What can we learn from the past performance of infrastructure investments? In our most elaborate retrospective study of the sector, S&P Global Ratings recently assessed the credit quality, defaults and recoveries of its rated portfolio over the past quarter century.
Over the past 25 years, rated infrastructure has risen with few interruptions – by a factor of three, no less. In 1991, rated corporate and project finance infrastructure issues totalled 355. By 2016, that number had grown to 1,440. Aside from brief spells of weaker growth, both project finance and corporates have continued to attract ever greater amounts of financing. This appears to offer a promising view of the future for investors.
Not only is the infrastructure sector growing, it’s also becoming more robust. Over the past two decades, S&P Global Ratings’ cohort of rated infrastructure credits have enjoyed lower default rates and rating volatility, and higher recovery prospects than non-financial corporates (NFCs), or those involved in the production of goods.
Unsurprisingly, macroeconomic conditions have tested the sector. One of the highest incidences of default rates in the study came in the early-1990s, when a brief recession in America was accompanied by a contraction for many industries. In turn, infrastructure defaults increased and a similar pattern for NFC defaults also became evident.
Infrastructure’s most severe period of credit degradation came during the 2000-03 cycle – a time punctuated by Argentina’s financial crisis and the greater liberalisation of America’s energy markets.
Nonetheless, the sector has prevailed. Infrastructure still enjoys a higher percentage of investment-grade ratings than NFCs. And, though the infrastructure market now has more speculative-grade investments than ever, this is not alarming in its own right: in fact, the sector emerged from the 2008 global crisis mostly unharmed.
Compared with NFCs, infrastructure defaults and downgrades during the crisis were fewer. They were less severe, too: the monthly peak default rate remained below 1 percent, compared with little under 6 percent for NFCs. Even in the worst-case scenario, more than half of infrastructure instruments boast recovery rates of 80 percent or higher. For NFCs, this rate is far lower (at just 39 percent).
Default rates for both infrastructure corporates and project financings, have also been edging lower: in 2001, default rates for project finance peaked at 3.6 percent, while the peak for infrastructure corporate defaults (2.8 percent) came soon after in 2002. Moreover, for corporates, this peak has been exacerbated by the higher-risk sectors such as power. If we exclude power from our data, this default measure falls to 1.5 percent.
The next 25 years
This display of resilience could teach the sector many things about the future. Expansion, of course, comes with risks. But there are other conclusions to glean, too.
First, the market is not only expanding in size but also in geography. In 1991, 96 percent of the total infrastructure credits were issued in North America – by 2016, the region accounts for little over half. The cause? The emergence of the infrastructure demand in the Europe, Middle East, and Africa markets. Latin America could be next: though the region accounts for just 3 percent of the market (128 issues), it is crucial to note that, in 1991, we rated just one project on the continent.
Second, some risks remain. Across the sector, the power market continues to show higher risks than elsewhere. This market typically displays low barriers to entry, aggressive and unregulated leverages, and its heightened exposure should demand fall below forecasts.
Further, the power market is undergoing various disruptions: from falling electricity prices (thanks to burgeoning gas-fired production), to a drive toward renewables in a bid to meet emission-reduction targets. Understandably, this has weighed most heavily on baseload coal plants.
In turn, one key trend is the rising number of speculative-grade credits (rated BB+ or lower) infrastructure portfolios today. This number has risen during blips of macroeconomic uncertainty and sector-specific headwinds – take the oil and gas sector since 2014, for instance.
The next conclusion might appear contradictory, at first glance. Investors across the sector do not seem perturbed by speculative-grade ratings, which have been rising. Instead, investors are looking toward higher-risk assets or leverage levels in the search for attractive yields.
One explanation is that regulatory rigour across the sector provides greater confidence. After all, infrastructure assets are typically essential ones. At the same time, regulatory rigour often limits their scope to increase leverage. Project financings, for instance, benefit from many in-built protections – including offtake agreements, hedging, reserve accounts and distribution traps. Project financings have more stringent limitations when it comes to taking on new debt and selling assets. And these factors serve to bolster market confidence.
Over the past 25 years, the infrastructure market has become an increasingly diverse landscape for investors to find opportunities. Here’s to the next 25.
Mar Beltran is a senior director, sector lead for infrastructure, EMEA, S&P Global Ratings