Infrastructure debt – sexy but complex

Despite their complexity investment in infrastructure debt can be quite attractive

In the past infrastructure investment have predominantly been made by private equity managers. However, the desperate search for yield other investors have drawn into this assetsegment.

The debt element of infrastructure projects offers greater insight for investors than the equity side. Stable and recurring cash flows and ultimately the return of capital are well known fixed income elements. For many investors the long duration is a welcome and additional argument helping to close duration mismatch.

A complex asset segment

Whilst many elements are well known their others that require expertise to invest successfully and private infrastructure debt. Many investors are still considered at the low end of their learning curve as this segment is relatively new and it combines elements of bonds, real estate and private equity. Furthermore infrastructure projects involve political and demographic risks in addition to a liquidity and counterparty risks. These new risks at a level of uncertainty which is difficult to price.

Three elements ultimately contribute to the credit spreads: the repayment risk, the illiquidity and the complex nature of this investment.

Apart from analysing the structure of the financing, you need to consider a regional aspects as well as the project focus itself.   Some managers for gross on providing subordinated loans, which for behind the bank debt and others prefer senior debt, which tend to be richer but safer. Some prefer greenfield sites, which their risks much beyond the known ones but yield substantially more than brown field sites. The letter warns usually have comparable projects elsewhere that already exists and produce cash.

Alignment of Interests

Basel III forces banks to reduce their loan portfolios and RWA’s. In theory this leads to a wider offer but in fact banks are opportunistic enough to enjoy a portion of loans that produce stable income which does not lead to the alarming trend worsening asset quality banks are experiencing.

On the other hand you cannot and should not avoid working with banks using their experience in lending to complex projects. You will notice quite a bunch of former bank loan managers turned asset managers.

However if banks are caught shipping their loans into special-purpose vehicles that are ultimately funded by long-term investors you should focus on the way the lawns are considered eligible prior to moving them into your accounts. Alignment of Interests is one recipe that could help you in retaining their commercial interests: they retain a sizeable portion of the special-purpose vehicle and the risks associated with it.

Equity or Debt ?

In case you are invited to join a great deal you are much better off funding the entire portion with equity. However, as you never know a great deal in advance you should consider the coal investments aspect with a private equity investor holding the equity portion and you holding the dead portion.Think about the following: the manager of the toll road goes belly up and with him your entire equity portion. If you were the debt owner you wait for the successor and join him for a new beginning provided the local government has not closed the road for traffic and kept it exclusively for mules.