Infrastructure debt: M&A is down, but refinancings grow

When the economy turns, infrastructure investment has often been seen as a safe harbour from tailwinds affecting other parts of the market. Infrastructure projects are typically long-term investments with government support, usually fulfilling essential needs that consumers cannot easily cut out of their budgets.

Investment in infrastructure debt cannot ignore what is going on in the wider market and issues such as depressed M&A activity and a sluggish fundraising market are taking their toll. That said, infrastructure investment is still holding up well, according to Schroders’ head of junior infrastructure debt, Augustin Segard.

“It’s a case of ‘so far so good’ in infrastructure debt. We have a portfolio of 150 transactions and in 10 years we’ve not had any defaults. But there are challenges today facing a lot of players in the infrastructure market from inflation, interest rates and supply chains,” he explains.

Schroders’ junior debt strategy focuses on investing in brownfield sites and providing shorter-term capital. 

“Most of the time, inflation is neutral or positive for us,” Segard says. “Interest rates have increased sharply but we require assets in our portfolio to be hedged against interest rate rises, so we have protection there as well. Supply-chain problems have put many projects on hold too, but because we back brownfield sites we usually don’t need a large amount of materials to construct the asset.”

But for some projects, issues around interest rates and inflation could become a serious problem.

“In general, the asset class is resilient with regards to inflation with the ability to pass through increased costs to customers,” says Claus Fintzen, chief investment officer of infrastructure debt at Allianz Global Investors.

“In cases where you can’t pass through costs, there could well be issues when it comes to refinancing, but in most infrastructure projects this is less of a concern than in some corporate lending or residential real estate for example.”

Refinancing risk is increasing across the board for private credit investments as both inflation and rapidly rising interest rates hit firms’ profitability and their ability to service their debt. For infrastructure lenders this is one area where strong underwriting discipline can help to prevent
problems.

“Refinancing has become more expensive,” says Roopa Murthy, partner and head of infrastructure debt Europe at Ares. “When we look at deals we analyse this risk and we try to look at investments which have a strong delevering story, so that when refinancing occurs the company has a smaller overall debt burden.”

The refi shift

Interestingly, Murthy says that while refinancing risk is a bigger issue than it was in the past, a slowdown in M&A activity in the sector has resulted in a shift towards more refinancing.

“While M&A has slowed we haven’t seen a reduction in dealflow, but the type of deals has changed. Now we see more refinancings as sponsors look to extend their investment to wait out this difficult M&A environment.”

This has also provided an opportunity for lenders that focus more on short-term debt provision and bridge finance, such as Berenberg. It offers unitranche and junior financing for infrastructure projects with typical durations of between one and three years, while a more conventional senior infrastructure loan might have a lifespan of between five and 30 years, reflecting the long-term nature of infrastructure projects.

“We have a situation where equity buyers and sellers can’t find each other and that makes our product, which offers short-term finance to bridge gaps and allow more time to prepare for a sale,” says Torsten Heidemann, head of infrastructure and energy at Berenberg.

He notes that this is particularly an issue for deals in the energy market today as the volatile price of energy, which dropped considerably when the covid-19 pandemic broke out, then spiked when Russia invaded Ukraine in early 2022 but has since fallen again. This can make it difficult for investors to agree a fair price for assets and more complex for traditional debt providers to underwrite.

Despite these recent difficulties, Schroders’ Segard says the long-term outlook for infrastructure credit is good.

“We have a lot of positive tailwinds such as energy transition which means we see a continuing supply of projects that need financing,” he says. “Most of it is in the energy and telecoms sectors, which makes up around two-thirds of our dealflow.”

He adds that while there is less M&A activity today, a lot of borrowers are instead opting for capex facilities to grow their business organically but with non-dilutive capital at a time when equity values are low.

While infrastructure debt is far from immune to the wider issues facing private debt as a whole today, it is relatively insulated from many of these concerns simply by the fact the projects managers back are seen as critical services that cannot be given up. With many governments signed up to strict international treaties to reduce emissions, energy transition will continue to be a major investment theme in the decades ahead, and improving connectivity in the telecoms sector is also seen as essential for bolstering growth as the economy begins to recover and market conditions normalise.

For investors, infrastructure debt funds are offering good returns in light of interest rate increases but with low risk of default. However, issues are affecting LPs, which could hamper their ability to increase their commitments to infra debt funds. 

LPs feel the strain 

Infrastructure debt is an asset class with many defensive characteristics that make it an attractive option in more volatile market conditions. However, LPs are facing wider issues that may be hampering their ability to invest in the asset class. 

The denominator effect, where a fall in the value of public market portfolios means many LPs are now overallocated to private debt, makes it more difficult for them to increase the capital they have committed to the asset class. The latest figures from PDI’s database paint a grim picture for fundraising in 2023, with just €1.39 billion raised across four funds in the first six months of the year.