Lease of life
Post-Enron, power sponsors are more reluctant to become embroiled
in complicated financing structures to fund acquisitions and
expansions. However, while a number of key power players are facing
investigations into round-trip trading and corporates getting
nervous about off balance-sheet obligations, the progress of true
lease transactions with capital markets characteristics, structured
lease obligation bonds (SLOBs), could yet pick up.
So far two SLOB transactions have closed this year ? one for Kinder Morgan and one for PG&E National Energy Group. And in both cases they were deals delayed from 2001. ?The synthetic lease is dead,? says one equity provider. ?Now the market is waiting for new rulings on synthetic leases and true leases. In the meantime there is a hiatus in the market as we await the results of the investigations.?
But the re-emergence of the SLOB indicates that, despite power companies' desire for more flexible financing, the lease structure remains popular with sponsors. In particular the structure offers the opportunity to enhance a corporate's earnings without denting its credit rating.
In the earlier deals, such capital market lease structures were used to take out bridge financing for some of the older generation of US power assets when they changed hands. They proved popular because the lease debt financing was interchangeable with the project debt for a power asset or pool of assets. This meant the parameters for coverage ratios were the same for straight debt as they were for leveraged leases.
But following a glut of new power developments over the past years and the retirement of many older plants, bankers had expected to see the structure applied to more modern power assets and state of the art technology in 2002.
In some cases this should have meant deals done on the back of plants that sell electricity on a merchant basis rather than to an offtaker under a 15 to 20-year power-purchase agreement, for example. While these deals are expected to emerge, bankers, sponsors and equity providers are now taking a wait-and-see approach, with some speculating that we may have to wait until next year to see the first of the semi-perm financing structures taken out by leases.
?In the US this is likely to be a growing market because many new facilities are coming on stream which were financed with short-term funding,? says a banker. ?The lease structure gives them longer-term financing in line with the longer-term nature of the asset.? The leveraged lease deal, in other words, could be a partial solution to the glut of mini-perm financings maturing in the near future.
At the beginning of May, Kinder Morgan secured a $192 million private placement to finance the construction of a 535MW combined-cycle greenfield power generation plant in Jackson, Michigan. The deal is financed using a construction and leveraged lease project financing managed by Citibank.
Like many others the deal was affected by Enron, and the banks and equity, cautious in the jittery market, delayed the timing slightly. However, Kinder Morgan had already funded the power plant on balance sheet, so the financing structure merely acted to free up cashflow for the company.
Lease mechanics
Standard & Poor's describes how the structure works: ?Many leveraged lease financings are sale-leaseback transactions. In their simplest form, they involve the issuance by a newly formed, special-purpose bankruptcy-remote entity (SPE) (traditionally an owner or business trust, but increasingly a limited liability company, called the owner lessor) of limited recourse debt, whether directly or through a pass-through trust.?
In this case Kinder Morgan Power, a subsidiary of Kinder Morgan, is building the $364.1 million plant, but the facility will be owned by AlphaGen Power LLC, a special-purpose lessor owned by the CIT Group, and leased to Triton Power Michigan LLC.
Output from the plant is contracted under a 16-year tolling agreement with Williams Energy Marketing and Trading, a subsidiary of the Williams Companies. After the offtake agreement expires, the plant is then exposed to the merchant risk for the remaining six years of the bond term.
A single-purpose limited liability company owns the facility during the construction period. Upon completion of the facility, AlphaGen Power LLC, which was the construction company before lease began, will enter into a 40-year lease agreement with Triton Power Michigan LLC, a single-purpose limited liability company.
AlphaGen issued $194.3 million senior secured bonds, following the downsizing of the transaction from $201.3 million to maintain consistent debt service coverage. The transaction was originally priced at a higher-than-assumed interest rate of 9.018%.
Kinder Morgan Power funded all preferred equity positions but lessor equity is arranged by CIT. CIT and its partner, Investment Management Holdings Co. (IMH), provide the lessee common equity. Kinder Morgan then provides a guarantee for all of its power subsidiary's equity commitments.
Of the deals to close in the past couple of years, only a few have done so without a corporate guarantee ? among them the transactions for Reliant/Sithe and PPL Montana. Corporate guarantees ease doubts concerning a power plant's market performance, so pricing on deals without guarantees tends to be higher. But banks point out that sponsors who choose to go without guarantees make that trade-off to gain off-balance sheet financing.
The Kinder Morgan deal is essentially a US capital markets transaction within a US leveraged lease. Such deals work by setting up a lease company, or special purpose vehicle, which buys the plant and then, under a sale-and-lease-back arrangement, allows the sponsor to use the facilities. The special purpose company then issues bonds to cover the debt portion of the deal.
The lease equity also provides a favourable tax position. The equity holders receive part of the depreciation expenses of the deal. For them the benefit lies in the tax deduction derived from the ownership of a depreciable asset, as well as in the expected rate of return through the lease payments. Equity providers like the way these deals match the revenue stream on the one side with the expenses on the capital side.
The format also offers a number of advantages for the sponsor. In the Kinder Morgan case there is favourable accounting treatment in a quasi off-balance sheet format: resembling something between an asset financing and a project finance capital markets transaction. As a result the project no longer hits the company's after tax earnings. Those deals done within a project finance structure allow an off-credit ruling from the ratings agencies.
Standard & Poor's says: ?An added benefit lies, in some cases, in the possibility of obtaining a higher debt rating on the owner lessor debt, and therefore an even greater reduction in borrowing costs...Project finance equipment, typically capital-intensive facilities such as power generating plants, refineries, and industrial plants, constitute another category of assets that are particularly well suited to leveraged lease financing.
?When the project is a single asset owned by an SPE [special-purpose bankruptcy-remote entity], where the cashflows from the project can be rated independently of the rating of the sponsors ... the rating of the leveraged lease debt may be able to rise above the sponsors' ratings.?
Just as important, the deal also enables the project sponsor to obtain a longer tenor. A typical project finance transaction, for example, can only command a tenor of up to about 20 years. Under the lease structure, the term is much longer at about 30 to 35 years.
The other clear advantage of using this kind of transaction is that it is tried and tested.
Post-Enron market jitters mean that more complicated lease structures are unwelcome additions to the company accounts. But the true lease structure should not affected by Enron. ?It is a very common structure with nothing unusual about it,? says a banker. ?More importantly it is something the ratings agency and the accounting people understand.?
The structure is also fairly flexible, being able to fit with the corporate financing or non-recourse jacket in either a bank or capital markets transaction.
One banker says he expects to see a growing number of power companies using this kind of structured lease. ?Now that a lot of power projects have been completed, this kind of financing structure allows companies to get the benefits of a lease and in some cases an off credit rating from the agencies.?
Putting a time frame on when the market will pick up is more tricky.
Kinder Morgan's transaction follows PG&E National Energy Group's Attala plant leveraged lease financing, the other deal to close this year. JP Morgan arranged the deal, with CIT and Verizon as investors.
The National Energy Group agreed to acquire the 526MW Attala energy facility in Attala County, Mississippi, from Duke Energy North America in September 2000 as part of the group's move into the southern US. The project, a combined cycle, natural gas-fired merchant generation facility, will sell power into the Entergy spot market.
At the time of the agreement, the group said the innovative financing plan would allow the company ?to achieve capital velocity by using our resources in an effective, and efficient manner that provides the greatest shareholder value.? The aim was to maintain control of operations and output, while minimising the need for PG&E's equity capital. Indications were that it would follow the earlier hybrid project/synthetic template laid down by the NEG's La Paloma and Lake Road deals. But new market conditions have forced a slightly more conservative approach.
Attala Generating LLC issued just under $300 million of pass-through certificates on the back of the facility, which has been in operation since June 2001. Payments under the lease are supported by a 25-year tolling agreement with Attala Energy Company. These payments are in turn guaranteed by PG&E National Energy Group.
There is potential for many more new deals to be financed under the SLOB structure, the question will be how many deals get away and how many on a merchant basis.
?Merchant financing spreads in general are very wide at the moment,? says a banker. ?So almost any type of long-term financing for power assets is expensive. Consequently you could see a push towards the equity side.?
One equity provider points out that as synthetic leases are forced out, these deals may very well be refinanced with a true lease. But he says that while there may be appetite from the banks and institutional investors for further deals ?until the dust settles many sponsors are going to settle with short-term financings. And until new SEC regulations are published, they will wait.?
So far two SLOB transactions have closed this year ? one for Kinder Morgan and one for PG&E National Energy Group. And in both cases they were deals delayed from 2001. ?The synthetic lease is dead,? says one equity provider. ?Now the market is waiting for new rulings on synthetic leases and true leases. In the meantime there is a hiatus in the market as we await the results of the investigations.?
But the re-emergence of the SLOB indicates that, despite power companies' desire for more flexible financing, the lease structure remains popular with sponsors. In particular the structure offers the opportunity to enhance a corporate's earnings without denting its credit rating.
In the earlier deals, such capital market lease structures were used to take out bridge financing for some of the older generation of US power assets when they changed hands. They proved popular because the lease debt financing was interchangeable with the project debt for a power asset or pool of assets. This meant the parameters for coverage ratios were the same for straight debt as they were for leveraged leases.
But following a glut of new power developments over the past years and the retirement of many older plants, bankers had expected to see the structure applied to more modern power assets and state of the art technology in 2002.
In some cases this should have meant deals done on the back of plants that sell electricity on a merchant basis rather than to an offtaker under a 15 to 20-year power-purchase agreement, for example. While these deals are expected to emerge, bankers, sponsors and equity providers are now taking a wait-and-see approach, with some speculating that we may have to wait until next year to see the first of the semi-perm financing structures taken out by leases.
?In the US this is likely to be a growing market because many new facilities are coming on stream which were financed with short-term funding,? says a banker. ?The lease structure gives them longer-term financing in line with the longer-term nature of the asset.? The leveraged lease deal, in other words, could be a partial solution to the glut of mini-perm financings maturing in the near future.
At the beginning of May, Kinder Morgan secured a $192 million private placement to finance the construction of a 535MW combined-cycle greenfield power generation plant in Jackson, Michigan. The deal is financed using a construction and leveraged lease project financing managed by Citibank.
Like many others the deal was affected by Enron, and the banks and equity, cautious in the jittery market, delayed the timing slightly. However, Kinder Morgan had already funded the power plant on balance sheet, so the financing structure merely acted to free up cashflow for the company.
Lease mechanics
Standard & Poor's describes how the structure works: ?Many leveraged lease financings are sale-leaseback transactions. In their simplest form, they involve the issuance by a newly formed, special-purpose bankruptcy-remote entity (SPE) (traditionally an owner or business trust, but increasingly a limited liability company, called the owner lessor) of limited recourse debt, whether directly or through a pass-through trust.?
In this case Kinder Morgan Power, a subsidiary of Kinder Morgan, is building the $364.1 million plant, but the facility will be owned by AlphaGen Power LLC, a special-purpose lessor owned by the CIT Group, and leased to Triton Power Michigan LLC.
Output from the plant is contracted under a 16-year tolling agreement with Williams Energy Marketing and Trading, a subsidiary of the Williams Companies. After the offtake agreement expires, the plant is then exposed to the merchant risk for the remaining six years of the bond term.
A single-purpose limited liability company owns the facility during the construction period. Upon completion of the facility, AlphaGen Power LLC, which was the construction company before lease began, will enter into a 40-year lease agreement with Triton Power Michigan LLC, a single-purpose limited liability company.
AlphaGen issued $194.3 million senior secured bonds, following the downsizing of the transaction from $201.3 million to maintain consistent debt service coverage. The transaction was originally priced at a higher-than-assumed interest rate of 9.018%.
Kinder Morgan Power funded all preferred equity positions but lessor equity is arranged by CIT. CIT and its partner, Investment Management Holdings Co. (IMH), provide the lessee common equity. Kinder Morgan then provides a guarantee for all of its power subsidiary's equity commitments.
Of the deals to close in the past couple of years, only a few have done so without a corporate guarantee ? among them the transactions for Reliant/Sithe and PPL Montana. Corporate guarantees ease doubts concerning a power plant's market performance, so pricing on deals without guarantees tends to be higher. But banks point out that sponsors who choose to go without guarantees make that trade-off to gain off-balance sheet financing.
The Kinder Morgan deal is essentially a US capital markets transaction within a US leveraged lease. Such deals work by setting up a lease company, or special purpose vehicle, which buys the plant and then, under a sale-and-lease-back arrangement, allows the sponsor to use the facilities. The special purpose company then issues bonds to cover the debt portion of the deal.
The lease equity also provides a favourable tax position. The equity holders receive part of the depreciation expenses of the deal. For them the benefit lies in the tax deduction derived from the ownership of a depreciable asset, as well as in the expected rate of return through the lease payments. Equity providers like the way these deals match the revenue stream on the one side with the expenses on the capital side.
The format also offers a number of advantages for the sponsor. In the Kinder Morgan case there is favourable accounting treatment in a quasi off-balance sheet format: resembling something between an asset financing and a project finance capital markets transaction. As a result the project no longer hits the company's after tax earnings. Those deals done within a project finance structure allow an off-credit ruling from the ratings agencies.
Standard & Poor's says: ?An added benefit lies, in some cases, in the possibility of obtaining a higher debt rating on the owner lessor debt, and therefore an even greater reduction in borrowing costs...Project finance equipment, typically capital-intensive facilities such as power generating plants, refineries, and industrial plants, constitute another category of assets that are particularly well suited to leveraged lease financing.
?When the project is a single asset owned by an SPE [special-purpose bankruptcy-remote entity], where the cashflows from the project can be rated independently of the rating of the sponsors ... the rating of the leveraged lease debt may be able to rise above the sponsors' ratings.?
Just as important, the deal also enables the project sponsor to obtain a longer tenor. A typical project finance transaction, for example, can only command a tenor of up to about 20 years. Under the lease structure, the term is much longer at about 30 to 35 years.
The other clear advantage of using this kind of transaction is that it is tried and tested.
Post-Enron market jitters mean that more complicated lease structures are unwelcome additions to the company accounts. But the true lease structure should not affected by Enron. ?It is a very common structure with nothing unusual about it,? says a banker. ?More importantly it is something the ratings agency and the accounting people understand.?
The structure is also fairly flexible, being able to fit with the corporate financing or non-recourse jacket in either a bank or capital markets transaction.
One banker says he expects to see a growing number of power companies using this kind of structured lease. ?Now that a lot of power projects have been completed, this kind of financing structure allows companies to get the benefits of a lease and in some cases an off credit rating from the agencies.?
Putting a time frame on when the market will pick up is more tricky.
Kinder Morgan's transaction follows PG&E National Energy Group's Attala plant leveraged lease financing, the other deal to close this year. JP Morgan arranged the deal, with CIT and Verizon as investors.
The National Energy Group agreed to acquire the 526MW Attala energy facility in Attala County, Mississippi, from Duke Energy North America in September 2000 as part of the group's move into the southern US. The project, a combined cycle, natural gas-fired merchant generation facility, will sell power into the Entergy spot market.
At the time of the agreement, the group said the innovative financing plan would allow the company ?to achieve capital velocity by using our resources in an effective, and efficient manner that provides the greatest shareholder value.? The aim was to maintain control of operations and output, while minimising the need for PG&E's equity capital. Indications were that it would follow the earlier hybrid project/synthetic template laid down by the NEG's La Paloma and Lake Road deals. But new market conditions have forced a slightly more conservative approach.
Attala Generating LLC issued just under $300 million of pass-through certificates on the back of the facility, which has been in operation since June 2001. Payments under the lease are supported by a 25-year tolling agreement with Attala Energy Company. These payments are in turn guaranteed by PG&E National Energy Group.
There is potential for many more new deals to be financed under the SLOB structure, the question will be how many deals get away and how many on a merchant basis.
?Merchant financing spreads in general are very wide at the moment,? says a banker. ?So almost any type of long-term financing for power assets is expensive. Consequently you could see a push towards the equity side.?
One equity provider points out that as synthetic leases are forced out, these deals may very well be refinanced with a true lease. But he says that while there may be appetite from the banks and institutional investors for further deals ?until the dust settles many sponsors are going to settle with short-term financings. And until new SEC regulations are published, they will wait.?
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