Disintermediation can take different forms, with banks supplanted as front-line lenders not only by the public markets but also by individual institutional investors. This is becoming a welcome feature of project finance as players, including investment manager Allianz Global Investors (AGI), lend directly to greenfield infrastructure projects.
AGI's latest infrastructure play is a £193m (€293m) investment in Scotland's largest public-private partnership (PPP), a road bypass round the Scottish city of Aberdeen, otherwise known as the Aberdeen Western Peripheral Road, Balmedie to Tipperty (AWPR) project.
AGI is one of two asset management arms of Germany-based Allianz, the world's largest insurer, and it runs assets amounting to some €380bn. Its sharpened focus on infrastructure debt dates from 2012, when AGI lured a specialist five-person loan advisory team, led by Deborah Zurkow, away from US monoline insurer MBIA.
Based in London and Paris, that team has now grown to 14 people, with an infrastructure debt portfolio worth €2.5bn. With 11 assets in eight countries, it includes private finance initiative schemes for roads and university accommodation, as well as gas storage and electricity distribution projects. The team's pre-investment checklist restricts investments to 'essential' physical assets, with a long-term, stable revenue stream and a clear business purpose. Given the long-term nature of its parent's liabilities, it is only interested in providing long-term debt.
New launch
Today, the team invests on behalf of three different entities. The most important, responsible for about 80% of its funding, is the Allianz group itself. Next are third-party investors or separately managed accounts – institutional investors who have decided to allocate some funds to illiquid investments. The third and newest entity is AGI's UK infrastructure debt fund. This was launched in June 2014, having raised £150m from institutional clients including Nippon Life, a Japanese insurer.
The UK fund provides access to infrastructure projects for smaller institutional investors, and hopes eventually to raise up to £500m. Overall, AGI has said it wants to invest more than £3bn in UK infrastructure in the next three to five years.
December 2014 saw two UK investments in quick succession, with tranches of both ending up in the UK fund. The first – which included the first investment for the UK fund – was £119.7m for the refinancing of a student accommodation project at the University of Exeter. The financial sponsor of the 2600-room concession is student accommodation manager, UPP Group.
Paul David, director of infrastructure debt at AGI, points out that the UK market for student accommodation is underpinned by strong historical growth in higher education. Its occupancy and rental growth have defied the downturn in other property sectors since 2008. "There is significant undersupply of student accommodation in the UK," says Mr David, adding that AGI wants to do more deals at the premium end of this market.
Flexible timing
The next transaction was altogether larger and more ambitious, taking on a limited form of construction risk. AGI was approached in mid-2014 by what is now the Aberdeen Roads consortium, consisting of infrastructure and construction firms Balfour Beatty, Carillion and Galliford Try.
They were planning to pitch for AWPR, which involves the upgrade and new build of some 58 kilometres of roads, including two bridges over major rivers. It is a 33-year design, build, finance, maintain and operate project procured under the non-profit distributing (NPD) model. After three years of construction, the consortium will maintain and operate the roads for 30 years. NPD is a Scottish variant of PPP which caps equity returns and channels any excess back to the state.
The consortium members were putting up all the equity themselves and, advised by Royal Bank of Canada, were looking for debt on the best terms they could find.
"They had a financial plan," says Adrian Jones, a director in AGI's infrastructure debt team. "We had to assess whether it was acceptable to us and indicate a price."
An obvious alternative to this form of private placement was a public bond issue, and the investment bank would have modelled the comparative costs. One advantage offered by the private route is in the timing of receipt of the investment proceeds. "We can defer payment to match the spend profile of the underlying project," Mr Jones explains. With a public bond, all the proceeds are received upfront and, if they are not being spent, they must be invested.
"In this interest rate and spread environment, the ability to defer funding is a benefit for the borrower," says Mr Jones. "The alternative is borrowing at 4% and then having to invest at 0%." By optimising timing in this way, the investor can get paid more on the funded amounts, but the cost to the borrower is less.
Greenfield approach
The benefit to the institutional lender is enhanced yield for the life of the project and an opportunity to shape the debt to suit its own investors. Funding an asset that is already operational is more straightforward, requiring less due diligence and negotiation. However, since its rating will have improved since the construction phase, this will be reflected in the spread.
As AGI likes to tell potential clients, primary projects can be structured to investment-grade quality from the outset. Any successful project should enjoy an upwards trend in its rating once operational. But projects funded with bank loans typically start at a lower point (just below investment grade), so their finishing point will also be lower.
Another feature stressed by AGI is that senior debt holders in infrastructure projects do not face the construction risks associated with commercial property development. Construction does not start until the project is fully funded, and the construction risk itself is borne by the contractor via fixed-price, date-certain turnkey contracts. The principal risk is contractor insolvency but, even here, debt holders are largely protected by the equity layer and by surety bonds.
There was a moment of hesitance on AGI's part in the run up to the September 2014 referendum on Scottish independence. As reported in the local press, it put any investment plans on hold until after the vote, because of uncertainties over what currency an independent Scotland would adopt. Shortly after the 'no' vote, however, AGI emerged conditionally successful from a shortlist of three.
Raising the bar
In the deal, which finally closed in December 2014, AGI has taken up £193m of listed bonds, rated A- by ratings agency Standard & Poor's and privately placed with its clients. The bonds have a 4.218% coupon, a tenor of 31 years and a weighted average life of 24 years.
The European Investment Bank has made a £273m loan – 50% of the total debt package – with the same 31-year tenor, while the Bank of Tokyo-Mitsubishi has provided a 14-year commercial term loan facility.
"We were approached in July and the transaction closed in December, which is about as quick as it gets in project finance," says Mr Jones.
Besides representing an innovative mix of all three principal methods of infrastructure debt financing, the debt package is unusually large. "Two years ago, you could have asked whether a [£546m] PPP was beyond the market's capacity," says Mr Jones. "But what is the maximum size is a question answered with each passing deal."
Ms Zurkow, CIO for infrastructure debt at AGI, says the AWPR deal typifies what her team is looking for. "It’s a core, essential project that’s of significant importance to the local community and will provide the long-term stable cash flows our clients want to match their long-dated liabilities," she says.
Ms Zurkow believes that the UK government's recent commitment to exempt private placements from withholding tax is good news for anyone who cares about UK infrastructure. "Compared to the stability and depth of its US counterpart, the European private placement market remains in its infancy," she says. "So it will need continued careful nurturing to achieve its full potential."
