Cautious optimism: key themes from the Infra-Americas forum on February 24, 2009
Infrastructure as an asset class is being tested as never before. Although infrastructure investors are not immune to the global financial crisis, the infrastructure sector is proving relatively resilient, albeit that changes in appetites for leverage are affecting valuations. In this environment, approximately 170 representatives from banks, infrastructure funds, financial advisers, the public sector, technical advisers, accountants and lawyers attended the Infra-Americas' executive briefing "Assessing the future for infrastructure investors in the new economic climate", co-sponsored by our firm on February 24, 2009.
The seven panel discussions focused mainly on the impact of the global financial crisis, including government policy responses such as the Obama administration's stimulus plan, the infrastructure fund model and the liquidity available for infrastructure as an asset class in the United States and the Americas. Detailed in this briefing are some of what we believe are the key themes that emerged from the discussions during and after the event.
The "Yes we can" factor
The federal stimulus package has limited direct utility for infrastructure investment. It provides just a small down payment towards a multi-trillion dollar long-term infrastructure funding gap, with an emphasis on direct payments to the states for repair and maintenance projects (with the exception of green energy). Perhaps because of its limitations, the federal stimulus package has contributed to a consensus that infrastructure investment should be a national priority in the U.S. Existing funding methods are not adequate to address this need. The demand far exceeds the means available to the public sector to meet it. This will push the country towards embracing innovative financing techniques employing private capital within the next two years.
During 2009, attention in Washington D.C. will shift from the stimulus package to the multi-year transportation reauthorization and to energy policy. In both transportation and energy, Congress and the Obama administration have signaled a willingness to innovate but, in the short to medium term, reform is more likely to be regulatory than legislative. Initiatives, such as the creation of a "National Infrastructure Bank", may not materialize for some time as legislative priorities such as healthcare and tax reform occupy Congress and the administration.
Maturity of the market and public-private partnerships uptake
Overall, the U.S. infrastructure market is immature and will continue to evolve – patience is key as the fundamentals remain unchanged. Policy makers and the public need to be educated as to the reality of public-private partnerships. As part of this, key stakeholders such as the unions need to be brought on board. Policy reform is necessary at both the federal and state level to unlock the potential of publicprivate partnerships. The recession will pressure governors, particularly in states that are looking to alternatives to cutting social programs and to alternative delivery methods. In the meantime, individual municipalities may take advantage of private capital. Public-private partnerships where the city is the contracting authority can be easier to execute than large-scale state-sponsored programs.
The U.S. public-private partnership market suffers from a lack of consistency among the states in approach and from inefficient and costly procurement processes. Basic documentation, regulations and guidelines should be adopted nationwide, with national (and state) centers of excellence modeled on the UK's and Canada's approaches. The federal government has an important role to play in this regard by conditioning federal funding assistance on the use of a proven, standardized approach – though care will be needed to avoid adding another layer of bureaucracy.
Liquidity constraints concerns
Securing debt financing constitutes a challenge to project viability in the short term. Banks are lending on a club basis rather than taking any new underwriting or syndication risk. Margins and up-front fees remain high, while covenants have become tighter. Bankers foresee another 18 months of constrained activity. Arranging is likely to be on a best-efforts basis. Debt to equity ratios will be more conservative, so that deals will be structured with less leverage than before the economic crisis. Going forward, investors are expected to focus on more conservative valuations. Of the banks that remain active, a disproportionate number are non-U.S. based. This presents a potential challenge as European banks retrench in their home markets.
As a response to the liquidity crisis, during the past year a number of transactions have achieved success with all equity bids. These are terms that make sense for the investor now but are likely to anticipate refinancing in three to five years. Equity-only bids may create a competitive advantage for well capitalized investors. Valuations have fallen globally but a gap remains between sellers and buyers. Later this year, sellers should begin to accept market-based valuations and as a result the volume of distressed private-to-private sales should increase.
The future of the infrastructure fund model
U.S. pension funds have continued allocating significant funds towards infrastructure investment as a discrete class. While allocations remain in the single digit percentages, they are expected to increase over time to the 10 to 20 per cent range seen in Australia and Canada. The infrastructure funds model remains attractive to limited partnerships (LPs), but they are becoming more assertive in terms of fee structures and transparency in fund governance. Increasingly, major pension funds are moving towards a direct investment and co-investment model. "Allocations by U.S. public pension plans to infrastructure are just a drop in the bucket to where they are envisaged to be in future", said Peter Allison, Infra-Americas executive editor. "Ultimately, pension funds will become huge investors in the infrastructure sector in the U.S., with some perhaps even becoming direct investors as the market matures. As allocations to infrastructure increase, momentum will gather as new capital seeks to find a home. With time, this source of capital will be seen as a one solution to bridging the funding gap in infrastructure".
So what are the future opportunities?
The big infrastructure deal that makes the headlines is being replaced by the smaller deal that gets done. Struggles with high-profile, high-risk transactions have led to renewed focus on less controversial assets such as parking, stadiums and energy, where private sector involvement is relatively more welcome and the basic characteristics of an infrastructure investment can still be found.
Significant opportunities will be available in the energy sector as a result of a policy focus on green energy and the transmission system. Within the next year, privateto- private activity should increase with a focus on generating assets. The scope of potential energy-investment opportunities is narrowed by the need to avoid exposure to commodity price volatility and by the complexity of U.S. utility regulation. In the case of smart grid initiatives and transmission expansion, the problem may be "too little" regulation (not "too much"), as the Federal Energy Regulatory Commission (FERC) lacks sufficient central authority to steer projects past local challenges. Significant new coal generation is unlikely. Gas cogeneration, renewables and nuclear power will create promising investment opportunities.
Latin America, while affected by the global recession, should weather the storm relatively well compared to past crises. Several countries, notably Chile, Brazil, Mexico, Peru and Columbia, present strong investment profiles with transparent procurement systems. As deals are more likely to be negotiated than bid, local connections are key to the region. With valuations down, opportunities should open up during the next year.
Despite these short to mid-term concerns, the fundamentals remain strong for infrastructure investments to perform relatively well in the Americas as financing and government policy hurdles are cleared over the next 18-24 months.
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