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Primary Credit Analyst: Manuel Dusina, London (44) 20-7176-5530; manuel.dusina@standardandpoors.com Secondary Contact: Michela Bariletti, London (44) 20-7176-3804; michela.bariletti@standardandpoors.com
Table Of Contents
The Government Moves To Promote Private Investment Greater Transparency Is Key Tapping Into Investors' Appetite For Italian Securities Project Size Will Determine The Nature Of Funding Used Related Criteria And Research Appendix: How Standard & Poor's Rating Methodology Might Apply To Italian Project Bonds
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The third law, known as the Second Growth and Development Decree (Decreto Legge 18 ottobre 2012, n. 179), promotes the development of an entrepreneurial culture that is appealing for foreign investment. We believe these laws introduce a more innovative and benign legal and fiscal regulatory regime, one that could support the development of a project bond market. This should enable Italy to tap into the increasing demand, confidence, and appetite among European and worldwide institutional investors for infrastructure assets that we've observed in other European markets. In a recent survey by Preqin, an infrastructure data and research firm, 58% of investors questioned said they were planning to increase their allocation to the asset class over the longer term. Project bonds could in our view constitute an ideal match for these investors' investment strategies, at the same time lifting the burden of infrastructure funding from government and providing an alternative source of financing from the banking sector. The new legal regime should also help to reduce some of the costs previously associated with infrastructure investments. For example, prior to the approval of the First Growth and Development Decree on Aug. 8, 2012, unlisted issuers, such as project finance SPVs, issuing bonds in excess of a 2 to 1 debt-to-equity ratio were charged a withholding tax on interest payable. This prevented the deduction of interest payable and made access to the capital markets onerous. And although issuers could have pursued securitization, this would have resulted in significant additional costs compared with bank financing. In addition, the First Growth and Development Decree allows guarantees--which must be explicit, irrevocable, unconditional, and in a written form--to be provided to project bonds. The Decree also identifies international and national financial institutions that can provide such guarantees, including CDP and Servizi Assicurativi del Commercio Estero (SACE; the Italian export credit agency), along with foundations and private funds. We understand that the guarantee is only available for a specific period, likely during a project's construction phase or until such time as the project is picked up by the concession holder. This should in our view further support infrastructure investments funded through the capital markets because it addresses investors' reluctance to invest directly in projects that are pre-completion, commonly known as greenfield projects. However, we believe any shift to bond financing from bank loans is likely to be gradual, for two reasons: First, investors have up to now been reluctant to invest in infrastructure projects due the lack of data and their inexperience of this asset class (see "How To Unlock Long-Term Investment In EMEA Infrastructure," published Oct. 4, 2013). What's more, the Italian project bond market remains untested and market participants will, in our view, take some time to get acquainted with the new legislation. (We outline the factors that we might consider when rating Italian project transactions in the Appendix.) The second reason is that Italy has always used banks to finance infrastructure programs. The BreBeMi motorway in Italy, for instance, was the largest European PPP transaction completed in the market in the first half of 2013 (2.3 billion). The project involves the construction a 62-kilometer motorway between Brescia and Milan, under a 20-year real toll concession. Although this transaction provides clear evidence that the revised PPP framework has had a positive impact, allowing the country's first large greenfield PPP transaction to achieve financial close on a project finance basis, it is financed entirely by bank loans. And we understand that the Tangenziale Est Milano road concession (2.2 billion), on target to reach financial close by the end of this year, will also rely on bank funding.
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Chart 1
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Chart 2
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euro-denominated bond via its vehicle Fiat Finance and Trade with a coupon of 6.625%, which we rated 'BB-'. This compares with the same issuer 7% coupon euro-denominated bond in March 2012, which we rated 'BB'. Therefore, we believe that Italy now has a framework in place to fund its infrastructure investments through a combination of bank and bond finance. However, over the next 18 to 24 months, we anticipate that projects with construction risk will still be financed mainly through banks loans, and possibly refinanced via the capital markets once the assets are in operation. We believe this will be the case unless the construction risk is satisfactorily mitigated--by recourse to guarantees or adequately structured credit enhancements such as the European Investment Bank's (EIB's) Project Bond Credit Enhancement (PBCE) initiative, currently in its pilot phase. (For more details on the PCBE program, see "How Europe's New Credit Enhancements For Project Finance Bonds Could Affect Ratings," published Nov. 13, 2012.)
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Appendix: How Standard & Poor's Rating Methodology Might Apply To Italian Project Bonds
We rate project bonds according to our project finance criteria (see "Updated Project Finance Summary Debt Rating Criteria," published Sept. 18, 2007). Unlike our approach for rating corporate issuers, we do not assign an issuer credit rating (ICR) to a project finance transaction. This is because an ICR reflects the terms and features of the various debt tranches issued by the project obligor, which may result in different default expectations. Rather, the issue rating on a project focuses on the risks of construction and operation, the project's long-term competitive position, its legal characteristics, and its financial performance. Our project finance ratings address default risk and do not include any material consideration of the potential recoveries following a payment default on the rated issue. The new Italian legal framework introduces the possible use of debt guarantors and identifies permitted applications under which their guarantee could apply. Under our criteria, issued debt can benefit from an unconditional and irrevocable payment guarantee of timely interest and principal provided by an entity, such as a monoline insurer. When such a guarantee exists for the life of the transaction, the long-term rating on the guaranteed debt issue will reflect the higher of the rating on the guarantor and the Standard & Poor's underlying rating (SPUR). However, if a guarantee is offered only for a limited period of time during the life of the project (as we understand will be the case under the new Italian legislation), the issue rating on the project may be constrained by the project's credit quality. This is because the project rating reflects the probability of default of the project during its entire life. If, during the period where the guarantee is not available, the project's credit quality is weaker than the issue rating during the guaranteed period, then the project issue rating will reflect the weaker period.
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on time.
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