The Infrastructure Debt Conundrum – Is There a Role for Debt Funds?

By Jorge Rodriguez

Financing for all types of infrastructure projects, from construction of new facilities through brownfield acquisitions has been severely affected due to the financial crisis. Traditional sector lenders, the European commercial banks, have become increasingly capacity constrained as they refocus their strategies on home markets and core client relationships. Furthermore, increased capital pressure from regulators and sovereign debt issues have further reduced the lending capacity of these banks.

These financing challenges have also acutely affected the market for private infrastructure acquisitions. Prior to the crisis it is estimated that private infrastructure acquisition financing in Europe and North America reached as much as USD60bn per annum. During the crisis lending declined 90% from its zenith in 2007 to its nadir in 2009.

This lending model remains a far cry from the banks’ pre-crisis appetite which included the regular underwriting and syndication of unrated deals down to an implied BB credit rating. Lending remains constrained by the lack of lenders, in fact it is estimated that active infrastructure lenders have declined from 50-60 globally pre-crisis to roughly a dozen today.

Nor is this dynamic expected to change in the near to medium term. Those lenders that remain active in infrastructure are enduring both weakness in their legacy balance sheets and turmoil in the Eurozone sovereign markets. In the absence of a syndication market for infrastructure loans, banks have been relegated to “buy and hold” positions on club deals which further exacerbates the capital issue by preventing the customary recycling of capital.

Debt Bottleneck Causing Dry Powder To Accumulate
Private infrastructure equity fund (infrastructure fund) acquisition activity has been severely curtailed since the financial crisis. The primary restriction to deal activity has been the scarcity of dedicated sector debt as described above.

Since 2006, USD150bn has been raised privately by infrastructure funds and, according to Preqin, infrastructure funds are sitting on an equity backlog of approximately USD60bn as of March 2011. It is important to understand why this huge amount of money is on the sidelines.

Simply put, the lack of adequate acquisition financing is a significant bottleneck to the deployment of infrastructure fund money. Potentially lucrative acquisition opportunities are not being pursued because debt levels do not provide an efficient capital structure or proper allocation of risk for infrastructure funds. To be clear, the model does not require excessive debt to work, but with acquisition debt limited to investment grade club financings there are a limited amount of acquisitions that make sense for infrastructure funds.

Meanwhile allocations to infrastructure funds continue to grow, further exacerbating the equity backlog. According to Preqin over 120 infrastructure funds are currently on the road seeking to raise USD86bn. Given the enormity of the equity funds dedicated to the sector as well as the required refinancing of existing deals, it is estimated that there is demand for over USD250bn in private debt over the next five years.

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