Southern Power recently closed a $575 million bond offering to service construction of its rapidly expanding generation portfolio and has introduced a number of new elements to the traditional genco finance template. It also keeps the Southern Company ahead of the competition in its home market of the southeastern United States. The financing confirms the current trend in US power ? winners are the old-economy utility-led generators rather than the formerly dynamic independent power producers and merchant players.

Southern Company has already created a presence through its Southern Energy subsidiary, which was renamed as Mirant and then spun off. Mirant produced a tidy windfall for Southern shareholders, although Mirant' stock performance since has not been stellar. The word to bond investors is, however, that Southern Power is not Mirant Mark II.

Whilst Mirant was a pure merchant play deigned to expand into deregulated markets outside of Southern's service territory, Southern Power will work in close co-ordination with Southern's utility subsidiaries in Alabama, Georgia, Florida and Mississippi. Southern Company has managed to maintain such a large size because of the high-level of interconnection of its various utilities' grids.

Moreover, Southern enjoys the benefits of incumbency to the full, both in terms of in depth knowledge of its service territory and political clout. Indeed, deregulation is proceeding slowly in the southeast. There are plans to allow large-scale industrial users to choose alternative suppliers at some point in the future, but full retail competition is some way off.

The genesis behind Southern Power was the requirement that Southern Company's utility operations ? Georgia Power, Alabama Power, Gulf Power and Savannah Power ? take bids from a number of different suppliers for generating capacity. Mirroring current regulatory thinking, however, Southern was also allowed to bid. The contracts to be bid out share some common features with those offered to PSE&G (by New Jersey regulators) and PPL (in Pennsylvania). Those deals covered the basic service requirements, and were the bedrock on which PSEG Power and PPL Energy Supply were financed. Southern Power's contracts are a little more extensive, and it won 80% of those on offer.

While the impetus came from regulators, the move mirrors current thinking at utilities that face a benign enough environment. This is that, whether a spot market exists or not, the utility is better off using its own generating capacity to either force down spike in electricity prices by bringing extra units on line, or capturing the premium for peaking capacity itself. Its neighbour Progress Energy has a high proportion of peaking capacity in its new Progress Ventures genco.

Southern Power completed an $850 million bank financing led by Citibank that is structured as a construction revolving credit. So far, Power has drawn down around $500 million of that total, and the bond issue is designed to pay back that loan and free up capacity on the bank loan. Three plants ? Wansley, Goat Rock 1 and Dahlberg ? have been funded so far by the revolver. While Power's obligations are not explicitly and unconditionally guaranteed by Southern Company, there are a number of corporate mitigants in place. Bankers, after all, have been strenuous in their protests that they will never do a Calpine or NRG revolver again.

The most important mitigant is that Southern Company provides completion guarantees, and that its utilities are the offtakers or most of the power, although Dynegy and LG&E buy some of the portfolio's output. All of the plants are gas-fired, and all use GE technology, and all lie within Southern Company's service territory. Moreover, the plan on the part of Power is to keep its exposure to spot markets to a minimum.

Southern selected Lehman Brothers and Citibank/Salomon Smith Barney (both loan providers and frequent genco underwriters) as bookrunners on the bond. The notes have a ten-year bullet maturity, and priced at 137.5bp over the ten-year Treasury for a 6.25% coupon. They received ratings of BBB+/BBB+/Baa1 (S&P/Fitch/Moody's).

The covenant structure on the deal is roughly similar to other gencos and is largely corporate. This is impressive since other gencos usually have a more diverse geographical and fuel mix, and tend to include a greater proportion of operating assets. Asset sales cannot take place on more than 10% of the portfolio, however.

There are, however, two interesting covenants. The first of these is that recourse debt cannot stand at more than 60% of total capitalization. The second is that the contracted portion of the portfolio's output should not stand at less than 80%. Payments are restricted to the parent without these conditions being met. The idea owes a little to the borrowing base that has been popular on single-asset deals such as those from InterGen. It's enthusiastic reception from investors (the leads built a $2 billion order book) suggests that bond buyers are interested in structures that accommodate a flexible contracting policy as well.

In practice the plants, despite their varied offtakers, will be dispatched as a single system. Moreover the operational closeness to Southern Company is a clear plus a far as investors are concerned. The successful close of the deal will not be encouraging to any sponsor that has dreams of breaking into the closed markets of the south. It does, however, show incumbent utilities the way to match the sophistication of the merchants in exploiting developing electricity markets. A second issue of $650 million is planned for June 2003.