Post crisis market conditions driving Infrastructure strategies

By Nick Crawley on July 30 2010

Lenders are keen on infrastructure but are treading carefully

ANZ Banking Group has identified infrastructure funding as a key area of lending growth in the Asian region, but highlights that major lenders in the Australian market are unlikely to be able to meet the private sector component of Australia’s large infrastructure financing task.

This view is supported by ratings agencies who have signaled a more conservative approach to infrastructure debt ratings. On 15 July 2010, in its note “Refinance Risk in Australian Infrastructure Debt”, Fitch suggested that while the market has moved on from many of the liquidity issues of the recent Global Financial Crisis (GFC), infrastructure companies refinancing their debt will face significant changes to lending practices compared to before the GFC, and as demand for debt outstrips liquidity bank debt pricing is expected to converge with bond pricing.

New lending practices apply the hand brake to growth

In 2007 debt was a commodity, easy to source from a variety of global lenders. Now, as infrastructure companies’ demand new capital, major lenders will grow their loan exposure to the sector while picking and choosing the assets they lend to, as well as demanding higher prices and increasingly restrictive terms for the debt they provide.

Infrastructure companies holding mature but long duration assets will undoubtedly be the preferred exposure for the major banks. Greenfield assets and businesses that have proven to be more cyclical are likely to have to compete hard to attract capital.

However, even the mature asset portfolios that have continued to post favourable operating performances will face increasingly restrictive equity lock-up provisions imposed by the banks (from ICR metrics of 1.1x-1.2x before the GFC, to 1.5x-1.6x after the GFC) and higher spreads ranging from 200bps-350bps.

Furthermore, many infrastructure companies continue to hold non-amortising medium term notes. These were commonly provided to infrastructure businesses by the major Australian banks. In the current market companies are likely to be able to refinance this debt on a 5-6 year term; however amortisation of these notes will be mandatory.

These new lending practices and market dynamics look as if they will set the tone for the sector, at least in the medium term. The impact is likely to be significant. Without availability of debt, riskier greenfield developments will struggle to meet equity hurdle rates, restrictive debt covenants will reduce overall gearing, M&A will slow, and amortisation of debt over the medium term will further erode equity yields.

Evidence of successful infrastructure refinancings

Since the financial crisis hit in 2009 many infrastructure businesses have been able to refinance their loan portfolios. These include Sydney Airport and the four Sydney orbital toll roads owned by Transurban: the M7, M2, Eastern Distributor and the M5 Motorway. Successful greenfield refinancings are more difficult to find. Many, such as the Melbourne desalination plant, are not comparable. They are backed by government-guaranteed availability payments which reduces their refinance risk and minimizes the risk to equity.

Key drivers for the Australian infrastructure sector

The financial crisis has shown that the operating performance of the sector is closely linked to the domestic and global economic growth cycle. The outlook for the sector at the start of FY11 is as uncertain as the rest of the economy. The key issues set to drive the sector are:

Improving economic environment
Lending practices in the sector
Continued bond market liquidity

Improving economic environment

Pessimism has returned to global markets, with US Federal Reserve Chairman Ben Bernanke describing the US economic outlook as “unusually uncertain”. Typically, port volumes, airport passenger numbers and toll road traffic growth will be driven by local and global GDP growth. While Australia has avoided a recession in the recent economic cycle, risk of the downside continues to overshadow the recovery process.

Lending practices to the sector

Tightened lending covenants, rising credit spreads and scarcity of capital relative to demand from the sector will reduce overall corporate activity including greenfield developments and M&A. Heightened cost of capital will also drive down asset valuations of mature portfolios.

Continued bond market liquidity

With major banks unable to meet infrastructure companies’ demand for capital, debt from bond markets will need to fill the gap. Pricing meant that bonds were undesirable for many businesses; however, bond and bank debt pricing are reportedly converging. Consequently, Sydney Airport and Transurban have access to bond markets to refinance their medium term notes.