The middle two quarters of 2002 look like being the most poisonous syndication market in living memory. Coupled to the signals, already apparent in 2001, that co-arranger tier banks were not happy with the commitment levels asked of them by arrangers, is a new ? and very unforgiving ? focus on credit. Several participants claim that it is impossible to get merchant deals done given near-daily questions about the viability of deregulated markets. There is, it must be admitted, a slightly ritualised air to the talk coming back from the syndication agents' targets. It is difficult to accept some of the accusations slung at forthcoming jumbo deals without a degree of scepticism. Even in the wake of the California crisis in 2001, American National Power, PSEG Power, NRG Energy, TECO-Panda and even PG&E's National Energy Group all managed to complete $1 billion-plus deals. Several of the deals came in accompanied either by significant increases in pricing or severe structural adjustments. Most of them have been performing adequately, with the exception of the only runaway syndication success ? TECO-Panda ? which has been an unfortunate casualty of the Enron bankruptcy. The most notable casualty of last year's change in investor sentiment was the $1 billion non-recourse portion of the Credit Suisse First Boston-led Mirant deal. Mirant is currently back in the market with a construction revolver ? of sorts ? albeit a more modest one than last year's model. This deal, on which BNP Paribas, Bank of America, Royal Bank of Scotland and WestLB are lead arrangers, is considerably smaller than the first, at around $440 million, according to current pre-marketing. The issues with this deal will in part be the same as before ? the degree of flexibility available to the sponsor and its ability to handle a bank group. Mirant may be a little chastened by last year's experience ? less inclined to chide (largely British) commentators for their pronunciation of the name and (more significantly) to manage the paper that it puts out into the market. Mirant also has the retooled Perryville financing out to syndicate banks, a $251 million deal for which lead arranger KBC is seeking around $120 million from a second round. Most potential observers are happy this time round with a shorter tenor, lower leverage and greater amortization.

The issue this time is Mirant, not so much its ability to stagger issues as its credit profile. Even if the project, presently 50% owned by Cleco, is bought out by Cleco, Mirant remains the offtaker, through its marketing arm, Mirant Americas Energy Marketing (MAEM). For a brief period MAEM had a better credit profile than Mirant, a legacy of Mirant's former life as Southern Company's Southern Energy arm. Mirant wanted to be a standalone merchant player, and is now being evaluated as such. Mirant's share price has suffered, and continues to suffer, as a result of its belonging to a peer group that includes Enron, Dynegy and Reliant. It has not yet been implicated in any of the current energy marketing scandals, involving gaming the Californian market and engaging in ?wash? (or neutral) trades. But it has a split rating and has not been a stellar stock market performer of late. Any deal with a Mirant offtake credit is largely to be evaluated as a merchant credit and getting commitments in has been understandably difficult, despite a solid, and conservative financial structure. The biggest difference between the market now and last year is the difficulty with which even the biggest utilities have been getting deals done. This year, the most important bellweather of market sentiment will be the FPL Energy loan, another construction revolver that sponsor pressure dictates must be completed. This has received a mixed response. Some lending banks ? a very small part of the co-arranging tier ? expressed an interest in a co-underwriting role, largely to bring in ancillary business. Such banks are getting rarer, since few have credit committees that would approve a $100 million position. FPL is looking for a $2.5 billion construction revolver, larger than predecessors from NRG Energy and Calpine. Unfortunately, if market rumour is to be believed, it was also looking for underwriting commitments from the two leads ? Scotia Capital and Citigroup. Citi is apparently no longer with the deal, and Royal Bank of Scotland may step up to provide support. It is always possible that the deal may be retooled to reflect the fact that construction revolver deals probably cannot be done in the present climate. FPL Energy is a rare beast in merchant power ? an A-rated counterparty. This is exceeded only by the Shell affiliate Coral Energy, which has been responsible for making many of InterGen's projects bankable. FPL, however, appears to be looking for a trade-off in covenant flexibility for this ? at least one indication that offtake risk is not the most important factors preying on bankers' minds. As one arranger put it, ?if the banks want to load up on construction revolver paper, then they could probably buy Calpine's deals [the 1999 and 2000 revolvers] for 90 cents on the dollar?. The most important risk at present is underwriting risk ? the very real danger of not selling down to a reasonable hold position. Market sources suggest that Citi's unwillingness to provide a fully underwritten commitment caused the parting of ways. Citi, remember, after the departures of Chase and Bank of America, is the last remaining synications powerhouse among the US banks.

Citi, to its credit, is getting more creative, as was suggested by the syndication of the $1.4 billion portfolio deal for PG&E's National Energy Group (NEG). This deal covers four plants, of which one ? the 360MW Millenium facility in Massachusetts ? is completed. The next two ? the 1080 Athens, New York, plant and the 1092MW Harquahala, Arizona plant ? are under construction. Harquahala was initially mandated to SG as a standalone synthetic lease financing until investor sentiment and NEG's parent's bankruptcy turned sponsors against the structure. The final plant, in Covert, Michigan, is a 1170MW gas-fired station on which ground broke on 29 October 2001. Anticipating a tricky selldown, the arrangers, Citi and SG, used two interesting features, the first of which was a flex on the deal size. If only $1.2 billion could be raised then Covert would have to wait for another financing. $1.7 billion guaranteed all four, but in the event, participants brought the total to $1.4 billion, and the NEG fronted the remainder in equity. The other feature was the use of commercial paper conduits set up by several banks to provide some of the funding. Market participants are fond of saying that the NEG has already suffered its beating, having to restructure itself and bolster is liquidity position after its affiliate, Pacific Gas & Electric, filed for bankruptcy. Its most recent financing, a leveraged lease obligation issue, led by JP Morgan and featuring CIT lease equity, sold down last month and took the Attala plant in Mississippi, off balance sheet. But the NEG, while ringfenced from its parent, is still 100%-owned by PG&E Corp., and if listed would probably have suffered with its peers. It is, after all, a merchant player and was forced to drag a number of synthetic leases done 1999-2000 back onto its balance sheet after they fell foul of the Financial Accounting Standards Board (FASB)'s 3% minimum outside equity interest rule. Indications are that tougher standards on the consolidation of synthetics will emerge, although leveraged lease deals look safe. Leveraged lease deals have indeed escaped any censure. One banker that recently completed a structured lease obligation issue says that ?these assets are very solid and investors can adequately evaluate credit issues ? many have been done and it's considered a fairly vanilla product. The accounting is all understood?. Synthetic leases, as their name suggests, were an artificial arbitrage of taxation and accounting standards, and caused equity investors to panic. But leveraged leases also face little scrutiny outside of specialised finance circles ? share picks commonly now suggest that if a buyer does not understand a company's financial structure he or she should not buy stock. If, as ratings agencies now suggest, cashflow analysis should govern considerations of financial health, many sponsors may need to give more consideration as to how to report off balance sheet deals. Away from the pitfalls of headline risk, the list of overbuilt or otherwise off limits power markets continues to lengthen. The NEPOOL and ERCOT power pools have for some time been problem areas ? the former because it is too much interconnected (especially with Canada, and for the time being New York is not connected), the latter because it is not much interconnected at all. Mexican market observers have suggested, perhaps only half seriously, complete interconnection and synchronisation of the two grids ? an unlikely possibility at present. California has its fans, especially at institutions that have spent serious time and money restructuring and recapitalising its utilities ? bankrupt PG&E and near-bankrupt Southern California Edison. Edison Mission, for example, has a number of plants that are looking for finance, as soon as the State becomes truly creditworthy. Some, more cynically, suggest that they would not consider any deals until its political make-up becomes more stable. One banker puts it more simplistically, saying, ?I wouldn't be happy to lend to the market in California with the current administration in charge.? According to Paul Meyers, managing director at market consultants Pace Global Energy, the most robust markets will be those with a high degree of interconnection ? MAIN, ECAR and the PJM grids. The Entergy and ERCOT grids, covering the Southwest region, has been demonstrating more overbuild characteristics due to lack of export capability. Meyers believes that the signs of a contraction in the market have been there for some time, saying, ?we believed that what's happening was going to happen for some time. A fair part of the current market situation has been due to extended period of new unit expansions in the market ? some pullback is inevitable, but we had anticipated an earlier slow down which would create make the ?pull back' less drastic.? He adds, ?portfolio deals were often seen as bankable because there was diversification present, although there was very little effort to quantify this exposure.? At this stage of deregulation there is one serious pitfall for merchant players ? that many incumbent utilities are becoming wise to the benefits of the process and looking beyond the forced divestments that mark the first stage. Many are beginning to build peaker plants that eliminate, or at least capture the benefits of, the price spikes that make merchant plants so profitable. The idea is not new, but there is evidence that utilities are starting to lock in this type of capacity, including Southern Company, through the Southern Power subsidiary, and Progress Energy, whose last financing, a $440 million loan led by JP Morgan Chase, backed simple-cycle, usually peaker, plants with offtake agreements with southeastern utilities.

Meyers echoes the sentiments of the participant banks, that some tightening of covenants is necessary, and also that lenders need to look at how competitive a plant can be, whether there is a clear marginal cost advantage over potential competition. In terms of structure, for instance, the more flexible structures such as InterGen's borrowing base approach, which looks at forward price predictions when setting equity distributions, has found increased favour to deal with changing market conditions. The latest rumours surrounding the gestation of the Tractebel portfolio deal have it emerging as a series of InterGen-style financings. From a deal structuring perspective, the pricing of loans, equity levels, and covenant provisions are all tightening for current deals. Meyers looks at the current situation as the market based response or correction response to changes in the power market.  These deal structure refinements will be the evolution needed start a next wave of power projects with lenders setting clear parameters for new merchant deals. Painful as it is, the current climate underlies the difference in a merchant project versus traditional contract based project finance deals and how these structures need to be structured to make them risk neutral for lenders. Painful as it may be to admit it, the current climate may be best viewed as a learning experience for the market.