Private debt funds are rapidly expanding into a segment of the market traditionally dominated by banks

Bank lenders have traditionally been the primary providers of debt to finance infrastructure project development, but private debt providers have recently expanded their presence in the space, opening up an alternative financing source to the market.

Despite the presently difficult fundraising environment—the most challenging for private markets since the global financial crisis—infrastructure debt fundraising more than doubled year-on-year in 2023, including two of the year’s 10 biggest private debt funds, according to Pitchbook.

Unsurprisingly, the largest private debt fund managers have led the way. Industry giants such as Ares Management, Blackstone and Brookfield Asset Management helped to drive almost US$9 billion in fundraising in 2023 for infrastructure financing strategies.

Private debt funds have historically focused on providing financing to private equity sponsors and sub-investment grade borrowers, while infrastructure assets have typically raised their financing from banks, governmental financing sources and public debt capital markets. However, private debt funds are looking for ways to diversify beyond their core direct lending offerings, with infrastructure debt emerging as an appealing adjacent lending category.

Moreover, opportunities for these firms to win more market share in the infrastructure financing space have increased in recent years, with regulatory pressures limiting incentives for commercial banks to hold long-term debt on their balance sheets and the risk that government financing sources will not be able to fill a funding gap.

According to a study by Ares Management, nearly half of all infrastructure financing in 2022 (around US$300 billion) came from non-bank, private lenders. The study shows that if these figures are extrapolated over a five-year period, the infrastructure debt market could have the potential to grow into a US$1.5 trillion financing opportunity for private credit providers as demand for investment grows amid a pull-back in traditional bank lending.

An attractive strategy in choppy markets

Private infrastructure debt has grown considerably through a period of market disruption characterized by high inflation and elevated interest rates over the past 24 months.

The underlying infrastructure assets financed by infrastructure lenders are counter-cyclical and offer a good hedge against inflation and market volatility, as they typically provide critical core, non-discretionary services to businesses and consumers. Infrastructure asset revenues are usually underpinned by long-term contracts with pricing that is correlated to inflation, while historical default levels and loss rates are relatively low. And amid higher interest rates set by central banks, financing these assets with floating-rate debt packages has presented investors and lenders with attractive risk-return dynamics.

Growth fundamentals

Besides offering protection against downside risk, infrastructure debt is also positioned to benefit from strong long-term growth fundamentals.

Over the past several years, infrastructure has evolved from an asset class focused on core utility services such as water, power and transport to a much broader category that includes digital infrastructure and investment in decarbonization.

The amount of capital required to deliver on the world’s future infrastructure requirements will create a pipeline of funding opportunities for private capital, with infrastructure debt promising to be one of the primary channels for funneling investor capital toward these projects.

Investment in basic infrastructure is forecast to total US$79 trillion between 2016 and 2040, driven by demand from growing populations and urbanization, according to the Global Infrastructure Hub. And that figure only covers core infrastructure spending, with digital infrastructure and decarbonization investments adding significantly to the amount of overall infrastructure investment required in the years ahead. The Organization for Economic Cooperation and Development estimates that an annual investment of US$6.9 trillion per year is needed just for low-carbon infrastructure to meet net-zero pledges.

Meanwhile, new asset classes, such as data centers, require funding not only for construction, but also for ancillary projects, such as meeting higher demands on related utilities. Boston Consulting Group estimates that rising demand for computing power and data storage capacity will see the amount of electricity that data centers consume more than triple between 2022 and 2030.

Versatile funding source

The flexibility inherent in private debt structures is well suited to support a range of infrastructure financing requirements throughout the lifecycle of an infrastructure asset, allowing managers to offer investors opportunities with varied risk profiles and price points. Investors with a greater appetite for risk might seek opportunities at a project’s development phase, while those favoring stability might look to support operational assets that are generating steady cashflows.

Providing capital through these debt financing channels will likely see private debt funds compete with traditional bank lenders in the infrastructure space. But there are also opportunities for private debt funds to partner with banks and government financing sources to fund projects on a blended or multi-tranche basis.

For example, in complex, capital-intensive projects, private debt providers may seek to support—rather than supplant—banks by supplying mezzanine or other junior capital tranches to fill gaps in capital structures and partner with underwriting banks.

With Bloomberg reporting that infrastructure debt can deliver yields in the 8%-10% range with interest rates at their current levels, private debt players will be eager to capitalize on opportunities to provide financing for infrastructure deals, whether alongside banks, in partnership with other private debt lenders, or unilaterally.

Infrastructure debt, once on the margins of private credit, is firmly establishing its position in the private debt market.

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