Despite the 'credit crunch', demand for infrastructure assets is expected to hold up well during 2008, though buyers will have to face tighter covenants and higher pricing on bank loans.

But capital markets pricing may well be more heavily impacted, which is bad news for BAA Limited, whose securitisation has been continually pushed back since March 2007, and which is not now expected until March 2008. The new estimate of the timing of the deal was made by BAA on 3 October, reacting to the publication of the Competition Commission report to the Civil Aviation Authority (CAA) on the subject of price controls at Heathrow and Gatwick airports over the next five years.

BAA noted that it had made significant progress during 2007 with the development of a structure to refinance existing Airport Development Investment (ADI) and BAA debt, but argued that "the effective implementation of the refinancing has been negatively affected, both in terms of timing and practicability, by the Competition Commission report, particularly with regard to the cost of capital and the corresponding return on investment as well as cost of operating Heathrow and Gatwick Airport."

BAA was back with a further clarification to creditors on 8 October, and said that its intention remains to effect a refinancing consistent with other established regulated financing platforms, which involved a migration of existing bondholders into an investment grade, ring-fenced structure backed by the designated assets of the group.

"BAA will, over the coming months, be working with its advisers and other key transaction parties including the rating agencies, to continue to design a refinancing plan, although it may well not be able to finalise any such plan until the regulatory settlement is published by the CAA next March," the company statement said.

In April 2006, at the time the ADI consortium led by Grupo Ferrovial made its cash offer for BAA, Moody's placed the Baa2 ratings of BAA Limited on review for possible downgrade.

They have remained on review ever since, and on 22 October Moody's announced that the Baa2 rating was being retained, though it is still on review for downgrade. But there are nonetheless fears at BAA that a drop into junk bond status for its senior unsecured debt could be a possibility over the next 12 months.

"The Baa2 rating is predicated on the assumption that BAA executes a ring-fenced financing of its London airports that will incorporate a transfer of the rated bonds into the ring-fenced structure, and that the credit profile of the rated bonds in the ring-fenced financing will be commensurate with either a Baa2 or Baa3 rating," Moody's commented. "In the event that this is not achieved, and absent any particular credit enhancements provided to the rated bonds, Moody's would see the rating of the rated bonds in the Ba rating category."

More BAA delays

The key events now being awaited are the final CAA proposals for the regulatory settlement for Heathrow and Gatwick, expected in March 2008, and the 'emerging thinking' guidance expected in February 2008, or provisional findings in June/July 2008, of the Competition Commission's reference on the supply of airport services in the UK by BAA.

Moody's notes that even without a change in policy by the CAA, the delay in concluding a ring-fenced financing has created greater uncertainty of execution. This is because the debt markets may become less amenable to a ring-fenced financing in the light of the then approaching time for the publication of the Competition Commission's review of the ownership of BAA's airports. Furthermore, a material period of delay beyond BAA's current timetable may pressure BAA's liquidity position in the absence of the sourcing of additional committed facilities.

Airport re-regulation

The goings on at BAA have focused attention across Europe on the issue of regulation of airports, reversing the trend towards steady deregulation seen over the past decade. Some airlines have been vocal in suggesting that airport operators should be set investment targets to deliver capacity growth and avoid overcrowding.

In mid October, British Airways chief executive Willie Walsh called for BAA to be forced to increase the amount of passengers and aircraft that it can handle. He suggested that firm commitments to capacity development might be an alternative to breaking BAA up and making it sell off some of its airports.

And IATA Director General Giovanni Bisignani has been sharply critical of the rising costs to airlines of using European airports, at a time when the airlines themselves have been making so much progress on increased efficiency and cost cutting. He has pointed to Manchester Airport as an example of a regulated airport which has produced good results for airline operators, and called for more effective regulation across the EU.

"The experience of what has happened with BAA is influencing national governments across Europe, and how they look at privatisation, and certainly within the UK it is a live issue within government," comments one analyst. "There is debate about whether deregulation is working, and whether there should instead be forced delivery of capacity."

It is ironic that the UK led the world in establishing airports as tradeable assets with a very light regulatory touch, but that heavier regulation is now back on the agenda. Investors, who in 2005 and 2006 were primarily concerned with traffic risk, are now also viewing the risks associated with changes to regulatory regimes.

Nonetheless, there are still plenty of buyers out there, and infrastructure assets are tipped to be well-bid during 2008, in spite of the changed environment in the wake of events at BAA, and the problems in the global credit markets.
"In 2006 and the first half of 2007 sponsors had been using hybrid project and acquisition finance structures to acquire assets not traditionally considered as infrastructure," says Michael Wilkins, Head of Infrastructure Finance Ratings at Standard & Poor's.

"Cheap debt with relatively generous terms was the order of the day among infrastructure sponsors," he adds. "To meet market demand, banks have combined project finance structuring techniques with covenants prevalent in leveraged finance facilities- allowing sponsors to acquire infrastructure assets at record breaking debt multiples. Now that the cycle has turned in the global credit markets, loosely structured and highly leveraged acquisition loans are looking far less attractive."

Real development rather than refinancing profits

"Demand for true infrastructure assets is holding up pretty well, but where there could potentially be problems is where quasi-infrastructure transactions have been dressed up as infrastructure. For pure infrastructure plays covenants may become tighter, leverage may come down slightly, and there will be some re-pricing of bank debt, but there will still be healthy appetite among lenders for deals such as airport acquisitions," says Wilkins.

Covenants will undoubtedly be tighter than for the acquisition finance facilities agreed in 2006 and 2007. "The current environment favours investors who are able to drive value in the underlying business versus investors who are simply focussed on being able to refinance the assets," says Richard Tollis, partner at Ernst & Young.

Consortia are likely to feature a strong contractor/operator together with financial investors such as pension funds and insurance companies, who still like the very long term returns on regulated assets such as airports.

One example of this type of consortium is the Hochtief-led group which this year acquired a controlling stake in Budapest Airport, whose debt financing was being syndicated in October.

BAA originally won the rights to operate the Budapest Airport concession back in 2005, and held a stake of 75% less one share. However, after BAA was itself acquired, new parent company Ferrovial decided to sell the airport. The 75% stake was acquired in May of this year by a consortium led by Hochtief AirPort (49.67%), together with Caisse de Depot et Placement du Quebec (23.17%), Government Investment Corporation (GIC) of Singapore (23.17%) and KfW IPEX Bank (4%).

The Hochtief consortium paid BAA Eu1.9 billion, with Eu1.5 billion due immediately and the Eu400 million balance to be paid in 2011. According to Hochtief, this staggered purchase price allows for an optimised financing structure and a significantly lower equity commitment.

In May the Hochtief consortium signed a loan with a group of banks for a Eu1.52 billion project facility, a Eu400 million Letter of Credit for Hochtief, together with structured interest rate swaps totalling Eu1.02 billion.

This loan was being syndicated in mid-October, though clearly conditions in the global credit markets have changed considerably since May. The mandated lead arrangers and bookrunners are BNP Paribas, Calyon, Royal Bank of Scotland, SMBC, BayernLB, K&H Bank, KBC, MKB Bank, SG and WestLB.

Banks were being offered Eu75 million arranger tickets, Eu50 million co-arranger tickets and Eu25 million lead manager tickets. The deal matures in December 2014. The Eu1.13 billion senior A loan includes a Eu830 million AMC loan and a Eu300 million capex facility. There is also a Eu370 million B loan and a Eu20 million working capital facility that will not be syndicated.

This loan is something of a litmus test for the infrastructure sector, since some banks will be re-assessing their margins on project lending in the light of the disruption in the credit markets. Nonetheless, with infrastructure remaining in fashion at a time when lending in many other sectors is being cut back, many banks remain keen to participate in such a high profile loan syndication.

The next big European airport which is attracting attention from bidders is Prague Airport, which is expected to be privatised in 2008. This could either take the form of an outright sale of shares, or a concession.

Prague has already attracted plenty of expressions of interest, and players such as Flughafen Wien, Hochtief, Fraport, and Abertis would all be expected to bid.

Beyond that, the market is also looking forward to a possible forced sale of one of the three London airports operated by BAA, possibly Gatwick. With traffic growth outstripping forecasts at airports across the UK, Gatwick would be viewed as a prize asset by many international airport operators, provided that the regulatory picture looks favourable.