Energy Capital Partners is close to completing its $1.34 billion acquisition of Northeast Utilities' (NU) generation assets. Barclays, Goldman Sachs, JP Morgan and WestLB led the $855 million financing for acquisition vehicle NE Energy, which was 4x oversubscribed and brought in a group of over 15 predominantly institutional investors, according to a source close to the deal. The financing displays, however, high levels of leverage (roughly $721 per kW), and a challenging operational profile

The final structure was split into two tranches. The first lien debt consists of a $550 million term loan due 2013, a $100 million cash-collateralised letter of credit due 2013 and a $35 million revolving credit facility due 2011. The first lien is understood to be priced at around 250bp over Libor. The second lien is a $170 million term loan due 2014, priced around 450bp over Libor. Roughly a quarter of the first lien's principal will amortise in quarterly instalments. The second lien has no scheduled amortisation.

Proceeds from the term loans, along with $397 million of cash equity from the sponsor, will fund the acquisition of 15 generating plants at 14 sites with a total capacity of 1,442MW. The letter of credit facility and revolving credit will be used to provide collateral to contract counterparties and also used as a reserve for debt service.

The sale was announced on 24 July, following a competitive bidding process run by JP Morgan. ECP's principals include Doug Kimmelman, formerly of Goldman Sachs, Scott Helm, formerly of Orion Power, and Andrew Singer, formerly of Latham & Watkins. This is the team's first acquisition, and consists of Northeast Generation Company (NGC) – 1,296MW of predominantly hydroelectric generation facilities in Massachusetts and Connecticut, and the 146MW Mt. Tom coal-fired facility in Holyoke, Massachusetts, which was formerly owned by NU subsidiary Holyoke Water Power Company.

NU's competitive supply division bought most of the assets from its utility division in 2000 as part of the deregulation process in the region. The assets, with the exception of Mt. Tom, were the subjects of a $430 million bond financing, led by Citibank, in 2001. Of these bonds, due 2026 and rated BBB- by Fitch, and Ba3 by Moody's, $320 million are outstanding. The financing has thus been structured around existing operating level debt, and an operational profile that is almost unique within power finance.

The Northfield Mountain plant accounts for 1,080MW (75%) of NGC's capacity, and over 50% of its expected revenues. But Northfield is a pumped storage facility, which uses water pumped uphill during off-peak periods to capture value from short-term and on-peak spike prices. The electricity is generated during hours of peak consumption by using water that has been pumped into an elevated reservoir during the hours of low consumption. The water risk associated with this type of facility is essentially eliminated due to its ability to produce power as a closed loop, recycling the same water. But the most challenging aspect of the financing is that Northfield is run entirely on a merchant basis.

Northfield Mountain has the ability to generate attractive margins due to the spread between off-peak pumping costs and on-peak hour electricity prices. In addition it has the potential to respond quickly to volatile energy prices. It is conveniently situated in the NEPOOL market where gas-fired generation sets spot power prices 86% of the time, and as a low-cost generation facility Northfield Mountain is well-positioned to compete against more expensive alternative energy sources.

ECP has hedged the output of Mt. Tom and NGC's conventional hydro facilities, but not Northfield, through to 2011 with J.Aron, the commodity trading unit of Goldman Sachs. This will provide some cash flow stability, with an estimated $80 million per year being generated from this arrangement. Combined, the capacity payments plus the hedging arrangement will account for 65% of the issuer's gross margins and stabilize cashflow.

The first lien gained a B1/BB- (Moody's/ Fitch) rating and the second lien gained a B3/B-(Moody's/Fitch) rating. Moody's notes that the issuer suffers from high leverage, and also the market and concentration risk associated with Northfield Mountain. But the strong operating history of the assets, plus their competitive position, should insulate lenders from market volatility. Still, as Fitch notes in its rating, the management's projections include $10 million in potential cost savings that may be difficult to achieve, and predicting the behaviour of the portfolio, particularly the pumped storage facility, is difficult in the face of a developing energy and capacity market in New England.

Good news for the buyer, however, comes from approval of a new forward capacity market framework in NEPOOL in June this year, which should result in increased capacity revenues. The new framework mandates credits, and thus payments, from the New England ISO to producers based on them making capacity available in a given month three years down the line.

The payments have been set at $3.05 per kW each month, and rise to $4.10 per kW each month over the next 3.5 years. In 2010, however, the prices will be set through an auction process. The values that will be attached to these capacity credits are difficult to predict, since the purpose of the framework is to create price signals and thus allow developers to know whether new capacity will be viable.

Financial close is expected during the first week of November. The leads were working on final allocations and finishing documentation as Project Finance went to press. The deal illustrates in its own way the continuing ability of issuers and underwriters to drive aggressive terms through the debt market. But it also illustrates how competitive the bidding process has become. According to one source close to the transaction, the cash sweep provisions on the debt are so aggressive that under some scenarios ECP will not be able to draw a dividend from the assets until 2011. "It may want to flip the assets again before that point," notes the source.

NE Energy Inc
Status: Closed 10 October
Size: $1.34 billion
Locations: Massachusetts and Connecticut.
Description: Acquisition financing of Northeast Utilities' generation assets.
Sponsor: NE Energy
Debt: $855 million
Lead Arrangers: Barclays, Goldman Sachs, JP Morgan, WestLB.
Financial Adviser to NU: JP Morgan Securities
Market consultant: Pace
Legal counsel to the sponsor: Latham Watkins
Legal counsel to the lenders: Shearman Sterling