The precarious economic climate in Spain is shaking up the country’s infrastructure market, even though PPP deal flow has remained relatively consistent, with several infrastructure deals reaching financial close in 2010. The shift in emphasis in the market towards availability-based concessions, coupled with sponsor interest in new foreign oppor­tunities is a more telling reaction to the risks associated with domestic borrowing and investment.

Foreign appeal

Since the downgrade of its sovereign rating from AAA, an increase in Spanish lenders’ cost of funding has resulted in stiffer competition for them and increased opportunities for foreign lenders to step in, offering more attractive margins and slightly longer maturities.

According to a lender at a large Spanish bank, “Our margins on debt for pure availability deals now need to be between 325bp and 400bp for mini-perm financings, if the liquidity is even available. Our French and German com­petition can probably do it for around 275bp.”

Another problem for Spanish infrastructure lenders is that the inflated funding costs will affect their activities internationally as well as at home. “For our bank,” he continues, “60% of our infrastructure activity is outside of Spain. The sovereign problem is contaminating potential deals in other areas where we have a strong presence, like in the US and Latin America, because we have to pass the increased mar­gins on to our clients and, since December, we are already seeing the effects.”

“There are only six or eight Spanish banks still active in the domestic infrastructure market,” he says. “The rest have drop­ped out of the market and distributed their loan portfolios.”

Maturities are also a significant point of contention post-downgrade, with sponsors complaining that mini-perms of seven or eight years, both soft and hard, are the only debt products that banks are able to offer.

“There is still some latitude for longer tenors on re­financ­ing existing Spanish assets,” continues the Spanish lender. “The early real toll assets are coming to the end of their original debt obligations and are likely to be able to get long-term credit because they are assets with good historical traffic performance. But they are the exception.”

“The problem is that the debt on offer doesn’t match up with the asset and the concession length,” he continues. “It’s preferable for everyone to accommodate the cash flow projections with the debt service obligations in infrastructure deals, but the pressure from the banks as a larger institution is to shorten terms on all transactions even if the asset and the tenor are a comfortable fit. And that’s not just in Spain. It’s everywhere.”

Foreign lenders are, however, benefitting from the disparities in funding costs, but there are distinct caveats. “Our Spanish group has had a remarkably successful year,” notes an infrastructure lender at a German bank. “The only real challenge we have faced in that market is trying to deter­mine our own exposure in-house. We can afford to be more competitive than the Spanish banks because our cost of funding hasn’t been forced up, but we can’t undercut what they are able to offer by much because the sponsors all have a lot of exposure to the Spanish market.”

The construction companies are also acutely aware of the domestic challenges, though for project sponsors such as Cintra/Ferrovial, ACS, Acciona and OHL, the exposure is significantly mitigated because of their activities in the Americas and for some, only 30% of their business is domestic. “There is now a definite appeal in markets in East­ern Europe and Asia,” notes one Spanish sponsor. “They are emerging markets for sure, but we don’t know what is going to happen in Spain. We are still pursuing domestic opportunities but it is even more important to diversify now, especially after Greece and Ireland. We and Portugal are in a tenuous position.”

“Sponsors are still reluctant to assume any degree of traffic risk,” he notes, “though there have been a couple of deals with a traffic component [such as the FCC-led concession for the C25 in Catalonia, and Itinere/Sacyr’s AP-46 in Malaga, which is due to reach financial close any day]. I don’t think that there will be any more for a while, now.”

Domestic opportunities

The Spanish ministry of public works has announced a number of new concessions to be put to tender in 2011, with the aim of stimulating the economy, including one major availability-based toll road project in Andalucia and two high-speed rail lines, for which details are expected in the first quarter of 2011.

The plan to develop the existing line, running from Madrid through Castille into the north-west of the country into Galicia, is expected to cost in the region of Eu5 billion ($6.8 billion) to Eu6 billion, though the Spanish government has not yet finalised the concession structure and lined up all available funding sources. The European Investment Bank (EIB) is expected to put up about 50% of the financ­ing, with a combination of debt from state-owned lender Instituto de Credit Oficial (ICO), public and municipal lenders and sponsor/recourse loans accounting for around 30% of the costs, meaning that sponsor equity will need to stretch to 20% of the project.

“The 20% equity ticket, especially on such an expensive project, will not be seen as ideal,” believes one lender. “They like their gear­ing at around 10%, maybe a little higher if it’s competitive. This high-speed rail project may be carved into smaller concessions to make it more palatable.” According to a source at the EIB, the size of its participation has yet to be determined and the deal is unlikely to close in 2011.

There is also a relatively robust pipe­line of smaller, regional deals. “We saw a lot of activity with hospital PPPs, water treatment facilities, as well as the smaller roads deals,” says a project spon­sor. “We’re pursuing all asset classes, but we don’t expect to see much closing this year. There were a lot of deals to reach financial close at the end of last year and we’re now moving into the phase where the next wave is just being tendered and discussed.”

The EIB expects its activity in the region to remain stable. “The EIB was involved in four major PPP projects last year, we signed around Eu670 million,” says the EIB source. “We expect that level of activity to remain about the same in 2011. We have to choose carefully which project we are involved with in terms of eligibility criteria.” The EIB’s 2011 focuses are a waste management project in the north of Spain; all of the pipeline of projects to be developed by ADIF and the Ministry of Fomento; and regional development initiatives in general and Andalucía package in particular. Other smaller, regional developments include a mountain road programme in the Pyrenees, two availability-based toll road deals in Andalucia and a social infrastructure programme in Galicia, which includes the Digo hospital project, which has been pre-awarded to a consortium led by Acciona.

Regulatory changes

The downgrade has crystallised a number concerns for both Spanish lenders and borrowers. “Everyone has been forced to become more prudent in which deals are appropriate,” explains an adviser familiar with the Spanish PPP market. “It was the case, before the economy became so bad, that the government would award projects to the cheapest bid, even if it seemed obvious that it was impossible. Traffic projections have proved problematic in this way, too, when all concerned recognised that the numbers were ambitious, to say the least, and in some cases, vastly inflated.”

“There have been a number of projects,” he continues, “where the sponsor has gone back to the authority to bail out the project and it has ended up costing more than the highest of the bids. Nobody was happy. The authorities are not obliged to save the projects, technically, but of course they have to in reality.”

The Spanish government is now working with the private sector and local and municipal authorities to make the way in which projects are tendered and awarded more transparent and sustainable. The new regulations are amendments to the existing guidelines for procurement: Ley de Captacion de Financiacion en los Mercados por los Concesionarios de Obras Públicas.

According to one lender, the Spanish banks were historically under excessive pressure to offer competitive debt solu­tions that were unrealistic. “When the market was strong, some lenders felt they could get away with slim margins, over-leveraging and stretched maturities, just to win the project. It was crazy, very imprudent.”

“We believe that these regulatory changes will make procurement easier for everyone involved, but it is un­fortunate that it has taken a sovereign crisis of this magni­tude to make the government address some of the inherent prob­lems with the procurement processes that were ex­acer­bating that over-competitive behaviour.” he continues. “A lot of the processes were quite hidden, but now we hope that they will be more consistent across all of the regions of Spain.”

But some lenders believe that it may be too little too late for the Spanish PPP market. “Fixing the PPP procurement process is completely necessary,” says one European banker, “But the Spanish government needs to work out whether it can afford these new deals in the first place. It is rolling out a lot of new pro­grammes which will mean a big invest­ment obligation. The inter-creditor risks [from combining several sources of public and private lending] are pretty substantial and we’re not sure we want the exposure.”

Sources of equity

“The Spanish market has been very much directed by the handful of large domestic construction companies for years,” says one lender at a Spanish bank, “and they are continuing to determine the trends to some extent. The Spanish con­structors are now multinational market players, they have the experience and the reputation worldwide.”

The international success of Spanish-led consortiums has spurred a broad range of investor interest in infrastructure as an asset class. Though sovereign risks and domestic ex­po­sures mean that the Spanish companies remain very cautious about how and where to leverage their equity investment, international financial equity players are keen to hitch a ride to the Spanish contractors’ bids. And the more equity on the table, the more likely sponsors’ historic relationship banks will be to stretch to longer maturities for their clients.

“The big sponsors are beginning to see the appeal of partnering with infrastructure funds,” says one lender. “Macquarie, Meridiam, even a few of the American public pension funds are courting Spanish constructors. There is a trade-off, whether they’ll dilute their equity in exchange for slightly better leverage and perhaps a competitive edge in bidding for projects internationally. My guess is that we’ll see more and more partnerships of this kind.”

A diverse portfolio and international presence is high on the priority list for both Spanish lenders and borrowers to mitigate domestic exposure. Despite the precarious nature of the Spanish economy, Spain has not fallen quite so far as other sovereign casualties and that there are still deals closing and bids coming. According to some observers, private sector restraint and lender prudence, though long overdue, is welcome.