Infrastructure investment is something that almost everyone can agree on. Hard right US president Donald Trump and left wing UK opposition leader Jeremy Corbyn both want to unleash infrastructure construction programmes in their countries — and so do the globalist elites crowding development bank meetings, and the protestors outside those meetings.
So, too, do fixed income investors, seeking shelter from public markets where returns have become increasingly hard to find. With the pre-crisis monoline insurers hardly to be seen, and limited bank balance sheet on offer, there is an opportunity to be had.
Infrastructure assets are illiquid, but that doesn’t matter — long-term pension fund and insurance money has flooded in to take advantage of the illiquidity premium, and as public bond markets have ground tighter and tighter, the attractions of the private market have grown more and more obvious. A December paper from UBS, The Case for Infrastructure Debt said just 1% of institutional investment was in infrastructure — but that’s still a lot of cash.
Moreover, it’s mostly private. The same paper cited figures for the European market in 2016 showing €37bn of infrastructure debt in rated public format, and €97bn in private markets — mostly banks — with just €8bn in institutional private placements.
Even a small shift from banks to institutional private placements, therefore, expands supply in the market extensively.
The report notes: “The mid-market space offers a large addressable market, and could present opportunities for investors able to offer long-term funding, a competitive advantage.”
But it’s not always easy for would-be infrastructure debt buyers to get access to dealflow — this, along with the complexity of the assets, is the major obstacle for institutional buyers.
“Getting out there and bringing in opportunities directly is absolutely essential in delivering alpha compared with syndications,” says Jonathan Stevens, head of European infrastructure debt at BlackRock.
“If you are sitting there waiting for a borrower with two ratings, an adviser and two placement agents to come to you with a deal, your ability to generate alpha is very limited. We see private infrastructure debt as a fixed income business, executed private equity-style.”
Stevens illustrates the broader trends in the market — he headed the European infrastructure group at WestLB before the crisis, moved to CIBC’s team in 2014, before joining BlackRock in 2016.
“Every manager will tell you they have the best proprietary deal access, and I will too — we have 22 investors between London and New York, which gives us sufficient time and impetus to build relationships with corporate treasurers, with sponsors, and generate the broadest possible range of investment opportunities,” says Stevens.
Since the crisis, as well as being reluctant to lend, banks have also been less involved as underwriters of risk, according to Ian Simes, senior vice-president, infrastructure debt at Brookfield Asset Management.
“If a bank is going to underwrite and syndicate risk, then they will be sure to price at a level that makes sure they can move it,” says Simes. “The borrower is paying for that and knows it, so financings are typically done bilaterally, or possibly in a small club.”
Brookfield is a big infrastructure equity investor, which helps give the firm access to dealflow in an intensely private market.
“Sometimes we will look at an asset or a transaction and find the returns don’t make sense from an equity perspective,” says Simes. “But that doesn’t mean we don’t like the asset, and it might end up being an attractive mezzanine. So our equity platform can be a helpful source of dealflow.”
Beneath the surface
Lots of major UK infrastructure is financed in public markets — for example, the water companies, Heathrow Airport, port companies ABP and Peel, and High Speed One, the old Channel Tunnel Rail Link.
But this is far less prevalent across the rest of Europe. Power assets are often financed on the balance sheets of the major utilities such as EDF or RWE, while municipal assets and transport are usually owned by the state, or state-owned corporations such as SNCF or Deutsche Bahn.
The European Investment Bank, one of the largest infrastructure lenders in Europe in its own right, has a scheme to credit-enhance project bonds — essentially, a mezzanine guarantee to make sure the senior financing for a project makes it to investment grade. But the structure has seen limited use, with many investors preferring to access unenhanced project risk and get paid for it.
Public markets also aren’t really an option for smaller firms. It’s easy to think of infrastructure as being about the big deals — airports, rail links and power stations — and easy to forget about smaller trades, which make up the bulk of the flow.
These sponsors cannot justify the cost and expense of accessing the public markets, and are precisely the clients that remain less appealing to banks.
Europe’s bank balance sheets are much healthier than in the immediate post-crisis years, and the lending taps are back on — but elements of post-crisis parsimony remain in how banks treat their smaller corporate clients.
“If you are a borrower client of a bank, then they will want you to use as many services as possible — hedging, ratings advisory, structuring, a bit of balance sheet, DCM and so on,” says Stevens. “If you’re a borrower that just wants €50m of sticky capital, then you are not very interesting to a bank, but you are very interesting to us.”
Stevens says his fund’s largest investment to date is a $400m commitment in the US, showing that large tickets can be written if needed — but he says that €20m-€50m tickets would “fly below the radar” of the banks, giving a better opportunity to lift returns.
He cites a €100m-plus investment in the Walney Extension wind farm project, which was financed with a non-recourse investment grade project bond, distributed to a “consortium” which also included L&G, Aviva and Macquarie Infra Debt Solutions. This deal, according to Stevens, was a trade in which BlackRock got paid for the complexity involved.
Brown to bring you down
Funds historically found it harder to lend against new projects — infrastructure frequently runs up against political difficulties in getting off the ground, and construction can be prone to overruns of cost and time.
Banks, meanwhile, like the shorter-dated risk, and have the flexibility to renegotiate loan terms and timings.
But the lines are blurred — particularly when only a handful of funds are lending to a project, rather than a broad syndication of risk.
“We do take construction risk, but selectively,” says Stevens. “The risk can be fine, but greenfield lending can be very time-consuming to execute. We might have a mandate with a pension fund or insurer with an investment period of 12 or 24 months, but the cycle of investment for greenfield can be much longer.”
Going deeper
That has pushed down returns. But there’s still some juice offered in mezzanine direct lending, where Brookfield specialises. This can be extending the leverage on an infrastructure asset at construction, or helping an asset owner to releverage and take cash off the table
According to Simes, this remains a less competitive place to deploy cash privately.
“In senior debt, there’s so much liquidity looking for a home, and spreads continue to be under a lot of pressure. Returns just aren’t very attractive anymore,” says Simes. “It’s a similar story in the equity — lots of money has been deployed into equity infrastructure strategies, and in one sense that has been great. But when there’s lots of capital chasing the same assets, equity owners can often end up accepting a lower IRR than they had expected.”
UBS’s report said that since 2013, about €7bn had been raised for infra debt funds, according to public disclosures, with 2016 seeing record fundraising of €2.6bn.
It doesn’t break down how much of it was focused on mezzanine investment, but probably very little — meaning it is still an attractive spot for the specialists.
Liquidity
Private infrastructure debt is no exception. Funds buy intending to hold debt for the lifetime of exposure, usually deploying institutional money with long time horizons. But sometimes things go wrong, and market views can change.
Some senior exposures can be moved quite quickly, if needed, but mezzanine or highly structured debt can take a long time to sell — and a lot of market experience.
“There are enough participants in the market for it to be possible to sell exposures, but it’s a long process,” says Simes. “Buyers would need to enter confidentiality agreements, review all the documentation, get comfortable with the risk and transaction structure. It’s liquid, but it might take a couple of months.”
The market is too illiquid to have a well-developed broker network, meaning a portfolio manager might have to call their competitors directly and try to arrange a bilateral sale if they want to exit a position.
Despite all the recent growth in direct infra debt investment, it’s still a niche strategy — and may come under renewed threat from the banks, as balance sheet repairs and European regulatory tweaks designed to boost the market take effect.
But some changes to the market’s structure are permanent. Infrastructure is a complex and difficult asset class that needs independent origination to bring in deals — and much of the market’s expertise has followed the money to the buy-side. Yields might be squeezed here as elsewhere, but the private debt investor is in infrastructure to stay.