In the currently volatile market, bankers and investors may be looking toward infrastructure as a relatively safe asset class, assuming it to offer stable returns with relatively little ri
In the currently volatile market, bankers and investors may be looking toward infrastructure as a relatively safe asset class, assuming it to offer stable returns with relatively little risk. But as Standard & Poor’s Ratings Services warns in a new report, bank lenders and institutional investors have traded favourable debt terms against the management of credit risk during the infrastructure finance boom of the past 18 months.
Now, with the cycle turning in the global credit markets, these loosely structured and highly leveraged loans are looking far less attractive. As a result, it is estimated that up to USD34 billion of leveraged infrastructure loans may be left paralyzed under current market conditions.
The report, titled ‘The Changing Face Of Infrastructure Finance: Beware The Acquisition Hybrid,’ highlights the increasing combination of project structuring techniques with the relatively slack covenants prevalent in leveraged finance facilities.
This new form of acquisition hybrid lending has allowed sponsors to acquire assets at record-breaking debt multiples, but has simultaneously dragged down credit quality across the infrastructure sector.
‘Many assets recently purchased for eye-watering acquisition multiples have failed to boast the operating and cash flow strengths assumed typical of infrastructure assets,’ said Standard & Poor’s credit analyst Michael Wilkins. ‘Such risks are likely to be exacerbated as credit markets become increasingly volatile and investor confidence fragile.’
Investors and lenders alike therefore need to examine the risks associated with each individual transaction when looking to acquire infrastructure assets and, if necessary, seek more credit protection than is currently being provided within the hybrid structure.
Not all assets can be assumed investment grade. For example, Associated British Ports (ABP) was purchased for GBP2.8 billion, with a debt-to-EBITDA ratio of 16.6x. Despite the asset’s strong monopolistic position and stable cash flow, these terms are unlikely to fully mitigate risk arising from the high level of debt. Nor are they likely to mitigate market risks such as the increasing environmental and regulatory hurdles limiting ABP’s ability to expand capacity in the future.
Furthermore, sponsors have also been using the hybrid structure to acquire assets not traditionally considered as infrastructure–such as car parks, motorway service stations, and motor vehicle certificates. These assets do not benefit from the significant track record of traditional sectors such as ports, and therefore may be even less suited to supporting such high debt multiples–lacking the necessary long-term stable cash flows or a strong monopoly position in the market.
Poor performance among key assets such as the UK-based underground rail infrastructure financing companies Metronet Rail BCV and Metronet Rail SSL has served to highlight that there are some notable exceptions to the rule that infrastructure represents a stable asset class. We nevertheless recognize that for well-structured and more conservatively leveraged transactions, such as the refinancing notes issued in August 2007 by Channel Link Enterprises Finance PLC as part of the GBP2.8 billion securitization of Eurotunnel, it is still possible to achieve investment-grade underlying ratings.
‘Hybrid structuring techniques must be restricted to infrastructure operating within monopolistic environments with stable cash flows over the long term,’ Mr Wilkins added. ‘Moreover, high leverage should be accompanied by the necessary structural package and creditor protections.’