“ESG is just another credit point. If you’re looking at an asset that in 15 years cannot function with the business that it currently has, that’s a credit point,” said Lucy Dale, a director in BlackRock’s infrastructure debt group.
“We’re a value investor, not a values investor. We’re looking at the risk and how it’s mitigated, and whether it’s appropriate risk-return for that particular asset. We look at risk in and of itself, rather than it being tied to a specific sector such as oil or coal,” Dale told delegates at affiliate title Infrastructure Investor’s Global Summit in Berlin.
Dale shared five things on her mind when she measures risks related to the energy transition in BlackRock’s underwriting process for infrastructure loans.
1. Will the business need to transition?
Dale considers how the asset will operate by the end of the loan term, particularly for bullet loans – a type of loan in which the borrower pays the entire principal, and sometimes interest payments, at the end of the term.
“I’m not lending 12 years on a bullet to something that’s not going to have the same business unless they have a plan to transition. For example, a storage asset might be moving into the minerals business.
“There are some assets where when we invested five years ago, we couldn’t tell how quick the transition would be.”
2. How much will that cost?
Dale asks how much capital an asset would need to spend to change its operations to keep up with the energy transition.
“You see all these people wanting to spend all this capex. You’re now looking at gas transmission networks – what are they going to turn into in five years? How much capex are they going to have to spend on developing their ability to, say, transport hydrogen instead?
“The conversations with borrowers and sponsors with what their plan is in the energy transition are very important.”
3. The downside: could the asset lose value?
Dale considers whether the infrastructure asset the loan is secured against could lose value or become stranded as the energy transition accelerates.
“I’ve seen a shift in the way we’ve thought about downside scenarios post-Covid. Asset classes that we previously thought were less volatile can be more volatile. We’re going to carry that forward with us. The downside scenario testing is going to be more stringent than three years ago.”
But an investor must avoid confusing a short-term stress scenario in the market with long-term market change and asset obsolescence, Dale added: “The challenge is to be realistic in our downsides. We’re long-term investors. We’re looking for the long-term sustainable story.
“I’m not sure any of the assets in our portfolio are definitely going to become stranded. But you do need to do the work upfront to make sure you don’t end up with a stranded asset in your portfolio.”
4. Can the borrower be replaced?
It’s not just about calculating the default risk of the borrower. If the borrower defaults on the loan, Dale asks how much it would cost to find another asset owner to assume the loan agreement.
“It’s about replaceability as well. You’re taking this risk – do you have an off-market contract? Do you have something that someone else could easily step into?
“You can take a view on the credit risk of that particular counterparty, but are they replaceable? If the answer is yes, that makes it a little bit easier.”
5. What controls does the lender have?
Dale asks what negative undertakings clauses in the loan agreement can include – whether the lender has control “around permitted additional indebtedness, about permitted business, permitted acquisition”.
“Those controls we have as lenders are being diluted. There’s a lot of risk there. We don’t have that control that we felt like we needed to make sure that they don’t behave in a certain way that’s going to dilute your credit risk.”