Calpine's recent refinancing of its CCFC I genco is a clear statement that Calpine is still in the merchant power business. Following a string of recent financings where contracts took centre stage, Calpine's much-vaunted flexible operations looked like being a casualty of the current power crisis. This high-yield refinancing, which features an innovative price hedge, suggests that the generator is still saying faithful to its roots, albeit at a price.

The first Calpine Construction Finance facility, which signed in August 1999, was a genuine step forward in power finance. No sponsor had previously been allowed such a wide frame of reference in building power plants with non-recourse debt. The $1 billion revolving credit allowed the sponsor to build as many plants as the maturity of the facility, and a bank-led technical committee, would allow. CFO Bob Kelly banned the use of the phrase 'project finance' in discussions with banks.

Nevertheless, the banks retained a number of comforting features, including solid equity commitment and the inability of Calpine to remove plants from the collateral package, meaning that each additional plant that Calpine built under the facility stayed locked in to maximise recovery prospects. The sponsor improved on this with the CCFC II deal, which signed in 2000.

According to Zamir Rauf, vice-president, finance, at Calpine, it considered three options for the 30 November maturity: rolling over the CCFC I debt, issuing corporate debt, or attempting a note issue at the generating company level. However, having just issued $3.3 billion as part of ongoing efforts to shore up its capital base, corporate debt was not really an option.

According to Rauf, Calpine examined rolling over the debt with the existing bank syndicate, led by CIBC, TD, Credit Suisse First Boston and Scotia, and he says that the assets were good enough to tempt lenders into staying in. However, Calpine decided to refinance, pay off lenders, and hit the high-yield market, where flexibility was not an obstacle.

Nevertheless, the deal did release Calpine from some burdensome obligations, and included the ability to replace operations and maintenance agreements. The original lenders wanted these to reside with manufacturers GE and Siemens. Calpine now has the opportunity to sign new agreements with its own corporate operating services company, known as COSCI. Rauf says that the operational freedom allows Calpine to design flexible products for its customers - probably an allusion to the power on demand products pioneered by Orion Power and others.

The portfolio now consists of seven plants, since two have now been taken out. Those remaining are:

Project Name Location MW

Sutter Yuba City, California 543

Magic Valley Edinburg, Texas 751

Lost Pines Bastrop, Texas 280

Ontelaunee Reading, Pennsylvania 584

Westbrook Westbrook, Maine 528

Hermiston Hermiston, Oregon 642

Osprey Auburndale, Florida 609

Total 3,937

This portfolio, which nudges 4000MW, can be viewed as a small generating company, and investors were pitched with this image in mind. The fleet, however, is fully integrated with Calpine's other operations, and dispatched through Calpine Energy Services.

While it does not have any restricted payment tests, the portfolio does have restrictions on what can be done with assets, or the collateral package, as most investors view it. The proceeds of any sale (or, more likely, sale-leaseback) must be offered to debt holders, should they be above a certain level. Indeed, as Project Finance went to press, Calpine sold 70% of the Osprey plant to ArcLight, but the $86 million price tag excluded it from being sold, and the plant was subject to a carve-out in the financing.

The most unusual feature of the deal, however, is the presence of a commodity hedge from advisor and bookrunner Goldman Sachs. The hedge, which was fully paid up at close, is a financial, rather than a physical transaction, and provides a floor on the spark spread (i.e. difference between fuel costs and power prices, or, put crudely, a plant's profit margin) received by the portfolio. This floor has been sized to assure investors that interest on the debt will be repaid.

This has to be adjusted to the forward Libor rate to ensure that the floating rate debt does not leave the hedge out of market. It is based on an average of pool prices, and supported by analysis from Henwood. Of the plants' markets, two are located in ERCOT, two in California, one in PJM, one in Florida, and one in NEPOOL.

The $750 million debt is split into two tranches. The first consists of $385 million in first priority secured term loans due 2009, which were offered at 98% of par and priced at 600bp over Libor, with a Libor floor of 150 basis points. The second tranche consists of $365 million of second priority secured floating rate notes due 2011, which were offered at 98.01% of par and priced at 850bp over Libor with a Libor floor of 125 basis points. Both the discount and the floor preserve the lender's economics even in a low interest rate environment, and enables the bookrunner to make a market relatively easily. The deal would probably have benefited from coming to market a little earlier - yields in the bond market have inched up, and high-yield bond spreads have started to widen markedly.

Standard & Poor's rated the genco, which is not off-credit, at B, noting its direct linkage to the Calpine corporate rating. The 2009 notes gained a B+ rating, reflecting recovery prospects, while the second tranche, which extends beyond the term of the hedge, gained a B- rating. This second tranche also benefits from a $250 million working capital facility.

Calpine liked the experience, which has enabled it to stay true to its philosophy of running its assets as it see fit. It wants to start pulling away from the pack of distressed merchants, and "marry commodity risk to its financials", as Kelly is fond of saying. The CCFC II refinancing, due next year, will borrow heavily from this deal.

Calpine Construction Finance Company I

Status: Closed 14 August 2003

Size: $2.35 billion

Location: United States

Description: refinancing of seven gas-fired plants with total capacity of just under 4000MW, featuring a price hedge.

Sponsor: Calpine Corporation

Debt: $750 million, consisting of $385 million due 2009, at 98% of par, priced at 600bp over Libor, with a Libor floor of 150 basis points, and $365 million due 2011, 98.01% of par, priced at 850bp over Libor with a Libor floor of 125 basis points

Bookrunner, financial advisor and hedge provider: Goldman Sachs

Market consultant: Henwood

Engineer: RW Beck

Lawyers to the lenders: Latham & Watkins

Lawyers to the borrower:

Covington & Burling, Stoel Rives