The growth of private debt strategies has continued apace since the beginning of the global financial crisis. What’s more, the rapid growth of this asset class is largely a consequence of the crisis: private investors have absorbed market share that was previously provided by banks. With lending to businesses gradually increasing over the past decade, 2017 at last saw deployment and fundraising surpass pre-crisis highs1.
The financial crisis altered the lending landscape
From an LP perspective, the draw of the private debt asset class is clear: it offers returns that exceed most defined benefit plan actuarial return assumptions, while providing better downside protection than other private 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.
Infrastructure debt makes up a small but growing sub-niche of the private debt market, with $43bn raised globally since 20132. One of the key drivers of the recent private debt explosion is the pull-back of traditional bank lenders due to increased regulations 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 considering the risk mitigation provided by infrastructure’s ring-fenced structure and stable characteristics.
The larger the scale of the financing, the more restrictive these capital buffer regulations become. Philippe Brassac, CEO of Crédit Agricole, one of France’s largest banks, recently lamented that due to the changes of the Basel regulatory framework, “financing for infrastructure such as motorways, bridges and airports would be hard hit because the amount of capital needed for banks to fund such deals could increase more than fivefold in some cases.”
The alarms raised by Mr. Brassac and others have proven prescient, with banks’ share of total financing decreasing substantially. Between 2000 and 2008, bank loans’ share of global GDP doubled to 20 percent, according to the Bank for International Settlements (BIS). Since 2008, bank lending has flatlined. Within advanced economies, debt securities, which comprised less than 50% of the total international noninterbank lending market in 2008, now make up 57% while the bank loan share of GDP in advanced economies has dropped to 18%.4
This shift has exacerbated an advantage long held by private debt capital: structural flexibility. The natural replacement for bank loans would be to tap the public markets, and for many large borrowers this has been the chosen solution.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.
Capital market solutions (also referred to as project bonds in the infrastructure space) offer borrowers attractive, long-term fixed interest rates. Broadly syndicated project bonds, however, are not-well suited for borrowers who require any type of structural flexibility. Project bond buyers are typically insurance companies who require the bonds to carry investment grade ratings. In order to achieve these ratings, the bond issues must meet strict criteria outlined in the rating agency’s methodologies. Capital market products do not offer highly desired features like delayed funding or multi-currency availability. These - as well as less common features like pay-in-kind ability and contractual or structural subordination – can be immensely valuable to certain projects and borrowers.
Institutional private capital is exceptionally well positioned to fill the gap. Unconstrained by one-size-fits-all capital adequacy regulations or the need to satisfy ratings agency criteria, private lenders can analyse and price the risk associated with these features.
At AMP Capital, our Infrastructure Debt Fund series has been designed to harness structuring expertise and flexibility to fill this gap in the market. Our most recently constructed portfolio, Infrastructure Debt Fund III, has created investment opportunities for our partners across infrastructure sectors and geographies that drive value from unique structural features.
In Europe, we recently made one of our most complex loans to date, investing into a global portfolio of renewable assets with Neoen, the largest renewable energy provider in France and a global leader in the sector. The €244 million transaction featured bespoke structuring to suit Neoen’s long-term goals for this portfolio, which was made up of 51 solar and onshore wind assets, located primarily in France and Australia, with around a fifth located in emerging market jurisdictions. 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 some asset rotation rights, and full multicurrency cash pooling.
On a bilateral basis, we negotiated an optimal structure that met the needs of both Neoen and IDF III’s objectives. This 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.
In the U.S., we have supported the fastgrowing telecommunications towers sector with a $500 million loan to a developer/owner/operator. Backed by 10-15 year contracts with some of the largest telecommunications companies in the world, the loan includes delayed draw features, payment-in-kind ability for assets in construction, and a mechanism to reorganize the collateral pool in the future without repaying the entire loan once the borrower has developed a more permanent portfolio with the critical mass required to access the capital markets.
Furthermore, this was an investment made by IDF III alongside an institutional partner in what was one of the first unitranche loans made in the infrastructure space.
Not only is this transaction an example of the flexible solutions that institutional lenders can provide, it’s also an example of the increasing collaboration on co-investments between investment managers and institutions which can facilitate channelling more capital into this asset class, which, while highly attractive, requires specialised knowledge and experience to structure this kind of deal.
With private infrastructure equity fundraising continuing at record levels and governments throughout the world looking to the private sector to resuscitate out-dated infrastructure and meet future challenges across energy, transportation, water and telecommunications sectors, we see ample opportunities to continue to deploy capital. 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, like ourselves in niches such as mezzanine debt – can ensure attractive returns for their clients. The infrastructure debt sector brings less economic sensitivity than other parts of the private debt space, and more predictable returns than other parts of the real assets space.
In the new lending landscape, opportunities abound for private capital to fill the gap left by banks in the growing demand for infrastructure funding. As infrastructure debt investors help infrastructure businesses with their financing solutions, ability to create and underwrite customized solutions will be a key differentiator.
1. Source: PitchBook, ‘Private Debt Performance Warrants A Closer Look’, 1Q 2018
2. Source: Private Debt Investor, ‘Infrastructure debt reels in $43bn’, September 2018
3. Source: Philippe Brassac, ‘Basel IV: a real threat to financing for the economy,’ September 2016
4. Source: Bank for International Settlements, ‘Global liquidity: changing instrument and currency patterns,’ September 2018
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