Five of us are assembled for the Infrastructure Investor debt roundtable, and there is no excuse for losing track of time. Looking out the window of our circular meeting room at One Poultry, we stare at the back of one of London’s most famous clocks. Formerly the headquarters of crown jeweler, Mappin and Webb, the old building was demolished in 1994 – but the clock was put back in place when the new version was erected. The striking view of old and modern architecture from our third-floor vantage point is now enjoyed by employees of Aviva Investors.
In the infrastructure debt market, time once seemed a precious commodity. In the wake of the Financial Crisis, with banks keen to sell off positions even at heavy discounts, a pricing arbitrage was available for short-term opportunistic investors which rushed in to snap up bargains. “Since then, returns have come down significantly as the volume of capital entering the space has increased and the banks have returned to lending,” notes Bruce Chapman, partner at London-based capital raising and advisory firm Threadmark.
He adds: “Appetite among investors for infrastructure debt is as strong as ever, perhaps even stronger than ever. It’s now recognised that interest rates are likely to remain low for the long term and many European investors are over-exposed to government bonds, so infrastructure debt is being used to diversify portfolios and enhance returns.”
Guillaume Fleuti, head of infrastructure and energy in the commercial banking division of Lloyds Bank, says there has been a marked increase in interest from institutional investors for infrastructure debt. “A lot of people have been calling us and asking what we have currently and in our pipeline,” he says.
These investors include those of a sophisticated variety which are prepared to consider many different types of opportunity, together with those which focus on just one part of the market such as Private Finance Initiative (PFI) debt. Fleuti’s view is that the latter type may struggle to maintain a long-term presence in the market as “there is price compression and very little pipeline”.
But if some players on the margins may be poised to exit the market, they are in a minority. Despite the pricing environment not being optimal, Laurence Monnier, head of infrastructure debt at Aviva Investors, believes that there are three main reasons why appetite continues to be strong: firstly, there is still an illiquidity premium, though this has diminished somewhat; secondly, infrastructure debt offers a compelling match with long-term liabilities; and thirdly, it represents a means of diversifying away from fixed income.
“If you divert just 5 to 10 percent of current fixed income allocations into infrastructure, that would be a large volume,” Monnier points out. “There is a need for infrastructure exposure now that is structural rather than opportunistic.”
Tim Cable, head of the European infrastructure debt business at Australia’s Hastings Funds Management, points out that it’s hard to find long-dated investments which match the liabilities of insurance and pension companies. As such, infrastructure debt has a natural allure. Furthermore, he adds: “People want more private credit, of which infrastructure debt is one segment, while moving away from low-yielding investments. There is no perception that infrastructure debt is a ‘here today, gone tomorrow’ market.”
Chapman picks up on the point regarding the attractiveness of private credit in general. “There has been a huge growth in private credit since the Crisis, initially as an opportunistic response to the departure of the banks, and more recently as a result of the need to chase higher yields. Infrastructure debt is a part of that, but it applies to many different credit opportunities.”
He notes increased appetite for infrastructure debt in Europe coming primarily from the likes of UK, French, German and Benelux insurance companies together with pension funds in the UK, Germany and Ireland. On a global level, North American and Japanese insurance companies are increasingly dipping their toes in the water, and appetite from Australian institutions also appears to be on the rise.
Chapman says he has seen “quite a few fixed income pools moving into infrastructure debt, despite the challenges of illiquidity” and also ponders whether a similar migration may be seen from real estate mezzanine which had looked “very attractive” post-Crisis but where “returns are now coming down”. “Where does that money go?” he ponders.
Cable feels that a growing variety of participants in infrastructure debt is a sign of the market’s maturity. “More organisations are investing, and different types of organisations,” he says. “The early movers bought positions themselves but now there are smaller investors and a wider range of products – pooled arrangements, funds, co-investments etc. All of these different approaches are valid.”
Chapman adds: “If you just want to participate passively, to dip in and out of the market on an inconsistent basis, and are happy taking syndicated pieces from a bank then it is certainly possible to invest on a direct basis. But if you want to be selective in deal sourcing, to have a voice in the structuring of the paper, to be consistently active and to build a balanced portfolio, then you need to work with a sophisticated manager.”
He adds: “Many are recognising the need to work with managers in some form. Indeed, both in equity and debt we see investment allocations getting ahead of managers’ capacity to absorb the capital. There has been continuing movement into the infrastructure space over the last 18 to 24 months and, as a result, there are fewer funds than there is appetite. The major constraint is the market opportunity – are managers able to deploy capital at the pace and level of returns that investors require?”
Fleuti agrees that deploying the capital is a challenge: “When you raise a lot of capital, it sounds like a good achievement – but that’s not necessarily the case. The difficult task is the investment. You can only find good deals if you’re looking at a wide range of opportunities.”
“There is definitely perceived to be no shortage of liquidity,” comments Aviva’s Monnier. “A few investors like us have been in the market a long time and we see a lot of opportunities because we have the relationships and track record. But there have been a number of new entrants in the market. Which sectors you are targeting and how you source deals are key factors because you have to be selective in this market.”
Adds Cable: “Where you are participating is crucial. In some areas it’s crowded and it will be for some time. You need to be active in responding to where opportunities are coming from and be consistent over time. Anyone can come in and buy market share but it’s long-term value creation that will differentiate you.”
Monnier notes that, as in the infrastructure equity market, more institutions have sought to invest directly without necessarily appreciating how time-consuming and resource-intensive such an approach can be. But she says that “those which have built a well-resourced team will stay” and argues that there is a modestly sized core of institutions that are “more and more strategically committed” to the market.
In forming this ‘core’, Monnier believes institutional involvement in the market is beginning to mirror the prior evolution that took place when it was bank-dominated. “The banks were active in project finance for decades and you had 40 or 50 of them that were active – but only around 10 or so were consistently sourcing and arranging transactions, and the rest bought syndicated loans. The institutional market may go the same way.”
With the subject having been raised, talk turns to the current role of the banks and the relevance that they have in today’s market. One sentiment that appears to be shared by all those round the table is that the banks never have – and probably never will – exit the market. The interesting aspect to contemplate is how their role has changed.
Fleuti says there is more confidence now in the banking community and this is reflected in a willingness to once again engage in a major way with project finance. “The banks have by and large repaired their balance sheets and there is a lot of focus on deploying capital,” he says. “For some banks, long-term project finance is simply not part of their business planning any more – but there are definitely more going back in.”
He adds: “Some banks want to put assets on their books simply for the income; others look more at the relationship angle where the loan is one aspect of a transaction but not the goal. At Lloyds Bank, we do not have an appetite for long-term holds of long-dated debt, but we will look at long-dated positions if there is a distribution or placement angle, or if there is a potential refinancing expected ahead of the contractual maturity, for example post construction.”
Cable acknowledges that “banks will always have a role – but whether they hold positions on their balance sheet is another matter. The number of banks doing that is much smaller. But banks have always intermediated credit in some way. They can facilitate transactions, they can provide hedging and ultimately it’s all about finding solutions for their clients.”
Monnier swats away any suggestion that the banks and institutions are in competition in the infrastructure debt market. She points out that institutions’ appetite for long-dated positions has grown in tandem with the banks’ declining appetite – and that this resulted in a complementary relationship between the two. At the same time, she believes the relationship is a nuanced one: “Institutions can invest through banks, separately from banks or alongside banks – and we at Aviva will do all of those things. We’ve also refinanced banks when they’ve wanted to exit. Our capital is a lot more flexible than many people realise.”
Moreover, that institutional capital is increasingly being courted by countries which have seen bank finance dry up. This may be seen in regulatory changes which allow deals to happen that couldn’t previously have happened. Witness Italy, for example, where new laws have supported the development of that country’s project bond market.
Speaking of Italy, Monnier says: “Bank liquidity was scarce and the regulators opened things up so that institutional investors could take the lead in that market. As a result, we recently saw the country’s first project bond. I believe regulation will allow more direct access to infrastructure debt and also more cross-border investment.”
Chapman points out that recent regulatory changes could perversely have a positive effect on the infrastructure debt market. “It’s the converse of the situation facing equity investors in light of regulatory change such as the Alternative Investment Fund Managers Directive and Solvency 2 regulation. While capital charges and regulatory restrictions for equity investment in infrastructure have gone up significantly for many investors, debt investment is often treated differently; capital charges have largely remained unchanged or even fallen. The situation is particularly acute in Germany where local regulatory changes have magnified such issues. Maybe as a result, we will see even more capital heading to debt rather than equity.”
TO STIMULATE OR NOT?
This of course would increase liquidity still further – prompting consideration of market-boosting mechanisms which seem increasingly out of step in a market where appetite is strong and growing.
“There is perhaps less need for market stimulus, such as the European Investment Bank’s project bond initiative and the UK Guarantees Scheme but they definitely still have an important role to play,” acknowledges Fleuti.
He adds: “Some investors, especially traditional bond funds, are not ready to take project risk. Some don’t have big resources for infrastructure and, if there’s no credit enhancement, they say they can’t do it.”
The attachment that some investors still have to credit enhancement is perhaps not surprising in an environment where more risk factors – many of them of a macro-economic variety – appear to be impinging on the market.
“People are always asking us about the unexpected things that have happened, such as the oil price drop,” says Cable. “Other considerations include things like quantitative easing, the instability in Ukraine/Russia, the UK general election and the prospect of deflation. How do you deal with all that? One clear conclusion is that credit analysis is becoming a highly valued skill set.”
Adds Monnier: “There is a lot of market risk. This is illustrated, for example, by the expectation that there would be long-term inflation and now you have deflation. Generally, infrastructure is relatively immune to GDP risk but a lot of macroeconomic risk is hard to mitigate except through very thorough stress testing.”
Asked to bring final thoughts to the discussion, Fleuti predicts the gap between available opportunities and demand to invest may grow even greater in the period ahead. “There are a number of projects in the UK that are trying to close ahead of the general election, in particular PFI refinancings,” he says. “Some won’t be able to close that quickly, and will get pushed back to later in the year – and that may further increase the imbalance between demand and supply, and create more pricing pressure.”
There are also concerns about the possibility of the European Commission’s €315 billion “Juncker Plan” for infrastructure unleashing a new wave of liquidity – though there appear to be more questions than answers about its likely impact at this stage.
“Banks and institutions have been working well together but could public institutions, through things like the Juncker Plan, end up changing market dynamics?” ponders Monnier.
However, the overriding sentiment in the room is one of optimism – and that has much to do with the sense that the infrastructure debt market has proved its ability to ride out cycles. With the famous clock behind us undoubtedly ticking (though we can’t hear it), Chapman brings the discussion to an end with the following observation: “Deal pricing and structures today in many ways resemble those which existed prior to the Crisis (though hopefully not the excesses of the peak of the pre-Crisis market). It might sound odd, but this gives people comfort that the market has passed through a difficult period and come through the other side. Most investors seem to prefer a stable norm to an environment of significant but short-term opportunity.”
AROUND THE TABLE
Tim Cable, Hastings Funds Management
Cable joined Hastings in April 2012 and is based in London. He is responsible for the European Infrastructure Debt business, including capital raising, origination and asset management. He has extensive financial services experience, having worked for Westpac in Sydney and London for more than 13 years in a number of different roles and on numerous debt transactions. Most recently, he was a director in the Infrastructure and Utilities group at Westpac, where his responsibilities included the management of a portfolio of infrastructure funds, utilities and transport infrastructure clients, transaction origination and execution.
Bruce Chapman, Threadmark
Chapman co-founded Threadmark in 2009 and brings extensive experience of raising capital for private equity, infrastructure, energy, real estate and hedge funds. He started working in fund placement in 2001, since when he has worked with some of the leading managers in the alternative investment space, raising capital for more than 40 separate opportunities. During this time he has covered institutional investors based in Europe, the Middle East, Asia and North America. Prior to co-founding Threadmark, Chapman was a partner at C.P. Eaton Partners from 2005 to 2009, where he focused on all elements of the fundraising process.
Guillaume Fleuti, Lloyds Bank
Joining Lloyds Bank in 2009, Fleuti has also actively participated in the development of the Lloyds Bank bond and USPP franchise and successfully executed major transactions for corporates in the utility, natural resources, property and telecommunications sectors. He joined Goldman Sachs in 2007 and was responsible for the origination of bonds and the associated hedging strategies for corporate clients in the UK, Switzerland and in the Nordic region. Fleuti has over 14 years of experience in capital markets, spending the first four years of his career at UBS in Zurich in the Swiss debt capital markets team before moving to London in 2005.
Laurence Monnier, Aviva Investors
Monnier is responsible for managing infrastructure debt within Aviva Investors’ infrastructure investment business. She has over 25 years of experience in infrastructure and energy finance. Prior to joining Aviva Investors, she was head of Credit Infrastructure and the Public Sector at Depfa. Between 2002 to 2007, as director at Fitch Ratings, Monnier established and managed the European project finance ratings practice. Earlier in her career, she was a director at Deutsche Bank, with responsibility for the European project finance portfolio.