Infrastructure finance sources diversify
In the void left by Europe’s shrinking banks, asset managers and insurers are eyeing opportunities in infrastructure – spurred on by the prospect that returns on investments in power stations, toll roads and pipelines will outpace other assets.
A sector that has long relied on European banks offering long-term loans based on the revenue from the underlying assets is changing.
Banks such as Royal Bank of Scotland and Bank of Ireland have already sold bundles of project finance debt. But faced with the eurozone crisis and new regulations, other European banks are expected to cut their dollar-funded, long-term liabilities by selling portfolios of debt in North American and Asian infrastructure assets as they focus on their domestic markets.
In the new environment, infrastructure projects such as the Nîmes-Montpellier high speed rail link continue to attract bank funding. But given the number of projects that will require financing over the next few years, the bank market alone is unlikely to be able to satisfy demand.
Bill Appleby, head of project finance for Emea at Citi, says to plug the gap multilaterals and export-credit agencies may play a bigger role in funding new infrastructure projects.
He says there is also the potential to move towards a US model with more European projects funded first in the loan market by banks, with institutional investors taking on that debt, possibly in the capital markets, once construction is completed.
Others point to the EU’s project bond initiative as a solution.
But Matthew Vickerstaff, global head of infrastructure and asset-based finance at Société Générale, says that as the yields on sovereign and some corporate bonds have diminished, there has been a “huge” amount of interest from institutional investors in long-term infrastructure.
Russell Steenberg, global head of BlackRock’s fund of funds platform, agrees. Funds that “have a pool of assets and can’t get return in the public market are increasing looking to private markets,” he says.
BlackRock is making a more aggressive push into providing financing for infrastructure projects to fill the void left by European banks. It already offers debt and equity for new projects and is eyeing opportunities to buy existing debt portfolios from banks that are withdrawing from project finance.
The group also recently acquired Swiss Re’s private equity fund of funds, which specialises in investing in infrastructure.
According to data from Preqin there has been a sharp rise in the amount of money being raised in dedicated infrastructure funds over the past few years.
David Krischer, global head of capital markets at law firm Allen & Overy, says there is also a lot of talk about what the insurance sector can do for the project finance and other lending markets. “But the question is whether they can leverage themselves in the same way as the banks.”
Analysts point out that under Solvency II regulations it may be more difficult for insurers to make direct investments in infrastructure projects. And there are other hurdles.
Mr Vickerstaff says that many institutional investors are looking for fixed rates when project finance debt has traditionally been funded on a floating-rate basis. “Many also do not want to take on construction risk,” he says.
Among those taking a more active approach to the sector is Allianz Global Investors. The asset management arm of the German insurer recently established a new team to scout for infrastructure assets for its parents and clients, many of which want long-term assets with solid returns.
And in June, Aviva Investors, the asset management arm of the UK insurer, agreed to acquire a portfolio of Bank of Ireland’s infrastructure loans.
Aviva and Hadrian’s Wall Capital are also pursuing an innovative structure that involves issuing investment grade infrastructure senior debt that is then split in two. One part is purchased by the fund as a subordinated infrastructure bond and the other part, whose credit is enhanced by the fund’s investment, is placed as senior infrastructure bonds in the capital markets.
Mark Parry, senior investment manager at Aberdeen Asset Management, says: “Infrastructure projects do offer an attractive source of income. However, the variety of types of deals and of structures makes rigorous analysis important to ensure investors find the most suitable option for them.”
Analysts expect European banks, particularly those in Spain and Italy, to try and sell bundles of project finance debt in the next 18 months. They say that while many of these banks have been able to delay sales after borrowing cheaply from the European Central Bank, they will need to offload project finance debt in places such as the US.
“The stress in Europe has pressured their banks to raise capital through asset sales and US infrastructure financings are among those assets,” says Hector Negroni, a partner at Fundamental Advisors, a private equity and hedge fund manager dedicated to municipals.
“That may create a shadow inventory that could weigh on the marketplace just as US municipal governments need to borrow for new infrastructure. The supply of new credit for infrastructure is building, but it has been painfully slow.”