Infrastructure investments that were attractive before the 2008-2009 global economic crisis could make a comeback for investors who can provide cash for those debt-laden deals.
The opportunity could be massive. Industry participants estimate that more than $1 trillion in infrastructure debt issued between 2005 and 2008 is coming due. Much of that debt is estimated to have five- to seven-year terms, according to a soon-to-be-released white paper by J.P. Morgan Asset Management.
Infrastructure is not the only asset class to be deleveraging since the financial crisis. Investors are also coming in to provide capital for highly leveraged real estate and private equity deals made before 2008.
“There's a wall of refinancing coming in the next two or three years as the debt matures and has to be refinanced,” said Mark Weisdorf, CEO and head of OECD infrastructure investments for J.P. Morgan Asset Management, New York.
Since the crisis, banks, regulators and the capital markets will not allow as much leverage in infrastructure deals. When the debt from the pre-crisis infrastructure debt comes due, it will have to be refinanced, Mr. Weisdorf said.
”For some with too much leverage there will be a decline in value, and for new investors, there will be an opportunity to replace debt with equity,” he said. “It's a double-edged sword. For new capital, this makes infrastructure very compelling.”
And there are a lot of pre-crisis projects in need of cash. One sector in which many deals were purchased at high prices with overly optimistic revenue and demand projections is transportation, including ports and toll roads, Mr. Weisdorf said. “During the crisis, transportation assets had greater volatility,” carrying more risk than originally projected, he said.
Some of the biggest, most highly touted projects might have a tough time giving original investors the return they seek because of their debt loads and high purchase prices, but could provide opportunity for new investors with cash.
So far, two projects have gone bankrupt. One, South Bay Expressway Ltd., which runs a 10-mile, privately operated toll road near San Diego, filed for Chapter 11 bankruptcy protection last year. Macquarie Atlas Roads, formerly Macquarie Infrastructure Group, which held the equity in the project wrote down its entire $200 million investment between 2007 and 2009.
A number of port deals entered before the recession also are near bankruptcy. Insiders who asked not to be identified said many of the toll-road deals in the U.S. have unsustainable financial structures, such as those involving the Indiana Toll Road and the Chicago Skyway.
Whether lenders will force investors in those debt-laden, high-priced assets to foreclose or extend the loans is an open question, said Alec Montgomery, executive director for the U.S. operations of Melbourne, Australia-based Industry Funds Management.
“There are big deals done back four or five years ago that everyone knows have too much debt on them, and eventually they could look for more equity and lenders could get control of the assets, which could trigger a sale,” said Mr. Montgomery, who declined to identify those deals.
Even if only a portion of the $1 trillion in loans coming due over the next few years is foreclosed on, causing a sale of the project, or the borrowers seek equity from new investors to avoid default, it will result in a substantial investment opportunity for new infrastructure investors, J.P. Morgan's Mr. Weisdorf said.
“Look at the amount,” he said. “Some projects will have to take a haircut. It just has to happen. It happened in the real estate world as well. In the end, if prices that were paid for assets were too high, which I am suggesting in the transportation sector they were, they will have to be sold at a discount.”
“Most of these assets … are fundamentally good businesses but have capital structures that could be unsustainable,” IFM's Mr. Montgomery said.
This would make them ripe for investors looking to pick off good projects at lower prices, he said.
And people are taking notice.
In the past, consultants at Wurts & Associates had not endorsed infrastructure because of concerns about the amount of leverage, the potential mismatch of leverage to the project, and the sensitivity of the projects to the economy, said Jeffrey J. MacLean, president and CEO of the Seattle-based firm.
“Infrastructure investing is changing from roads, bridges and ports to energy, water, transmission lines and pipelines,” Mr. MacLean said. “We are considering these types of investments because we believe they address some of the problems contained in the deals over the last several years. “
Some transportation projects have recovered from the economic meltdown. Usage and revenue are returning, but their valuations are not yet back to pre-2008 prices, J.P. Morgan's Mr. Weisdorf said. This provides bargains for investors and investment managers with capital.
There are other infrastructure investment opportunities, he added, which were also noted in the J.P. Morgan white paper. The U.S. has inefficient and fragmented water and waste water systems. While 75% are operated by government entities, which have been slow to seek private capital, some 25% are privately owned. Many are family owned, Mr. Weisdorf said. At this point, private owners are the most likely sellers.
“Over time as family members retired and looked to pass on the business, often their choice is to sell to a larger entity that can bring capital and best practices to bear,” he said.
Also, some systems are owned by communities cooperatively and these cooperatives are considering private-public partnerships to operate the projects, he said.
More institutional investors are starting to move, albeit slowly, into infrastructure investing after all investment nearly stopped during the crisis.
For example, the Oregon Investment Council, Tigard, which manages the $59.6 billion Oregon Public Employees' Retirement Fund, Salem, made its first infrastructure investment at its July 27 meeting: a $100 million commitment to Highstar Capital IV LP. James Sinks, council spokesman, said investing in infrastructure was part of the council's diversification strategy. A staff memorandum to the board said returns are expected to fall between equities and fixed income, with relatively low volatility and less correlated returns. It also stated infrastructure is a hedge against inflation with “long-lived real assets to match nicely with a pension plan's liability.”
Other investors have increased their infrastructure allocations. Within the past 18 months, the $237.6 billion California Public Employees' Retirement System, Sacramento, increased its infrastructure allocation to 3% of total assets, from 1%. In May, the $40 billion Alaska Permanent Fund Corp., Juneau, plans to invest $400 million to infrastructure investments in fiscal year 2012. The fund has a 3% target infrastructure allocation.