NRG Energy and United Illuminating (UI) closed the $534 million construction financing for their GenConn joint venture on 24 April. It was the first deal in the US market since the onset of the credit crunch and introduced to the US bank market a new regulatory framework for power generators, the contract for differences.

The deal, led by Royal Bank of Scotland and Union Bank, also reintroduced NRG to the project bank market after a hiatus and UI, a well-known utility, but a new entrant as a sponsor. The robust financing metrics showed a keen awareness on the part of the sponsors of execution risk, given that many lenders at the time of financial close could not lend to five years.

The debt package finances the construction of two peaking power projects, each with a 194MW capacity, in Devon and Middletown, Connecticut. Devon, located in the southwest of the state, and Middletown, located in the centre, have similar configurations and use GE LM6000 turbines.

The two projects are being built in response to a request for proposals for peaking capacity run by the Connecticut Department of Public Utility Control (DPUC). The DPUC received the mandate under the 2007 Connecticut Electricity and Energy Efficiency Act, and by late 2007 issued a docket inviting proposals, which were submitted in March 2008.

NRG and UI formed GenConn in late 2007 to bid on the projects. The counterparty under the power purchase agreements is BBB-rated Connecticut Light & Power, an affiliate of Northeast Utilities, a utility holding company.

The agreement is structured as a contract for differences, with the offtaker obliged to make up the difference between the contract's annual revenue requirement and the revenues that the project makes on energy and capacity markets. The annual revenue requirement is set with reference to the plants' capital costs, operation and maintenance expenses, depreciation, fuel costs, taxes and other governmental charges and debt service. The cost of the plant is reviewed yearly to take account of changes in the plant's operating and financing environment, although the sponsors' return on equity cannot fall below 9.75%.

The contract for differences is designed to mimic a cost-plus approach, often seen in transmission deals, but also to create more competition. Bidders were expected to provide a schedule of costs to allow comparisons to be made more easily. Bidders were allowed to select their own sites, which gave NRG, which has access to several near its existing generating fleet, a strong advantage. The ROE figure was a key bidding metric.

GenConn picked up its first 200MW contract in June 2008, for Devon, and planned to build another 200MW at the same time, which would not be covered by the contract for differences. But then LS Power, which held another contract for 200MW at its Bridgeport site, withdrew from the process, saying that an error in its planning for dispatching into the region's forward capacity markets left it unable to sign the contract.

The DPUC awarded GenConn's Middletown plant a second contract for 200MW, and allowed the developer to stagger the opening dates for the two, with June 2010 the date for Devon and June 2011 the date for Middletown. The staggering allowed the sponsors to eliminate some duplication in costs, and did not come late enough in the sponsors' procurement process to cause any disruption.

NRG is managing the construction of the project without the benefit of a fixed-price turnkey guarantee. It has, however, locked in component prices, as well as high levels of liquidated damages, for most of the parts of the two plants.

Credit markets proved to be less straightforward. GenConn bid for its projects on the basis of a 30-year long-term private placement with a bank ready to step in if this did not materialise. RBS provided the venture with a commitment letter, and also pitched the sponsors with an equity bridge, which reduced the sponsors' cost of capital during the construction period, and allowed them to offer a lower annual revenue requirement.

By November, when the Middletown contract was approved, financial markets had deteriorated so much that GenConn, and the other two projects, which also had respectable power contracts, missed their window. RBS, joined by Union Bank in January, reworked the financing as a combination of bank mini-perm debt and equity bridges.

Since the contract for differences encompasses debt service, DPUC would have preferred a fully amortising long-dated deal to be locked in. However, after market testing RBS and Union Bank decided that seven years was the maximum tenor the bank market could take, and were keen to make sure the project did not stretch lenders with some fairly comfortable metrics.

Leverage after the equity bridges are repaid will be around 50%, with an average debt service coverage ratio of around 1.75x. The mini-perm amortises in line with 30-year debt, leaving a balloon in excess of 80% of the debt at year 7. The transaction marks the longest amortisation profile accepted by the market in the last several years, and the vast majority of deals have closed with amortisation profiles of less than 20 years. If the balloon is not refinanced, full cash sweeps should repay the banks with six years.

The $243 million bank term debt has a seven-year term, while the equity bridge loans, which are provided to each sponsor on a corporate basis, have 2.5-year terms. The package also includes a $48 million five-year working capital facility. The term and working capital debt is priced at 350bp over Libor, the UI bridge at 300bp, and the NRG debt, thanks to letter of credit support, at 200bp.

The two leads went out to potential joint lead arrangers looking for $65 million tickets, slightly less than the sponsors' preferred $75 million, but above the more bearish $50 million level some middle-tier banks prefer. The corporate equity was a potent weapon, enticing UI's relationship bank Bank of America to come in on UI's equity bridge. The rest of the banks – BNP Paribas, ING, Natixis, CoBank and WestLB – committed across the tranches, with the exception of TD Banknorth, which committed to the term debt alone.

GenConn Energy LLC
Status: Closed 27 April 2009
Size: $534 million
Location: Connecticut
Description: Construction financing for two 194MW peaking projects
Sponsors: NRG Energy and United Illuminating
Debt: $242 million seven-year term loan, $243 million in 2.5-year equity bridge loans and $48 million five-year working capital facility
Administrative agents: Royal Bank of Scotland (term debt), Union Bank of California (equity bridge)
Joint lead arrangers: BNP Paribas, ING, Natixis, and CoBank, TD Banknorth, WestLB, Citizens and Bank of America
Independent engineer: E3
Insurance: Moore-McNeil
Lender legal adviser: Chadbourne & Parke
Sponsor legal adviser: Dewey LeBoeuf