Calpine's run of good fortune in the capital markets continues. The last major pure-play independent power producer in the US has defied its critics on several occasions during the downturn in the US power sector. With the $2.4 billion refinancing of the CalGen portfolio - one that was in doubt as recently as February - it left itself clear of further maturities till 2008. Its main goal now is to optimise its fleet of generating assets while servicing the high interest rates attached to recent financings.

Calpine Generating Company - or CalGen - is the new name for the Calpine Construction Finance Company II (CCFCII) portfolio. CCFCII was almost the zenith of the art of construction finance - only NRG's construction revolver exceeded it in ambition. It improved upon Calpine's earlier revolver in its covenant package, which allowed for substantially fewer restrictions upon asset sales.

That $2.5 billion financing, led by Credit Suisse First Boston and Scotia Capital, closed in November 2000, and would have come due in November 2004. It was an interest-only revolving credit whereby Calpine borrowed to construct plants and was to pay down debt through sales and operating cashflows. Such an arrangement is now unlikely to pass muster since banks require much more rigid contractual underpinnings to extend finance.

CCFCII, however, is largely a merchant portfolio. It has around 20% of its 9,820MW of capacity contracted to third parties, while a further 40% of the portfolio has a contract with Calpine Energy Services, a wholly-owned dedicated marketing subsidiary of Calpine. Such a contract does not have much of an effect on the CalGen credit, which is already an extension of the Calpine credit.

Indeed, the CalGen portfolio represents almost half of the total 22,000MW that it has under operation. In the circumstances Calpine would be hard pressed to walk away from its commitments, and the struggle to refinance the debt took on special significance. At twice the size of the CCFC I genco it was likely to be much harder to refinance or roll over.

Calpine exuded bravado over CCFC's financing, saying that the deal could have been rolled over with the banks, such was its generous collateral package. Whether true or not, this was unlikely to hold for the follow-on. Calpine had much fewer restrictions on asset sales, and the exposure levels were much higher. The arrangers, as well as their co-leads CIBC, ING, TD, and Bank of America, were likely to want out.

According to Zamir Rauf, vice-president, finance, the deal could not have been financed using corporate debt. As far as the company operates as a semi-autonomous part of the Calpine empire, it would have its own debt offering.

Goldman Sachs, financial advisor on the first refinancing, as well as the deal's bookrunner and hedge provider, would have been firm favourite on the mandate. However, Deutsche Bank emerged as the mandated bookrunner when the deal neared market early in 2004. Since the deal was set to dispense with the price support mechanism developed by Goldman, and Calpine would have been eager to dispense with too many burdensome covenants, competition would have been intense.

Calpine's Rauf, noting that Calpine chose its bookrunners based on structuring and distribution ability, as well as price, is too polite to comment. Market speculation is that Deutsche's bid was based on a confidence in the ability of the B loan and high-yield markets to absorb the debt without enhancement. The original structure envisaged $1.3 billion in term B debt and $1 billion in notes, as well as a $200 million working capital revolver.

But Deutsche was unable to issue the debt, and Calpine announced in a statement at the end of February that it was unable to complete the deal, and Rauf adds that pricing in the high-yield market had been creeping up since the start of the year. Nevertheless, the cancellation will have been a disappointment to Deutsche, which also pulled a financing for Calpine's Gilroy plant last year.

Calpine now turned to Morgan Stanley, which, in the form of its Capital Group (MSCG), had the commodities trading ability necessary to replicate the CCFC I hedge. Morgan Stanley has also performed a contract securitisation for Calpine. It was also able to tighten up the covenants on the deal.

According to Rauf, the most significant change is that "there is now a provision that the proceeds of any asset should be used to pay down debt, and must be offered to the various classes of loan and note holders in turn. Only if all had turned them down can they be retained by Calpine." The various classes of debt are:

* $600 million of first priority secured floating rate term loans due 2009 priced at 375bp over Libor, with a Libor floor of 125bp

* $235 million of first priority secured floating rate notes due 2009 priced at 375bp over Libor, with a Libor floor of 125bp

* $100 million of second priority secured floating rate term loans due 2010 offered at 98.5% of par and priced at Libor plus 575 basis points, with a Libor floor of 125 basis points;

* $640 million of second priority secured floating rate notes due 2010 offered at 98.5% of par and priced at 575bp over Libor, with a Libor floor of 125 basis points;

* $680 million of third priority secured floating rate notes due 2011 priced at 900bp over Libor, with a Libor floor of 125 basis points; and

* $150 million of third priority secured fixed rate notes due 2011 priced at 11.50%.

The notes and loans within each level of priority, with the exception of the third priority tranches, are to all intents and purposes identical. The deal also features a spark spread floor hedge, to allow for greater certainty of interest payments.

This is important, since the plants in the portfolio have a heavy concentration in California, Texas, and the South-east. California is still a relatively lucrative place to sell power, although one of the contracts that Calpine signed with the California Department of Water Resources (CDWR) has since been monetised through Morgan Stanley - the Power Contract Funding deal (see Project Finance, August 2003). Most market observers, however, would not be surprised to find CES fulfilling MSCG's obligations under the PCF contract.

Of the other two markets in which CalGen has a presence, Texas is also promising. Although the Electric Reliability Council of Texas (ERCOT) has been the subject of dire overbuild warnings, the state is also one of the few markets dependent upon gas-fired capacity, and where gas sets the market price. Says Rauf: "Calpine is the largest independent power producer in ERCOT and has the cleanest, most fuel-efficient fleet of natural gas-fired facilities. As such, Calpine has a tremendous operating advantage over its competition."

The South-east is a much less promising market for any generator. It is this market that will have stretched the spark spread insurance most.

The tranching is believed to be one of the most complex ever for a high-yield deal, and reflects the struggle to reach as many corners of the market as possible. While the common assumption, keenly promoted by banks with loan trading capabilities, is that there is so much money sloshing around in hedge funds, and other institutional funds chasing yields, that the B loan and high-yield markets are open to most borrowers. $2.4 billion is, however, a huge raid on the available pools of liquidity.

This is borne out by suggestions from bankers familiar with the market that Morgan Stanley has not fully syndicated the lower rated tranches, which are believed to be rated below single B. Morgan Stanley has not commented on the financing, but trading values on the debt are believed to be low. The higher tranches, which are paid first in the event of a default, have a very low debt per kW value.

Rauf notes, however, that the CCFC I notes are trading at 106% of par, meaning that there is still a certain appetite for Calpine risk. Also worth noting is that one of the aspects most worrying to banks on the original revolver - that Calpine was managing construction of the plants within the portfolio - has been one of the most successful parts of the financing. "We've demonstrated our ability to complete plants on time and within budget," says Rauf, so construction risk was less of an issue.

Nevertheless, there is some work left to do to complete some of the plants in the portfolio. So, to round out the financing there is a $200 million revolving credit led by Scotia Capital, and including TD Securities, Credit Lyonnais, Bayerische Landesbank, Union Bank of California, and ING. The revolver will provide working capital and support letters of credit to back power sales.

Rauf says that "with the completion of this refinancing, Calpine has no more significant liquidity events till 2008." However, it will examine any single-asset deals that justify a project financing.

The last major project financing to close is the Rocky Mountain Energy Centre deal, underwritten by Credit Lyonnais (co-syndication agent and co-bookrunner), CoBank (co-syndication agent and co-bookrunner), DZ Bank (administrative agent and collateral agent), HSH-Nordbank (co-documentation agent), HVB Group (co-documentation agent) and GMAC. This $250 million deal closed in February, and was syndicated to seven agricultural lenders and GE and HVB's project fund. Since these participations amounted to roughly $100 million, the leads did not need to syndicate the deal further.

Rocky Mountain is a 600MW gas fired plant located Weld County, Colorado, and will sell its power to Xcel subsidiary Public Service Company of Colorado under a 10-year power purchase agreement. The financing is priced at 250bp over Libor until construction is complete (in June 2004, tentatively), and 325bp thereafter, based on the offtaker's credit rating.

Calpine has also been making old project lenders happy - by buying Brazos Valley and restructuring the Aries deal. Brazos Valley, a 570MW former NRG Energy plant, was bought from an ABN Amro-led group of lenders for $175 million. Aries was a $270 million project lease, with debt led by DZ Bank (then DG Bank), Union Bank of California and Credit Lyonnais. Aquila's slide in rating meant that the lease equity was not drawn down. The deal has been in front of the arrangers, and recently closed with the departure of Aquila.

Aquila was released from the equity, and the tolling agreement that it had provided to the project, for the payment of $5 million. Aquila, which is based in Kansas City, close to where the 585MW Pleasant Hills plant is located, also gets the transmission rights that connect the plant to the SPP/ERCOT DC intertie. This should enhance the plant's ability to dispatch.

It was enough to persuade the syndicate of banks, led by DZ, to convert the construction loan to a $178.8 million two-tranche term loan with a 16-year weighted average life and 9.75% weighted average interest rate. But Aries still needs long-term contracts - its PPA with Missouri Public Service expires in 2005. Calpine's future now rests on contract negotiation, rather than covenant negotiation.

Calpine Generating Company

Status: Closed 23 March 2004

Size: $2.4 billion

Description: High-yield and term B refinancing of construction revolver for 9,080MW of capacity.

Sponsor: Calpine

Bookrunner: Morgan Stanley

Lawyers to the borrower: Stoel Rives, Covington & Burling

Lawyers to the lenders: Latham & Watkins

Engineer: RW Beck

Banks' consultant: Pace Global