The New Landscape of the Infrastructure Debt Market ------------------------- Opportunities for Banks and Institutional Investors Prof. Issam Hallak Mathias Wambeke 1 Vlerick Business School Report for the Centre of Financial Services at the Vlerick Business School 1 Issam Hallak is Professor of Banking and Finance at Vlerick Business School. Mathias Wambeke is Research Associate at Vlerick Business School. Contact: Mathias Wambeke, email: [email protected].
Transcript
The New Landscape of the Infrastructure Debt Market
-------------------------
Opportunities for Banks and Institutional Investors
Prof. Issam Hallak
Mathias Wambeke1
Vlerick Business School
Report for the Centre of Financial Services
at the Vlerick Business School
1 Issam Hallak is Professor of Banking and Finance at Vlerick Business School. Mathias Wambeke is Research
Associate at Vlerick Business School. Contact: Mathias Wambeke, email: [email protected].
New Landscape of the Infrastructure Debt Market
Opportunities for Banks and Institutional Investors
EXECUTIVE SUMMARY
While banks are the traditional suppliers of infrastructure loans, Basel III capital and liquidity
requirements have made these particularly long-term loans prohibitively expensive for banks.
Therefore, new players with less liquidity constraints are entering the infrastructure loan
market. In this note we report the latest trends in the infrastructure market using not only
numbers analysis, but also interviews with market players. We also present various possible
scenarios for the future. Even though we focus on the Belgian market, most features are
generalizable at European level.
The first result that comes out from our interviews is that pension funds and insurance
companies – the so-called institutional investors – view infrastructure loans as an investment
opportunity essentially for three reasons. First, infrastructure loans match the maturity
structure of the long term liabilities of institutional investors. Second, pension funds and
insurance companies are less concerned with liquidity issues. Third, among all infrastructure
loans, so-called Private-Public Partnerships (PPP’s) constitute the most suitable substitute to
government bonds because they provide higher yield at relatively low risk.
The second result is that institutional investors are yet faced with major challenges. They
lack the valuable expertise and network of banks, and are unwilling to take the higher risk
associated with the first construction phase of projects. Therefore both banks and institutional
investors see their partnership as a necessary condition for success. In latest deals we observe
that banks finance the construction phase, while institutional investors take over through a
refinancing once the construction is completed and operations start. Obviously respective
lending remunerations are function of the level of risk. Also a number of related innovations
are emerging, such as the pooling of smaller infrastructure projects, infrastructure debt funds,
and the development of infrastructure bonds. Challenges seem to be turned into opportunities
through financial innovations which benefit all market players.
Nevertheless, due to limited financing capacities, Belgian institutional investors are
unlikely to fill the gap left by banks. Hence, lower total supply is likely to lead to higher
yields, unless additional players enter the Belgian infrastructure debt market, whether these
are new financiers or international players.
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INTRODUCTION
The financing of infrastructure projects has undergone considerable changes in the past years.
While banks have been reliable suppliers of infrastructure loans in the past, there is general
agreement in the market that Basel III capital and liquidity requirements will make
infrastructure loans far more expensive for banks. As a result, institutional investors such as
insurers and pension funds are increasing their market share. In order to investigate current
and future developments of the infrastructure financing market, we conducted interviews with
experts as well as practitioners from the banking, insurance, pension fund, and private equity
industry.
Our interviews show that infrastructure financing constitute a major investment
opportunity for institutional investors. The long-term horizon – typically 25 to 30 years – of
infrastructure loans seems to match the long-term liabilities of pension funds and insurance
companies. Furthermore, liquidity constraints are less of a concern for institutional investors
compared to banks. However, these institutional investors still face some major challenges,
such as a lack of knowledge and skills in project risk valuation and pricing. Also the risk
associated with the first construction phase of infrastructure projects are viewed as excessive
by institutional investors.
In order to address such challenges, collaborations between banks and insurance
companies are set up, and innovative contracts reflecting this collaboration are designed. In
recent deals, banks financed the construction phase of the project, while institutional
investors financed the later operational and maintenance phase until maturity. This requires
substantial trust between the two partners. This innovative partnership has turned challenges
into opportunities for both banks and institutional investors to extend their own knowledge
and product range.
METHODOLOGY
Our study is chiefly based on interviews. We aimed at obtaining a comprehensive overview
of the market by interviewing representatives of each categories of market players. We first
split market players in five categories, and obtained interviews with representative
institutions of each of these categories in Belgium. The list of institutions who kindly
accepted to meet with us is reported in Appendix. Categories are:
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1. Main Lenders: we split the main lenders between banks – the traditional lenders –
and insurance companies and pension funds – the new lenders. We met loan officers
in charge of infrastructure and project financing in each of these institutions, or top
investment officers. Our selection of interviewees is in line with our objective to
obtain information from hands-on staff members as well as senior members.
2. Other Types of Funders: Other financiers include private equity funds and public
funding institutions. They represent the equity side of infrastructure investments. We
were interested in obtaining a view from equity funders about the changes in the
sector and their impacts on their activities, but also whether they witnessed and
forecasted changes in the equity side of the project financing.
3. Borrowers: We met with public entities active or potentially interested in
infrastructure financing. The objective was to obtain their opinions as to whether new
financiers have changed the rules of the game – or are expected so – and the pros and
cons of these new financiers for them.
4. Facilitators and Advisors: Financial advisors play a key role in the market and are
likely to be affected by the changes. Most financial advisors provide services to
borrowers. We expected a more sophisticated view of the changes in the market, still
somewhat from a borrowers’ perspective.
5. Regulators: We chiefly met with banking and insurance regulators in order to obtain
feedback about the regulatory factors that explain the changes as well as the potential
limitations foreseen.
Together with the interviews, we conducted an investigation of the current developments
of the infrastructure debt market using the Infrastructure Journal database. The
Infrastructure Journal database provides comprehensive information about all financial deals
related to infrastructure projects since 2005. Information includes details about debt and
equity deals, borrowers, arrangers and equity sponsors. We compiled statistics from
Infrastructure Journal to provide a picture of the market, but also to support the assertions of
our interviewees.
For clarity purpose, we define infrastructure finance the same way Infrastructure
Journal. Infrastructure projects are projects that are either largely supported by a concession,
operating in a regulated environment, or that benefit from a (quasi-)monopolistic position.
Such projects ensure a sufficient stability of cash flows in the medium/long term in order to
3
justify the traditional leveraged financing structures. Ports, oil pipelines, schools, hospitals
and prisons definitely fall under this definition. Hybrid structures such as car parks or
motorway service stations generally lack the necessary long-term stable cash flows or a
strong monopoly position in order to be included under traditional definition of infrastructure.
OVERVIEW OF THE INFRASTRUCTURE DEBT MARKET
a. Infrastructure finance needs, PPPs and recent developments in Belgium
In their report, the World Economic Forum estimated infrastructure investment needs to
exceed 4% of global GDP2. The structural growth of infrastructure investments is likely to
continue due to trends such as population ageing or climate change. However, the global
financial and debt crises have raised major questions about the financing of the infrastructure
market. While governments generally recognise the economic beneficial effects of
infrastructure investments, they are looking for formulas which do not inflate their ratios of
debt. The private financing of public infrastructure projects therefore appears to be a
promising market.
A major way of financing public projects without creating debt is by establishing a so-
called Private-Public Partnership (PPP). A PPP is a standard project finance where a special
purpose vehicle (SPV) is created partly funded with equity and to a large extent with debt.
Typically, equity is provided by the constructor consortium and private equity funds.
Sometimes, the commissioning public entity takes a minority share of the equity of the SPV –
up to 49%. The objective of the vehicle is to construct and operate infrastructures, whose
cash-flows are obtained either from operations or from direct payment of the ordering public
entity. PPP’s can be applied to any type of project, from toll-roads to hospitals and prisons.
Our interviews show that even though Belgium has been slow in establishing Public Private
Partnerships (PPPs), Belgian domestic market is today equally advanced in PPPs as any of
our neighbouring countries. Figure 1 illustrates such development.
2 World Economic Forum, 2012. Strategic Infrastructure Steps to Prioritize and Deliver Infrastructure Effectively and Efficiently.
4
b. New Banking Regulation affects Banks’ Infrastructure Financing
Because of Basel III new banking regulation, banks have reduced infrastructure
financing. The main motivation relates to the introduction of minimum liquidity ratios.
Infrastructure projects are typically very long term contracts – typically between 25 and 30
years – and Basel III liquidity requirements have made long term bank loans substantially
more expensive. Long term infrastructure financing create major mismatch between liability
and asset durations of banks. The second motivation relates to the “uncertainty” around
regulation: higher capital requirements and liquidity constraints may vary or increase.
Experience shows that banks could go through three major and tightening regulatory changes
within two decades, which is less than the average maturity of infrastructure loans.
As a result, banks have modified their investment preferences. As an illustration, Figure 2
shows that banks cut the average maturity of PPP loans in Europe from above twenty years in
the pre-crisis period (2006-2009) to ten years in the post-crisis period (2012-2013). Because
banks will not be able to provide as much long-term credit volume as they used to,
infrastructure projects will need to be funded by other intermediaries.
€0.2bn€1.2bn
€1.6bn
€4.6bn €2.6bn
0%
2%
4%
6%
8%
2005 2006-2007 2008-2009 2010-2011 2012-2013
Figure 1 - Belgium's share in the European PPP marketCompiled from the Infrastructure Journal database.
0
5
10
15
20
25
2005 2006 2007 2008 2009 2010 2011 2012 2013
Figure 2 - Average maturity (years) of PPP bank loans in EuropeCompiled from the Infrastructure Journal database.
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INSTITUTIONAL INVESTORS AND INFRASTRUCTURE FINANCE
Institutional investors, such as insurers and pension funds, show growing interest in the
infrastructure sector. For example, six majors UK insurance companies recently announced
they will invest £25bn in infrastructure projects3. From our interviews, we extract four main
motivations for institutional investors to be interested in the infrastructure debt market.
a. Motivations for Institutional Investors to Particip ate to Infrastructure Loans
We highlight four reasons why institutional investors enter the infrastructure debt market.
1. Long-term fixed rate investments suit their long-term liabilities
2. Low-risk investment suits their low-risk profile
3. New insurance regulatory environment
4. Current low interest-rates environment
The first reason is that long term fixed rate investments suits long term liabilities of
institutional investors. In our interviews, the latter emphasised that unlike banks their
liabilities have a very long term maturity. For instance, pension funds’ liabilities mature when
their customers retire, and life insurers have liabilities over their customers’ lifetime. Given
such liability structure, institutional investors favor long-term assets. Therefore, long term
investments such as infrastructure debts match their long-term liability structure. Should
banks have approached institutional investors in the past, they would have been just as
interested.
The second reason is the low risk investment which suits the low risk profile of
institutional investors. Typically PPPs are remunerated through an “availability fee” which
governments start paying as soon as the infrastructure is “available”, independently of the
extent to which the infrastructure is used. This fee is thus constant and independent of
business cycles. Therefore, creditors essentially bear sovereign risks during the operation
phase.
The third reason institutional investors are interested in infrastructure debts relates to
Solvency II, the new insurance regulatory environment. The Solvency Capital Requirement
(SCR) for insurance companies explicitly takes into account interest rate risk. More
specifically, the capital charge for interest rate risk in Solvency II is determined by the loss
which insurers face when their balance sheet is subject to interest rate shocks. This means
3 Financial Times, 4 December 2013, Insurers to promise £25bn for infrastructure.
6
that the capital charge will increase when insurers do not match their assets and liabilities.
Indeed, a mismatch between the duration of assets and liabilities will result in an interest rate
risk, which requires additional capital. The Solvency II matching adjustment4 further
encourages the matching of assets and liabilities. Because of their long term nature,
infrastructure loans are generally considered as a good match for institutional investors’
liabilities. Hence, infrastructure loans enable to obtain a low interest rate risk, resulting in
lower capital charges.
Solvency I had a very limited approach towards market or credit risks. Such risks were
merely addressed in Solvency I by setting concentration limits for certain assets. Solvency II
now explicitly addresses market and credit risk in its calculation of the SCR. The inclusion of
these risks into the new regulatory framework again means that insurers have to adapt their
investment strategy accordingly. Infrastructure debt is generally seen as a low risk investment
and therefore does not require substantial capital under Solvency II.
The fourth reason is the current low interest rates environment. Institutional investors
such as insurers and pension funds have historically always invested a large share of their
portfolios in government debts. As negative real returns have emerged for the core Eurozone
countries, institutional investors are now looking to new investment opportunities, with low
risk but higher returns. Infrastructure finance is one fitting candidate.
b. Major Challenges for New Entrants
New entrants to the infrastructure debt market are likely to face three major challenges:
1. Lack of lending and credit risk evaluation expertise;
2. Lack of network among construction consortia;
3. Unwillingness to finance the riskier construction phase.
Banks have traditionally been the exclusive suppliers of infrastructure loans. Therefore,
they have gained not only valuable lending expertise in this domain but also a network built
on confidence with construction firms. Lending expertise includes credit risk valuation and
loan contracting. Confidence with constructor companies builds on banks’ commitment to
offer contracting flexibility so to meet borrowers’ needs at best pricing terms. These two
advantages, lending expertise and network, are missing to new entrants.
4 The matching adjustment is a applied as an adjustment to the discount rate used to value liabilities. It encourages insurance companies to maintain their long-term investment horizon.
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Besides the lack of experience, institutional investors generally look for high grade
investments (A- is considered as the minimum). Yet infrastructure projects contain a risky
construction phase which makes the rating for an average project around BBB. Risks in the
construction phase essentially relate to potential delays in permits and construction, and
technical problems. Institutional investors seem unwilling to take these risks, leaving the
latter to third-parties.
Yet, some institutional investors are willing to take such risk, but still face expertise
problems. Provided they are sufficiently large to bear the cost, these institutions may decide
to hire skilled human resources specialized in this sector who would technically investigate
and evaluate projects, have a full understanding of the construction risks, and maintain a
relationship with constructing companies. They may then give loans with ratings below A-. It
is likely that these large institutional investors will soon be participating single-handed in big
infrastructure projects. Among others, our interviewees mentioned that at European level,
Allianz is already in this situation. Allianz has its own team, is ready to invest in PPP’s
including construction phases, and is indifferent between bond and loan financing.5 Another
example is AXA, which recently announced that it will allocate €10 billion to infrastructure
loans over the next five years.6
BANK–INSTITUTIONAL INVESTOR COLLABORATION
The expertise of banks in providing long term funding, together with institutional investors’
appetite for low risk and high duration investments creates opportunities for a new value
network in the infrastructure debt market.
Refinancing Strategy:
Banks finance construction phase, institutional investors finance later phases.
The construction phase is the first phase of the project and bears the highest risk. Risks
essentially relate to obtaining construction permits and construction delays. Banks are still
willing to bear these risks and finance the project at the early stage. In fact they have
sufficient risk valuation skills, and they stand ready for flexibility during the construction
phase. Our interviews show that it is widely acknowledged that Basel III mainly affect banks
in terms of maturity, so that providing longer term (30 year) illiquid funding is a problem,
while financing BBB rated loans is not (assuming medium-term maturity, e.g. 3 years). In 5 See also on Allianz site: http://www.infrastructuredebt.co.uk/en/Pages/default.aspx 6Financial Times, June 18 2013, AXA will lend €10bn for infrastructure projects.
8
fact, risk weights for such loans remain unchanged under Basel III. Thus, by providing
subordinated loans in construction phases, banks effectively enhance the longer term senior
debt provided by non-banks.
Once the construction period is completed, institutional investors either buy the
receivables of the project finance company, or provide a long term senior loan to the SPV.
Thus, institutional investors now hold a long term asset with stable yearly cash flows. Cash-
flows paid by the project finance entity are often determined by government payments to the
project finance entity. Importantly since the construction phase of the infrastructure project is
completed, little uncertainty remains. The main source of risk for lenders stems from a
default from the ordering public entity. Such event of default is viewed nearly as likely as
government default on public debts. As a result, the loan provided after the construction
phase benefits from a high sovereign rating, usually assumed to be above A-.
This division of respective advantages of banks and institutional investors does not only
make sense from a theoretical perspective, it is also observed in practice. As an example,
several interviewees mentioned that the bank Natixis regularly teams up with the insurer
Ageas when participating in public tenders. This collaboration already resulted in the
construction and operation of a highway, prison and railroad.7 ING bank also realizes the
benefits of collaborating with institutional investors and therefore has published, together
with Allen & Overy, an open standard for these type of projects. This standard, named
“Pebble” has been adopted by the International Project Finance Association (IPFA).8 The
Dutch N33 highway PPP project is an example of a funding structure based on the pebble
standard.
The regulator’s point of view
Insurance regulators and supervisors question the above collaboration between banks and
insurers. Regulators and supervisors want to exclude the possibility for insurers to
“outsource” expertise to banks in making investment decisions if they are not acquainted with
project financing. An assessment made by a bank or rating agency is insufficient to assess
risks of projects, and supervisors urge insurers to develop in-house risk valuation skills.
Therefore for relatively risky assets, insurers may use standard formulas up to a certain
duration of these assets, while they should develop an internal formula when investment
duration is above this threshold. The concern of supervisors is that looking at matching
7 Infrastructure Journal, 20 May 2013, “Ageas infra debt portfolio grows to €300m.” 8 IPFA, 5 December 2012, Pebble Consultation with the Industry.
9
maturities and matching cash flows only, may lead insurers to wrong investment decisions.
That is why insurance companies need to demonstrate that they sufficiently understand the
risks behind these projects, especially those in the construction phase. Yet, some supervisors
viewed bonds, including corporate bonds, as “excellent” investment instruments for insurers
as they provide more stable cash-flow and liquidity than loans, while being less complicated
compared to infrastructure loan.
INNOVATIONS IN INFRASTRUCTURE FINANCE
Pooling smaller infrastructure projects
Some projects are not eligible for a PPP construction because their scale is insufficient to
justify a thorough due diligence. As an example, some municipalities consider a PPP for their
local sports centre or swimming pool, but a PPP for such a €1 to €2 million project is
impossible due to the administrative burden. A possible solution is to pool similar projects
into one SPV. Recently, the Flemish Government set up “Schools of Tomorrow”, together
with AG Real Estate and BNP Paribas Fortis. This is a “Design Build Finance Maintain”
(DBFM) contract for a collection of local schools pooled into one SPV. With a total cost
estimated at €1.5 billion, this contract has a sufficient scale for institutional investors. The
goal is to build 165 schools by 2017, with no significant delays encountered so far.
Infrastructure debt funds
A large number of small institutional investors show interest in the infrastructure debt market,
but find individual infrastructure debt assessment time-consuming and would require
additional human resources. Among others, case by case due diligence analysis of small
projects is excessively time-consuming for investors with less than $1bn assets. Such
investors are more used to the documentation of ordinary investment funds. This is why
infrastructure debt definitely constitutes an attractive investment. Therefore “infrastructure
debt funds” is one solution. Some examples of recently launched infrastructure debt funds
include the Sequoia Euro Infrastructure Debt Fund and the Macquarie Infrastructure Debt UK
Inflation Linked Fund.
Nevertheless, these funds are new and lack skills. Institutional investors are used to
invest in infrastructure equity funds, and question how such infrastructure equity fund
managers may run infrastructure debt funds, and how they would function. Investing in
equity is a very different business from investing in debt: debt investments require skills
10
relating to the origination and structuring of debt, managing creditor control rights and skills
on how to renegotiate loans. Infrastructure equity fund managers usually do not have the
required experience in these areas.
A second complicating factor for such infrastructure debt funds are the large cross-
jurisdictional differences in regulatory requirements for providing loans. In Belgium and
Spain, for example, institutional investors are allowed to give loans to corporates, while in
France, licenced banks have a monopoly on loan activities9. Complex fund structures
comprising feeder funds may be necessary in order to start a pan-European infrastructure debt
fund which complies with all cross-jurisdictional regulations.
Fee structures can also pose problems for infrastructure debt funds. As infrastructure
debt funds will have an inherently lower return than their infrastructure equity counterparts,
fund managers will not be able to charge the same fee structure applied for equity funds. An
excessively high fee structure has been the reason why many infrastructure debt funds have
failed to gather sufficient capital in the past10. Nevertheless, we expect infrastructure debt
funds to become widespread over the next years once those issues are resolved.
Bonds in PPPs
One solution observed in the market is the issuance of project bonds. Opinions of
interviewees on the suitability of bond placements for PPPs are mixed. Some viewed bonds
as a means of providing liquidity and transparency to creditors. Nevertheless, some argued
that bonds with a maturity around 30 years are rarely seen in the marketplace today: a
standard bond is a bullet with a maturity of no more than 15 years.
Interviewees reported major issues are yet associated with infrastructure-related bonds.
First, issuing costs are higher, due to the documentation and rating. Second, bonds miss bank
loans’ flexibility, especially in terms of disbursement and repayment schedule, let alone the
provision of revolving credit tranches. This lending flexibility is essential to avoid additional
costs for borrowers. Last but not least, there is substantial pricing risk during the procurement
period. Indeed, unlike bank loans, pricing of bonds are usually only determined upon
issuance, and bonds are rarely underwritten. The government authorities must decide between
bank financing where interest spreads are offered and guaranteed by banks early in the
procurement process, and a bond financing where interest spreads are determined at the
issuance date. Bidders may offer to share the pricing risk, but they usually are unwilling to do
9 Infrastructure Journal, 16 May 2013, IFM debt fund to be sterling or dollar. 10 Infrastructure Journal, 18 March 2014, Macquarie to launch inflation linked UK debt fund.
11
so. To some interviewees, it will take several projects and several years before the
government can manage this uncertainty, but this will happen.11
As a result, project bonds are likely to be issued for sufficiently large PPP transactions,
likely above €100 million. Public offerings, which indeed provide highest liquidity for
subscribers, may be considered for the largest projects. Private placements, on the other hand,
will be more adapted to smaller contracts as they require less administration and on-going
expenses. Figure 3 shows that bond issuances were increasing in share of total PPP volumes
until 2006, but then decreased considerably in the period 2007-2011. The drop is due to the
disappearance of monoline credit insurance which typically provide an insurance on bonds12.
In 2013 however, bonds re-emerged in some larger PPP projects thanks to the support of the
European Investment Bank (EIB).
European Investment Bank’s Project Bond Initiative
The EIB’s Project Bond Initiative (PBI) is an important catalyst for bond issues in European
infrastructure projects. The EIB, through Project Bond Credit Enhancement (PBCE), either
provides a subordinated loan to the project company for half of the project cost, or provides a
guarantee if the cash flows generated by the project are not sufficient to ensure senior debt
service. The project company then obtains its remaining senior debt in the form of a bond
issued to banks or institutional investors. This bond will on average be A-rated thanks to the
EIB’s credit enhancement.
11
See e.g., European Investment Bank report, October 2012, for further discussion. 12 Monoline credit insurers used to provide credit enhancement for municipal bond issues and later moved to credit enhancement for securitizations. The monoline insurance business suffered heavily from the subprime crisis.
7
1624
1711 12
1 1
18
0%
1%
2%
3%
2005 2006 2007 2008 2009 2010 2011 2012 2013
Figure 3 - Share of bonds in European PPP transactionsThe number of tranches invloving bond issuance is indicated above the charts.
Compiled from the Infrastructure Journal databse.
12
The first deal that benefitted from EIB Project Bond Credit Enhancement is the Castor
Underground Gas Storage (Castor UGS) refinancing. This refinancing deal was made up of a
€1.4 billion, 21.5 year bond issuance, purchased mainly by institutional investors and debt
funds. The deal benefitted from the EIB’s PBCE program as EIB financed a €200 million
subordinated letter of credit, which effectively enhances the credit rating of the issued bonds.
Nevertheless, there are limitations to EIB’s support to infrastructure financing, and
specifically Project Bond Credit Enhancement. For instance, a few years ago, the hospital
group AZ Maria Middelares obtained €200 million financing for a new building from the EIB
(50%) and two commercial banks (50%). The financing included a 33 years tranche for
infrastructure. The project passed EIB audit tests and became eligible for funding under the
criteria of “promoting environmental sustainability.” Banks had two cut costs consequently.
New but smaller projects needed by the Hospital are yet unlikely to benefit from such
financing structure. The reason is that today banks are unwilling to lend for maturities longer
than 10 years. Besides there are regulatory limitations for hospitals financing schemes, and
the size is anyway insufficient for bond issuance.
LIMITED FINANCING CAPACITIES
Institutional investors we interviewed emphasised their limited financial capacities to
substitute banks in the Belgian PPP debt market, let alone infrastructure debt market as a
whole. We compared balance sheet dimensions of Belgian banks and institutional investors.
In Belgium, the combined size of the insurance and pension fund’s assets (around €270
billion) is not even a fourth of the consolidated banking industry’s balance sheets13. Similar
patterns are observed across Europe14. With a total of more than €1.6 billion of Belgian
infrastructure projects financially closed in 201215, Belgian institutional investors could
indeed be constrained in providing all of the funding needed in the infrastructure market.
Unless additional investors enter the market, the demise of banks in this sector is likely to
lead to lower funding supply, thus higher spreads.
13 European Banking Federation, 2012. European banking sector Facts and Figures IMF, 2013. Belgium: Financial System Stability Assessment OECD, 2013. Global Pension Statistics, http://www.oecd.org/daf/fin/private-pensions/globalpensionstatistics.htm 14 Insurance Europe and Oliver Wyman, 2013. Funding the future: insurers’ role as institutional investors 15 Infrastructure Journal, 2012, http://www.ijonline.com/
13
CONCLUSION
The private funding of public infrastructure projects appears to be a promising market.
However, banks are constrained in supplying infrastructure loans as Basel III capital and
liquidity requirements have become substantially more stringent. Therefore, new players
bearing weaker liquidity constraints are entering the infrastructure loan market. In order to
analyse these developments in the infrastructure market, we conducted interviews with
market players and gathered data from the Infrastructure Journal database.
We find that institutional investors have multiple incentives to assume a part of the
infrastructure loan market. First, institutional investors are less exposed to liquidity risk and
see infrastructure loans as a good match for the structure of their liabilities. Second,
infrastructure loans have an interesting risk/return profile compared to low-yield government
bonds that traditionally take up large shares of institutional investors’ portfolios.
In addition, we find that institutional investors are yet faced with major challenges: they
lack the valuable expertise and network of banks, and for now are unwilling to take the
construction risk of infrastructure projects viewed as excessive. Therefore, banks and
institutional investors more frequently team up in infrastructure debt. In recent deals, banks
finance the construction phase, while institutional investors take over the financing after the
project is completed and operations start. A number of related innovations are also emerging,
such as the pooling of smaller infrastructure projects, infrastructure debt funds, and the
development of infrastructure bonds. Challenges seem to be turned into opportunities for
innovations that will benefit banks as well as institutional investors.
However, the relatively small size of insurers’ and pension funds’ assets raises additional
challenges for the infrastructure market. Unless additional investors enter the infrastructure
market, a lower total supply might lead to less competition and higher spreads (to compensate
for further exposure).
We expect that the financing of infrastructure projects will undergo considerable changes
over the coming years. Banks will phase out their infrastructure debt and the remaining loans
provided by banks will have shorter maturities. Banks may even consider selling their legacy
infrastructure loans on the secondary market. Institutional investors will instead become
important players, and gain in skills. There is going to be a transition period where banks and
institutional investors will probably extend their collaboration. The EIB is likely to continue
supporting infrastructure projects in this transition period, and which will give rise to a wider
use of project bonds. A final expected development is the expansion of infrastructure debt
14
funds, which are viewed as an interesting way for smaller institutional investors to enter the
infrastructure market. Yet, infrastructure debt funds still need to find a suitable setting.
ACKNOWLEDGEMENTS
We wish to thank those who kindly accepted to meet with us and patiently answered our
questions. We appreciate the dedicated time, and their contribution was essential for this
study. Also, we wish to thank David Devigne for his valuable help, and Stephan Cammaert
for his excellent assistance.
15
APPENDIX A
LIST OF INSTITUTIONS
List of institutions we interviewed for this study. Unless indicated, we met with top management of indicated divisions.
- Ageas: Investment Division
- AZ Maria Middelares Hospital: Directors.
- Clairfield/SynCap: Project Finance Division
- Cofinimmo: Treasurer
- DG Infra: Directors
- European Commission: Insurance and Pension Fund Regulator
- ING: Infrastructure Loan Division
- KBC Loan Division
- KBC Pension Fund
- National Bank of Belgium: Banking and Insurance Supervisors
- PMV Flemish Investment Company: Infrastructure & Real Estate Division
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APPENDIX B
CASE: CASTOR UNDERGROUND GAS STORAGE
The Castor UGS Project
The Castor UGS project is a 1.3 billion cubic metre submarine natural gas storage facility. It
is located in a depleted oil reservoir in the east coast of Spain. The facility serves as a
strategic reserve intended to assist in ensuring Spain’s gas supply. It is able to provide up to
25 million cubic metres of gas per day (i.e. approximately 30% of Spain’s consumption) and
can sustain this supply for 50 consecutive days. The special purpose company Escal UGS
S.L. has been awarded, in 2008, a 30-year concession to construct and operate the
underground offshore gas storage facility. Revenues are provided by grid users, which in turn
are passed onto Spanish gas consumers. The project operates under the regulated asset value
regime, meaning that the cash flows paid to the SPV are not impacted by the actual
utilisation, changes in the performance, or adjustments in the operating or capital expenses of
the project.
Initial Financing
The project was financially closed in June 2010. The table below provides details on the
different debt tranches.
Tranche name Amount Pricing Maturity
Term loan €1.276 billion Euribor + 300 to 450 bps 10 years
VAT facility €9.5 million 5 years
Letter of credit €32.83 million Euribor + 250 bps 5 years
The construction phase was financed through €209 million of equity and a debt total of €1.3
billion, of which €1.276 billion is a term loan with a 10 year maturity, priced at Euribor + 300
bps to 450 bps post completion. Part of this debt was used to refinance a €200 million short-
term bridge loan. Other debt tranches include a €9.5 million VAT facility and a €32.83
million letter of credit. These last two tranches have a 5-year maturity. The debt-equity ratio
of this project is 85:15. The five mandated lead arrangers were Banesto, Santander, Caja
Madrid, Credit Agricole, Société Générale, joined by a team of 14 other arrangers.
Refinancing
The construction phase of the Castor project was finished in July 2012, with the only
remaining major milestone being the injection of cushion gas into the reservoir. The
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refinancing deal, including a €1.4 billion bond issue and a €200 million letter of credit, was
closed in August 2013. Proceeds of the refinancing were used mainly to repay existing loans
that funded the construction phase. A smaller portion of the loans were issued to meet other
costs and expenses required to achieve project start. A simplified scheme of the Castor UGS
refinancing is provided in figure 4.
Figure 4 – Key actors in the Castor UGS refinancing
Spanish Government
European Investment BankProject Bond Credit
Enhancement€200m subordinated letter of
credit21.5 year maturity
Bondholders61% institutional
investors21.4% EIB3.9% banks
€1.4bn project bondsRated BBB+
5,756%21.5 year maturity“Escal UGS”
Project SPV and borrower
Concessions
PB
CE
agr
eem
ent
Final compensation (€)
The Castor refinancing was the first deal to benefit from the EIB’s Project Bond Credit
Enhancement Initiative. This initiative entails a €200 million letter of credit used to cover
cash shortfalls upon an event of construction shortfall, restoration of target ratios, scheduled
debt services or accelerated payments. This form of credit enhancement allows the project to
achieve a credit rating more attractive to bond investors. Furthermore, the EIB will also
purchase €300 million of the bonds as an anchor investor.
A total of €1.4 billion bonds have been issued through this refinancing. These bonds are
amortizing over a 21.5 year maturity and pay a semi-annual coupon of 5.756%. The bonds
have been rated BBB+ by Fitch and BBB by Standard & Poor’s, a notch above the Spanish
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sovereign rating. BNP Paribas, Credit Agricole, Bankia, La Caixa, Natixis, Santander and
Sociéte Générale were the bond arrangers.
The final bond investors are composed of:
61% institutional investors
25% agencies, including the EIB’s €300 million senior debt investment
10.2% fund managers
3.9% banks
Hence, this bond deal is a good example of how institutionals are set to invest in long
term infrastructure deals, when construction risk has been properly taken care of. Indeed,
construction has been largely completed before the refinancing round, and the EIB provides
additional risk mitigation in an event of construction shortfall.
Conclusion
The castor UGS refinancing is a successful example where infrastructure debt has been
issued to institutional investors. The long term nature of the project (the bonds mature in
2034) is a good match for institutional investor’s long term liabilities. The cash flows to the
SPV are highly stable and predictable, resulting in an investment grade rating for the project
bonds. Construction risk has been mitigated through completing the construction to a large
extent before the refinancing round. In addition, the EIB’s subordinated liquidity facility
provides an effective means of credit enhancement. This combination of a long term and low
risk investment attracted institutional investors: 61% of the bonds were issued to institutional
investors, compared to only 3.9% to banks.
REFERENCES
ESCAL UGS S.L., 24 October 2013, Report UGS Castor.
ESCAL UGS S.L., 28 January 2014, Report UGS Castor.
European Investment Bank, 28 April 2010, Castor Underground Gas Storage. EIB Pipeline.
