BNP Paribas: Expanding the horizons of infrastructure debt

The asset class is adding bulk, both in terms of the sectors it targets and the types of financing it can offer to borrowers, says Karen Azoulay, head of infrastructure debt at BNP Paribas Asset Management.

This article is sponsored by BNP Paribas Asset Management

What are the key drivers behind the dealflow you are seeing today?

There are two easily identifiable market drivers that we are seeing: the energy transition and digitisation. Those trends existed before the covid crisis but have been accelerated as a result of the pandemic. Clearly, renewable energy generation and other areas of the energy transition are vital to building a more sustainable economy.

Karen Azoulay
Karen Azoulay

Meanwhile, we have all experienced the need for high-speed internet access to enable us to work remotely. And so, the telecoms sector is now also considered an essential service by governments and by regulators.

Initially, transactions in that space are primarily related to the deployment of broadband networks outside of major cities and we will continue to see capital expenditure supporting that roll-out, as well as M&A as the sector consolidates. But we are now also seeing more tower and data centre financings. We are active in all three areas – in fact, we were one of the first lenders to data centres in Europe – and we will continue to be active in the future.

Renewables and digital infrastructure have proved resilient. How have other sectors fared over the past year?

Airports have clearly been hit the hardest, with traffic down, in some cases, by 90 or 95 percent. But given the slow recovery this sector faces, it is important to differentiate between those with a strong liquidity position that can weather the crisis without any serious downgrade or defaults, and those, often regional, airports that have been more aggressively structured and are now facing difficulties. Toll roads were also hit by the initial lockdowns, with traffic down by around 60 percent, but the damage was mitigated by heavy vehicles, which continued to be able to travel. More importantly, toll roads recovered quickly as lockdowns ended and people chose to use private vehicles as opposed to public transport due to infection concerns.

Meanwhile, you are right to say that renewables have been largely resilient, particularly those that have benefitted from regulated tariffs. Assets that carry some merchant risk were impacted, however, by the fall in electricity prices, although that is not a major part of the market. When the crisis first struck, we put all transactions on hold due to the uncertainty around risk profile and pricing. But we quickly realised that some sectors would be more resilient than others and moved forward with digital and renewables financings. Now we are ready to start working with transportation assets once again, bearing in mind lessons learned from the pandemic.

What are those lessons that the asset class has been able to take from the crisis, particularly around risk and risk mitigation?

“The telecoms sector is now also considered an essential service by governments and by regulators”

Over the past 10 months, we have all experienced what it is like to live through crash test scenarios. The big learning has been that the conservative financing structures and cash buffers we routinely employ, are absolutely justified. Of course, merchant risk is part of the market. We can’t ignore it. We need to be able to assess that risk and put the relevant financing structure in front of it. For example, as renewables assets increasingly reach grid parity, subsidies are no longer justified in most cases, and merchant risk needs to be mitigated through prudent structuring, ratios and buffers. The same is true for fibre optic networks, which need reserve accounts to mitigate merchant risk in the ramp up phase.

What changes have you seen in financing structures in the run up to the pandemic and has there been any movement since?

We have seen a move from pure project finance to more corporate-like transactions with the use of leverage loan features. That has involved the development of junior debt, which is a part of the market we are involved in. That tends to be seen more on brownfield acquisition financings where borrowers may have leverage constraints and so look to raise a junior layer at the holdco level. That is also attractive for investors that are looking for a higher absolute return, while still benefiting from those stable and predictable cashflows because the underlying assets are the same.

But we have not seen any real movement in structuring or price adjustments over the past year. In the middle of the first lockdown, we were all waiting for that to happen, but any changes have been minimal. Of course, as infrastructure lenders, we would be wary about any aggressive financing structures at a time like this.

How would you describe your approach to sustainable financing and why is that important?

For us, ESG criteria are fully integrated at both a policy and project level. Policy implementation is overseen by our dedicated sustainability centre, and our internal ESG (environmental, social and governance) team uses a tailored taxonomy based on the European taxonomy to provide an ESG assessment. We also have mandated an independent expert focusing an environmental tool focused on climate impact. That is based on four pillars: avoided emissions, reduced emissions, net environmental contribution and alignment with the 2 degrees objective. Both assessments are fully embedded in our investment process and forms part of the ESG reporting to our investors, because there is absolutely no doubt that our investors are demanding more and more transparency around ESG matters.

How is a focus on sustainable investment translating into short and longer-term financing opportunities?

It is important to remember that sustainability, and even the energy transition, are not only about renewable generation. We are also highly focused on the phase-out from conventional energy, for example, working within the utilities sector to help finance the transition itself. We are also very interested in sectors that combine digital features with green energy, and sometimes even transportation as well. We expect to see more dealflow emanating from green mobility, such as EV (electric vehicles) charging point platforms, and smart city infrastructure, including smart grid.

“There is absolutely no doubt that our investors are demanding more and more transparency around ESG matters”

In the longer term, meanwhile, we may also see transactions emerge around hydrogen. With strong incentives to develop that sector, it is certainly a hot topic within the asset class. Finally, we are seeing equity sponsors pay very close attention to deals in the healthcare space – that is as a direct result of the covid crisis. We follow all these trends very closely, getting to know the key market players, so that we are ready to act when the timing is right.

What advantages does exposure to infrastructure debt strategies offer institutional investors, at this point in time?

Infrastructure debt offers attractive relative value, thanks to the illiquidity premium, low default rate and high recovery rate, as well as diversification and decorrelation to other credit markets.

Meanwhile, this asset class has long been extolling the virtues of low volatility, but that has actually been proven this year. Pricing was more or less stable, with movements of no more than 20 or 30bps, significantly lower than for the corporate bond market.

Infrastructure debt has also shown itself to be highly resilient to the crisis and so we are seeing an increased volume of appetite from investors, and not only insurance companies, but pension funds and large corporates, as well. Last but not least, infrastructure debt is also extremely ESG friendly, due primarily to the sectors we target.

What do you think the future holds for infrastructure debt as an asset class?

Going forward, I think infrastructure debt will continue to expand as an asset class. By that, I mean that new trends and new sectors will continue to emerge, allowing us to be more and more diverse in the transactions we pursue. That diversification continues in the types of financing we are able to offer to borrowers. We will be able to provide not only senior debt, but all the layers that exist between senior and equity – subordinated tranches, acquisition financing, holdco financing – structures are only going to become more sophisticated and more interesting.

Finally, it will become increasingly important to build portfolios that are compliant with ESG constraints and policies. Infrastructure debt has a crucial role to play in the fight against climate change.

Office meeting discussion

What should investors be looking for in an infrastructure debt manager?

Investors should definitely be looking for yield and diversification. They should also be looking for a credible player with proven and expansive sourcing capabilities. You need to have that access to the market. You also need an established track record because borrowers need to be able to trust that lenders can execute and follow through on transactions. And while investment debt managers should, of course, have strict investment guidelines in place, they need to be as agile and flexible as possible as well, in order to work on complex and fast-moving M&A processes. Finally, as we have already discussed, it is vital that ESG analysis is deeply embedded into the credit approval process.

All of this is even more true for junior debt. A junior debt asset manager needs to be closer to the structuring process and to really understand what that entails. We are seeing more and more direct investors looking for straightforward 10-year triple B transactions in order to deploy massive amounts of liquidity. But when you are talking about a junior debt opportunity, or a complex senior debt financing as part of an M&A bidding process, you need to have those structuring and originating capabilities to hand.