Why Is Private Infrastructure Debt So Trendy?
The steady expansion of private credit has been astonishing. Prior to 2008, it did not exist as a distinct asset class. By 2023, total assets were $1.6 trillion, roughly the amount of the U S. high-yield bond market. Preqin, a data provider, predicts that these assets will total $2.3 trillion by 2027.
That’s a vast pool for investors to tap into, yet it only pertains to corporate loans. Adding other types of private credit, such as commercial real estate, infrastructure, and consumer-oriented specialty finance, expands the possibility set even further.
According to Preqin, nearly all investors, 90%, believe private debt performance has met or exceeded their expectations, and 51% of limited partners intend to increase commitments to private credit, while 40% intend to maintain their commitments, the highest percentage of any asset class.
Preqin predicts an average internal rate of return of 9.8% in private debt between 2022 and 2028, compared to 14.3% in venture capital, 12.6% in private equity, 11.5% in secondary markets, and 10.9% in infrastructure, all of which have greater risk profiles.
Given elevated interest rates and stiffer controls on bank capital allocation, private lending for infrastructure projects is progressively becoming an appealing option to commercial bank project financing.
“We see a lot to like at the top of the capital structure,” wrote Matthew Bass, head of private alternatives at Alliance Berstein. “This includes loans secured by hard assets and the financing of ground leases, which give investors first claim on project cashflows.”
Private credit has expanded beyond its usual basis in insurance companies to include infrastructure funds and, in some circumstances, general corporate investors looking to take advantage of tax credits introduced under the Inflation Reduction Act of 2022.
Private credit lenders are not confined to senior secured operating corporate debt; they might be senior secured, mezzanine, holding company, or back leveraged. Furthermore, direct lenders are more prepared to lend on a portfolio of projects, infrastructure businesses, or minority stakes in traditional infrastructure assets. Private credit can also provide infrastructure developers with greater leverage and flexibility in credit terms than traditional commercial lenders.
As a result, infrastructure fund managers have gained extensive knowledge of a wide range of infrastructure projects, allowing them to tailor their credit packages to the specific requirements of various borrowers, such as solar portfolio developers, data centers, fiber-optic telecoms, and others.
Higher interest rates have made private credit more appealing, and capital has flowed into the asset class. According to McKinsey, infrastructure investment and private financing will remain strong this year.
The consultancy firm said investors have been increasing their exposure to infrastructure due to an expanding definition of the asset class, its growing maturity and uncorrelated returns.
“As banks continue to limit their own lending, opportunities to put capital to work will be numerous as dealmaking resumes, prior vintage loans reach their cliffs, and private lenders foray into new areas, including asset-backed and investment-grade loans,” added McKinsey.
Neuberger Berman echoed McKinsey’s view on private credit, predicting that it will be resilient in the face of unprecedented economic instability, particularly since rising interest rates have not dampened the performance of the private credit markets.
“We find that private credit funds often take on less balance sheet risk by employing either modest leverage (up to 1-times equity capital) or none,” noted the investment management firm. “Banks, by comparison, tend to be levered 10 to 1. We believe private credit arrangements can be more transparent than critics suggest.”
Preqin warned, however, that the asset class is not risk-free for investors. “If the economy slows, some companies will struggle to service debts at higher rates. U.S. credit default risk could peak in mid-2024. At best, this would hit returns to LPs. At worst, it could put a few GPs in deep water.”
