CalPeak: Cash in second-hand

Tyr Capital and Starwood Energy Group closed the acquisition of Calpeak Power on 26 May 2006. Lead arranged by SMBC, the $123.4 million portfolio financing was designed to maximize debt whilst also providing current cash returns to equity through an A and B loan structure with the B loan based on the residual value of the turbines in the plant.

CalPeak is a 250MW portfolio of peaker projects located in San Diego and San Francisco. The assets consist of five 50MW units – four FT8 Pratt & Whitney Twinpac systems, with two gas turbine engines and one 49.5MW generator, and one Swiftpac unit. Pratt & Whitney, a division of United Technologies, installed the units in response to the state of emergency that California's then-governor, Gray Davis, declared after blackouts hit California in 2000.

Pratt & Whitney built the projects using its own resources and signed power purchase agreements with the California Department of Water Resources (CDWR) for 42MW of capacity at four of the units (El Cajon, Borders, Enterprise and Vaca Dixon) running from 29 May 2002 until 1 January 2012. The 'reliability must run' contracts mean the operator is paid for availability rather than what it supplies.

In January 2006 United Technologies agreed to sell Calpeak to Tyr Energy. Tyr brought in Starwood Energy Group (a subsidiary of Starwood Capital) to provide the bulk of the project's equity – 80% – with Tyr providing the remainder. As the transaction was closing, however, Itochu bought out the founder of Tyr, who promptly moved to Starwood.

Due to the structure of the contracts with the CDWR and the transportability of the turbines, the financing is designed to maximize debt while still providing current cash returns to the equity sponsors. Capacity payments from the CDWR contracts provide 95% of the revenue to the project with the remaining 5% from reliability-must-run (RMR) contracts. These revenues were more than sufficient to repay the $70 million of fully amortizing debt originally envisaged and backstop other credit instruments including letters of credit and a working capital revolver prior to the maturity of the five PPAs.

Consequently there was enough excess cash flow from the assets to allow dividends to the new equity holders. But a deal along those lines would have resulted in leverage of less than 60%, which the equity sponsors felt would be less than optimal. Conversely, increasing the amount of fully-amortizing debt would have meant much lower debt service coverage ratios, higher interest spreads, and a non-optimised debt structure.

The key to raising more debt on the project was an understanding of the residual value of the gas turbine generators. As Steve Zaminski, a principal at Starwood says, "we considered a lot of structures, and settled on the sweet spot between a very comfortable risk profile and our views concerning the residual value of the project."

The Pratt & Whitney systems are widespread and easily transportable, and both sponsors and arranger concluded that there was substantial value in the turbines – even if they were transported elsewhere. SMBC eventually became comfortable with lending an additional $37.5 million against the value of the turbines. This value was judged as approximately 50% of the value six years from closing, taking into the account the costs of packaging, moving, and setting up the turbines in a new location.

The market for financing the turbines would normally have required interest spreads in excess of what was charged by SMBC for this portion of the financing. But SMBC and the other banks in the deal felt comfortable with both parts of the transaction, and CalPeak achieved interest rates below what would have been charged for either the A loan or the B loan if done independently.

Based on the rating of CDWR (A-/A2) and the short tenor remaining in the PPAs, the six-year A loan and related facilities priced at 100bp over Libor while the residuals-based B loan priced at 300bp over Libor – around 75-100bp below a standalone B loan for similar assets.

The tight pricing meant that typical B loan investors would not be interested in the paper, since it would not meet their return hurdles. Nevertheless, by stapling the B loan to the A loan and highlighting mitigating factors for the low rate – robust debt coverage, no construction risk, strong operators with significant equity and a good operating history – SMBC had little trouble in getting the deal away: AIB, Deka Bank, Erste Bank and Mizuho came into syndication which closed in one month and without market flex.

The B loan was also half the size of the A loan and, therefore, had the effect of raising the weighted average returns to A lenders from 100 bps to 170 bps. Banks could take comfort that they had further support to the credit – in addition to the possibility that the turbines could be reassembled on another site, some or all of the five contracts could be extended, or barring an extension, CalPeak could bid its capacity into what seemed likely to be annual or bi-annual peaking capacity auctions.

The CalPeak template is an innovative twist on the B loan structure and has application anywhere there are easily transportable long-life assets. It combines the residual skills of big-ticket lease arranging with project debt and is certain to find new takers.

CalPeak Power LLC
Status: Closed 26 May 2006
Debt size: $123.4 million
Location: California
Description: 250MW peaking power portfolio
Sponsors: Tyr Capital (Itochu), Starwood Energy Group
Mandated lead arranger: SMBC
Lead arrangers: AIB, Deka Bank, Erste Bank, Mizuho
Lender legal counsel: Paul, Hastings Janofsky & Walker
Sponsor legal counsel: Bryan Cave; Chadbourne & Parke
Financial adviser: Fieldstone Private Capital Group
Market consultant: Global Energy Decisions