It’s mid-morning at the office of Hastings Funds Management in the City of London and those professionals gathered for our latest infrastructure debt roundtable are reflecting on a kind of liquid – i.e. the kind that falls from the sky. For several months now, the UK has been battered by heavy rainfall that has resulted in frequent and widespread flooding.
Three of the participants – David Cooper of IFM Investors, James Wilson of Macquarie and Sergio Ronga of DC Advisory – all scurry in, seeking refuge from yet another soaking under leaden skies (Tim Cable of Hastings is the lucky one – he was in the building already). With coats having been removed and umbrellas given a brisk shaking, the conversation takes an all-too familiar turn these days – i.e., weekend plans that ended up being ruined by mischievous weather systems.
With clothes having dried a little and cups of steaming coffee having been poured, official business is underway. This time, the word ‘liquid’ has a new point of reference. We all know that the world for long-term infrastructure financing has changed dramatically since so many of the banks, post-financial crisis, shifted their sights to much shorter tenors. So just how liquid is the market these days for infrastructure debt financing?
Tough approval process
First of all, the impact of bank withdrawal receives acknowledgement. “A lot of the banks, including those who were very active in project finance such as WestLB, are simply not in the market anymore,” says Ronga, UK managing director at DC Advisory, an international advisory firm. “Some banks are only focusing on key clients in their core markets and won’t look at certain sectors and regions. Others say they will consider most deals but know they’re facing a very thorough internal approval process. In reality, there are currently very few banks that will look at every opportunity that’s out there.”
But while it’s easy to assume – six years on from the Crisis breaking – that the situation has now stabilised, there is a view that this may not be the case. “There is still some evolution to come with respect to the role of banks – it was not fully worked out in 2008,” suggests Cooper, investment director of debt investments at Melbourne-based IFM Investors, who has responsibility for leading the expansion of the firm’s infrastructure debt activities in Europe.
Cooper – who was head of the London-based infrastructure and structured project finance team at Barclays prior to joining IFM Investors in September 2012 – adds: “In some banks, there is still a debate about whether they want to continue being in project finance. There can be political reasons why you carry on doing five- to seven-year project finance, but there may also be strategic pressure in the other direction.”
Furthermore, Cooper believes that banks are effectively fronting for institutional investors on some transactions. “They say they will lend £100 million (€121 million; $163 million) or £150 million on the basis that institutions will take £50 million to £75 million pounds of it,” he contends. “So I’m sceptical of ticket sizes. They won’t hold it all. They think they have someone lined up, and that someone will be an institution, not another bank.”
Filling the gap
If it’s accepted that the banks are generally not as committed to long-term infrastructure debt as they once were, the question then becomes whether institutional investors such as pension funds and insurance companies can step in to fill the gap. Cooper’s answer hints that they are already doing precisely that, and he’s certainly not the only person around the table who holds that view.
“There’s not a shortage of liquidity. Capital for infrastructure is still available,” asserts Cable, a director of infrastructure debt at Melbourne-based Hastings. He believes that the capital markets are increasingly being seen as a solid financing source in Europe (as well as in the US, where the capital markets have traditionally been front and centre in infrastructure finance). As an example, he points to the refinancing of German motorway services provider Tank und Rast towards the end of last year, which included the successful placement of €460 million of senior second-lien high yield bonds.
Another transaction that gets a mention in this context is the placement of £200 million in inflation-linked bonds by UK airport operator Heathrow towards the end of January. The deal – which was a three-tranche issue (two tranches of £75 million and one of £50 million), maturing between 2032 and 2049 – was struck with a single investor, the identity of which was not disclosed but was known to be a European insurance company.
Ronga says that the negotiations that resulted in the Heathrow deal have been a “regular scenario over the last 18 months where we have seen bilateral conversations taking place at the likes of airport and water assets. It’s about understanding the requirements of the borrower for a wide source of funding options and doing one-to-one deals in a private process that you feel comfortable with and which builds a good relationship for future funding needs”.
“There is some competition from the bond market, but we’re really offering something different to borrowers,” says James Wilson, senior managing director and chief executive of Macquarie Infrastructure Debt Investment Solutions (part of Australia’s Macquarie Funds Group), reflecting on these types of deals. “Our investors are primarily focussed on opportunities where borrowers don’t have ready access to the public bond markets.”
‘Big place’ for debt
Cable agrees that the key point is not competition but increased sources of liquidity. “It reinforces that there’s a big place in the market for private debt,” he asserts. “Whether it’s a transaction like Heathrow, or the emergence of infrastructure debt funds, it all goes to show that this is a good place for private investors whether institutions want large tickets or whether they want value and diversification through fund vehicles.”
Two thoughts are volunteered as the roundtable participants ponder the implications of the choice that borrowers have today. Cooper speaks of the “value attached to a good quality adviser as the market is now a lot more complex. There are so many different tranches of debt and different routes that you can go down”.
This appears to be an open goal for Ronga, representing as he does the advisory perspective. But his response is modest. He admits that there is a lot of M&A work, where there is increased demand for support in areas such as technical and regulatory due diligence. But he adds: “On the refinancing side, we have noticed a reduced number of opportunities as borrowers have been actively refinancing bank deals by alternative sources of funding. The capital markets are currently an obvious solution for a lot of refinancings and there is less need for independent debt advisers. But there are still some complex refinancings and debt restructuring where the benefits of having an independent adviser are recognised.”
A second reflection that’s triggered by discussion of the liquidity options is whether there is now any need for the various market support mechanisms that were introduced in the wake of the Crisis, including the European Investment Bank’s (EIB) project bond initiative and the UK government’s guarantees scheme – both designed to help projects over the finishing line that might otherwise not make it for lack of financing.
The general view is that – even if the market ‘boosters’ once served a useful purpose – that time has probably come and gone. “Some investors value credit support but by no means all. The market has moved on since the various credit support mechanisms were put in place and there’s no question that there’s now sufficient well-priced liquidity for most deals to get done without,” maintains Wilson.
“The market in general doesn’t need support,” adds Cable. “Some markets may still benefit from additional liquidity, such as some sectors in Spain for example, but Northern Europe doesn’t require this and there is a risk of crowding out of private capital.”
“There’s a need in certain deals but, at the moment, support mechanisms are being used too extensively and often in inappropriate deals,” continues Cooper.
The supply is already there
While those present are reluctant to point the finger at specific transactions, one deal that frequently crops up when infrastructure investors dwell on the subject is Greater Gabbard, the offshore transmission (OFTO) link, which in December last year became the first UK project to utilise the EIB’s project bond credit enhancement initiative.
Hailing the Greater Gabbard deal, Guenther Oettinger, European Commissioner for Energy, said the following in a statement: “Unlocking support of institutional investors to provide long-term investment in European energy infrastructure is crucial for stimulating economic growth and creating new jobs. The Greater Gabbard OFTO project has successfully shown how the Project Bond Credit Enhancement product can attract competitive, long-term investment from capital markets to vital energy infrastructure.”
However, Cable expresses the view that – far from a market in need of the kiss of life – there is something approaching supply/demand equilibrium in infrastructure finance that has been achieved without institutions requiring state-sponsored stimuli. “Infrastructure project finance has a funding need globally of around $100 billion a year and that figure has been consistent for about the last five or six years. So the need is stable, even though the participants have changed a lot. My view is that the supply of capital is right for the current environment. The banks will continue to step away from long-term funding and institutions will continue to invest.”
For the three representatives of funds and investment platforms around the table, the key to getting institutions to invest more is to get them comfortable with the risks and increase their knowledge of exactly what they will be investing in – a task for which responsibility is shared with advisers and consultants.
Cable believes good progress is being made: “The awareness level is much higher. Institutional investors understand that the deals are there and that they represent good risk-adjusted value.”
Wilson adds: “It’s not just awareness – the underlying attributes of what we are investing in is also increasingly understood. For example, most pension funds used to have no interest in taking construction risk – period. Now they are more likely than not to include an allowance for well-structured construction risk as part of an investment grade infrastructure debt portfolio.”
Cable says he thinks would-be investors can take comfort from the knowledge of risk that infrastructure debt providers have: “The risks to debt investors in infrastructure transactions are well understood and the banks are used to analysing them and structuring facilities to mitigate these risks, as evidenced by rating agency studies. This expertise is available and it gets you to good risk outcomes. Many of the leading infrastructure debt providers have taken that banking experience and incorporated it in their teams.”
However, although those around the table are confident in their risk assessments, they are also aware that goalposts can sometimes be moved in a manner that can only be described as disconcerting. The oft-cited example of renewable energy tariff changes in Europe highlighted that, post-Crisis, regulators and politicians were not averse to taking punitive actions against investors in the face of extreme economic circumstances. This puts the onus on those involved in any kind of infrastructure investment to be more sensitive to developments at the macro level.
“For us, that means making sure that the asset is a core infrastructure asset and has all the characteristics of core,” says Cooper. “There are deals where the legal and regulatory environment seems very strong but you may have reservations about whether the economy really needs this asset or whether it’s a ‘white elephant’ that, when a new government comes in, may be vulnerable to the unpicking of investor protections.”
A further risk aspect – and one which has received little commentary – is that of the impact that certain assets might have in the event of a pension scheme going through a buyout; a trend that has gathered pace in recent years. “Trustees are focused on the longer term, including the potential for a buyout,” says Wilson. “Many are thinking about investing in infrastructure debt for the first time and they want to make sure that the assets will be also be attractive to buyout investors.”
Arguably of at least equal concern to risk considerations today is the danger of overheating in the infrastructure investment market. “Core is a very hot market and there are full prices being paid on the equity side,” notes Ronga. “On the debt side, it’s equally aggressive from the lending banks.”
However, Ronga believes the crucial difference with pre-Crisis froth is that the banks are structuring deals carefully so their positions “can be shifted into the bond market as soon as possible”. Therefore, despite pricing pressure meaning there is “an element of overheating, it’s balanced by reasonable lending structures”.
Talk then turns to how infrastructure debt providers can compete effectively in today’s market – whether they are fund managers or those providing platforms outside the traditional fund structure. Wilson provides an answer: “We offer experience, credibility and proven ability to deliver. Some less experienced investors have stumbled on delivery and that’s bad for borrowers. Credibility and ability to deliver is every bit as important as price.”
“What is valued highly is the ability to manage the loans themselves,” adds Cooper. “They’re not hugely complex but you need an administrative function to deal with things like waivers and draw-downs, i.e. the monitoring side of it. It’s relatively simple but there’s a cost attached and it’s an advantage if you have efficiency of scale. I look at some players in the market and think – how can they do it?”
Watch out for rate rises
With the clock by now ticking – a sounds that competes with the relentless tap-tap of rain on the window – participants are asked for their concluding thoughts on the market and what factors are likely to impact upon it.
Ronga focuses on interest rates and the unsustainability of rates at their current historic lows. “At some point there will be an increase in interest rates and you have to ask whether that has been priced in. It’s likely that there will be increasing defaults as interest rates revert to long-term averages.”
Cooper points to anxieties relating to pricing, but insists this is a general portfolio issue rather than one relating specifically to infrastructure. “Although pricing has come under pressure in infrastructure debt, that’s a trend across all credit markets. Our investors understand that the same thing is happening elsewhere and, as long as they still think we offer a premium, there will always be a conversation to be had.”
Indeed, Cable sees pricing pressures, higher interest rates and the like as part of a potentially threatening scenario that is nonetheless likely to benefit infrastructure in a relative sense. “In infrastructure debt, there tends to be less volatility when things change. There will always be a lot of refinancing activity to drive the market. We would expect less cyclicality than areas like real estate or leveraged finance.”
Wilson also believes that the “sure and steady” nature of infrastructure is an advantage, but cautions that certain risks may be added to infrastructure in a difficult overall environment. “During and post-Crisis, infrastructure has performed as described on the tin,” says Wilson. “But the economic climate does have knock-on effects, for example on regulation. So deals always have to be structured with room to absorb the unexpected.”
It’s clear from hearing the views of this cross-section of professionals operating in the infrastructure debt space that the mood is confident but far from complacent. They would advise against assuming that, post-Crisis, the infrastructure market (and markets more broadly) have settled into a contented period of stabilisation. In fact, the situation remains highly fluid. But they’re pretty sure they can weather whatever storms lie ahead – the British weather has prepared them for that.