The recovery in steel prices has been welcome news to emerging markets lenders, which have financed projects in Brazil and China on the back of roaring Chinese demand. Now US power lenders have had a chance to buy indirect exposure to steel markets ? in the form of Primary Energy's $165 million deal.

The acquisition financing covers a portfolio of power plants that sell power either to steel producers and Californian utilities, a challenging credit in the best market. But the lead manager, Lehman Brothers, and co-manager, CIT, have benefited from recent improvements in the credits of both groups. But the deal still exhibits some long-term uncertainty, making it an ideal candidate for a B loan.

Primary's main equity investor, through the Private Power LLC holding company, is American Securities Capital Partners (ASCP), which was formed to invest the Rosenwald family's Sears-based fortune, and now includes other wealthy investors. Private Power bought Primary Energy from NiSource in July 2003 for $335 million. ASCP put up all of the equity for this deal.

The six plants, all located in Northern Indiana, are Lakeside Energy in Gary; Portside Energy in Portage; and Cokenergy, North Lake Energy, Ironside Energy, and Harbor Coal, all in East Chicago. They are all dependent for revenue on steel producers.

The buyers initially mandated Credit Suisse First Boston to look at structuring a dividend deal, since some of the the projects are already the subject of a $261 million lease financing that Merrill Lynch arranged for NiSource in December 1999, as well as additional loans from GE Capital. But the then poor outlook for the steel industry delayed a financing, and the financings, while in theory per project, are cash cross-collateralised. And in July 2004, Primary agreed to buy a portfolio of qualifying facilities from Reservoir Capital.

Reservoir had bought the facilities from Sithe Energies, the original developer. Since ASCP was apparently unwilling to do another all-equity deal, and since the diversity of revenue sources would create a stronger deal, the sponsors decided to combine the two acquisitions in one.

In the intervening period, the steel plants have experienced consolidation, with Ispat and International Steel now all part of the Mittal Steel group. Strong demand from China has also contributed to healthy returns for steel producers, although some forecasts suggest that a plant-building boom in China might cause it to start dumping onto world markets in the event of a slump. Nevertheless, the Indiana plants are very efficient, and the nearby urban areas might provide alternative electricity consumers.

The intervening period has also been kind to the Qualifying Facilities (QFs) ? Moody's upgraded Southern California Edison's rating in August, and Sempra and Xcel are both investment grade. FirstEnergy is reeling from problems at its nuclear plants, although Jersey Central is barely investment grade. The most pressing problem for the Californian QFs is the possibility that the short-run avoided cost formula, which governs the prices that QFs can charge, might be adjusted to a level that does not match fuel costs. All the QFs, with the exception of Kenilworth, have long-term PPAs that expire after the B loan's 2011 maturity.

The deal priced on 29 December 2005, and benefited from strong demand ? according to sources close to the arranger the debt was between 2.5 and three times oversubscribed. The loan pays 650bp over Libor, and has a rating of B2/B (Moody's/S&P).

Lenders needed to get comfortable with existing liens on the assets held by NiSource, which still guarantees some of the steel plants' performance, and GE Capital. But the deal features a stronger set of enhancements than many B loans, including a cash sweep of 75% of excess cash after debt service to pay down debt and mandatory 1% amortization. It also features a six-month debt service reserve and restrictions on additional business activities.

Primary Energy Holdings
Status: Closed 29 December 2004
Size: $165 million
Location: Indiana, California, Colorado and New Jersey
Description: Portfolio holding company financing of two sets of heat and power assets
Sponsor: Primary Energy, American Securities
Bookrunner: Lehman Brothers
Co manager: CIT
Borrower legal: Cravath, Swain & Moore
Lender legal: Skadden Arps