Scott Zuchorski is a Managing Director and the Global Head of Infrastructure and Project Finance at Fitch Ratings.
Ever since the infrastructure became an asset class, it has been evolving. Early on this was a natural evolution that should be expected whenever a sector goes from zero to a percentage point or two of institutional portfolios. But the asset class didn’t stop growing there, and soon some of that evolution was driven by constrained supply in some of the “traditional” subsectors of project finance, like transportation P3s. Institutional allocations were growing but governments weren’t commensurately bringing bankable projects to market. So the definition of infrastructure expanded a bit as investors sought to recreate the economic profile of the asset class in innovative ways.
That evolution continues today, but some of the more recent changes to the asset class are also far more sectoral. The primary driver is the datacenter investment boom. That sector alone is shifting the balance, and the financial characteristics, if the infrastructure asset class. However, the datacenter boom is also largely driving a related investment shift: demand for U.S. energy development is no longer just transitioning into renewables; it is growing in aggregate as well.
These two (or three) overlapping trends are changing the financial characteristics of the U.S. project finance industry as well. To talk about both the nature and the magnitude of these shifts, and what they might meet for project finance credits going forward, Public Works Financing sat down with Scott Zuchorski from Fitch Ratings.
Scott is a Managing Director and the Global Head of Infrastructure and Project Finance at Fitch Ratings, where he oversees the analysis and rating of project finance debt credits in the U.S. and internationally. Prior to joining Fitch he was a First Vice President at Ambac Assurance.
His remit covers project finance debt for P3s as well as other sectors like energy, digital and increasingly bespoke transactions. This interview was partially prompted by a new report that his team put out on how the above trends are impacting the infrastructure credit sector, titled The Future of Infrastructure Finance: New Assets, Emerging Structures.
See Related PWF Articles
Scott Zuchorski
PWF: Fitch published a report on how some recent changes to the infrastructure asset class are translating to trends in the credit profile of projects that your team is rating. Can you start by talking a bit about what prompted the report and what you see as unique in some of these trends?
SZ: Sure. The asset class is always evolving, but I think the thing that is a bit unique now, and what prompted us to write about it, is how some recent trends in the asset class are translating into how projects are structured on the debt side.
Historically, the asset class has evolved but it has still really been centered around project financing. That project financing comes along with a set of common terms, a non-recourse structure, amortizing debt, strong lender protections, covenants, reserves, etc.
While project financing is still core to the industry we’re starting to see much more blending between corporate and project financing. We’re also seeing a lot more credit profiles that don’t fully amortize and come with a bullet. Both of those trends also mean more market exposure, both in terms of the economic cycle via corporate credit linkages and financial cycles via refinancing risk. Some of these trends on the finance side are most pronounced in the digital infra and energy transition transactions.
PWF: So this isn’t just a ‘too much capital and not enough projects’ situation? Or is it? One of the big sectoral trends on the asset management side of the industry has been a lot of institutional capital coming into the space and not enough sources of project financings from the usual sectors that defined the asset class. So asset managers have gotten a bit creative – both good and bad kind – in expanding the asset class to include other things. Is that what we’re talking about here or is this driven by something else?
SZ: No, I don’t think we’re seeing just that shift in the asset class, but we are seeing more institutional investors entering the sector. I think what’s really changed on that side of the industry has been the recent success of private infrastructure credit fundraising. Now we’re seeing asset managers in the private credit space become much more active in deploying capital by developing structures that work for their risk / return profile and bringing them through the ratings process.
Overall, I think its driven by a combination of new “proactive” investors and the emergence of new asset classes such as digital infrastructure.
PWF: So this is really is just the datacenter boom?
SZ: Not just, but it’s a big deal! Three years ago we had zero datacenter project financing deals in our portfolio. Now we have approximately 60 transactions that we’ve taken through the ratings process – not all of those deals get closed but it’s a huge shift. Sometimes it seems that we should change our name from the infrastructure group to the datacenter group.
One of the challenges for us is that the datacenter investment industry has grown so fast that it still hasn’t had much time to standardize. Even at the scale it takes to come to us for a rating, these are still very, very bespoke deals. Lease arrangements and risk allocation are still far from standardized and so each deal still requires a lot of analysis.
PWF: So one of the big trends highlighted in your report was this blurring between corporate and project financing for these deals. Is that largely driven by technology risk? That is typically what you expect to see in first-of-a-kind financings with lots of technology risk – there typically ends up being more corporate or other guarantees layered on to resolve the tech risk hurdle.
SZ: Hybrid transactions aren’t new to infrastructure, so I think some of this blurring between corporate and project financing is something we’ve seen before, but the scale at which these hybrid credits are occurring is very different, for both energy transition and digital infrastructure in particular.
The key issue for datacenter financing isn’t so much the technology risk. It is often re-contracting or renewal risk. A key question is whether the debt can be paid off over the current lease term. Otherwise there is re-contracting or renewal risk. That may seem minor now but it could be a more important risk in the future. The datacenter finance space is still developing– we are starting to see more lease terms north of 10 or even 15 years followed by optional renewal periods, but there is still plenty of variation.
PWF: What I find interesting about the datacenter boom is just how much of it is backed by very small number of hyperscaler credits. Obviously they are hyperscaler credits for a reason, and it is hard to imagine them as a source of credit risk. But how does this filter into a credit assessment of these datacenters given the scale and the number of concurrent projects and the disclosure limitations.
SZ: Well, this is how it is now! And of course we need to understand the credit quality of any tenant backstopping a project. From a project finance ratings perspective, we still focus on the fundamentals like long-term cash flows, and limitations on future borrowing etc. If cash flow visibility is more short term in nature and/or if the credit requires significant growth (through acquisition) to cover debt service, then that is more of a corporate credit.
PWF: How does this play into the trend towards bullet financings, though? Surely that isn’t driven exclusively by the datacenter boom or another technology trend?
SZ: I think the market now is more open to bringing investors with different risk appetites deals with a bit more refinancing risk. The key for us is to incorporate that refinancing risk into our ratings case, given the context of all of the other factors we talked about. Depending on the specifics of the lease terms and other contracts supporting the project, we could see refinancing risk as significant, or relatively low.
PWF: Well then, are datacenters becoming “infrastructure” or is the datacenter investment boom pushing the asset class out of its original value proposition?
SZ: I think a lot of what we’re seeing is a natural evolution of data and digital infrastructure into a core infrastructure asset. The investment characteristics of the asset class are driven by the essentiality of the assets. As digital infrastructure becomes more integral to the economy, its financing will increasingly depend on stable cash flows that are resilient to market volatility.