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The Pricing of Private Infrastructure Debt A Publication of the EDHEC Infrastructure Institute-Singapore The Pricing of Private Infrastructure Debt A Dynamic Approach and Comparison with Corporate Debt April 2019 with the support of Table of Contents Executive Summary ............................... 4 1 Introduction ................................. 9 2 Credit Spreads in Corporate and Infrastructure Loans ........ 13 3 Approach & Data .............................. 19 4 Dynamic Modeling ............................. 31 5 Findings ................................... 37 6 Market Trends ................................ 54 7 Conclusions ................................. 62 References .................................... 71 About Natixis ................................... 72 About EDHEC Infrastructure Institute-Singapore .............. 74 EDHEC Infrastructure Institute Publications ................. 78 The author would like to thank Anne-Christine Champion, Herve Chopard and Bruno Deichelbohrer for useful comments and suggestions. Financial support from Natixis is acknowledged. This study presents the author’s views and conclusions which are not necessarily those of EDHEC Business School or Natixis The Pricing of Private Infrastructure Debt - April 2019 About the Authors Frédéric Blanc-Brude is the Director of EDHEC Infrastructure Institute. He holds a PhD in Finance (King’s College London) and degrees from the London School of Economics, the Sorbonne, and Sciences Po Paris. He is a member of the editorial board of the Journal of Alternative Investments, a regular contributor to G20 and WEF working groups on long-term infras- tructure investment, and has advised the European Insurance and Occupa- tional Pensions Authority (EIOPA) on the prudential treatment of infras- tructure investments. He also represents EDHEC on the Advisory Board of the Global Infrastructure Facility of the World Bank. Jing-Li Yim is a Senior Corporate Analyst at EDHEC Infrastructure Institute. She has prior experience in a major accounting firm analysing financial statements of electronics and technology companies. She holds a Bachelor of Commerce (Accounting and Finance) from the University of Queensland and is an associate member of CPA Australia. A Publication of the EDHEC Infrastructure Institute-Singapore 3 Executive Summary 4 A Publication of the EDHEC Infrastructure Institute-Singapore The Pricing of Private Infrastructure Debt - April 2019 Executive Summary This paper examines the drivers and evolution Secondary transactions are very rare and of credit spreads in private infrastructure usually not instrument-level sales. Still, a debt. We ask two main questions: large number of primary transactions (at the time of origination) can be observed. 1. Which factors explain private infras- tructure credit spreads (and discount Nevertheless, this data is biased: origination rates) and how do they evolve over time? follows procurement and industrial trends, 2. Are infrastructure project finance spreads that is, it tends to cluster in time and and infrastructure corporate spreads space when and where governments procure driven by common factors? new infrastructure using a privately financed model. The simple observation of credit We show that common risk factors partly spreads over time does not take into account explain both infrastructure and corporate the underlying market for private infras- debt spreads. However, the pricing of these tructure debt to which investors are exposed. factors differs, sometimes considerably, between the two types of private-debt Primary spread data is also autocorrelated, instruments. that is, what best explains the spread for a given infrastructure borrower is not its We also find that private infrastructure debt characteristics but the spread of the previous has been ‘fairly’ priced even after the 2008 transaction. credit crisis. That is because spread levels are well-explained by the evolution of systematic To address these issues and estimate the risk factor premia and, taking these into effect of individual risk factors on spreads, we account, current spreads are only about 29bps proceed in two steps: above their pre-2008 level. In other words, taking into account the level of risk (factor 1. We estimate the evolution over time of loadings) in the investible universe and the the risk-factor premia and determine their price of risk (risk factor premia) over the past unbiased effects on spreads over time. 20 years, we only find a small ‘unexplained’ 2. We use the EDHECinfra universe, a repre- increase in the average level of credit spreads, sentative sample of existing infrastructure whereas absolute spread levels are twice as borrowers – as opposed to the biased high today as they were before 2008. sample of new borrowers in the primary market – to apply the risk premia estimated in the first step to the “factor loadings” A Better Approach to Estimating (the characteristics) of this better sample, Market Credit Spreads thus computing a current market spread The main difficulty facing econometric for each one, at each point in time. research on the pricing of infrastructure debt is the paucity and biases of observable data. A Publication of the EDHEC Infrastructure Institute-Singapore 5 The Pricing of Private Infrastructure Debt - April 2019 Executive Summary Using a factor model in combination in 2008 and 2012. We find a 29bps increase with a representative sample of investable of infrastructure spreads compared to pre- assets can correct the bias and paucity of crisis levels, down from 75bps at the height available data: as long as such factors can of the credit crisis, indicating a degree of be documented in a robust and unbiased mean-reversion. manner, they can be used to assess the fair l Credit Risk only explains part of the level value of private-debt investments over of credit spreads. time, whether they are traded or not. « We find that infrastructure borrowers that are exposed to Merchant risk are required to pay a time-varying premium What Factors Explain Infrastructure from 20 to 40% above the market Credit Spreads? average at the time. Our results show how the aftermath of the « Size has no effect on average corporate 2008 crisis changed and sometimes removed spreads but is a driver of lower risk well-established relationships between premium in infrastructure debt. In effect, certain factors and the cost of corporate larger loans can be interpreted as a signal and infrastructure debt: the impact of base of lower credit risk in infrastructure rates on loan pricing disappeared, structural finance. differences between markets vanished, and « Industrial groups can be considered certain sectors, like roads, experienced a a partial proxy for credit risk but are continued increase in the price of long-term mostly not significant, except for social private financing. infrastructure and, amongst corporate borrowers, infrastructure corporates, Our results are statistically robust and explain which have come to benefit from a the data well. We show that infrastructure and substantial discount relative to average corporate credit spreads are determined by a market spreads in recent years. combination of common factors that can be l Liquidity: Other drivers of spreads are grouped into four categories: proxies of the cost of liquidity for creditors. l Market Trend: the largest effect driving « Maturity: While it is difficult to capture credit spreads in both infrastructure and in static models, maturity is found corporate debt is a time-varying trend to be a significant and time-varying factor which captures the state of the driver of spreads for corporate debt, credit market over time. This effect is not with higher premium charged during explained by loan or borrower character- periods of lower bank liquidity (2008- istics. In the case of infrastructure debt, 2016), whereas infrastructure debt has a this effect is roughly constant but exhibits constant maturity premium. “regime shifts”, especially 2008 (up) and « While the effect of size is primarily 2014 (down). In the case of corporate debt, a matter of credit risk, we note that it is an upward trend also exhibiting jumps 6 A Publication of the EDHEC Infrastructure Institute-Singapore The Pricing of Private Infrastructure Debt - April 2019 Executive Summary in periods of limited creditor liquidity Toward Fair Value in Private (2008), even infrastructure debt Infrastructure Debt becomes more expensive as a function Our assessment of the impact of certain risk of size. However, this effect is not strong factors in the formation of aggregate credit enough to create a size premium. spreads is relevant for at least three reasons: « Refinancings, which are not a significant driver of spreads in normal times, are l While observable spreads are biased due shown to be more expensive in times to the segmentation and low liquidity of credit-market stress, especially for of the private credit market, unbiased infrastructure debt. factor prices (premia) can be estimated from observable spreads and used to l Cost of funds: The benchmark against determine the factor-implied spreads for which floating-rate debt is priced has been any instrument at any time; a factor explaining the level of credit l The time-varying nature of individual risk spreads. premia implies that repricing individual « Base rates are inversely related to spread instruments over time can be material and i.e. higher rates imply lower spreads, but is required if such investments are to be this effect is shown to have all but evaluated on a fair-value
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