Junior infrastructure debt. Investment Case KPMG Investment Advisory Credit Research January 2019

Transcription

1 Junior infrastructure debt Investment Case KPMG Credit Research January 2019

2 Junior Infrastructure Debt Inv Executive Summary estment Case Example Assets Airports Hospitals Telecommunication Towers KPMG View We believe that the current supply and demand imbalance within the junior infrastructure debt space offers attractive risk-adjusted returns for institutional investors. The essential nature of infrastructure assets, coupled with the presence of protective covenants, enables investors to mitigate downside risk. Clients should take into consideration the illiquidity and high concentration in the fund. We recommend an allocation of 5-10%. Target return (net of fees): LIBOR %* Fund structure: Closed-ended Fund term: Typically 10 years Indicative fees: 0.50% % p.a. (no performance element) Geography: Global *Return target quoted by investment manager What is it? Infrastructure refers to a broad range of physical or organisational structures that are vital for modern economies to operate. Examples include Heathrow airport and the M6 motorway. Infrastructure debt involves lending for the construction/expansion, refinancing or purchase of infrastructure assets. Junior debt sits in the middle of the capital structure, protected by the equity position (typically 15% - 40%) and the asset itself, but ranks below senior debt. How does it fit in to your portfolio? Return Seeker: Returns are inherently high and can be seen as an equity alternative with reduced volatility. Diversifier: Low correlation to traditional investments, private market alternatives and low GDP linkage can provide genuine portfolio diversification. Why Junior Infrastructure? Funding Gap: Regulation has reduced the supply of lending, providing attractive risk-adjusted returns. Contractual Returns: Provides greater certainty under a range of economic scenarios. Illiquidity Premium: Offers an attractive risk-adjusted return over public bond markets due to the inherent illiquidity of the underlying loans. Downside Protection: Historically low defaults due to the essential nature of the assets and risk protections. What are the key risks? Political/Regulatory: Given the monopolistic nature of the underlying business, assets can often be heavily regulated and subject to political intervention. Asset Specific Risk: Infrastructure assets are exposed to varying levels of credit, operational and technological risks. Concentration Risk: The size and cost of infrastructure assets means portfolios are more concentrated compared to other alternatives.

3 Summary: Junior infrastructure debt involves lending for the acquisition, construction, expansion or refinancing of infrastructure assets. Debt repayments are financed through a combination of underlying demand based revenue streams and government contracts. The level of risk varies by asset. Junior debt sits in the middle of the capital structure, protected by the equity cushion but ranked below senior debt. Junior Infrastructu What is it? Utility and Energy Provision or transportation of essential services such as water, gas, electricity. Power generation Revenue Stream: low risk, regulated re Debt Investment Case Sector of underlying assets 1 Communications TV, telecom and broadcasting towers Data centres Revenue Stream: includes demand risk³ Social Infrastructure Education, medical and correction facilities Community and sports facilities Revenue Stream: exposed to demand risk by usage but can also be backed by the government Transportation Related Rail, toll roads, bridges, tunnels. Airports, ports, parking. Revenue Stream: exposed to demand risk by usage Key characteristics 2 KPMG return assumption Gilts + 3% Fees % Management Fund term 10 years No leverage at fund level Geography No Performance Fee No. of positions Brownfield/Greenfield* Predominantly 100% 90% 80% 70% 60% 50% 40% 30% Global 20% 10% Fund brownfield currency GBP** 0% Senior Junior Equity Junior debt is protected by the equity cushion (typically c.15-40% of the total asset value) but ranks lower than senior debt. Capital structures will vary by assets. Source: Investment Managers. 1. Not exclusive to only these sectors. 2.The information shown is indicative only. Due to the wide range of strategies within the asset class there is no guarantee that these exact characteristics will be achieved. Final asset allocation could be significantly different. 3.Demand risk: the success of certain projects or assets may depend on the demand from consumers. *Brownfield assets: mature projects that are already in operation. Brownfield infrastructure is considered to be of lower risk, as projects are already operating and provide a reliable stream of cashflows. Greenfield assets: projects which are still in the development stage. Greenfield infrastructure is often associated with a higher risk, as the investor may be exposed to the construction risk of the asset, so there is less certainty of the outcome. **Subject to a minimum investment 3

4 Summary: The essential nature of infrastructure assets along with strong levels of risk protections written into loan documentation has resulted in low default levels historically. Increased regulation has restricted the supply of junior loans previously provided by banks and insurance companies. The result is a compelling risk/return profile for junior infrastructure debt investments. Junior Infrastructure Debt Investment Case Why Junior Infrastructure Debt? Historically shown to have downside protection Sub-Investment Grade (Junior) Infrastructure debt has incurred lower credit loss rates, when compared to similarly rated non-financial corporate bonds (10 year cumulative data below). 40% Funding gap has created attractive opportunity Infrastructure assets are essential to economic activities and modern life. Often seen as a key factor to economic growth, governments across the globe are pledging to increase infrastructure expenditure, increasing demand. Europe Estimated Gap: $2.0trn 30% Default Percentages 20% 10% 0% Years Corporate Infrastructure Non-Financial Corporate Issuers The Americas Estimated Gap : $6.5trn Africa Estimates Gap: $1.7trn Infrastructure debt provides better risk adjusted return compared to public market bonds (e.g. BB Infrastructure debt has comparable default characteristics to a BBB public corporate bond). Why Now? However, there is a funding gap between infrastructure demand and the current level of funding, due to regulation on banks. Institutional investors can help plug this funding gap and capture attractive riskadjusted returns. Source: Moody s Infrastructure Default and Recovery Rates , Global Infrastructure Hub 4 Document Classification: KPMG Public

5 Summary: Investors need to consider whether they are comfortable taking on the illiquidity and other risks associated with senior infrastructure debt investments before making an allocation. As with any other investment, there are risks associated with infrastructure. Emphasis should be placed on selecting managers who have demonstrated an ability to deploy capital and manage risks within this space. Junior Infrastructure Debt Investment Case Key Risks Political/Regulatory Infrastructure projects are often initiated by governments. Assets are also monopolistic in nature. Therefore assets are exposed to any changes in regulation and/or government intervention. Asset Specific Risk Typical risks include: Credit Risk There is the risk that the sponsor (equity holder) may default on debt repayment. Operational Risk The asset is run by the equity holder and is therefore subject to their skill in running the asset efficiently. Technology Risk - Specific assets may be subject to rapid technology advances and could become obsolete. Construction Risks A relatively small amount of investments may can be exposed to this risk. Greenfield (assets in construction) Risk through securing of permission, cost overruns and any unexpected expenses. Illiquidity Risk Underlying investments are inherently long term, disinvestments before fund expiry will likely result in receiving a reduced price Construction Risks For greenfield assets, which typically comprise a minority allocation, investments can be made in assets that are at various stages of construction. Greenfield (assets in construction) General development and construction risk as a result of attempting to secure building permission, cost overruns, unexpected expenses and global downturns. Mitigations: 1. Documentation: Better protection is based on the managers ability to negotiate strong covenants. (Covenants are the terms and conditions that govern the actions of the debtor) 2. Diversification: Having the flexibility to allocate globally will ensure both sector and geographic diversification. 3. Manager skill: The manager will undertake a thorough due diligence process and risk assessment. All risks are stressed in a scenario analysis before the investment in made. We target managers with strong track records, a focus on ESG, robust risk management processes and workout experience. We also target funds that have guidelines for brownfield investments, preventing excessive construction risk. 5

6 Ajith Nair Benjamin Finestein Rav Sangha Daniel Sykes Head of Manager Research Head of Private Credit Research Assistant Consultant Assistant Consultant Tel: Tel: Tel: Tel: kpmg.com/uk The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International The KPMG name and logo are registered trademarks or trademarks of KPMG International. CREATE: CRT Document Classification: KPMG Public