Fitch: Growing Capital Pool Driving Riskier Infrastructure Deals

The ever-increasing pool of capital allocated to investing in infrastructure will drive a new wave of riskier "infrastructure-like" transactions that mirrors what was seen in 2007-08, Fitch Ratings says.

Life insurers, fund managers and pension funds are increasing their allocations to infrastructure transactions as they seek out stable returns from real assets. Our conversations with investors suggest this trend will continue. However, years of austerity measures in many countries has resulted in a very limited flow of new traditional infrastructure projects, as in some cases privatisations have already been done or budgets are limited for PPP-like activity.

So far, investors have focused on buying and refinancing existing assets, which, given the level of competition, has led to higher multiples being paid for assets, but not necessarily the higher gearing seen in the past. This is because the emergence of long-term infrastructure private equity investors since 2007-08 has helped change the market.

 

These investors are more aligned with debt investors in looking at the long-term stability of a business and thus keeping leverage within manageable levels. Previously, some short-term infrastructure equity investors were structuring highly-leveraged transactions and expecting underlying asset improvement together with more favourable debt terms, enabling them to refinance transactions within five years and improve equity returns.

Now, we are starting to see growth of transactions that are structured like traditional infrastructure investments, but which involve assets not previously considered infrastructure, such as airport services or landing slots. Some market participants refer to this as "Asset Class Stretch".

These transactions, which have become a hot topic at industry conferences, are often referred to as "infrastructure-like," "hybrid infrastructure," "infrastructure plus" or "non-core infrastructure." They are likely to be fundamentally riskier than traditional infrastructure deals (which some now call "Super Core Infrastructure") because the underlying asset may be less essential to the public, may not have the same high barriers to entry and may experience more variable costs, together with less sustainable revenue streams. Such financings would likely require lower leverage than more traditional infrastructure projects to achieve investment-grade ratings.

This trend is reminiscent of 2007-08, when transactions involving private hospitals or care homes businesses were being structured in a similar way. While, at inception, they were considered to be essential services, some of these assets were shown to have a higher cost base and insufficiently stable revenue streams, resulting in an inability to sustain the leverage generally associated with infrastructure deals.

However, other innovative assets that emerged at the time, including telecom towers or smart meters, are now considered by some market participants as "core infrastructure" assets. Therefore, the new flow of "infrastructure-like" transactions could involve some assets that will be eventually considered "core infrastructure" assets.

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