Josh Pandolfi, managing director and senior portfolio manager at financial technology company Pontoro, explains how institutional investors can better access infrastructure debt – and discusses why infrastructure bank loan investments would provide a creative and efficient solution to the banks’ current balance sheet crisis.
I never thought I’d have the chance to fly over the Panama Canal in a helicopter, but due diligence can sometimes take some unexpected turns. I was on my way to see an empty field that would someday serve as the location for a large, new, gas-fired power plant. During the flight, I marveled at the canal expansion project, one of the most impressive engineering feats I’ve ever seen. The $5.5bn project was recently completed, and large ships passed through its new lanes and locks. It was the extraordinary result of creatively mobilizing capital to help get a critical infrastructure project funded and built. Close to a decade later, efficient capital remains the lifeblood of essential infrastructure, and creativity is still necessary to keep it flowing. Where can we find it today? In the same way development banks stepped in to finance the canal expansion, the introduction of new infrastructure bank loan funds is an innovative solution to unlock capital for critical, large-scale projects, while also helping tackle an expected shortfall in funding for infrastructure around the world.
The robust interest in infrastructure investments from institutional investors is well known. Unfortunately, they have historically been unable to access one of the largest and most attractive investment options in the space, project finance bank loans. By opening up this market through new opportunities, institutional investors could supply the missing, efficient capital for our global infrastructure financing shortfall and alleviate separate burdens faced by loan originating banks. For their part, investors would get the benefit of a product that’s secured by hard assets typically characterized by long-term investment horizons, steady and stable returns, cash yields, downside protection, inflation resistance, and strong credit metrics.
Banks’ Need to Offload Infrastructure Debt Creates a New Opportunity for Institutional Investors
Banks are under increasing pressure to deploy more capital towards infrastructure projects, but recent developments have presented challenges restricting their ability to fully tackle this on their own. These issues include capital constraints due to Basel III and IV, consolidation amongst the banks creating concentration issues within individual deal names, tightening liquidity due to deposit flight from regional banks, and a pullback from overseas lenders due to increased FOREX risk. At the same time borrowers have tended to pushback on alternative lenders in the bank loan market, as they’re more expensive and could potentially be an adverse lender within a bank group.
Based on these issues, banks have been forced to increase pricing over the past 12 months and actively seek liquidity solutions to alleviate some of the pressure on their balance sheets. This has created a prime opportunity for new sources of capital to enter the market. For example, new funds or other structures focused solely on purchasing existing performing loans off bank balance sheets could avoid certain competitive issues and allow banks the ability to recycle capital into new loans. Institutional investors in these vehicles would potentially gain access to a diversified pool of relatively safe, senior-secured bank underwritten loans that have previously been inaccessible to all but the largest investors.
Bank Loan Funds Can Provide Institutional Investors a New, More Attractive Entry Point to Infrastructure Investing
Typically, investors have accessed infrastructure either in the public markets through municipal bonds, corporate bonds, and equities, or private markets using credit/equity funds and direct investments. These are important entry points that remain vital to funding the infrastructure ecosystem, but ignore a prudent opportunity through the bank-originated project finance loan market for investors that potentially provides an attractive risk-adjusted return and represents $300bn a year in global volume since 2018, according to LSEG Data & Analytics.
Developers and owners of infrastructure assets prefer to reach out to the bank market for financing, as the banks offer borrowers large and flexible balance sheets (including an ability to provide letters of credit and fund on a delayed draw basis), deep expertise to analyze the assets, low funding costs, an ability to hold for long durations, and a stable partner willing to navigate complex issues. This is generally the first stop for owners of mature infrastructure assets throughout the world, which creates a lot of diverse financing opportunities.
After the lead banks have completed diligence and structured the transaction, they will generally bring in additional lenders to help fill out the rest of the senior loan, consisting mainly of other large commercial and regional banks, or overseas lenders, specialized financial institutions, and insurance companies. Traditional infrastructure credit funds generally don’t participate in commercial bank loans but may provide mezzanine facilities or debt that is otherwise subordinated to the bank loans, as they’re willing to take on more risk to reach their higher net return targets. In these instances, the bank loans will be first in line for repayment, while the credit funds will be structurally subordinated.
This was exactly the situation that occurred for the power generation asset in Panama that I visited. The banks were able to provide a senior tranche, while the credit funds provided financing that was subordinated to the bank debt. Both markets played an essential role in funding the project, but consider if institutional investors had an alternative entry point outside of the traditional credit fund that provided access higher up the capital structure to the senior-secured, floating-rate loans. Not only would this create more participation, but lower fees associated with an efficiently constructed investment structure could enable investors to receive higher economic benefits from the loans, while adding the relative safety and diversification that these loans generally offer.
Conclusion
Infrastructure bank loan investments (for example, through new fund structures) would provide a creative and efficient solution to the banks’ balance sheet crisis and the global infrastructure shortfall, while providing a wider spectrum of institutional investors access to a diversified pool of relatively safe, senior-secured bank underwritten loans. The introduction of these types of assets and investment vehicles would be a win all around – for investors, who could access attractive risk-adjusted returns in a relatively safe asset class; for banks, who would gain more efficient use of capital; and most importantly, for society, who would benefit from much-needed new infrastructure projects.
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