Changing Times

Five years after the collapse of Lehman Brothers precipitated the global financial crisis, Paul Jarvis considers the new landscape and the rise of the bond

“The banks were in dire straits and it was going to end in tears.”

Recalling his experiences of that time five years on, then Chancellor Alistair Darling told the BBC this year that he had already formed the view that some sort of collapse was inevitable before the Lehman situation brought matters to a head in September 2008.

The UK’s partnerships industry bore the brunt of the crisis that followed, with a lack of bank debt resulting in projects either stalling or being cancelled altogether. But the question today is whether the lessons of the past have been learned, and whether the outcome will eventually be a more sustainable and efficient infrastructure market.

The growing mistrust of banks’ liquidity in the months leading up to the Lehman collapse sparked a change in culture that has had long lasting effects.

“Five years ago, people did not worry about liquidity,” says James Stewart, global chairman of infrastructure at consultancy KPMG. “People were willing to lend long-term and were able to access cheap money, and infrastructure benefited from that.

“That trust or belief that the capital markets would remain liquid and stable has gone, and that represents a big change. People didn’t necessarily look at the underlying risks, and looked only at who they could sell on to during the heyday of the 1990s and early 2000s.”

Everyone agrees that long-term bank finance today is no better than half of what it was back in 2007. Banks themselves, however, argue that they remain in the infrastructure game. And to an extent, that is true. For example, Glasgow’s non-profit distributing college campus project reached financial close in September with debt provided from banks Helaba and KfW.

Last year, the Agility Trains consortium managed to bring in 10 private banks to finance the more technically challenging Intercity Express Programme contract for the delivery of new train sets. That success was followed up this June with the financial close of the Thameslink deal, where four banks acted as lead arrangers for the finance.

“If you look at Thameslink, that deal was oversubscribed,” says Stewart.

It was the length of time that it took to find that debt finance, however, which in part persuaded the government to move away from a private finance route for its Crossrail rolling stock procurement. Although it ended up oversubscribed, the Thameslink deal dragged on for many months as haggling over who would provide the debt – and how much – delayed the process, and forced the government to even consider alternative options in case the money could not be found.

And if the government is true to its word on trying to increase infrastructure investment in new areas such as renewable energy and cutting-edge waste technology, then the bank market will not be able to fill that financial void.

“At the moment there is sufficient long-term bank debt to finance the handful of projects in England,” says Richard Abadie, head of consultancy at PwC’s global PPP network. “If by some miracle the number of projects increased to the pre-global financial crisis levels, the long term bank debt market is unlikely to be able to finance the required level of debt. The rise in institutional lenders would go some way to plugging the gap”.

“If governments were investing to the level of five years ago we would be in trouble,” agrees Stewart.

Given the concerns over the Thameslink project, it is perhaps little surprise that Treasury officials have spent a huge amount of time over the last five years trying to establish some sort of replacement or alternative to the banks.

“A number of ideas were dreamt up in the immediate aftermath of the crisis,” says one former banker. “But because of the long gestation period of anything developed by the public sector, many of these are now effectively answering a problem that is not there anymore. We now have instruments to address a market failure that is not there.”

One of the most high profile responses from the government to tackle the debt market issues has been the creation of the UK Guarantees initiative.

While many in the industry recognise that the product could be of significant benefit for the really big, complex projects – such as the Battersea Power Station Tube extension project and the investment in new nuclear power – question marks remain.

“What is the purpose of the UK Guarantee?” asks Abadie. “In the handful of current PPPs it is crowding out private finance which, while arguably cheaper, surely cannot be the policy objective. Its use on mega projects such as new nuclear would be very valuable given the construction risk and size of the projects coming up. Government guarantees combined with institutional debt will be more expensive than government gilts but help minimise the impact on the government’s balance sheet.”

One financial consultant is scathing about the way in which Treasury has used this product. “They are behaving like insurance salesmen,” he says, arguing that one of the main reasons that the policy has been pushed so hard on a variety of projects is because their use provides a “rebate into the Treasury”, thereby creating a cashflow that can be used to employ more people.

Meanwhile, PF2 was also meant to entice the pension funds into the market, with its provision of an equity competition at preferred bidder stage. But the £700m of schools projects, plus a handful of hospitals that may yet be procured through the model, are not enough to create a whole new market.

“The hype around PF2 was a massive distraction,” says Abadie. “It was by and large a sensible tweak of PFI although it doesn’t look like it will have much use. I doubt the genuine value achieved will outweigh the cost, time and emotional capital spent on its creation.”

All in the private sector agree that what is needed from government today, far more than products to support the debt market, is dealflow. “In the immediate aftermath of Lehman, there were supply and demand issues,” says Nick Prior, leader of consultancy Deloitte’s government and infrastructure team. “Because Lehman had an effect on both sides at the same time, both were substantially depressed.”

While the background music has been increasingly positive over recent months, with a number of surveys showing both reasons for optimism and evidence of a more hopeful business world, many in the infrastructure sphere feel frustrated. After all, ministers have long promised that infrastructure investment would be a key lever of growth.

“It doesn’t feel like a recovery in terms of the infrastructure sector,” says the ex-banker. “The idea it is an infrastructure-led recovery is nonsense.”

“The bizarre thing over the past two or three years has been that the rhetoric around how important infrastructure is to economic recovery has not been matched by the reality of government being willing to invest in infrastructure,” adds Prior.

Officials at Treasury unit Infrastructure UK (IUK), however, reply that the work they have been doing has been ‘under the radar’, and critical to developing a more sustainable infrastructure market.

“Their work is very under the radar,” scoffs one source. “People are wondering what they are doing apart from creating lists. The private sector has not seen much evidence of all the work, just declining opportunities.”

A source at one construction giant agrees. While he recognises that there have been opportunities for those organisations with a strong support services division, he argues that for many traditional builders without that side to their business the past few years have been “dire” in the UK, with little hope of things getting better anytime soon.

Bringing in the cavalry
Notwithstanding the limited return of the banks to infrastructure over recent months, there remains an eagerness in the private sector to explore the potential offered by pension funds, insurers and the capital markets in general.

Most new products have looked to resurrect the bond market – which was also a victim of the crisis because all but one monoline insurer providing credit enhancement to bonds lost their investment grade ratings.

UK Guarantees, for example, is led by a former monoline insurer in Doug Segars, and certainly looks likely to provide what can essentially be regarded as a credit enhancement product to the Mersey Gateway PPP, allowing that deal to enter the bond market. Similarly, the EU has launched its Project Bonds initiative, albeit with limited effect so far.

Andrew Briggs, partner at law firm Hogan Lovells, suggests the change in the infrastructure finance market has been largely driven by the institutional investors themselves.

“Historically, institutional investors entered the infrastructure market through listed papers,” he explains. “But by the end of 2012, when they wanted to increase their infrastructure exposure, there was not enough paper trading, so they decided to make the market by moving from listed assets to quasi-bond deals.”

A series of funds have already done this – some, like Aviva, directly and independently, thanks to the fact they were already in this market. Others, meanwhile, have looked to team up with banks to use the project finance experience of those organisations to ensure they can manage their investments effectively.

Once again, though, the potential for such innovative approaches is hampered by a lack of dealflow, as many products that emerged from the private sector have withered without any real deals on which to test these ideas.

Institutional investors are also being put off building up their own expertise, because they simply do not see a long-term market for themselves at the moment. “One of the problems for the pension funds is that there are not enough deals for them to do,” says Stewart. “It is easy for banks to do the odd deal but the entry costs are very difficult to justify for pension funds on the basis of the number of deals available.”

So what does the future hold? Increasingly, it appears that we are entering into a ‘patch and mend’ phase, with the government only willing to spend significant capital in areas where there is no choice. Hence the Priority School Building Programme, or the focus on energy, where there is a real threat of the lights going out unless more power is generated.

“George Osborne’s recent conference speech talked of creating a surplus and you could argue that is even more bad news, because it is a clear indication that this government is not going to invest, but rather is going to further cut spending,” laments Prior. “All the evidence is that infrastructure is now pari passu with other government spending.”

He warns that the mantra over the coming years may well be “if it ain’t broke, don’t spend it”.

Where work does need to be done, however, there are already some examples of how the market has moved over the past five years to find and bring in new sources of finance.

In Barking, for example, the local authority has managed to craft an innovative deal with a fund manager that will see completely self-financed, affordable housing being delivered.

Meanwhile, the dark clouds that engulfed the world in 2008 have not yet completely cleared, as the recent furore around the US budget deficit has reminded everyone.

The original crisis was sparked by the American government’s policy decision not to support Lehman, as the UK had previously done with the (albeit much smaller) Northern Rock collapse. With the US currently lurching from one critical economic decision to the next, the world is again turning its eyes towards the biggest economy in the hope that some stability can be found. If it can’t, deals and the finance for them will remain in the doldrums.