The US power market is a great deal different than it was only a few years ago. No longer are project banks freely handing out money for plant acquisitions or for greenfield projects in development. The big project banks were burned too often after the merchant bubble burst and most have since reduced their risk appetite, or indeed withdrawn entirely from the power project space.

With few available choices but many deals still to be done, the power market has turned to a new source of funding - namely the institutional loan market. And the Term B market is opening its arms wide, with the promise of a captive audience - and healthy returns.

For many in the power market, Term B loans offer a lifeline where no other option is available. According to some, it has saved the sector from a deeper decline in the business cycle and started the ascent to better times.

Richard Ashby, managing director at advisory firm Pace Global, says that Term B has become a hot market. "Quite simply it is the only market out there for existing energy merchants. Although many have pushed off near term maturities, they have been moved back only by two or three years on average," he says. "There are a lot of companies out there that require funds. And most traditional project banks are now looking to become advisers rather than put their balance sheet at risk. Given the volume of refinancing needed over next few years, there will definitely be a necessity for the Term Loan B market to bridge the short-term liquidity gap."

Adds one market participant: "You won't see a Deutsche Bank or ABN Amro returning to the power project market any time soon. In the meantime there is the Term B market."

According to Joe Casson, managing director in the infrastructure and energy finance group at Citigroup, it is a matter of where the industry is at in the business cycle. At the bottom of the cycle, many companies moved down the credit spectrum, creating many non-investment-grade entities requiring restructuring. "Traditionally banks were not lenders further down the credit risk spectrum," he explains. "For non-investment grade companies it has not historically been the case that you can pay the banks an extra couple of hundred basis points and get a deal through."

"Generally you don't see many deals done in the commercial bank market where the credit is non-investment-grade. Term B is more oriented towards a risk-return model, and thus investors will take on double-B risk to get double-B returns," adds Casson.

As the power industry comes up out of the last cycle, as some of the credits move back up through the credit quality spectrum, and as a number of restructurings continue to happen, Term B has a natural investor-base for the sector. However, there are some hurdles still to overcome while institutional investors enter the arena, not least the structuring of deals.

Casson at Citi says comfort levels are growing for Term B investors looking at the project market: "It is a very liquid, traded market." Although there is always a educational phase, when new investors entering a market work out how to structure such deals, the market is developing. "There is always the question of waivers and amendments, and the high level of monitoring associated with projects, but this is something that we will find our way on," he says.

"We have had 144a financings for projects that are liquid and traded, so there is some precedent here," says Casson. "As the market develops, Term B investors will develop an understanding and comfort with these types of structures, and then maybe we will see even more participation in project financings from the Term B market. But that remains to be seen."

Prolonging the refinancing crunch

Although there benefits are clear, there are a number of concerns that have been raised with the entrance of Term B lenders in the power project market. One question that is on the lips of many power market players is whether this will turn out to be a long-term funding option or whether it is a stop-gap solution.

According to one market participant, it is somewhere in between: "For projects with well-structured payment periods and long tenors that have in the past been well-suited to institutional private placement, I don't know if that would be appropriate for the Term B market.

" don't see the Term B market being comfortable with those kinds of tenors, but it is very useful as an investor-base for the credit quality we are looking at now," he says.

Ashby at Pace believes that this will change: "Like most things, these markets are cyclical. Over the medium term we will likely see a rotation out of the Term B base. It is a function of the demand for this type of lending - which is pretty expensive - until a more attractive, less expensive, product comes along."

But whether the entrance of Term B investors has merely prolonged the refinancing crunch, rather than offering a concrete, long-term solution may be irrelevant. Says Ashby: "The opening of the Term B market has been good for the industry. It allows deals to go forward that wouldn't have a chance otherwise.

"It allows for businesses to change hands and thus it serves a very useful function," he says. "There are a lot of assets that still need to move around in order to once again become commercially viable, so this is a good thing for the industry."

Some examples of deals done that may have had a tough time without the Term B market include Calpine's $2.5 billion refinancing of its CalGen portfolio. The new deal, known as the Calpine Construction Finance Company II (CCFCII) portfolio, closed in March this year through Morgan Stanley.

The $300.9 million Teton Power Funding deal, with which Arclight Capital Partners bought Aquila's US and Jamaican generating assets, was syndicated in February this year and arranged by Lehman Brothers. KGen Partners also recently closed a deal for an institutional loan market financing of its $475 million purchase of Duke Energy's southeastern US merchant generating assets.

Another concern for power market participants is the sensitivity of such deals to interest-rate fluctuations. Says an arranger: "With most Term B deals typically being floating-rate in nature, the interest-rate question is key." While in the past this was typically up to the project banks, this is now the concern of the project sponsors. "The question is how the project sponsor has hedged its IR exposure."

Adds Ashby: "It is sensitive to IR fluctuations, but if you look at borrowers they have very little alternative. Interest rate increases will have some effect but it won't kill the market. The key is that low repayment requirements hold down the debt service costs."

Finally, as more deals enter the market this raises the concern that margins may become compressed relative to the risk that investors are taking, thus creating the possibility of an asset bubble. Says an adviser: "Once the market gets hot you see people chasing the deal rather than chasing the good deals."

"There is a danger of margins being compressed as more activity picks up, but there is nothing to be overly concerned about yet," he adds. "You still need to make certain that the deal is properly structured and not just look to spread above Libor. This is true in all markets."

Opening the market

Involving the institutional loan markets in power project funding was originally the brainchild of Credit Suisse First Boston, which put together the first such deals and has been instrumental in getting the market off the ground. But the interest of other project banks in joining the market as arranger is a testament to the attraction of such a product to both the Term B market and energy project sponsors.

Says one adviser: "There are other institutions who have the ability to act as advisers and arrangers looking to reproduce what CSFB has done. I think there will be a lot of activity going forward. We have one deal in the works right now that is being done by an institution other than CSFB, so it has already started." Indeed, Morgan Stanley, Citi, Lehmans, Goldman Sachs and Deutsche would all claim to have the ability to complete institutional loan financings for power assets. Among these players, however, there is a wide variance in project finance expertise.

And in addition to increasing arranger interest, the Term B market is opening up to more complex types of deals as well. The $690 million B loan financing for the Astoria Energy power project, which was launched by CSFB earlier this year, is the first-ever Greenfield power project funded through the Term B market. The deal is rated Ba3 by Moody's Investors Service. Astoria is a natural gas-fired plant in New York City that has a 10-year power purchase agreement with Consolidated Edison and a 10-year gas supply agreement with Sempra Energy.

Ashby at Pace says that Astoria represented a confluence of the right circumstances at the right time. "Astoria exists in a capacity-short market - New York City, has high construction costs, and had a PPA available. Therefore it provided a good combination of circumstances, and allowed the deal to go forward through the Term Loan B market."

"However, you would not see this is type of deal go ahead in, for example, Mississippi or Georgia - in a market with overcapacity and no PPA available," he says. "But given the right deal with the right circumstances, the Term B market will be open for further greenfield funding."

Adds one arranger: "Term B is a little more appropriate for deals that are already in operation where you are looking to recapitalise or refinance, where there are existing operating assets. But there is some room for other types of deals. But we are recovering from a very different period in merchant power. A year ago would have been difficult to find any funding for merchant power, but now term B lenders are once again interested."

Crystal balls come out

As the business cycle rises, there may be a return of interest by project banks in looking at high-quality credits. But that does not necessarily mean that Term B investors, and indeed power project sponsors, will lose interest and compatibility as soon as the cycle begins to reach its zenith. This may rather turn into a new investor-base that will offer more depth to the market and more choice to energy entities. Says one market participant: "While this part of the credit spectrum continues to be present in the market, there will likely be a place for the Term B market."

Term B institutional investors will continue to participate in the power market over the long term. "I can see a number of deals where there is more application ahead of us," says Casson. "This market could develop as an equal to the project finance bank market. Term B lenders tend to be yield investors - they are looking for risk and return. The market should continue to evolve for operating assets."

Nonetheless, the entrance of the Term B market has offered a reprieve and some options to those power market participants that are struggling to make change happen. Says Ashby at Pace: "I think that the market is improving. Certainly we felt a turn in the market occur last year - we are now out of the trough. From the spreads we are seeing, the market is not nearly as bad as most people may believe and not nearly as good as most people want it to be. But that is OK, in the end."