Australian superannuation funds are turning maverick as they attempt to snap up infrastructure projects, with unsolicited bids emerging as one way of getting ahead of the pack in the fight for assets that offer healthy returns.
Yet unsolicited bids leave some state governments wary – especially on more involved projects, or when competition emerges. As a result, Australia’s asset owners are pushing for other means to access infrastructure. In particular, they are seeking the inclusion of more complex layers of finance within capital structures, particularly mezzanine debt.
Sources told AsianInvestor that at least four or five large superannuation funds have advocated for such tranches to be built into financing packages, though there haven’t been any deals struck yet.
Funding void to fill
Structured correctly, such tranches can help fill a potential funding void for infrastructure projects.
“Project finance has been the purview of banks in this country for a long time, but when their loan appetite tops out at five to seven years, we are left with a lot of refinancing risk,” said said Sam Sicilia, chief investment officer at superannuation fund Hostplus. “There’s an opportunity for superannuation funds to provide debt out to 30 years or more, and mezzanine tranches offer a nice lift in yield.”
Capital structures that go beyond simple equity and senior debt could be used to fine-tune the price of infrastructure bids.
“Auction processes have become so competitive that often there is very little difference in the price between bids,” said Thomas Jacquot, an analyst at rating agency Standard and Poor’s in Sydney. “A layer of finely priced mezzanine debt could be a way of extracting more value and getting a bid across the line.”
The challenge is finding a price point for a mezzanine tranche that is attractive to both issuers and investors. Persistently low interest rates and a global banking system awash with liquidity means there isn’t much delta to play with between equity and debt. So while banks aren’t offering particularly appealing tenors, the pricing of the debt is so cheap that it hampers demand for mezz deals.
Jacquot estimates a mezz instrument for an investment-grade infrastructure company would probably price between 350 and 450 basis points. Senior debt tranches currently price at 150bp to 200bp.
While some market observers believe the market will eventually find a sweet spot for mezzanine tranches, it is likely to take some time.
Another impediment is governance, and in particular whether asset owners face conflicts from holding both mezzanine and equity in the same asset.
Since the global financial crisis, funds have shied away from owning both sides of the balance sheet, after having watched debt teams at the likes of Deutsche Bank and ABN Amro go through the fraught process of renegotiating terms on failing loans with their own internal equity divisions. It can lead to some awkward water-cooler conversations between colleagues.
“Even though mezzanine debt is intended to act as an equity-like instrument from the senior creditors’ perspective, mezzanine lenders have typically first recourse against equity and their interests might not be aligned with shareholders’ interests,” said Jacquot.
Sicilia at Hostplus is unequivocal. “We would consider owning mezzanine and senior debt in the same asset, but we just wouldn’t feel comfortable investing alongside an equity holder who was also a lender to the project. We want to be confident that when it comes time to protect our interests, they are standing on our side of the fence.”
Early attempts by asset owners to find new ways to invest into infrastructure may have delivered mixed results so far. But Australian pension funds are set to allocate an estimated A$200 billion to infrastructure assets by 2025, according to consultancy Ernst & Young.
Given this enormous appetite, the need to stretch the boundaries on the asset class is only set to intensify.