Infrastructure debt – the private capital advantage

Following a year of record deployment for AMP Capital’s Infrastructure Debt investment strategy, in a whitepaper released today, Emma Haight-Cheng, European Head of Infrastructure Debt, explains the market dynamics that have created a growth pathway for infrastructure debt in the past decade, and why the opportunities for infrastructure lenders globally have become so attractive.

Infrastructure debt makes up a small but growing niche of the private debt market, with $43bn having been raised globally since 2013¹ with AMP Capital’s infrastructure debt investor commitments ($5.45bn as at 31 August 2018²) equivalent to well over 10% of this total.

The financial crisis altered the lending landscape

One of the key drivers of the recent private debt explosion is the pull-back of traditional bank lenders due to regulations like Dodd-Frank and Basel III, implemented following the global financial crisis, that have increased the amount of capital that must be set aside against loans. This has been especially punitive in infrastructure and other real economy lending, where the higher loan-to-value ratios appropriate for monopolistic, regulated and long-term contracted assets are particularly punished, without taking into account the risk mitigation provided by infrastructure’s ring-fenced structure and stable characteristics.

An alternative to bank lending, capital market solutions (also referred to as project bonds in the infrastructure space) offer borrowers attractive, long-term fixed interest rates; the key advantages capital markets hold compared to bank loans are tenor and price. However, banks have historically been able to hold such a large share of the infrastructure lending market despite these factors because of their ability to underwrite the esoteric risks and provide the flexibility demanded for infrastructure transactions. Broadly syndicated project bonds are not well suited to borrowers who require any type of structural flexibility. Project bond buyers are typically insurance companies who require the bonds to carry investment grade ratings meaning bond issues must meet strict criteria outlined in the rating agency’s methodologies.

Capital market products typically do not offer desirable features like delayed funding or multi-currency availability. These - as well as less common features like an ability to pay-in-kind and contractual and/or structural subordination – can be immensely valuable to certain projects and borrowers.

Institutional investors can reap the benefits

Institutional private capital is exceptionally well positioned to provide the advantages that capital market borrowing and banks cannot. Unconstrained by one-size-fits-all capital adequacy regulations or the need to satisfy ratings agency criteria, private lenders can analyse and price idiosyncratic risks associated with the required features and circumstances.

From the perspective of institutional investors, the draw of the private debt asset class in general is clear: it offers returns that exceed most defined benefit plan actuarial return assumptions, whilst providing better downside protection than other private market asset classes, both through capital structure seniority and faster distribution-to-paid-in (DPI) capital return. The median private debt fund reaches a 1.0x DPI in its sixth year, compared to the eighth year for private equity.³

The stable business models and reliable cash yields of infrastructure providers make them a highly attractive proposition for liability-driven investors, so while playing an essential role in the funding landscape, managers – especially those in less competitive, higher-yielding niches such as mezzanine debt – can deliver attractive returns for their clients.

With its defensive infrastructure characteristics, the infrastructure debt sector brings less economic sensitivity than other parts of the private debt space, and with its fixed income return profile, offers more predictable returns than other parts of the real assets space.

How to invest with success

Specialised infrastructure debt investors harness structuring expertise and flexibility to fill the gap in the market, driving returns from unique structural features.

We recently made one of our most complex loans to date, investing into a global portfolio of renewable assets with Neoen, France’s largest independent renewable energy provider. The €244 million equivalent green bond featured bespoke structuring for the portfolio of 51 solar and onshore wind assets. As well as being geographically diversified, the portfolio also included assets at different stages of development and construction as well as operating assets. The loan was made in three currency tranches (EUR, USD and AUD) and included features such as asset rotation rights and multi-currency cash pooling.

The deal is notable for its structural complexity, but also its attractiveness to both the investor – providing diversity of market, technology and currency, as well attractive risk-adjusted returns – and the sponsor, as it met all of their funding aims for the portfolio, including serving as an alternative to exit, with one tailored deal.

Infrastructure equity fundraising is at record levels, deal flow – creating demand for acquisition debt – is strong, and governments are looking to the private sector to resuscitate out-dated infrastructure and meet future challenges in energy, transportation, utilities and telecommunications.

In the new lending landscape, opportunities abound for private capital to fill the vacancy left by banks in the growing demand for infrastructure funding. As infrastructure debt investors help infrastructure businesses with their financing solutions, the ability to create and underwrite customised solutions will be a key differentiator.

¹ Source: Private Debt Investor, ‘Infrastructure Debt reels in $43bn’, September 2018
² Including co-investment commitments.
³ Source: PitchBook, ‘Private Debt Performance Warrants a Closer Look’, September 2018