A long and winding road

AS INVESTMENT opportunities go, lending money to a consortium building three prisons in rural France does not have the cachet of backing the latest Silicon Valley IPO. A new subway line in Seoul or energy pipelines in Texas will not set many pulses racing, either. Unglamorous as they may be, such investments are vital for economic growth. Yet financing infrastructure is falling out of favour with banks. Can other investors plug the gap?

European lenders, which used to dominate infrastructure financing, are now busy repairing their dented balance-sheets. Meanwhile the new “Basel 3” rules are steering banks away from the long-term loans (often stretching beyond 20 years) required by backers of infrastructure projects. The one exception is Japanese banks, which have stronger balance-sheets and are keen to put money to work.

Banks are not only wary of making long-term loans, they are also reluctant to take as much risk as before. Whereas they used to be happy to lend 90% of the construction cost of a large project, such as a toll road in America, that figure is down to something like 70% now. This forces the backers to come up with more of their own cash. In the same way that housebuilding slows when banks cut the supply of cheap mortgages, infrastructure construction dries up when financing gets tighter.

All this is contributing to a widening gap between the amount that is being invested in infrastructure and the amount that ought to be. It will cost $57 trillion to build and maintain the world’s roads, power plants, pipelines and the like between now and 2030, reckon consultants at McKinsey (see chart). That is more than the value of today’s infrastructure. By one estimate, infrastructure spending currently amounts to $2.7 trillion a year (about 4% of global output), yet $3.7 trillion is needed.

With public finances straitened, governments are unable to make up all of the shortfall. Some, notably China, can pay outright for the stuff that needs to be built. But most others (and private investors such as telecoms firms) rely on financing of a sort which has not been as readily available since the financial crisis.

That is creating a need, and opportunity, for new entrants. Long-term investors such as insurers and pension funds are eager to plough money into infrastructure, as are endowments and sovereign-wealth funds. These financial titans have over $50 trillion to invest. Nobody is suggesting that their entire pile should be used to fill the $57 trillion hole. But only 0.8% of their assets are invested in infrastructure projects. That seems too low, given the natural match between the long-term liabilities of such investors and the long-term cash flows that come from these projects.

Better yet, returns from debt secured against real assets are high relative to similarly rated corporate or sovereign bonds. Financial instruments linked to infrastructure are typically hedged against inflation and offer stable returns, with low volatility and little correlation with other asset classes. They are illiquid, but that is of little concern if you are intent on holding on to stuff for decades. And when things go wrong, investors have a better chance of recovering most of their money, says Mike Wilkins of Standard & Poor’s, a ratings agency.

Enthusiasts speak of a budding asset class. Long-term investors have snapped up loans which were originally made by banks, or are figuring out ways to issue their own. Natixis, a bank, put together the €300m ($417m) loan to the trio of French prisons, but nearly €100m will go straight onto the balance-sheet of Ageas, a Belgian insurer. Such arrangements are becoming more common. Many bank teams have been poached by institutional investors. Issuance of bonds linked to infrastructure projects has soared, albeit from a low base.

Sovereign-wealth funds and others after the raciest returns are keen on owning infrastructure assets rather than just lending to them. Private-equity firms have raised $250 billion to spend on infrastructure, up from $9 billion a decade ago, says Preqin, a data provider. Blackstone, a buy-out firm, is among those that financed a $900m hydroelectric dam in Uganda that provides half the country’s electricity. Bringing in private investors has benefits beyond shifting debt off public balance-sheets (a wheeze behind many of Britain’s less-than-stellar public-finance initiatives). The three prisons in France will be built by a contractor that will bear the risk of cost overruns, for example. Unlike lackadaisical local authorities, the companies involved will be deeply bothered if the prisons open late, as payments will kick in only once they are available. If operating them is dearer than expected, investors will suffer. Private-sector rigour can thus bring down the cost of public services.

The transition from banks to other investors is, however, not seamless. Projects that are ideally suited for banks often don’t appeal to the new moneymen. Insurers and pension funds often dislike “greenfield” projects. Beyond construction delays and cost overruns, they worry assets will not prove as profitable as advertised. Much of their focus is on putting together straightforward deals—for roads and other well-understood kit—in predictable places such as Europe. Investing in 30-year projects further afield is too risky for most.

The main concern from investors is a shortage of suitable projects. In Europe, a wealth of capital is chasing a dearth of deals. For governments digging for growth, smarter planning could result in a lot more of the infrastructure they crave.