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Crédit Agricole on the evolution of the infrastructure debt market

With definitions of infrastructure expanding and abundant liquidity available in the debt market, managing risk is top priority, says Matthew Norman, Crédit Agricole CIB’s global head of infrastructure.

This article is sponsored by Crédit Agricole CIB

Given where we would appear to be in the economic cycle, how is infrastructure debt positioned, from a risk point of view?

Matthew Norman
Matthew Norman

When you compare infrastructure debt to other comparable asset classes, such as corporate debt, we have historically seen far lower default rates and higher recovery rates. The risk features for traditional, investment grade, core infrastructure are very attractive across the cycle and I think that is one of the principle draws of the industry.

What are the other attractions of infrastructure debt as an asset class?
For market participants, the infrastructure sector benefits from positive underlying fundamentals, including high capital intensity and large historic underinvestment. The sector simultaneously enjoys very strong tail winds from a set of longer-term mega trends sweeping the globe such as urbanisation, electric mobility and energy transition. In addition to these overarching macro factors, infrastructure debt can offer relatively attractive returns, superior structures and a highly visible way to invest in environmental and social impact products.

Specially in relation to returns, relative to that corporate benchmark, infrastructure debt offers an illiquidity and complexity premium, which is attractive for anyone looking for extra yield.

But the returns infrastructure debt can offer are proving to be appealing. I would add that, the ability to make an impact from an environmental and social perspective is also striking a real chord.

Finally, infrastructure debt can offer greater structural protection than other types of debt opportunities. While on a corporate, investment-grade transaction, you typically get limited structural protection, weaker covenant packages and relatively limited information, infrastructure debt can benefit from all three.

Are you seeing the same sorts of shifts in deal structuring that we are seeing in the LBO space?
Infrastructure is experiencing a similar phenomenon to that seen in other parts of the market. There is less protective documentation and, in some areas, elevated leverage. There is significantly more flexibility for borrowers and while I wouldn’t say that covenants have disappeared – as they have, in many cases in the LBO world as cov loose has given way to cov lite – some aggressive behaviour has crept into the infrastructure space.

The crucial point in this market is ensuring that you have patience, consistency and discipline in your approach to asset and deal selection over a long-term horizon which is suitable for this kind of industry. This is always a big challenge when operating on the buy-side in a predominantly long-only industry. Crédit Agricole CIB benefits from 30 years’ experience in the structured finance sector with a very strong and stable capital and shareholding base with an extensive international network and specialist infrastructure and energy teams.

“The big challenge is how to generate enough new opportunities to satisfy the huge level of demand that is out there from investors”

Where do you see the most attractive opportunities given where we appear to be in the market cycle?
What we like to see is a pipeline of opportunities coming to market supported by our core client base. We want to work with our core clients, and we want to work with them around the world. So, where does that lead us in terms of geography today? We see a very strong and healthy pipeline of large-scale, PPP-style greenfield opportunities in Australia. We also see interesting greenfield concession opportunities in Latin America, road and transportation assets in Columbia and Peru, for example.

The situation is a little different in Europe. What we see there is corporate clients focusing on rotating their mature portfolios to raise capital to invest in new growth areas. That has led to a lot of M&A activity involving infrastructure assets being brought to market by traditional corporates, which is creating an interesting flow of opportunities, particularly in Southern Europe – in France, Italy and Spain. Finally, of course, renewable energy is creating attractive opportunities on a worldwide basis, pushed by the energy transition.

How have you seen the make-up of the industry evolve?
Over the past few years, we have seen institutional investors playing a much more active role in the infrastructure debt market. Not only has the number of investors increased, but the appetite of those investors has increased as well. What has happened though, is that, as allocations for the sector have expanded, the number of opportunities has not expanded at the same rate. So now, not only are we seeing structures deteriorate as borrowers take advantage of a ground swell in liquidity, but pricing is also narrowing significantly. We have seen a significant reduction in that complexity and liquidity premium that I mentioned earlier.

In order to offer the same target yields that they initially promised their clients, investors are having to expand their definition of infrastructure moving into core plus or else change their geographical remit to capture the additional yield targets promised to their LPs.

You mentioned the ability to deliver impact as one of the key drivers of appetite for infrastructure debt. Can you explain what you mean by that?
ESG is one of the key themes that the investment community is focused on these days with many investors reporting their proportion of ESG investments. But what is changing is that investors now want to see concrete actions and tangible sustainable financing opportunities. That is an important point. When ESG first arrived on the horizon, the emphasis was on accessing green bonds, but the challenge became one of greenwashing.

How do you ensure money being raised is actually being invested in assets that produce a positive environmental, social or sustainable impact?
One of the key advantages of the real assets sector, including infrastructure debt, is that impact can be readily tied back to funds raised. For example, a light rail system will take cars and congestion off the streets, offering people green transportation. There is a very clear link there between the proceeds raised and the impact those proceeds are having.

Crédit Agricole was a pioneer in the field of green finance and is continuing to invest in that field, making it the societal aspect of its Medium Term Plan pillars. The Crédit Agricole Group intends to consolidate its role as a leader in green and sustainable finance, extending its offering of sustainable solutions to all business lines; we have a role to play in that in the infrastructure debt arena.

What are the other key challenges that the infrastructure industry is facing right now?
The big challenge that we see is how can we generate enough new opportunities to satisfy the huge level of demand that is out there? The PFI/PPP model has clearly come under a great deal of pressure, not only in the UK, but in other jurisdictions as well. Governments are stretched from a sovereign perspective, but with so much negative perception around these private financing models, how can the authorities bring forward new projects and get them financed?

The question is, if PFI has been put in the corner, what is going to replace that as a means of allowing the private sector to participate within the infrastructure market, with all the discipline that brings? Yes, we have renewables. But what about social infrastructure, transportation and other environmental projects? In the UK, the regulated asset-based approach appears to be providing an alternative, but, certainly, one of the big challenges over the past 18 to 24 months has been a pretty significant slow-down in core greenfield infrastructure, right across Europe. I really think the emphasis is on the industry to develop private initiatives and help the government re-invigorate the greenfield pipeline.

Can M&A opportunities not fill that gap?
We are certainly spending a lot of time on brownfield M&A opportunities. That is all well and good, but those opportunities are, by definition, finite. There are only so many times that you can trade around the same assets. The risk is, that if you are not continuing to feed that pipeline, the market could become unsustainable as assets are passed from player to player, with asset values increasing each time they change hands. We have already seen this happening in the equity market, with assets trading out of corporates into funds, and out of funds into direct investors. As asset pricing runs up and equity feels the squeeze, that gradually filters down into debt, too.

How are you preparing for a possible downturn? What skills or experience do you think you need to have in place?
In private markets, where there is less information available, you need to have the expertise and teams in place to ensure you are sourcing the right opportunities to put your portfolio in a strong position as we move through the cycle.

As debt investors, we are not as hands on as equity players, but we still need to be prepared if things don’t go according to plan, so that we can resolve those situations. At Crédit Agricole CIB, we are long-term investors. This isn’t an asset class that we will dip in and out of. It is all about patient capital, and when there are problems, we will seek to work those through with our clients, which is why we have not only invested heavily in our front office functions around the world, but in our portfolio management teams as well.

Beyond the immediate prospect of a downturn, what do you believe the future holds for infrastructure debt?
Investors will continue to be drawn to the asset class for its illiquidity premium, default rates and ESG credentials. I also expect to see more aggregation and consolidation as the asset class continues to mature. That is already happening on the equity side, and I think it will come to debt too. Finally, I think we will see the continued expansion of infrastructure debt as the industry becomes more adventurous in its search for yield, from the perspective of both geography and sector, as well as where the industry plays in the capital structure.

An illustration of business people rowingPutting clients first

What is your approach to deal selection?
We are a client-centric organisation offering a reliable, experienced and flexible client partnership. In terms of deal selection we have a strong, disciplined approach towards risk assessment which allows us flexibility to look at all infrastructure sectors whilst ensuring that these assets exhibit the relevant set of characteristics that we deem appropriate as agreed within the bank’s global strategy.

We are very much a long-term player within the sector providing financing for clients, not only in liquid market conditions like we see today, but also when and if the cycle turns we want to ensure that we offer agility and flexibility to support our clients in more difficult market conditions. That doesn’t mean we will do every deal with those clients, but it means that we will not work on deals where the bank has no broader business relationship.

Furthermore, we work with clients across our global advisory business sourcing opportunities in terms of both debt and equity which range from M&A services, capital structure optimisation and rating advisory.