Will Banks Invest in Infrastructure Again?

Six local banks in Kentucky banded together to create a $150 million investment fund to support public private partnerships. The fund is called the Commonwealth Infrastructure Fund and is intended to provide debt financing to state and local PPP initiatives in the state.

You might not think this is newsworthy, but it is for several reasons. It’s one of only a handful of examples of bank debt being clearly earmarked for infrastructure investing. In this country virtually all debt for projects that involve the government is financed with municipal bonds. But this wasn’t always the case. While municipal bonds, or their equivalent, have been around for centuries, as recently as fifty years ago banks also played a big role in lending to municipal projects.

But for various reasons banks backed out of infrastructure investing. First, banks have backed away over the years from lending into long-term projects. Municipal projects are often of long duration and it’s not unusual to see infrastructure projects financed over 20 – 30 years. That’s a long time for a bank to tie up money and it also carries the risk of lending into future higher interest rates.

There have also been some spectacular failures with municipal bond defaults in places like New York City and Detroit. While the risk of lending to commercial businesses is a lot higher, the municipal defaults have added risk to lending to municipal-based projects. However, to offset this, the collateral on municipal loans can be extremely safe, particularly if default on a loan is backed by tax revenues.

It’s important to note that this particular fund is looking specifically at public private partnerships. That is a venture that that benefits the government but is backed to some degree by private capital. PPPs come in many flavors. At one end of the spectrum are projects that are all private money, such as some recent projects where a commercial company built new schools and then leased them back to the government. At the other end of the spectrum are PPP projects where the government mostly finances but a private firm largely operates the venture. A good example of this is the fiber network in Huntsville, AL where the city built the project and Google Fiber operates the business.

This fund is something that the country really needs. I’ve seen estimates that there are somewhere between $4 – $6 trillion of needed infrastructure improvements in the country. This ranges from deteriorating roads, crumbling overpasses and bridges, old government buildings, outdated schools, old dams and water projects, etc. But currently there is already over $3.7 trillion in outstanding municipal bond debt. The cities and states can’t begin to take on all of the additional debt needed to bring our infrastructure up to snuff. So we need private money to enter the picture and to help pay for projects where that makes sense.

Anybody lending into PPPs understands the relatively low returns from infrastructure investing. Municipal bonds today generally pay interest rates of 2% to 5%. A lot of private money has been chasing the higher returns of technology investing, but there are still plenty of sources of money like pension funds that are happy with long-term stable and predictable returns. All of the financiers I know say that they are seeing a renewed interest in long-term safe returns.

This Kentucky fund would be a perfect place to look for help with fiber projects. Kentucky is one of the states that still has huge amounts of its geography with poor or non-existing broadband. I would be surprised if the telcos in the state don’t show interest in the fund, assuming the fund would be interested in them.

Raising $150 million for infrastructure lending is only a drop in the bucket when looking at the big picture. But it’s a start and hopefully this will lure other banks and sources of debt and equity to give more consideration to infrastructure funding.

Watching Interest Rates Again

eyeballWe have had an amazing run of stable interest rates. This has meant that I could create a business plan and have good confidence that the interest rate that I used would still be good a year or two later when it’s time to finance a project. That took one big worry off the plate because it hasn’t always been like this.

Historically interest rates have gone up and down and this period of steady rates is the exception in the way that interest rates have bounced during my career. Just within the last decade there were times where the bond markets were in such turmoil that it was nearly impossible to float new bonds. For the past few years we’ve seen nearly the opposite and the bond houses I know have instead been decrying the lack of bond deals wanting to get financed.

It’s not surprising to see interest rates starting to swing a bit again. We are going through a big stock market correction that has investors spooked. And the first thing that spooked investors affect is the bond market. The municipal bond market sells almost entirely to wealthy individuals looking for a safe haven for money. And corporate bonds are sold to both wealthy individuals and big pools of money like pension funds and insurance companies. As those buyers liquidate stock holdings there is a big increase in demand for bonds. Bank rates are the last to change, but they react over time to changes in the corporate bond rates.

Interest rates really matter to fiber projects. A project that might be feasible at a low interest rate might become risky at a higher one. I can remember times in the past when floating a municipal bond deal was dependent on the interest rate that was being offered on the day the bonds went to market. Bond sellers would hire experts who would try choose the right time to sell new bonds. And on the morning when a bond was to go for market I’d be sitting waiting to plug in the interest rate and bond term being offered that day to make sure it was a good deal.

I certainly don’t hope for a return to those kind of crazy times because high or fluctuating interest rates can put the kibosh on many good projects that would have easily been funded in better times. But since the payment term for bonds is so long the interest rate matters a lot – fiber bonds might last for 25 or even 30 years and might not be able to be called and refinanced for 10 or 12 years.

This blog was prompted by reading an article about the widening spread between corporate bonds and US Treasury bills. The spread for the whole corporate bond industry has opened up to 770 points, meaning that the interest rate being charged for issuing corporate bonds is a full 7.7% higher than the rate being paid on T-bills. That different climbed 1.1% just during the month of January. We haven’t seen a full 1% change in interest rates during a month for quite a while. More worry came when I just read that a Federal Reserve survey of banks shows that the majority of banks see a tightening of credit for 2016.

Why do interest rates matter to a fiber project? Consider a $50M fiber project. I just did a calculation of a project of this size for a client. In that project an increase of 1% in interest rate cut long-term cash flows by over $5 million if funded with bank debt. But if funded by municipal bonds the impact was $15 million due to the longer payment term plus the fact that muni bonds usually borrow money to make the first few years of interest payments up front. While a 1% change in interest rates might not kill a project, it’s easy to see that changes of more than 1% can be deadly.

Maybe worse of all is that we have been sitting with interest rates at historic lows for a long time. This means that the only place that rates can go is higher. At least, when rates finally go higher, there is always a chance that they might drop. So I will start keeping my eyes on news of interest rates again. It seems one of our old worries is back on the plate again after a nice hiatus.