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Fixed Income

Infrastructure Debt: Steady Activity, Lingering Macro Doubts

2019 October - 4 min read

Despite the expected seasonal summer slowdown, infrastructure debt financing deals remained steady overall in the third quarter of 2019—with strong activity in the U.S. and Canada, and slightly slowing activity in Europe, with a cautious eye toward Brexit.

Highlights

Infrastructure debt financing activity held steady in the third quarter despite the expected summer slowdown. In the U.S. and Canada, much of the financing activity was in energy infrastructure—particularly the midstream, renewables and conventional power sectors. In Europe, Brexit-induced volatility led to a preference for high-quality, utility-type assets. Australia also remained active with refinancings of core assets and an uptick in greenfield public-private partnership (P3) opportunities.
 

Americas: Energy Infrastructure Driving Activity

Midstream—Pipelines and Liquid Natural Gas (LNG): Shale gas production and energy exports—particularly the export of LNG—continue to drive the majority of infrastructure spending in the U.S. As significant investment is required to deliver hydrocarbons from their drilling locations to refineries and end markets, pipelines and LNG export facilities have presented attractive financing opportunities.  

Power: Conventional power deals—typically a mainstay of bank project financings—became a larger part of the institutional debt market in the third quarter. Driving this was the combination of increased new build activity for combined-cycle gas turbine plants, as well as increased willingness by institutions to underwrite construction risk. Cash flows associated with merchant energy sales were part of a number of third-quarter power deals, a deviation from institutional lenders’ historic focus on solely contracted cash flows.

Renewables: Contracted renewable wind and solar projects continued to drive deal flow in the third quarter, but both institutional bond and bank pricing became increasingly competitive. In California, regulatory risk for renewable projects seemed to recede with PG&E’s announced, but not yet approved, reorganization plan. Assuming all existing Power Purchase Agreements are executed, this plan could also reduce associated exposure concerns for lenders, including banks and some institutions.
 

Europe: Preference for High-Quality, Defensive Assets 

Core Assets: In Europe, continued uncertainty around Brexit caused financing activity to slow and dampened new investment in greenfield U.K. projects. However, core, utility-like, defensive assets—such as water, sewage and distribution systems—remained a source of financing opportunities. Additionally, rolling stock—a key transportation asset in the train-reliant regions of continental Europe and the U.K.—provided deal flow.

Fiber: The internet and digital economy—supported by the European Union’s pledge to deliver urban and rural connectivity to all European households—is driving the acceptance of assets such as data centers and fiber networks as infrastructure. Government support in these jurisdictions often includes some combination of monopoly service areas, state-owned aggregators and developers, and state-owned offtakers.
 

Other Themes

Holding Company Financings: Sales of partial ownerships in high-quality infrastructure assets provided a source of value-add financings during the third quarter, given the more limited number of lenders available to finance these positions. The underlying assets of these deals typically consist of steady, cash flowing critical infrastructure—such as hub airports, regional utilities or key regional pipelines.

GDP-Linked Assets: Projects with low investment grade credit profiles and exposure to macroeconomic factors—such as GDP growth and trade volumes—fell out of favor, and overall demand declined. Investor demand for increased pricing led to at least one existing deal being pulled during the quarter. 

Core Australia Development: In Australia, there was a renewed push for the development of core infrastructure assets. Bid submissions for a major road project in Victoria was completed, as was the refinancing of the Melbourne Airport.
 

Outlook

Following a ramp-up in September, we expect to see a busy pipeline of financings through November. Lower interest rates and demand for steady cash flow yields will likely drive activity in the space.

  • Renewables, Power and Midstream: In the U.S., we expect to see continued opportunities in renewables, and particularly in solar, where lower project and solar panel costs are supporting continued development. In the power sector, there may be an increase in speculative merchant cash flows as institutional lenders become more willing to take on refinancing risk. In midstream, at a time when speculative gathering systems are being built and financed in various basins, we believe established, contracted and cash-flowing pipelines look particularly attractive.
  • P3 Projects: Globally, fewer P3 projects are being developed given the increased political uncertainty in the U.K. and continental Europe—the core P3 markets. In the U.S., while no federal P3 bill has materialized, projects continue on a state-by-state basis. For instance, many state universities are privatizing energy systems to generate lump sum cash payments for their core educational missions. Social infrastructure assets—such as courthouses and civic centers—are also being developed on a one-off basis by counties and municipalities. We expect these projects to continue providing financing opportunities, although pricing may be tight.
  • GDP-Linked Assets: The refinancing of existing debt on GDP-linked assets, particularly in the U.K. and Europe, will likely provide opportunities in the fourth quarter. However, asset quality and pricing will require scrutiny, given the increased economic and political volatility in these markets. As Brexit continues to play out, defensive asset classes such as utilities and social housing may remain in higher-demand in the U.K.
  • M&A and Value-Add: Strong demand for steady, cash-flowing infrastructure and energy assets—particularly from strategic equity investors and institutional investors with long-term horizons—has kept prices high. While it’s difficult to predict M&A activity, we expect to see an increase in control transactions, as well as sales of partial interests, as sponsors and developers look to take profits, and other investors look to deploy capital. Renewable portfolio sales are likely to continue as well—a deep buyers’ market for these portfolios exists now, as non-infrastructure private equity funds continue to pursue steady cash flows, and international investors look to gain efficient scale and exposure to the U.S. renewable market.
     

In addition, as lenders continue to seek yield in the extended low-rate environment, we expect to see more non-traditional debt offerings—including minority holdco structured transactions, deals from Latin America, and power deals with merchant cash flows. That said, careful analysis is critical to ensuring returns are adequately compensating investors for the fundamental risks being assumed.

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