Heart of glass

Loans to infrastructure companies promise steady, predictable returns backed by solid assets. They are the sort of businesses that, in theory, shy away from fancy financial engineering – more solid redbrick than tinted glass. But during the credit boom, brittle structures did find their way into the infrastructure market and these may now start to crack. Ouida Taaffe reports.

A recent report from Standard & Poor’s – The Changing Face of Infrastructure Finance: Beware the Acquisition Hybrid – argues that by combining the looser covenants of leveraged financing with more traditional project financing, banks have created a “significant credit risk to the infrastructure sector”.

With new loan mandates from Southern Water, UUE and BEB Transport all expected in the autumn, a souring in sentiment could have unpleasant consequences. However, although banks agree that the definition of what constitutes infrastructure has changed over time, not all are convinced that this constitutes a problem.

“The so-called hybrid structure, with both elements of leveraged financing and project financing, is now what constitutes the infrastructure market,” says Dan Darley, a director in the infrastructure team at Dresdner Kleinwort. “It has an established track record. Where you see these tools used, there are always very favourable financing dynamics at companies that are often monopolies and often regulated.”

Furthermore, banks stress that they are still keen and have comfort that loans will be repaid.

“The typical profile of an infrastructure or infrastructure-like asset generally includes long-term visibility on revenues and cashflow and protection from cyclicality,” says Rebecca Manuel, managing director, head of corporate and structured loan syndicate at RBS.

Both Dresdner and RBS are currently working on infrastructure deals, notably the £3.4bn loan backing Macquarie‘s acquisition of National Grid Wireless (NGW), which is expected to be launched into general syndication this week.

As lenders become more wary about where they deploy capital in light of continued credit market turbulence, many in the market now believe that some sectors hitherto characterised as infrastructure will come under closer scrutiny.

“It should ideally be a regulated asset with a monopolistic market position. I think people will start to look closely at what really is infrastructure and, on the back of that, what the appropriate leverage and covenant structure is,” says Ashu Khullar, managing director in the fixed income capital markets group at Citi.

“Quasi-infrastructure credits will see both acceptable leverage levels and pricing firmly questioned. Real infrastructure assets will suffer much less, though they would most likely see margins go up.”

Furthermore, Khullar notes that lenders and borrowers have to come to terms with the new lending environment, saying: “In a market where banks have to ration credit, relationships matter – as do appropriate tenor and returns.

“I don’t buy the argument that all infrastructure type credits necessarily represent quality and that there will be a flight to that broad asset class. Banks will differentiate true infrastructure from quasi infrastructure.”

Darley agrees that funds have retreated from the infrastructure loan market, but does not see this as a reflection of concern about the underlying credits.

“This is a liquidity issue and the continued demand, albeit muted, reflects a flight to quality,” he says. He points out that junior infrastructure credit is currently trading better in secondary than comparable leveraged paper.

“Second-lien leveraged paper could be priced anywhere in the mid-90s while junior infrastructure pieces would only be one or two points below par – though both in a very illiquid market,” says Darley.

Neither Manuel nor Darley suggest that all infrastructure assets are created equal.

“Some assets financed do not fall into the ‘classic’ infrastructure box, but still have some infrastructure characteristics. Then underwriters have to take a view,” Darley says.

“Motorway service stations, for example, though not classic infrastructure, do have the strong dynamics you would expect from an infrastructure credit. They almost always benefit from some sort of protection as planning regulations along motorways are tight.”

Others are not so sure. “Taking the definition of infrastructure to include motorway restaurants is, to my mind, very stretched. You don’t necessarily have to eat at a motorway service station,” says one senior London-based banker.

The current motorway service station facility in the market, a loan backing the buyout of Autobahn Tank & Rast, is mandated to Barclays, RBS, SG and UBS and is said to be set for launch to general next week.

The leads are confident on the reception of Tank & Rast, though reluctant to give away detail. The company generates much of its revenue from petrol sales, which are considered highly predictable.

In terms of the wider view of demand for infrastructure credit, “underlying credit metrics and dynamics of a business case are what counts and we believe that investors understand that each transaction needs to be analysed on its own merits”, says Manuel.

Michael Wilkins, managing director of infrastructure finance ratings at S&P, argues in the report that “with US$332bn in leveraged loans currently sitting on banks’ balance sheets globally, bankers are unlikely to be keen to lend to infrastructure assets in the current climate without comfort that credit risks are well mitigated”. He highlights excessive leverage as one key issue.

Banks have replied that infrastructure debt structures are quite conservative.

“What a good infrastructure credit looks like varies enormously,” Darley says. “In terms of leverage, the debt to Ebitda at a regulated utility would look low, because its returns are capped by legislation. At National Grid Wireless, which is only partly price-regulated but has a favourable duopoly position and long-term contracts in other of its divisions, the debt/Ebitda ratio is 9x. Cory Environmental had a leverage of 7x.”

Wilkins cites the senior syndication of NGW as an example of a deal that “ran into difficulties”, partly due to excessive leverage. Banks argue that stickiness in the senior phase of NGW was due to a reluctance by banks to take underwriting risk in that climate, rather than a refusal to make commitments, and that the junior and A2 tranches were strongly oversubscribed. The NGW deal is due to be followed by the launch of a loan for

O2 Airwaves, mandated to DEPFA, Bank of Scotland, HSBC and RBS.

Given the general market nervousness, will ratings change on infrastructure credits?

“Not necessarily, although there could be credit stress for some heavily leveraged companies that masquerade as infrastructure [eg, motorway service stations] if operating performance deteriorates,” says Wilkins.

“Well structured, properly covenanted and conservatively leveraged infrastructure companies should still be able to achieve investment grade ratings and tap the capital markets for refinancing needs.”