It’s a well-rehearsed argument; so much so, in fact, that it can seem as if the theory is being recited like a mantra by some market observers. Namely, that banks should fund the construction period of public-private partnership (PPP) and private finance initiative (PFI) projects, while pension funds or other institutional investors should own the assets in the long term.
Hence, it’s somewhat arresting to hear someone volunteering to debunk the notion. “The viewpoint is too simplistic,” says Michael Dinham, managing director and head of infrastructure finance EMEA at ING Bank. “People who question the appropriateness of banks holding assets for the long term overlook the fact that we do mortgage lending. But the real question is what is the most appropriate financing product for an infrastructure asset bearing in mind that there are many types of assets needing a different approach. Banks provide a certain type of long-term product and sometimes that can be the most appropriate.”
Furthermore, he continues, pension funds and the like are simply not resourced to manage the assets in the way that some banks are capable of doing. “Most infrastructure loans are time-intensive to manage and what many people forget is that bond investors do not employ teams of professionals for this task. Pre-crisis most PPPs were wrapped and they relied on the monolines to do the managing. Fine if bond investors are happy with very covenant-light structures but otherwise borrowers could be facing a potential headache. In that sense, banks’ ability to manage the loans arguably makes them better long-term lenders than bond investors.”
Lack of appetite
Laughlan Waterston, deputy general manager and head of infrastructure and PPP at SMBC Europe, says he believes refinancing projects in the capital markets “at some point after construction” is a “reasonable assumption” to make. But as yet he sees little evidence of this assumption being realised – however reasonable. “What’s stopping it is the lack of appetite from the pension funds and other financial institutions. They need to buy into project bonds but, in Europe at least, there’s little evidence that they will. In the US and Canada it’s a different matter – there’s more capital markets activity.”
He adds: “In the boom years, the capital markets had more exposure through the monolines which would insure the projects and make sure they got a triple A rating. That meant there was a strong incentive to fund projects and there has been no effective filling of that gap since. European financial institutions have had little appetite for unwrapped project bonds, partly because these tend to be rated BBB rather than single A or better.”
As mentioned at the outset, there are people who would take issue with the notion that it’s optimal for banks to hold infrastructure assets over the long term. It’s striking though that the argument in favour of seeing banking finance as suited only to the construction period comes at a time when some banks are hampered from committing to long tenors by a particular set of circumstances. Would calls for an alternative source of long-term capital be quite so loud if this were not the case?
So what are these constraining factors? One of the key issues is pricing. Where there is an unwillingness to support long tenors, Dinham believes that it is often simply because the pricing is not seen as attractive. “Some banks are still providing long-term lending too cheaply but a lot of banks won’t commit their balance sheets long term at all,” he says. But he insists “there’s enough who will to keep things ticking over”.
Gershon Cohen, managing director and global head of project finance at Lloyds Banking Group, agrees that difficulty in pricing long-term debt is a hindrance; as is modest appetite in the syndication market. “Unwrapped bonds require a minimum A- rating and the rating profile of most infrastructure projects rarely get above BBB+. The default is therefore mini-perm [short-term financing] but this adds an element of risk to the project sponsors,” he says.
Another factor impacting the ability of banks to lend long term is the overhang caused by what one market source describes as the “stranded” PPP assets that are a legacy of pre-Crisis over-pricing and which are not able to be refinanced in the foreseeable future. Market sources say some banks are genuinely hurting as a result of their bad experiences while others, which are also hurting, are not so constrained that they are prevented from continuing to support new deals.
Dinham does not think “stranded assets” will ultimately be too debilitating: “Highly leveraged structures were imposed on a lot of assets and a number now face difficult discussions with their lenders. But most will inch their way out of difficulty. The equity always has the option of reducing the debt by enough to ensure a refinancing on sensible terms and that may occur in several cases. There won’t be a wave of defaults. The problem cases will be quietly managed.”
Certainly, the amount of refinancing of infrastructure assets that needs to be done is a big talking point. Sergio Ronga
, managing director of Macquarie Capital Advisers‘ UK and European debt advisory team, believes it needs to be faced up to: “With refinancings due in 2012 or 2013 it’s important to start work early. There’s structuring work to be done and rating agency processes to go through. There’s a real benefit in looking at issues sooner rather than later, especially given the current liquidity position within the market.”
While much of the focus has been on pension fund involvement in equity and debt, Ronga believes that the coming refinancing glut will attract keen pension interest at the less publicised quasi-equity level: “We are seeing a lot of interest from pension funds and other institutional investors as a liquidity solution. They like to be in the equity but there’s a lack of opportunities and it’s very competitive. Therefore, it makes sense for them to look at quasi-equity solutions.”
Whatever the problems still to be tackled in future, there are signs of increasing confidence in the present. In the UK PFI market, estimates suggest that there were as many as 50 banks prepared to consider lending to projects in the pre-credit crunch period – and that this community of banks shrank to around a dozen during the crunch. Now, there are considered to be around 25 to 30 banks actively looking at new opportunities. “There’s certainly evidence that some banks exited during the credit crunch; some exited and have since returned; and those that stayed active throughout are now doing more,” says Waterston.
Ignore the bubble
While there may be a widespread perception that banking liquidity remains low, some market participants challenge the notion in relation to the infrastructure market. One banking professional speaks of the “silly liquidity” of the pre-crunch era and, while admitting that the underwriting market has taken a knock, nonetheless suggests that historic benchmarks stretching beyond recent years should be referred to when evaluating whether or not the financing market is ‘normal’.
Certainly, there was sufficient liquidity to support the PFI project at Bristol’s Southmead Hospital earlier this year with a £939 million debt package with a 30-year tenor and no cash sweep. Observers point out, however, that there was strong backing from the European Investment Bank for the project, meaning that commercial banks were able to come in with more security and lower commitments than may otherwise have been the case.
Charles Greenfield, a London-based managing director at Societe Generale, believes the bank debt market is deeper than some might think. “There is genuine long-term finance for small- to medium-sized deals,” he says. “For debt of around €500 million to €600 million you can get long-term money on competitive terms, and you can probably get €1 billion, albeit at wider pricing. Beyond that, it’s different – you would most likely need mini-perm.”
Dinham’s view that there has been no “cataclysmic” fall in volume is, he says, evidenced by the level of appetite to finance the UK government’s High Speed 1 rail auction. Furthermore, he says that the inability to finance the €5 billion leveraged buyout of Spanish infrastructure group Abertis by European investment firm CVC Capital Partners should blind no one to the fact that some large chunks of debt were being pledged in support of the deal. He expects it to come back to market sooner rather than later.
In addition to steadily increasing confidence in the new deal pipeline, the importance of refinancing cannot be overlooked. “High yield bond issuance in Europe in the year to date has been the highest for a number of years,” says Ronga. “That’s a potential source of liquidity for subordinated refinancing. There is a question around structural issues such as dividend distributions and covenant requirements given the precedents are not there. But they are resolvable and will ultimately come down to pricing and appetite. The key issue is that people are chasing yield.”