Clearing today’s funding hurdles

A number of recent US infrastructure transactions have failed to reach financial close or have been restructured – Alligator Alley, FARAC II, Midway International Airport, Port of Miami Tunnel, and Maher Terminals, to name a few. The ongoing global recession and financial crisis have dampened the availability of financing – both equity and debt – in many sectors of the economy, and infrastructure is no exception. Despite these challenges, private sector investment in infrastructure, including through public-private partnerships (PPP), is here to stay. The debt and equity financing of infrastructure investments will continue to evolve as recent excesses in both markets are purged. Investments in infrastructure continue to be attractive to the private sector due to their favourable risk return profile, and will attract increasing amounts of capital from the private sector as the financial crisis recedes.

Before the financial crisis

Before the onset of the financial crisis in the fourth quarter of 2007, many European concession and construction companies were looking to invest significant capital in infrastructure – having invested in the sector in some cases since the 1960s. From 2001 to its peak in the fourth quarter of 2007, the total equity market value of twelve of the largest publicly-traded European concession and construction companies [1] increased over 395 percent [2] to approximately $215 billion, significantly outperforming the MSCI Europe Index [3], which rose only about 63 percent over the same period. Such strong stock performance provided the companies easy access to capital, and was mirrored by robust inflows into private equity investment funds focused on infrastructure.

Australia, Europe and Canada were among the pioneers in developing the PPP market.  In these regions institutional investors were attracted to infrastructure because of its unique characteristics.  Pension funds and insurance companies, in particular, were attracted to the relatively low risk, stable cash flows, high cash yields, low correlation to stocks and bonds, and the hedge against inflation that many infrastructure assets provided.  Globally, over 80 unlisted infrastructure-focused funds were raised from 2004 to 2008 with an estimated value of $100 billion [4]. In addition, a more liquid, exchange-traded form of infrastructure-focused fund emerged as an alternative investment vehicle for investors with shorter investment horizons.  From 2002 to 2007, more than 17 listed infrastructure-focused funds [5] were introduced with an aggregate equity market value of over $30 billion by the fourth quarter of 20076.
 
All of this equity capital was buoyed by the availability of cheap debt. Banks offered low fees and thin margins to win lending business. Terms and conditions became more lenient and leverage was increased through use of sophisticated financial engineering techniques – non-recourse borrowing, securitisations, accreting swaps and mezzanine financing – to supplement plain-vanilla bank loans and project bonds. Other factors that contributed to the increased availability of credit were the expansive use of monoline insurance and a robust market for syndicating bank loans. 

With all this capital pouring into the infrastructure sector, asset valuations rose.  For many infrastructure transactions, the expected equity returns decreased to between 10 and 15 percent per annum and in certain cases dipped below 10 percent. 

Current infrastructure financing market

The global recession and the financial crisis have changed all that. Current economic and market conditions are testing the theory that infrastructure assets are recession proof.  Certain highly leveraged transactions are already facing financial trouble. Some infrastructure funds and concession companies have initiated distressed asset sales to reduce debt levels.  The share prices of listed infrastructure-focused funds have traded off substantially, leading some shareholders to demand liquidation of these funds. 

As of June 20097, the equity market value of 21 listed infrastructure-focused [8] funds was less than half of its approximately $42 billion peak in the fourth quarter of 2007 [9].  The share prices of the twelve largest, publicly-traded European concession and construction companies have decreased by an average of over 50 percent since their peak in the fourth quarter of 2007 [10]. Unlisted infrastructure-focused funds are now finding it increasingly difficult to raise new capital, with the result that fund managers are lowering management and performance fees as institutional investors demand concessions on new commitments. Only $1.3 billion [11] was raised in the first quarter of this year versus $26 billion for all of 2008 [12].

The global financial crisis has forced the banks traditionally active in the infrastructure loan market to pull back substantially on new lending commitments. Leverage ratios are substantially lower on new debt packages. Fees and margins have become more costly, and banks are offering significantly shorter tenors. Debt structures are simpler; terms and conditions are much more restrictive. There is no bank syndication market – most current bank loans are club deals – often causing financing to take longer to put together. Most major monoline companies are teetering on the verge of bankruptcy and are unlikely to recover anytime soon. The securitisation market and accreting swaps are effectively non-existent.

Outlook

At the moment, the private and public sectors are assessing the implications of the financial crisis on the infrastructure financing market, particularly as it relates to PPPs. Governments globally are struggling with the need to invest trillions of dollars in infrastructure. Developed countries are facing the need to upgrade their existing infrastructure and emerging countries are focused on building new infrastructure; both recognise that public sector funding will be insufficient to meet needs.

Therein lies the investment opportunity. The current financial crisis is purging the recent excesses from the infrastructure equity and debt financing markets.  In the near-term, debt and equity capital will be less readily available and, therefore, more expensive.  This scarcity of capital will force the private sector to focus on smaller transactions until the financing markets strengthen. Infrastructure-focused funds and concession companies will need to rely not on boosting leverage, as before, but on superior management and operational excellence in order to attain high yields and solid investor returns. It is highly unlikely that any of the previously seen leverage-boosting financial structures, terms and conditions will return to their pre-crisis levels anytime soon, if ever. 

And yet, despite these higher hurdles, private sector debt and equity capital will become increasingly available over time. The capital markets largely froze when investors became unwilling to invest in anything other than the safest investments (e.g., US Treasuries) as a result of the financial crisis.  However, over time, investors’ risk tolerance will increase as they seek higher returns. We are already seeing some signs of this – the S&P 500 is up by approximately 40 percent [13] from its low in March 2009 [14]. Total 2009 year-to-date [15] investment-grade issuance in the US is up 105 percent [16] from total issuances in the second half of 2008 [17] and $46 billion of high yield capital has been issued in the US in the second quarter of the year (till date) [18] compared to $14 billion for the first quarter of the year [19]. Debt spreads have tightened substantially since the beginning of the year. Corporate10-year investment grade debt spreads [20] have tightened by over 160 basis points since the beginning of the year to 167 basis points [21], while the broad-market high yield debt spreads have tightened by 629 basis points since the beginning of the year to 919 basis points [22].

While these signs are promising, for the foreseeable future, investors are not going to invest in many of the riskier sectors and investment structures that experienced dramatic declines during the financial crisis.  Rather, today, more than ever, debt and equity investors are looking to invest in the sort of stable investments that properly capitalised infrastructure assets can offer.

In short, smaller deals, less leverage, lower valuations – that is the immediate outlook for the infrastructure market.

Tom Osborne is head of the Americas Infrastructure team at UBS Investment Bank. Henry J. Catry is an executive director in the Americas Infrastructure team at UBS Investment Bank. Both are based in New York.

Notes:

1  Comprised of : Abertis Infraestructuras S.A., Actividades de Construccion y Servicios S.A., Acciona S.A., Atlantia S.p.A., Bouygues S.A., Brisa-Autoestradas de Portugal S/A, Fomento de Construcciones y Contratas S.A., Hochtief AG, Sacyr-Vallehermoso S.A., SNC-Lavalin Group Inc., Vinci S.A., Transurban Group
2 From December 31, 2000 to October 31, 2007
3  MSCI Europe Index
4  Preqin report titled “2009 Preqin Global Private Equity Review”
5 Comprises of : Macquarie Airports, Macquarie Communications Infrastructure Group, Macquarie Infrastructure Company Limited Liability Company, Macquarie International Infrastructure Fund Limited, Macquarie Korea Infrastructure Fund, Macquarie Power & Infrastructure Income Fund, Macquarie/First Trust Global, Duet Group, Connecteast Group, Babcock & Brown Infrastructure Group, Hastings Diversified Utilities Fund
Alinta Infrastructure Holdings, Sp Ausnet, Challenger Infrastructure Fund, 3i Infrastructure plc, HSBC Infrastructure Company Limited, Infigen Energy (formerly: Babcock & Brown Wind Partners)
6  Market capitalization as of  October 31, 2007
7  As of June 12, 2009
8 Comprises of : Macquarie Airports, Macquarie Communications Infrastructure Group, Macquarie Infrastructure Company Limited Liability Company, Macquarie International Infrastructure Fund Limited, Macquarie Korea Infrastructure Fund, Macquarie Power & Infrastructure Income Fund, Macquarie/First Trust Global, Duet Group, Connecteast Group, Babcock & Brown Infrastructure Group, Apa Group, Envestra Limited, Hastings Diversified Utilities Fund, Alinta Infrastructure Holdings, Sp Ausnet, Macquarie Infrastructure Group, Australian Infrastructure Fund, Challenger Infrastructure Fund, 3i Infrastructure plc, HSBC Infrastructure Company Limited, Infigen Energy (formerly: Babcock & Brown Wind Partners)
9  Market capitalization as of October 31, 2007
10  From  October 31, 2007 to June 12, 2009
11  Probitas Equity Partners estimates, April 2009
12  Preqin report titled “2009 Preqin Global Private Equity Review”
13  S&P index as of June 12, 2009
14  S&P index as of March 9, 2009
15  From  January 1, 2009 to June 12, 2009
16  UBS Debt Capital Markets issuances data
17  From  July 1, 2008 to December 31, 2008
18  UBS Debt Capital Markets issuances data for the period April 1, 2009 to June 12, 2009
19  UBS Debt Capital Markets issuances data for the period January 1, 2009 to March 31, 2009
20  Bloomberg, A-rated 10-year Industrial debt issuances spreads
21  Bloomberg, A-rated 10-year Industrial debt issuances spreads as of June 12, 2009
22 UBS Debt Capital Markets issuances data as of June 12, 2009