Road race

Infrastructure finance in Europe has attracted more than its share of interest from new investors in the past two years. Now, it’s luring a certain type of veteran player out of retirement: banks.

In the years immediately following the financial crisis, bank lending for just about anything in Europe, including infrastructure projects, fell apart. However, such liquidity constraints now appear to be water under the Mersey Gateway Bridge.

Enticed by low default rates and relatively wide loan margins, some European banks – nine from Scandinavia, Germany, the Netherlands and most recently France – that exited the infrastructure space following the crisis have returned, market participants say.

“Within the EU, banks and institutional investors are trying to figure out where to put money to work to optimise risk and return in a market where returns are being squeezed by expansionary monetary policy,” said Andrew Davison, senior vice-president, infrastructure finance, at Moody’s.

Top of the list

“Infrastructure is now at the top of the list for many organisations. For banks in terms of loan margins and for bond investors in terms of credit spread, the sector is more attractively priced than other asset classes,” said Davison.

There’s also this: “Most of the banks lend on a floating basis, and most borrowers prefer to borrow on a fixed-rate basis,” said Priya Nair, managing director, infrastructure and structured DCM at Royal Bank of Canada in London.

“As a consequence, the bank loan product can be lucrative to banks as typically borrowers will seek long-dated swaps to match the corresponding loan. The swaps can be capital-intensive but lucrative, nevertheless.”

This renewed interest from the bank market brings additional competition for assets to a sector already crowded with infrastructure funds and institutional investors looking to pick up yield.

At the start of the fourth quarter, there were a record 152 infrastructure funds targeting an aggregate US$95bn globally, according to Preqin, the alternative assets data provider. And while not all of those funds are seeking assets in Europe and the UK – as of Q4 2014 some 68 funds were targeting Europe specifically – this is precisely the geography garnering the most attention from institutional investors.

Preqin currently tracks 675 European investors with an allocation to infrastructure opportunities, 41% of which are a form of pension scheme. Of those pension schemes, 71% are seeking European investment opportunities, either exclusively or as part of a more global mix, according to survey results released in July.

“The demand from institutional investors has increased, in terms of the number of investors, the ticket size that each investor is able to contribute and the terms that they’re able to agree to,” said Stewart Robinson, European head of project bonds at Societe Generale. “Appetites have changed drastically.”

Societe Generale and Credit Agricole acted as co-lead arrangers on the recent €430m project bond that provided funding for the A7 federal highway in Germany, which was priced with a 2.957% coupon.

The project was the latest of five supported by the European Investment Bank’s Project Bond Initiative, which supplied a further €170m in subordinated debt.

Indeed, efforts to stimulate the project bond segment of the market – including the EIB initiative and the UK Infrastructure Guarantee programme, which provides a monoline-like bond guarantee and earlier this year backed roughly €340m worth of bonds to help fund the Mersey Gateway Bridge project – are at least part of the reason institutional investors have begun paying more attention.

“Investors have seen the EIB saying, ‘I’m here, I’ve done due diligence, and if I’m willing to be in this transaction in a subordinated position does that not give you comfort that you’re in a senior position’?” said Katrina Haley, head of structured bonds EMEA at HSBC, which arranged the Mersey Gateway bond transaction.

“In that respect it’s been very successful. Is it essential any more, do you need it? Perhaps not so much. Most issuers now have a choice of debt sources, and that’s something that a couple of years ago they didn’t have … It’s more of a sellers market at the moment.”

“The funding mix for infrastructure and projects is very much that, a mix. There’s a much greater diversity of options available. And some of the larger transactions coming to market will really require sponsors and borrowers to look across that funding mix”

This is fantastic if you’re an issuer, especially those hoping to finance large projects that fit the classic definition of infrastructure such as a road, railway – anything transportation related, really.

According to the Preqin survey, core infrastructure sectors are the most popular among European pension plans, with 57% investing in transportation, 57% in the energy sector, 48% in utilities, and 37% in telecoms assets. With the availability of bank loans, bonds and equity; infrastructure funds and private placements; the options appear to be wide open.

“The funding mix for infrastructure and projects is very much that, a mix,” said Tim Conduit, a partner at British law firm Allen & Overy. “There’s a much greater diversity of options available. And some of the larger transactions coming to market will really require sponsors and borrowers to look across that funding mix.”

Challenges for newbies

Increased demand, however, presents a challenge for investors, many of which have only recently entered the project bond market. For one, it affects one of the main reasons they jumped on board in the first place: pricing.

For example, according to data by HSBC, a number of sterling-denominated project bond transactions have experienced spread compression on the secondary market:

– Derby Hospital traded at Gilts+165bp a year ago versus Gilts+140bp now;

– NATS, the air traffic control services provider, traded at G+135bp a year ago versus G+125bp now;

– Greater Gabbard, the offshore wind farm, was priced at G+125bp in November last year and is now trading at G+115bp.

As spreads get squeezed, some institutional investors are broadening their definition of infrastructure, as well as considering projects with lower ratings. These include public housing, liquid natural gas and biomass projects, though it should be said that, in some cases, these institutions have provided equity rather than debt.

“Nine months ago, some of these investors would not have looked at sub-investment-grade names, nor would they look at transactions where the asset is pushing the boundaries on infrastructure,” RBC’s Nair said.

“There’s been a bit of a change from the institutional side, a willingness to look at assets outside what would have been their original scope.”

Austerity effect

Some market participants do complain about a lack of projects in which to invest, which can, at least in part, be attributed to austerity measures in many European countries.

Completed project bond issuance in Europe stood at roughly US$6.6bn over 10 deals at the start of September, according to data provider Dealogic. (These numbers do not include the A7 transaction, which would bring the total to more than US$7.1bn). This is down some from 2013, which saw 16 transactions (nine of those in the UK) totalling roughly US$11bn, during the same time period.

That said, 2013 saw a huge increase in financing over previous post-crisis years. So the number of transactions, relatively, has improved; it’s just that competition for assets has outpaced any increase in volume.

And while most market participants don’t see issuance sky-rocketing in the near future, they do see activity and point to a few large deals in the pipeline, such as the £4bn Thames Tideway tunnel project.

Whether issuance will pick up enough to meet demand is the big question.

“There may be a reassessment of investment criteria, with some of these funds saying, I’ve been open for business a year, and I haven’t been able to buy anything … Or maybe they’ll go and widen their criteria to target other sectors or different geographies,” said HSBC’s Haley.

“It’s going to be an interesting time over the next three to 12 months to see if there is room for everybody, if there is a reassessment or if the project pipeline accelerates and there’s more assets for everyone to buy.”