The infrastructure debt market has shown strong resilience during the pandemic. In addition to the nature of the infrastructure sector’s cash flows, which are generally regulated or contractual, the orthodoxy of its financing structure has also been a clear advantage.

Even the challenges faced by the transport sector, which has seen an unprecedent reduction in passenger traffic, have so far been addressed by creditors. Reduced costs in terms of capex (capital expenditures) and opex (operating expenses), and the lengthening of business plans, have enabled structures to stay afloat. Moreover, reserve accounts and comfortable service coverage ratios have been highly effective in their role as shock absorbers.

Going forward, the outlook is very positive.

On the supply side, the push for energy transition and the trend towards digitalization should provide a constant and robust pipeline of primary market transactions. At the same time, European banking capacity is becoming saturated with large loan books, so the banks have no choice but to open those books to other lenders:

• New sectors have been enriching the diversity of infrastructure financing, such as the rollout of fiber in sparsely populated areas and the new generation of green data centers. The trend is expected to continue, with smart grids, regulatory frameworks for the charging of electric vehicles, and so on.
• Banks need alternative credit providers. The European Commission has estimated the total pandemic-related losses incurred by corporate firms at between EUR 720 billion and EUR 1.2 trillion, leading to liquidity shortfalls. Where the U.S. relies on its capital markets, Europe relies on its banks, and European governments are using them to address this shortfall. Their balance sheets can only extend so far, so sharing risk with non-banking organizations (such as asset managers and insurers) is a necessity.
• With 2020 characterized by a sub-normal primary market pipeline, the accumulated backlog should lead to significant activity in 2021 and 2022. This trend should be reinforced by governments’ need to boost their economic recovery through ambitious infrastructure plans.

On the demand side, the momentum should increase with the combined effect of a still very low yield environment and the implementation of the Sustainable Finance Disclosure Regulation (SFDR).

• Despite the slight increase in interest rates, the hunt for yield remains the key issue for institutional investors. The 10-year German bund is still at - 0.23% and the French OAT at +0.11%. Credit spreads are tight in both the investment grade and high yield space, with respective average asset swap spreads of 58 bps (average rating A-; 5.7 years to maturity) and 277 bps (average rating BB-; 4.5 years to maturity). By way of comparison, an infrastructure senior secured debt portfolio with an equivalent low investment grade rating (BBB/BBB-) can be built at an average asset swap spread of 200/250 bps. The floating rate feature is also a positive as it makes the product immune from a rise in interest rates.
• The first consequence of the Sustainable Finance Disclosure Regulation is a rush for investment managers to classify their funds as Article 8 or 9, but the rules are not entirely settled yet. When they are, there may be some disappointment. Because it is a natural landscape for sustainable investment, infrastructure appears very well positioned to weather any potential upcoming regulatory changes.

Obviously, capturing this opportunity requires a seasoned investment team with a strong footprint in the market. However, with banks no longer “short of assets”, direct origination capacity will be less critical. The key factors in terms of extracting excess returns should now be the nimbleness to finance the new sectors knocking at the door of the financing room, and the ability to provide innovative debt structuring solutions.
 

Fabrice Rossary

CIO SCOR Investment Partners

^{This article is an opinion article and does not constitute investment advice or recommendations. Neither the author nor SCOR Investment Partners assume any liability, direct or indirect, that may result from the use of information contained in this opinion article.}