The new dynamics of the infrastructure debt market
11 December 2013
Category: News, Asia, Global
By David Macfarlane
As an asset class, infrastructure assets typically can support leverage (debt to total capital) ratios from 50% to as much as 95% in some cases. The stability and predictability of cash flows generated by infrastructure assets, in comparison to other asset classes, typically allows for more leverage to be comfortably sustained.
That being said, Vijay Pattabhiraman, chief investment officer at J.P. Morgan Asset Management global real assets, points out that investments in growth opportunities generally adhere to lower leverage ratios in proportion to the stage of growth they are in and are kept at the lower end of the typical range, to avoid overly stressing or constraining a growing company with debt service payments.
“Over-capitalising with equity at the earlier stages of a project / company’s life-cycle allows for more comfortable debt service ratios; providing headroom should actual results differ from lender projections. As the company matures and the cash flow outlook stabilises (for example, a toll road which reaches a steady state traffic utilisation), the company’s leverage can be pushed higher, freeing up additional resources to pursue other projects as well as improving equity returns through the use of lower cost capital,” he explains
More specifically, in an Asian context, sources of infrastructure debt in the market have not changed significantly. Traditional project finance loans issued by local/regional banks remain the primary source of debt in the overall capital structure for infrastructure assets. Mr. Pattabhiraman says: “Unlike in more developed markets, such as the US, with banks selling off/syndicating longer-term loans to adhere to stricter capital requirements with Basel II and III, Asian banks are predominantly balance sheet lenders and continue to be the primary providers of long-term, non-recourse financing for infrastructure assets.”
Core infrastructure assets by their nature are assets which are required to provide essential services to the general population. They typically have steady and often regulated cash flows, high barriers to entry and are non-cyclical in nature. Historically, infrastructure debt investments have also shown low credit rating volatility and higher than average debt recovery levels in a distressed debt environment.
The financial crisis in 2008 saw bank debt dramatically fall off as banks de-levered. “However,” says Steve Gross, senior managing director at Macquarie Infrastructure and Real Assets (MIRA), “for quality assets, we continued to see support by select banks and to some extent the high yield market filled the gap. For a period, we also saw some mezzanine players come to the fore to fill the gap between the returns expectation of debt and equity providers, albeit only playing a minor role.”
Mr. Gross points out that the Organisation for Economic Co-operation and Development (OECD) estimates that US$3 trillion is needed for infrastructure projects by 2018 and US$50 trillion by 2030. “It is hard to see all this infrastructure debt being financed by traditional bank lending,” he says. “It’s likely that what we will now see in the infrastructure debt market is a more diverse source of debt funding in the form of recovering appetite from traditional banks; the bond markets and; potentially institutional investors and pension funds who will invest directly. Our view is that the bond market will continue to grow substantially as the asset class gains acceptance with institutional investors who like the risk profile, which is less correlated to the general economy, yield and liquidity.”
Looking ahead, Greg Maclean, global head of research, infrastructure at AMP Capital Investors, says: “We expect to see lot of innovation in the sector, particularly in the area of securitisation products. An example of this is subordinated debt. Following the global financial crisis, there is an increasing role for subordinated debt in capital structures, which provides an opportunity for third party providers. From an investor’s perspective, subordinated debt provides an opportunity to access higher risk weighted returns.”