Natixis: A covid crash test

The global pandemic has allowed infrastructure debt to prove its resilience credentials beyond all doubt, says head of infrastructure debt at Natixis Investment Managers, Céline Tercier.

This article is sponsored by Natixis Investment Managers

How has covid-19 impacted dealflow in the infrastructure debt space?

Céline Tercier
Céline Tercier

If I look back to the first quarter of last year, dealflow was pretty strong, although we started to see a fall-off in the number of deals emanating from the Asia region. As we moved into the second quarter, that fall-off began to take hold in Europe and then, in the third quarter, the Americas were hit too.

All in all, deal values did hold up because of a number of jumbo transactions, but the volume certainly decreased in those first nine or 10 months. The year end is always a busy time for project finance, however, and that was equally true of 2020. November and December were both extremely active and 2021 has got off to a good start as well.

And how did covid impact the performance of your existing assets, both financially and operationally?

Globally speaking, I think the asset class has proved itself to be highly resilient to the crisis. Obviously there have been some sub-sectors, particularly toll roads and airports, that have been severely impacted by traffic risk. That is not to say we expect to see widespread defaults. Clearly, one of the advantages of project finance is that it has very strong structuring features which can enable it to tolerate even the most stressed scenarios.

But some industries have experienced, and continue to experience, a tough time. At Natixis Investment Managers International, thankfully, we have been primarily focused on transactions in the renewables, green mobility and digital sectors, and so our portfolio has been largely immune to the effects of the pandemic and international lockdowns.

Do you think, then, that there are lessons to be learned from the covid crisis, particularly about the nature of merchant risk?

Yes, I absolutely think so. This crisis has shone a spotlight on merchant risk, and I think the experiences of the past year will encourage the project finance community to pay more attention to the level of merchant risk inherent in the transactions they undertake.

Of course, the pandemic is an extreme example of how circumstances beyond your control can impact demand, but that risk isn’t going to disappear once the crisis subsides. From our perspective, we will be paying close attention to the electricity price, for example. In almost all regions, renewable energy production is no longer subsidised and so it is vital to assess how the electricity price could evolve in different markets. Covid-19 has absolutely highlighted the vulnerabilities exposed by merchant risk, which means you have to be very careful in your structuring and in the hypotheses you employ to carry out your cashflow projections.

Covid-19 hasn’t been the only major macro event of the past 12 months. What other global stories have impacted infrastructure debt?

“The asset class has proved itself to be highly resilient to the crisis”

I do think that covid-19 has been the big one. We saw Brexit finally take place, but that event had been tracked for a very long time and so had already been absorbed by the market. There was no real impact felt this year. And then, of course, there was the explosive US election, which was a less anticipated event. But I still don’t think that has had a marked impact on deal volumes, even in the US. We believe that Biden’s election will even be positive, given the administration’s first announcements on transport infrastructure and renewables.

Some of the sectors you mention are at the cutting edge of the infrastructure spectrum. How do you get comfortable with the risk profile of those industries and the specific assets within them?

We are extremely strict about the way we approach transactions. We carry out thorough technical and market due diligence using experienced and reputable third parties and we are very careful about the way that we structure, including the use of covenants and the debt service coverage ratio that we apply. This is always true, but particularly the case for industries where there is less of a track record.

Have you seen much movement over the past year in the way that infrastructure debt is being structured, generally?

I think that in this past year, in particular, market participants have been careful not to push any boundaries. We haven’t come across many transactions that were not compliant with our own strict investment policies, so I think prudence is proving paramount in most cases.

And how have you seen ESG evolve within the infrastructure debt community?

I would say that ESG has now become mainstream. We have had an ESG policy in place from the very outset. We also received the Greenfin label to reassure investors that there is transparent ESG integration and ESG impact monitoring.

“All the claims we have been making about the asset class have been proved to be true”

In fact, I think this asset class provides a great fit for investors that are prioritising ESG ambitions. It is simple to put ESG covenants in place in credit documentation that ensure the effective monitoring of ESG criteria, particularly carbon emissions.

Infrastructure debt is ideally positioned for the growing number of investors for whom ESG compliance has become vitally important.

You mention the ability to monitor environmental impact such as carbon emissions. But do you think the social aspect of ESG has grown in importance as a result of the pandemic?

Yes, I absolutely think that the crisis has revealed that there are infrastructure assets that provide positive impact beyond the environment, including some aspects of social benefit that would not really have been considered before.

Most obviously, perhaps, digital infrastructure has proved critical to allowing people to continue to work through the pandemic. It has been digital infrastructure, after all, that has allowed us to reach a number of financial closes in the past year. That is a really important component of social impact. And then, of course, there have always been assets that have direct links into the communities they serve, namely hospitals, schools and other public buildings. Certainly, ESG is not just about the environment. The social and governance considerations are key as well.

What makes infrastructure debt such an attractive asset class for investors right now, beyond that neat fit with ESG?

Infrastructure debt is extremely well secured and, certainly with the way that we structure infrastructure debt, it provides headroom at multiple different levels.

There is headroom provided in the security we take. There is headroom in the debt service coverage ratios and debt sizing we use and there is headroom in the cash reserve accounts that we hold.

Having those multiple layers of headroom makes the asset class highly resilient to a crisis such as the one we are currently experiencing. Indeed, in many ways, this past year has been a crash test for infrastructure debt and the result is that all the claims we have been making about the asset class have been proved to be true. It does offer predictable cashflows and the structuring does allow it to weather even the most extreme cycles.

How is that proof of concept impacting investor appetite? Who is participating in the asset class and what are they looking for?

There are the really big institutional investors which have been involved in the asset class from the outset. They are poised to maintain, or even increase, their commitments. We are also seeing some large institutions, and particularly insurance companies, that are delegating the management of their fixed-income pocket to asset managers, with the aim of incorporating some level of alternative or illiquid assets into the mix. That is providing a new way for large-scale investors to access the asset class.

Then, there are the mid-sized institutions seeking customized solutions that can be tailored to their specific needs. And we are also starting to see the emergence of some initiatives aimed at individuals. We are still very much at the beginning of that journey, but I do think there could potentially be substantial interest for products distributed through retail networks that could incorporate a portfolio of illiquid private debt.

What do you think the future holds for infrastructure debt?

Not only have we proved the resilience of the asset class, but we have also demonstrated that infrastructure debt is a multifaceted proposition. There are multiple different regions to be accessed and multiple different sub-sectors.

We are also increasingly seeing the integration of mezzanine or junior debt, either in specific mandates or as part of a commingled strategy.

This is a big asset class. It is big in terms of volume and in terms of the diversification it offers by geography, industry and rank in the capital structure. There are different tenors available. It can be fixed tranche or floating rate. Infrastructure debt is rich in variety and can therefore be tailored to fit the needs of investors. I see the future as bright.

Which sectors and geographies are offering the most attractive infrastructure debt opportunities?

We are still focused on renewables, primarily in Europe but also in North America. We are particularly interested in some emerging sub-sectors that have yet to really take hold in the project finance market. Batteries, for example, could prove highly interesting going forward. The same is true of biofuels.

And while it is still early days, we may soon see the first hydrogen deals come to fruition. We believe that will be the next green revolution. Meanwhile, there are some attractive transactions taking place in the telecommunications space as well, ranging from data centres to broadband and, of course, the rollout of 5G.