May 2020 – Despite – or perhaps precisely because of – the extreme repercussions of the coronavirus pandemic on the German economy in particular, investors continue to be selective in looking for profitable as well as stable investment opportunities. Their focus is on infrastructure projects in particular, even though projects are currently facing delays or even being postponed completely for the time being. Alongside private equity funds, international pension funds especially have discovered this asset class for themselves. However, on the borrowing side what is needed is the right partner and the right financing structure for maximum cash yields and profitable success.
Those looking for a symbol cast in steel and concrete of the – in some cases – very poor condition of German infrastructure cannot ignore the highway bridge over the Rhine in Leverkusen. The six-lane bridge of the A1 autobahn is one of the busiest highway bridges in Europe. But 50 years of heavy cargo traffic along with hundreds of thousands of commuters every day have taken a heavy toll on the bridge. Due to cracks in the steel structure, it has been closed to vehicles with a gross weight of over 3.5 tons since November 2012. Furthermore, cars and smaller trucks may only cross the bridge at 60 km/h. Years will pass before there is any remedy. Particularly as work on the new bridge construction has stalled: The steel supplied from China for central girders has considerable quality defects.
Sadly, Leverkusen is not a one-off: Germany's bridges as a whole are in a sorry state. In the coming years, the Federal Ministry of Transport intends to spend billions on more than three million square meters of bridge surface.
But every crisis also brings opportunities: Since the need for the modernization and overhauling of European and, above all, German infrastructure is so great and the public coffers in the post-corona period in particular will be even emptier, the outlook here for institutional investors is good. At the moment, the German government and those of the federal states are concentrating on supporting SMEs and corporations along with their employees, who have got into difficulties due to the corona-related shutdowns. In the longer term, this will demand almost all of the attention and resources of Germany's national economic and financial policy. Less money than originally planned will probably be available for elaborate infrastructure projects. "However, this won't change the necessity for investments – a dilapidated bridge remains a dilapidated bridge. In future, important infrastructure projects will be financed increasingly with private capital," predicts Inka Klinger. She is Global Head of Infrastructure at Hamburg Commercial Bank. "The great advantage of infrastructure projects is the long term of such projects, generally speaking, and so the corresponding calculation basis for investors as well as equity and borrowed capital providers. However, financing durations will vary greatly according to the scope of projects. Depending on the asset class, we often see financing durations of much less than 10 years," says Inka Klinger.
Capital is still available to a sufficient extent – partly because investors have fewer and fewer alternatives in the low-interest environment. In general, amounts in the hundreds of billions are available for infrastructure measures. But whether it will be possible in future to implement all projects as cheaply as in the past currently remains to be seen. "After the coronavirus, a new reality will develop. This should apply to prime costs as well as to financing, since risks will have to be re-evaluated," comments Inka Klinger.
Apart from the sale of infrastructure investments ("brown-field investments"), the main driver for the infrastructure market is often also refinancing, for example for growth or expansion investments in existing projects. The development of new projects – technically known as "green-field investments" – "is by contrast more of an exception, since they demand a different approach and requirements with respect to analysis," says Klinger.
Whereas in the 1990s and 2000s it was above all major investment banks, huge pension funds and sovereign wealth funds from Norway, the Middle East or Singapore that discovered the infrastructure market, for some years insurers, private equity financiers and smaller pension funds, funds of funds or family offices have got involved too. As a result, the infrastructure business is becoming increasingly granular on the demand side. "At the same time, so-called ESG criteria are becoming more and more important in selecting specific projects. Greater attention is being paid to environmental aspects, the observance of social criteria and governance. This applies to both investors and banks," explains Klinger.
In her words, the "new" infrastructure investors are far more realistic in terms of returns. Whereas private equity investors used to calculate based on annual returns of about 20 percent, institutional investors today would be satisfied with much less – and have to be. "The stability of cash flows is an indicator of the risk level of transactions and the expectation of return rates. The more stable the cash flows, the lower the expectation of returns," says Klinger.
Infrastructure transactions in Europe on the advance [Transaction volumes in USD billions (Source: inframotionews.com)]
High stability, low defaults and sustainable returns compared to other investment classes: these are the advantages of infrastructure investments. On the other hand, there is the fact that valuations have picked up due to the increased demand and structures have weakened. Not every infrastructure project will be a guaranteed success. Whereas investors traditionally backed airports, harbors, railway infrastructure or power stations and renewable energy installations, new assets are now coming into focus: broadband expansion, data centers, radio towers, district energy or storage, but also service offers related to smart meters, smart cities and social infrastructure. As a result of climate change, investments will in future also revolve to an increased extent around the topic of "water." This includes the modernization of sewage plants, plants for sludge incineration and seawater desalinization plants. Experts from Hamburg Commercial Bank have profound specialist know-how in all of these sustainable segments. "For example, we have been following the subject of broadband for seven years and therefore see ourselves as pioneers on this topic in Germany,"
Many institutional investors' wallets are full. Nevertheless, borrowed capital as a leverage instrument makes a lot of sense to boost equity capital returns and facilitate greater financing volumes. "Depending on the risk level, the ratio of equity to borrowed capital fluctuates between 10:90 – as in public-private partnerships – and 50:50, depending on market risk and the stability of cash flows. Maximum leverage is no longer necessarily the focus," reports market expert Klinger. Banks like Hamburg Commercial Bank play the role of intermediary in all infrastructure projects: as consultants or arrangers, but also as recruiters of additional investors. For decades, Hamburg Commercial Bank has been active in this special and increasingly important market – and is among the top 15 infrastructure financiers Europe-wide. In 2019 alone, Hamburg Commercial Bank had a credit portfolio of about six billion euros [incl. renewables] on its books. It continues to concentrate on Europe but also supports its core customers selectively outside these markets.