improve its road network. The regional government will upgrade 13 sections of existing road totalling 204km. The programme is scheduled for completion in December 2013.

Non-transport infrastructure

There is also a pipeline for social infrastructure, and in the short run hospitals might prove a better bet for PPP activity than transport. A consortium led by FCC and Ribera Salud was appointed preferred bidder in July for the Eu139 million Torejon de Ardoz project, while adviser contracts were awarded for two health PPPs in the Canary Islands. Another hospital is also planned in Galicia.

The Torejon de Ardoz project – a 250-bed hospital with 10 operating theatres and maternity and dialysis facilities – is the first of four hospitals in Madrid that are to be awarded over the next two years. The others are Mostolos, Callada Villoba and Carabanchel. Despite reported interest early on in the tendering process, the Ribera Salud consortium was the only bidder on Torejon de Ardoz.

A potentially promising area for future PPP expansion is in water treatment projects. The National Plan for Water Quality has earmarked an investment of Eu19 billion between 2008 and 2015 to upgrade the country's water treatment facilities.

Acciona Agua closed a Eu120 million water treatment PPP at the port of Andratx in Majorca late last year. The project was part of Spain's A.G.U.A. programme, which was supposed to be implemented between 2004 and 2008, but ended up running behind schedule. It is the first desalination project to be tendered using the competitive dialogue procedure, and given Spain's deficit in adequate water treatment facilities, could lead to more PPP activity if market conditions are favourable.

Taking a toll

Spain's initial concentration on mini-perm financed real toll projects is catching up with it, as many of these projects approach the stage where they need to be refinanced and there is little appetite among bankers for projects with traffic risk.

Traffic volumes have been hit hard by the recession: in the first quarter of 2009 the country's real toll traffic dropped 15% on the year before. But many real toll projects were in trouble even before the recession. Perhaps the most notorious of these projects are Madrid's four radiales, which closed in 2002 and 2003 as three projects – the Dragados/ Acciona-sponsored Radial 2, the Cintra-sponsored Radial 4 and the Radiales 3 & 5, sponsored by a consortium of Sacyr, FCC, Dragados, Acesa, ENA, OHL and Caja Madrid.

These roads form spokes leading into and out of Madrid, built parallel to the first generation roads as a means of easing congestion on those roads and providing high speed means of entering or exiting the capital for commuters in a hurry. It turned out that not many commuters were in so much of a hurry to enter or exit the capital that they were prepared to pay. For example, according to Spain's Ministry of Development 10,000 vehicles traverse the R2 between the M-40 and the M-50 per day, compared with 112,000 vehicles on the same stretch of the A-2.

The R2 is actually free of refinancing pressure, as it was the only one out of the three projects to finance to term, with a 21-year tenor.

A refinancing of the 50-year R3+5 concession is imminent as the debt's tenor ends this March. It follows the 65-year R4, which refinanced in January 2009 with a three-year extension – hardly a template for a long-term solution to the roads' difficulties. The R4 originally priced at a flat 130bp, and the R3+5 at 140bp, but upfront fees on the extension will have brought the margins into line with today's margins, something the projects are ill able to to afford.

Other real toll projects that are struggling include the FCC-Ploder sponsored Cartagena-Vera highway, financed in 2005 under 8.5-year mini-perm and dubbed the Ghost Road because it attracts 2,000 vehicles a day instead of the projected 7,000; and the Dragados-Abertis sponsored Alicante semi-ring road, which financed in the same year, but with a 25-year financing. Mini-perms also featured on the Madrid-Toledo and Ocana-La Roda roads, which together with the previous two projects formed Phase 2 of Spain's national real toll programme.

It is not just traffic volumes that have hurt the real toll projects, but also higher-than-anticipated costs following a series of high court reverses over land expropriation values. This has been a problem for a number of years, and in November the government agreed to give a Eu100 million credit in 2010 to the road operators to help them cover the expropriation costs. At the end of last year it passed a law creating the legal provisions for government loans to be used to implement this policy. The precise implementation still needs to be worked out, but the basis for a solution has now been put in place.

To guarantee, or not to guarantee?

Negotiations are underway as to how these projects will be restructured, but it looks likely that provisions will be made for them under the Extraordinary Infrastructure Development Plan. Concessionaires lobbied hard to get the last year's law on covering expropriation costs passed, and the law has been described as crucial to the Extraordinary Plan's success.

Whereas in the past sponsors accepted low equity IRRs on projects, happy to pass on the cost to banks through razor-thin margins. Now that margins have risen significantly, deals have become difficult to bring to financial close. Closing deals like the Eje Diagonal project in Catalonia could restore some confidence in the market, but mini-perms are difficult for sponsors to accept, no mini-perms are difficult for bankers to accept, and government guarantees are difficult for governments to accept at a time of budget cuts. It is unlikely that Eurostat would treat these as off-balance sheet, and if national and regional governments are to be liable anyway, traditional public procurement becomes an option once again. Alternative means of restructuring risk allocation include greater SEITT involvement and more use of availability payments.

Given that the Catalonian government gave guarantees on the Vic-Ripoll project, it will probably be willing to do so on Eje Diagonal. However, the fragmented nature of Spanish PPP tendering means it does not necessarily follow that this will become a general trend.