Enron's bankruptcy is a neat bookend to a year when portfolio managers' attention has been more intense than ever before. In a year when PG&E, California, ERCOT and turbine exposures all came under scrutiny, Enron exposure now presents another painful task for banks attempting to fill their books before year-end. But the fall of the asset-light darling of the US stock market may eventually provide a useful fillip for project financiers attempting to pitch the classic model to clients and their own credit committees.

?The boys in Houston? always presented something of a mystery to many in the power finance business. Enron had a habit ? not admittedly a unique one amongst its peers ? of creating useful and tax-efficient structures to leverage investments, often after these had been separately financed. Part of the difficulty in assessing creditors' claims will come from the fact that many of the assets that could form part of a fire sale will have been subject to intricate and varied debt instruments.

The start of the run on confidence in Enron came from its use of share trust vehicles. The basic premise of such vehicles is that they use parent company equity either to replace or to backstop assets as collateral on lending or equity. The use of an equity backstop lowers the cost of capital (which would be equivalent to, or one notch below, that of the corporate credit), whilst ensuring that the debt does not become consolidated onto the company's balance sheet. The benefits to earnings per share figures, most clearly watched, and in Enron's case applauded, can be huge.

Enron's difficulties can be laid down to two, essentially endemic, sides of its corporate culture. The first of these was an extremely aggressive approach to valuations and earnings booking. Many of the assets held in trusts such as the LJM2 vehicle run by departed CFO Andy Fastow appear to have been overvalued. Buying back such assets, whilst inevitably involving some shareholder equity dilution, would not have led to as much of a loss of confidence as occurred had they been sensibly valued.

Much of the shock at the discovery of the vehicles appears to be exaggerated. Whilst Enron rarely disclosed partnerships by name, the extent of possible liabilities usually appeared in account footnotes. Moreover, several of Enron's more innovative transactions appeared either in specialist press analysis or as part of banks' marketing efforts. The existence of the California Public Employees Retirement System (CALPERS) joint venture JEDI (and the associated Chewco vehicle), the Marlim and Osprey trusts (which carried public ratings), the Yosemite and Rawhide asset pools and the European Power Company risk transfer transaction were all in the public domain.

Some bankers have even suggested that Enron's accounting practices took it close to the edge of legality in the way that it booked assets. Enron is believed to have booked into one year's figures the forward contract earnings from the Teesside plant, located in the UK, for several years in advance. This interesting classification of a power purchase agreement may even have extended to the Dabhol plant, whose non-payment troubles have been widely examined.

The second cause of Enron's misfortune lies in its investment strategy. One banker familiar with its record is more blunt ? ?they made some pretty lousy investments?. It was Enron's gas pipeline interests (that formed its asset backbone, and are now mortgaged to Dynegy, JP Morgan Chase and Citigroup), and its trading activities that caught analysts' attention. But its forays into broadband, water and even electricity distribution were much less successful.

The Azurix water services venture, formed from the nucleus of Enron's Wessex Water purchase, has been one of its more prominent failures. Rebecca Marks, a high-profile Dabhol alumnus, headed the unit, which expanded rapidly in the US and Latin America. Water, however, rarely provided the exponential returns that corporate earnings culture requires. The highly-regulated business has now been dismantled piecemeal, with the US side sold to American Water Works and Wessex up for sale.

The electricity business produces more of a mixed picture. The Teesside projects have been performing well, and are prime candidates for a sale, although if their earnings had indeed already been booked in advance, their continued use to Enron will have been limited. Nevertheless, its partners Mirant and PPL, who are 15% partners through the Western Power Distribution venture, will be nervous about the future of the plant, which includes Enron as a partial purchaser and operator.

Its other European investments ? Sarlux in Italy, Trakya Elektrik in Turkey and Nowa Sarzyna in Poland ? have all been performing relatively well, and the prospects for a recovery are in any case quite strong. The credit default swap nature of the European Power Company deal will be a harder one to unravel. This $140 million deal, led by Credit Suisse First Boston at the end of 2000, featured the swap payments made to a vehicle owned by Enron and Osprey, Pelican, by Enron North America. The deal is largely backstopped by the Enron corporate credit and was hailed at the time as a means of limiting disclosure (albeit at the request of Enron's partners). The last available rating on these bonds was Moody's Investors' Service's C.

Enron also found itself running distribution companies in Brazil. These companies have been poor earners for their owners, as AES recently disclosed in its earnings release. Recent auctions for the remaining have attracted scant interest and low bids, mostly because foreign investors are alarmed that there is little downside protection when sporadic devaluations in the Real erode returns from a Real-denominated business.

Its generating business, however, was thought to be doing a little better, especially after it became one of the most prominent new entrants into the nascent Brazilian spot market. Plants there were constructed on balance sheet (or, more accurately, on a full recourse basis) since no lender would countenance a project financing of a merchant plant. Word at the beginning of the year was that in the middle of the rationing crisis and electricity shortages, Enron made money hand over fist.

The only main difficulty with the generation investments comes from the way that at least one ? the Riogen plant ? was financed. This took the form of a synthetic turbine financing on which all of the risk, save that of the corporate (in this case the country risk and accounting regulation-dictated risk), was stripped out before syndication. Enron's latest project financing ? the SG-led Vitro plant in Mexico ? is understood to have largely been sold to Tractebel.

Standing at the front of the queue is the Dabhol debacle. Dabhol was a running sore on Enron's body of investments long before its collapse. Dabhol has been panned on many counts by its critics, who objected to its human rights record, relations with the Indian government, even its use of the (as its turned out) ruinously expensive naphtha fuel. It would be worth looking, however, at the reasons for this rare involvement in a massive ECA and multilateral project in a developing country.

Enron's political vision, as well as its eagerness to have a say in the development of promising unregulated markets, probably explains some its more apparently quixotic investments ? ones it have preferred not to have made. Whether in the developing water market in the UK, as a player on the Brazilian spot market, and especially as one of the largest foreign investors in India, it wanted to have a large and influential stake in how these markets emerged. Enron wanted a voice in restructuring water companies, setting spot market rules, and in gaining access to the restructuring of the electricity and gas industry in the world's second most populous country.

For a long time Dabhol was seen as the project that could not be allowed to fail. Aside from its prestige and the signals that repudiation would send to other potential investors, Enron had a large and diverse cast of lenders on its side. A statement from Lay that suggested that sanctions might help bring a resolution best summed up its attitude. Such a naked flaunting of political connections troubled many even in the US.

Project lenders, however, say that they have little to fear from the bankruptcy. In fact, some are quietly confident that it will strengthen the hands of their divisions when relationship managers deal with clients in the energy business. Project deals are often said to be distinguished by the fact that sponsors are able to walk away from them. Lenders know that as soon as they have the relevant contracts in place they have an asset of which to take charge. Dabhol's case is exceptional in its weak economic fundamentals ? other, more efficient and cost-effective gas-fired assets will provide reasonable means of recovery.

With luck, credit committees can be made comfortable by the fact that such investments, even with a protracted work-out period, tend to offer better recovery prospects than a corporate loan. As one senior financier puts it, ?even if there is a technical default, this is a good way of flagging up when a project starts getting into difficulties.? Technical defaults are a timely reminder of the final area in which Enron's demise is likely to be felt.

Two deals are currently on hold while the bankruptcy process plays out at Enron subsidiary Enron Facility Services (EFS). Company statements have stressed that EFS employees are presently not included in the Chapter 11 filing and are still at work. No matter, however, because EPC contractor arm NEPCO's obligations are usually backed by a corporate guarantee to cover its obligations. And replacing the contractor during the middle of the construction process will be tricky.

The first deal to become subject has been the AES Wolf Hollow syndication. KBC snatched the mandate from Scotia Capital in the middle of 2001, the deal has closed, and funds have been disbursed to AES for the work it has already spent on development. The $285 million loan is now in technical default and is now on hold until a solution can be crafted to replace the (now worthless) guarantee. Teco Power Service's second foray into the project market ? the $647 million TriCo deal ? has been put on hold by arrangers BNP Paribas and CSFB.

Whilst project lenders can afford to be more even-headed (and there is little sense of panic over the fate of the two stalled deals) structured lenders may have to be a little more circumspect. Signs are that the ratings agencies are moving towards a less lenient approach to how to treat these obligations. According to Moody's Investors Service, the work towards treating share trust deals as on-credit was underway before the LJM2 bombshell. This was first felt on its analysis of El Paso's Gemstone deal (see page 23).

The wider effects of this change in approach, as well as whatever opinion is coaxed from the SEC and the Accounting boards, will be felt more directly by investors and treasury managers than by lenders, who at least recognise that structured financings and synthetic leases are to be treated as corporate credits. Several received a lesson in this analysis when examining PG&E's NEG Group's synthetic portfolio in the months between the parents first difficulties and the ringfencing that took place for the NEG. In fact equity analysts and investors, with the exception of the brave souls who sold Enron stock short based on nuggets unearthed in earlier SEC filings, will have the most adjustment to do. For the time being, transparent structures and watertight security packages may grow into 2002's major financing flavour.