Yield hunters drive infrastructure debt boom

Infrastructure credit typically offers a premium of around 2.5% to 3% above Treasuries. Apart from credit risk, that prices in some fairly unusual contract risks that investors need to understand, however.

‘In an infrastructure loan, the issuer agrees to pay a floating rate coupon plus spread, based on a fixed principal repayment schedule,’ warned JP Morgan’s sector specialist team. ‘This amortisation schedule cannot be altered without the agreement of the lenders, nor can coupon payments be altered. However, the borrower has the option to repay the loan partially, or in its entirety, at par and would not have to pay any further coupons or compensate the lender for the loss of future spread payments.’

‘Although borrowers have this option, prepayment rates have historically been extremely low. Full prepayment rates for infrastructure, as defined by Standard & Poor’s and maintained on a bank consortia database, have been 1.6% in total in western Europe and virtually 0% in the UK since the database’s inception in the 1980s.’

The relative illiquidity of the market has also been one of the major factors deterring wider take-up of the asset class until now. Harder to quantify are political risks. For instance, in the UK, the government last year pledged to underwrite up to £40 billion in infrastructure credit.

While generating favourable headlines, Capital Economics said it would be prudent to take the commitments with a large pinch of salt.

‘Some of these measures are not quite as generous as they look,’ said the company’s chief UK economist Vicky Redwood. ‘For example, the money for the temporary lending programme will come out of departments’ existing budgets. And the investment in the railways will be funded by fare rises and efficiency savings rather than extra public sector money.

‘Meanwhile, take-up of the guarantees scheme may be limited due to the long list of conditions that companies have to fulfil. To qualify, projects have to be nationally significant, ready to start construction within a year, have equity finance already committed, be good value to the taxpayer and have acceptable credit quality.

‘Accordingly, it is questionable whether there are many projects that meet these criteria but cannot find full funding from the markets anyway.’