High NRG
2001 has been a year characterised by increased lender caution,
rising fees and continued nervousness about deregulation. This was
the backdrop to the ambitious launch of a $2.5 billion construction
revolving credit, lead arranged by Credit Suisse First Boston, to
an already wary market. The deal closed, after low-level sniping
from participant banks, and NRG has gone on to launch two new
single asset deals.
The first, Brazos Valley, is a single-asset, merchant financing located within the tricky ERCOT market. Brazos Valley is a 633MW natural gas fired merchant power plant located in Fort Bend County, Texas, 30 miles south-west of Houston. Avista-STEAG LLC had a 51% stake in the project while NRG was set to own 49%. After the departure dirt of Avista and then, at close, of STEAG, ABN Amro launched the $189 million debt to co-arrangers. Royal Bank of Scotland (documentation) and Hypovereinsbank (syndication agent) jointly underwrote with ABN at close.
The deal managed to pick up a different set of investors to those that came in on the revolver, and this may point to a divergence between the participant types on portfolio and single-asset deals. Certainly NRG will need all the debt capacity it can find in the coming months, despite the fact that much of its construction programme is now covered by the construction revolver (for more details on the deal, see Project Finance Magazine, June 2001).
NRG has stealthily built up a position as one of the world's leading independent power producers, with a total capacity of 28.927GW ? although this figure will probably change very fast. This puts it ahead of peers like Edison and PG&E's NEG, although a little way behind AES and Exelon. NRG has always said it wants to be in the top three of any country's generating market, and has made acquisitions from the likes of LS Power and Indeck to bulk up its business. It is estimating an earnings per share figure of $1.35 this year.
Its targets for the net four years are ambitious, and it wants to see its generation capacity grow to 50GW by 2005. The capital plan recently laid out before analysts showed a requirement of $19.3 billion to achieve this goal. Within this recourse debt will make up about $2.5 billion, with the vast majority ? $8.5 billion ? coming from non-recourse debt. With several sponsors (AES and the NEG honourably excepted), talking much less about project finance and more and more about hybrid corporate deals, NRG has the potential to become the Godzilla of the project finance market.
The reaction to the construction revolver suggests that NRG will still have to work hard on maintaining its relationships and managing this growth. It's corporate bonds are trading as benchmarks, alongside PSEG Power, and have maintained significantly slimmer spreads than some peers. NRG's recent launch of the McClain financing, led by WestLB, with its modified borrowing base approach, suggests that a combination of canny structuring and choice apportionment of arranging roles should allow NRG to stay ahead.
In the past two years the market has seen NRG Energy move from the use of bond financed acquisition vehicles to the use of the $2.5 billion construction revolver. Has there been an evolution in the way you look at financing solutions or has this been part of a plan that you've been looking at since the end of 1999?
Bird: Generally we're a company that uses non-recourse finance. The jury's still out on the companies that use it a lot and those that don't. We believe we can get a significant amount of leverage through non-recourse debt, and it helps the ratings agencies get some comfort with that because the assets are secured by the financing. In most cases we could walk away from those assets, so that allows us to gain additional leverage and better returns on equity. We've always tried to project finance and when we look at an asset we're trying to achieve on average 50% of the purchase price financed with non-recourse.
You've said in the past that your bond-financed gencos are the nucleus of regional generations development. But their acquisition, especially that of Cajun, could be described as opportunistic. Has this been an approach you've used from the start?
From a long-term perspective you'll see us use the bank market to finance assets over a shorter period of time and then when we build a sufficient portfolio you'll see us take out these bank financings with a portfolio genco. South Central [the Cajun vehicle] was unique ? in essence it was really one large asset. But we see a day that we could do additional debt at that genco for new projects that we put down there ? add an additional tranche of debt. Similarly in the Northeast ? if we had assets in that region we would want to be able to additional tranches of debt there. In other regions of the world, say in north central, where we have a large construction project there now, and as that and some other projects get completed that becomes primed for a regional genco as well.
Do you feel that there are any particular advantages, whether operational, or financial, to working that way?
We run our business regionally, and we set these regional companies up as their own businesses. So it makes sense that they have their own financings and that they're responsible for them, and that's where these gencos come into play and it's in line with everything else we do from an operational standpoint. Operations and power marketing is arranged from a regional standpoint so it makes sense that we establish these non-recourse financings at this level as well.
While this has been going on there's been a certain amount of reorganisation going on at your parent Xcel Energy. Has this been taken into account when you've been arranging these financings?
Not really. We're independent and we obviously factor in our majority shareholder and how they look at things in our decision making. But really nothing there influenced our establishment of these gencos. We have transitional contracts with utilities that we've purchased assets from, but none with Xcel. We don't operate in any of their service territories, either. We are very, very independent, and we need to be from a trading perspective. We have a very separate and distinct trading group.
Looking at the construction revolver, it's hard to discuss it without taking into account the shadow cast by the Calpine deal. That was represented as a useful tool for a sub investment-grade corporates. How long had you been looking at the structure, and what features attracted you to it?
We noted that we had a higher creditworthiness, but we were intrigued by it as a means to finance our construction programme. We had just announced a large entry into the construction marketplace with a number of projects. We didn't particularly care about their structure ? once the assets were in, they were in for the life of the loan. Instead of being able to revolve those projects they ended up having to go back to the bank market for a second construction revolver, and a third and so on. What we're trying to do is have NRG 1,2 and 3 all in one facility. In essence put the projects in, refinance them when they achieve commercial operation by putting them in one of the gencos. When we refinance and take them out of the pool, we replace them with new assets. The unique feature with this, and one of the difficulties the banks had was, what were these new projects going to be? We don't identify all of the projects, and we don't know what they might be three years from now, that's the blind pool concept. It's quite different, in that I call it the first true revolver for construction projects on a non-recourse basis.
What did you have to offer the banks in return?
We have restrictions in terms of what assets can go into the facility. We have certain criteria that need to be met, and equally as important the technical committee, made up of seven banks, reviews the materials for every project that comes in and approved it coming into the facility and the assets coming out of the facility. From the syndication standpoint, we pushed the marketplace hard in terms of the pricing, and the blind pool concept and the fact that the assets could come out of the facility. That was difficult for the banks to deal with. Nonetheless, we were able to do the facility we wanted to do.
One issue that arose during the syndication was that co-arrangers said, usually anonymously, that they were being asked for hold positions that were too high. Do you think that you managed to keep your core relationships with them going despite what you asked for?
I certainly do. And I think that those banks will try and manage their exposure to NRG. But we believe in freeing up capacity for other things, especially acquisition finance. We don't necessarily need additional financing for the construction phase, because we have this construction facility. We've made a concerted effort to reward those institutions that participated in this transaction. Everyone that's come in at a co-arranger level we've been able to provide additional business to, whether in the capital markets or in the ability to be a lead or a co-lead on a separate bank financing. We're willing to use banks like that and they understand that for coming in at a large ticket and with such a large buy and hold position for this transaction NRG needed to consider how to reward those folks.
The other issue that arose was that you were prepared to be flexible on the pricing on some other issues, and that you presented the market essentially with a wish-list of what you were prepared to scale it back. Is that an approach you have been prepared to take before?
We want these deals to sail through the marketplace and in almost all cases these deals are well syndicated. We certainly want to place them. But this was new ? this was different to Calpine. And a lot of banks that participated in Calpine were filled up on this concept and that made it mildly difficult for us. We knew that the banks we asked to come in at the top tier were all strong relationship banks. Then the issue was to look at the syndication in two steps. The first was how to get these guys in and I had to come up with the appropriate pricing to get them in. And then from there we got a lot of feedback from these very strong project finance banks and it helped us craft the second phase of the deal. We came with what we had to come with to get the deal done without having to leave too much on the table.
In terms of your relationship with the bank market, there have been a lot of institutions moving out. There appears to be a smaller universe. Is that a cause for worry for you?
Banks consolidate and come in and out of the market. We have a lot of other key business in the capital markets so a lot of the banks that call themselves quasi-commercial/investment banks are certainly intrigued to continue to support and to lend to us. Possibly a lot of the commercial banks would look to them to participate and support us in future deals. I'm concerned about the consolidation in the industry, and smaller universe of banks, and one plus one doesn't always mean two. I understand that. Another reason for the beauty of this construction revolver is that I've got this $2 billion of capacity for five years. The capacity is there and I don't need to go out again.
A lot of jumbo financings have gone through for sponsors that have subsequently found it hard to fill banks into smaller deals. Have you had any difficulties on the two you've done this year?
We did Brazos Valley, and in light of the syndication of the revolver and the fact that it was an ERCOT plant with a high level of merchant exposure, we priced and structured the deal to reflect that. It syndicated very well in the marketplace, however. There are fewer and fewer participant banks and those left want to be in the top tiers. Banks and sponsors are having trouble filling out those bottom tiers.
Did you find yourself dealing with a lot of unfamiliar European institutions when you were syndicating the revolver?
We actually did a roadshow in Frankfurt to entice the landesbanks in. We had a lot of European interest, and wanted to overturn some stones where there were banks that might have participated in our transactions.
Although you might not have had to offer them immediate ancillary business, did you allude to your European strategy?
Indeed. A lot of these people participate in our transactions in the states because they may be a significant lender to lead transactions in their home country. A lot of these German banks know that NRG has a big presence not only in Germany but throughout Europe. I think it's prudent for them to consider lending to NRG throughout the globe in order to pursue opportunities with us in their own countries and regions. So the trip to Frankfurt was well worth it. We had good dialogue.
Do think that either rated bank debt or a greater approach to the institutional market provide a solution to liquidity constraints?
I don't see us getting our bank debt rated, or very infrequently. We try and get the banks we work with to structure these financngs as investment grade transactions. We rely on the bank market to try and craft something without us having to get a rating.
And the institutional markets, the life companies and funds, are always meant to be hovering on the edge of the market. Are you interested in doing business with them?
Anybody who can broaden out the bank market is of interest to us. But I haven't seen that many instances of involvement on straight bank financings so far, mostly on wrapped transactions.
Another type of tool would be the tax and accounting friendly structures such as leasing. But you haven't been big, or at least public, users. Is there any reason for that?
Philosophically we've looked at leasing and haven't got comfortable in the past. But now, with some of the assets we've got on our books we might try to optimise our portfolio and its performance. We are looking at leasing on a going forward basis.
Are you happy with some of the issues, like trading away future earnings, and giving up financial flexibility?
Those are the issues. You're effectively trading earnings today and giving up earnings on the back end and paying someone to do it. That was one of our issues. The other one is you really reduce the flexibility in terms of what you can do with those assets. In light of that we see a lot of our competitors do that and understand why they do that, and we'll look at those as well, if it makes sense.
With your massive construction programme you presumably have a lot of turbines on order. Have you looked at synthetic warehouses for them?
Yes, we've looked at synthetic leasing for those assets but we didn't really get comfortable with the issues surrounding it.
Are you satisfied with the regulatory framework?
From a financing standpoint I don't have too many issues. The biggest issue we grapple with is FAS 133. That's not tied so much to the financing as to the derivatives activity we carry out.
In the US, do you have any particularly favoured or disfavoured markets right now?
We want to have a diversified portfolio and if we have the right assets in the right places in all of the different regions we can be profitable in those regions. Obviously we've had great success in the Northeast, so if we had to pick out a favourite market then New York has been very good to us. Other than that, if you structure things right you can be profitable anywhere.
In presentations you've put forward a very clear financing strategy with the revolver as the core, followed by various raids on the equity and debt capital markets. Is this a very strict timetable?
Put it this way. The construction revolver is effectively spoken for, and used for most construction activity, and we'll use acquisition bridge finance for other ways to grow our business, in the short term. And then we'll use the capital markets for the take out of both of those, and the capital markets, particularly debt capital markets, will be where we'll look to take those out. We laid out a plan for financing our equity as well over that time period.
To briefly go back to the revolver. You had a small blow with the Wisconsin Energy acquisitions, which were tentatively identified as candidates for inclusion. The arrangers say that this isn't a problem because of the flexibility, but do you have new candidates lined up?
We've identified two additional projects that will come into the facility that are not identified at that moment in time. The first one is Audrain projects which we've already funded, and Gilla Bend, which is another unidentified project we'd like to bring into the facility. As for what we've got done, Nelson is in, then the turbines for Pike and Gilla Bend are in and Audrain. What we're looking to put in beyond that is Pike, Gilla Bend, and Meriden, in Connecticut.
You recently made some acquisitions from Indeck. Are they under consideration?
No. We'll probably look at a standalone financing for those. The question's come up about whether we should use another construction revolver, but if we were to do it we'd have to do a large one and I'm not sure if that would be the best way because we'd have too much capacity available to us. We'll have to round out the edges with single-asset or portfolio standalone financings.
Overseas you have the oft-stated goal to be in the top three producers in any market where you work. So far you've done some deals in the UK, Australia and Latin America. Do you think these countries bring with them different financing approaches?
We find that for our assets in the UK and Australia that we can get very long tenors in the bank market, unlike the US right now. And so the financing strategy is somewhat different, because those markets are easier to operate in, from a financing standpoint. That could change, but right now, that's the case. The premise is still to use project finance debt.
These are two markets that showed a lot of promise in 1999, and since then a lot of people have found it really difficult to work there. Have your assets been operating well?
Certainly NETA has not provided the pricing expectations that anyone's had in the UK, but we have been able to get better performance out of our assets than Fiddler's Ferry, Ferrybridge and Drax, because we purchased Killingholme after that. During the whole purchase process the power price curve had stepped down, and continued to go down. So versus our competitors we weren't in too terrible shape. In fact, the UK market might be an attractive market to buy assets in right now, because I don't know if the current prices are sustainable.
You've been working on developing the Langage plant in south west England for a while. With the gas-fired moratorium lifted are you hoping to move that along now?
We will continue to evaluate the marketplace, and Langage is still in our sights, but we won't pull the trigger until were comfortable with how the marketplace is going and how NETA will work.
Do you anticipate expanding your trading operations in the region? Attention has shifted on the part of US firms from the distribution end to the generating and trading end.
What we do is we buy the generation and once we have significant critical mass then we provide the trading expertise behind it, not the other way around. I think you'll see us bulk up our trading operations there. We certainly have traders for our Killingholme facility, but in the rest of Europe our assets aren't 100% owned so it's difficult when we don't have complete control to provide our own trading.
The two plants that you've financed recently have been with outside partners. Is that for historical reasons, or to share a little risk? Would you be looking at getting 100% control eventually?
For international assets local partners have been preferred because they understand the marketplace and operating environment and also we are entering the marketplace to share the risk with third parties. We'll continue to use partnerships in new markets, but once we're established we'll move to 100% ownership.
You've developed Brazos Valley with Steag and Avista...
We bought them out and so, by the time we brought it to the marketplace it was 100% owed by NRG. We financed it on a single asset basis because we initially had partners and we'd made a commitment to the lead bank to do it. We had enough assets lined up for the construction revolver. That's a construction that rolls into a five-year financing. It would be easy to refinance, and that would be the structure that we'd want to use on our standalone financings.
Do you have any problems with the miniperm. It's presented as a flexible tool, but often represents the limit of bank appetite.
We're taking what the market will provide and since we believe that the best long-term solution lies in the capital markets, then the miniperm makes sense.
On the McClain financing, you have another partner...
Yes, that's the Oklahoma municipal utility. What happened was that this was a Duke Energy project that we acquired. They had worked on it with the municipality and put that structure in place, and we bought out their 77% stake. It's got planned commercial operation on June 15.
Is the output contracted?
It's 100% merchant but we will layer in contracts in the financing structure so that the leverage will increase according to the proportion of contracted output. In the revolver the coverages rely on the leverage we put on each asset, and contracts affect that. The McClain structure is very similar to a borrowing base approach. It's a $100 million non-recourse facility, assuming the contracted output happens. This is a five-year deal, led by WestLB, and the asset is already running.
One criticism that has come up is that you bid very aggressively for assets. Is that a product of your search for critical mass or do you feel that the quality of the assets justifies your approach?
Our strategy has been relatively consistent in terms of how we develop. It's done on a return basis ? when we believe that we can pay for these plants and that dictates the price. In the US, for instance, we believe that we've acquired assets at a lower price per kW than our competitors, particularly looking at our assets in California and our assets in New York. We believe that the prices we paid for these assets was very reasonable. Most of that is driven by return thresholds that we believe we can maintain.
The other big area where you've had a lot of development activity is Latin America, with the winding up of the joint venture with Vattenfall. How do think you'll go about supporting those?
I think you'll continue to see NRG being a small player here relative to the competition, in the near term. This is because of our investment criteria, which use our Euromoney-based risk ranking. The US, for instance, is a 94. On a MW average basis we have to have a score of 90 or higher. That requires us to have investments in very strong, westernised countries ? the US, Australia, the UK, Germany. That's why you'll see 90% of our assets in places like that, and that's why I don't see Latin America being a significant contributor to NRG in the short term.
You did recently buy an equity stake in TermoRio. What was the reason behind that stake?
That particular opportunity allows us to take a look at the Brazilian marketplace and understand that marketplace before we do anything in a major way there. The financing is still at an early stage.
One popular strategy is the so-called NAFTA approach, with the US, Mexico and Canada. You haven't yet done much north or south of the borders.
We're certainly intrigued with Canada. Mexico we're just observing right now.
The first, Brazos Valley, is a single-asset, merchant financing located within the tricky ERCOT market. Brazos Valley is a 633MW natural gas fired merchant power plant located in Fort Bend County, Texas, 30 miles south-west of Houston. Avista-STEAG LLC had a 51% stake in the project while NRG was set to own 49%. After the departure dirt of Avista and then, at close, of STEAG, ABN Amro launched the $189 million debt to co-arrangers. Royal Bank of Scotland (documentation) and Hypovereinsbank (syndication agent) jointly underwrote with ABN at close.
The deal managed to pick up a different set of investors to those that came in on the revolver, and this may point to a divergence between the participant types on portfolio and single-asset deals. Certainly NRG will need all the debt capacity it can find in the coming months, despite the fact that much of its construction programme is now covered by the construction revolver (for more details on the deal, see Project Finance Magazine, June 2001).
NRG has stealthily built up a position as one of the world's leading independent power producers, with a total capacity of 28.927GW ? although this figure will probably change very fast. This puts it ahead of peers like Edison and PG&E's NEG, although a little way behind AES and Exelon. NRG has always said it wants to be in the top three of any country's generating market, and has made acquisitions from the likes of LS Power and Indeck to bulk up its business. It is estimating an earnings per share figure of $1.35 this year.
Its targets for the net four years are ambitious, and it wants to see its generation capacity grow to 50GW by 2005. The capital plan recently laid out before analysts showed a requirement of $19.3 billion to achieve this goal. Within this recourse debt will make up about $2.5 billion, with the vast majority ? $8.5 billion ? coming from non-recourse debt. With several sponsors (AES and the NEG honourably excepted), talking much less about project finance and more and more about hybrid corporate deals, NRG has the potential to become the Godzilla of the project finance market.
The reaction to the construction revolver suggests that NRG will still have to work hard on maintaining its relationships and managing this growth. It's corporate bonds are trading as benchmarks, alongside PSEG Power, and have maintained significantly slimmer spreads than some peers. NRG's recent launch of the McClain financing, led by WestLB, with its modified borrowing base approach, suggests that a combination of canny structuring and choice apportionment of arranging roles should allow NRG to stay ahead.
In the past two years the market has seen NRG Energy move from the use of bond financed acquisition vehicles to the use of the $2.5 billion construction revolver. Has there been an evolution in the way you look at financing solutions or has this been part of a plan that you've been looking at since the end of 1999?
Bird: Generally we're a company that uses non-recourse finance. The jury's still out on the companies that use it a lot and those that don't. We believe we can get a significant amount of leverage through non-recourse debt, and it helps the ratings agencies get some comfort with that because the assets are secured by the financing. In most cases we could walk away from those assets, so that allows us to gain additional leverage and better returns on equity. We've always tried to project finance and when we look at an asset we're trying to achieve on average 50% of the purchase price financed with non-recourse.
You've said in the past that your bond-financed gencos are the nucleus of regional generations development. But their acquisition, especially that of Cajun, could be described as opportunistic. Has this been an approach you've used from the start?
From a long-term perspective you'll see us use the bank market to finance assets over a shorter period of time and then when we build a sufficient portfolio you'll see us take out these bank financings with a portfolio genco. South Central [the Cajun vehicle] was unique ? in essence it was really one large asset. But we see a day that we could do additional debt at that genco for new projects that we put down there ? add an additional tranche of debt. Similarly in the Northeast ? if we had assets in that region we would want to be able to additional tranches of debt there. In other regions of the world, say in north central, where we have a large construction project there now, and as that and some other projects get completed that becomes primed for a regional genco as well.
Do you feel that there are any particular advantages, whether operational, or financial, to working that way?
We run our business regionally, and we set these regional companies up as their own businesses. So it makes sense that they have their own financings and that they're responsible for them, and that's where these gencos come into play and it's in line with everything else we do from an operational standpoint. Operations and power marketing is arranged from a regional standpoint so it makes sense that we establish these non-recourse financings at this level as well.
While this has been going on there's been a certain amount of reorganisation going on at your parent Xcel Energy. Has this been taken into account when you've been arranging these financings?
Not really. We're independent and we obviously factor in our majority shareholder and how they look at things in our decision making. But really nothing there influenced our establishment of these gencos. We have transitional contracts with utilities that we've purchased assets from, but none with Xcel. We don't operate in any of their service territories, either. We are very, very independent, and we need to be from a trading perspective. We have a very separate and distinct trading group.
Looking at the construction revolver, it's hard to discuss it without taking into account the shadow cast by the Calpine deal. That was represented as a useful tool for a sub investment-grade corporates. How long had you been looking at the structure, and what features attracted you to it?
We noted that we had a higher creditworthiness, but we were intrigued by it as a means to finance our construction programme. We had just announced a large entry into the construction marketplace with a number of projects. We didn't particularly care about their structure ? once the assets were in, they were in for the life of the loan. Instead of being able to revolve those projects they ended up having to go back to the bank market for a second construction revolver, and a third and so on. What we're trying to do is have NRG 1,2 and 3 all in one facility. In essence put the projects in, refinance them when they achieve commercial operation by putting them in one of the gencos. When we refinance and take them out of the pool, we replace them with new assets. The unique feature with this, and one of the difficulties the banks had was, what were these new projects going to be? We don't identify all of the projects, and we don't know what they might be three years from now, that's the blind pool concept. It's quite different, in that I call it the first true revolver for construction projects on a non-recourse basis.
What did you have to offer the banks in return?
We have restrictions in terms of what assets can go into the facility. We have certain criteria that need to be met, and equally as important the technical committee, made up of seven banks, reviews the materials for every project that comes in and approved it coming into the facility and the assets coming out of the facility. From the syndication standpoint, we pushed the marketplace hard in terms of the pricing, and the blind pool concept and the fact that the assets could come out of the facility. That was difficult for the banks to deal with. Nonetheless, we were able to do the facility we wanted to do.
One issue that arose during the syndication was that co-arrangers said, usually anonymously, that they were being asked for hold positions that were too high. Do you think that you managed to keep your core relationships with them going despite what you asked for?
I certainly do. And I think that those banks will try and manage their exposure to NRG. But we believe in freeing up capacity for other things, especially acquisition finance. We don't necessarily need additional financing for the construction phase, because we have this construction facility. We've made a concerted effort to reward those institutions that participated in this transaction. Everyone that's come in at a co-arranger level we've been able to provide additional business to, whether in the capital markets or in the ability to be a lead or a co-lead on a separate bank financing. We're willing to use banks like that and they understand that for coming in at a large ticket and with such a large buy and hold position for this transaction NRG needed to consider how to reward those folks.
The other issue that arose was that you were prepared to be flexible on the pricing on some other issues, and that you presented the market essentially with a wish-list of what you were prepared to scale it back. Is that an approach you have been prepared to take before?
We want these deals to sail through the marketplace and in almost all cases these deals are well syndicated. We certainly want to place them. But this was new ? this was different to Calpine. And a lot of banks that participated in Calpine were filled up on this concept and that made it mildly difficult for us. We knew that the banks we asked to come in at the top tier were all strong relationship banks. Then the issue was to look at the syndication in two steps. The first was how to get these guys in and I had to come up with the appropriate pricing to get them in. And then from there we got a lot of feedback from these very strong project finance banks and it helped us craft the second phase of the deal. We came with what we had to come with to get the deal done without having to leave too much on the table.
In terms of your relationship with the bank market, there have been a lot of institutions moving out. There appears to be a smaller universe. Is that a cause for worry for you?
Banks consolidate and come in and out of the market. We have a lot of other key business in the capital markets so a lot of the banks that call themselves quasi-commercial/investment banks are certainly intrigued to continue to support and to lend to us. Possibly a lot of the commercial banks would look to them to participate and support us in future deals. I'm concerned about the consolidation in the industry, and smaller universe of banks, and one plus one doesn't always mean two. I understand that. Another reason for the beauty of this construction revolver is that I've got this $2 billion of capacity for five years. The capacity is there and I don't need to go out again.
A lot of jumbo financings have gone through for sponsors that have subsequently found it hard to fill banks into smaller deals. Have you had any difficulties on the two you've done this year?
We did Brazos Valley, and in light of the syndication of the revolver and the fact that it was an ERCOT plant with a high level of merchant exposure, we priced and structured the deal to reflect that. It syndicated very well in the marketplace, however. There are fewer and fewer participant banks and those left want to be in the top tiers. Banks and sponsors are having trouble filling out those bottom tiers.
Did you find yourself dealing with a lot of unfamiliar European institutions when you were syndicating the revolver?
We actually did a roadshow in Frankfurt to entice the landesbanks in. We had a lot of European interest, and wanted to overturn some stones where there were banks that might have participated in our transactions.
Although you might not have had to offer them immediate ancillary business, did you allude to your European strategy?
Indeed. A lot of these people participate in our transactions in the states because they may be a significant lender to lead transactions in their home country. A lot of these German banks know that NRG has a big presence not only in Germany but throughout Europe. I think it's prudent for them to consider lending to NRG throughout the globe in order to pursue opportunities with us in their own countries and regions. So the trip to Frankfurt was well worth it. We had good dialogue.
Do think that either rated bank debt or a greater approach to the institutional market provide a solution to liquidity constraints?
I don't see us getting our bank debt rated, or very infrequently. We try and get the banks we work with to structure these financngs as investment grade transactions. We rely on the bank market to try and craft something without us having to get a rating.
And the institutional markets, the life companies and funds, are always meant to be hovering on the edge of the market. Are you interested in doing business with them?
Anybody who can broaden out the bank market is of interest to us. But I haven't seen that many instances of involvement on straight bank financings so far, mostly on wrapped transactions.
Another type of tool would be the tax and accounting friendly structures such as leasing. But you haven't been big, or at least public, users. Is there any reason for that?
Philosophically we've looked at leasing and haven't got comfortable in the past. But now, with some of the assets we've got on our books we might try to optimise our portfolio and its performance. We are looking at leasing on a going forward basis.
Are you happy with some of the issues, like trading away future earnings, and giving up financial flexibility?
Those are the issues. You're effectively trading earnings today and giving up earnings on the back end and paying someone to do it. That was one of our issues. The other one is you really reduce the flexibility in terms of what you can do with those assets. In light of that we see a lot of our competitors do that and understand why they do that, and we'll look at those as well, if it makes sense.
With your massive construction programme you presumably have a lot of turbines on order. Have you looked at synthetic warehouses for them?
Yes, we've looked at synthetic leasing for those assets but we didn't really get comfortable with the issues surrounding it.
Are you satisfied with the regulatory framework?
From a financing standpoint I don't have too many issues. The biggest issue we grapple with is FAS 133. That's not tied so much to the financing as to the derivatives activity we carry out.
In the US, do you have any particularly favoured or disfavoured markets right now?
We want to have a diversified portfolio and if we have the right assets in the right places in all of the different regions we can be profitable in those regions. Obviously we've had great success in the Northeast, so if we had to pick out a favourite market then New York has been very good to us. Other than that, if you structure things right you can be profitable anywhere.
In presentations you've put forward a very clear financing strategy with the revolver as the core, followed by various raids on the equity and debt capital markets. Is this a very strict timetable?
Put it this way. The construction revolver is effectively spoken for, and used for most construction activity, and we'll use acquisition bridge finance for other ways to grow our business, in the short term. And then we'll use the capital markets for the take out of both of those, and the capital markets, particularly debt capital markets, will be where we'll look to take those out. We laid out a plan for financing our equity as well over that time period.
To briefly go back to the revolver. You had a small blow with the Wisconsin Energy acquisitions, which were tentatively identified as candidates for inclusion. The arrangers say that this isn't a problem because of the flexibility, but do you have new candidates lined up?
We've identified two additional projects that will come into the facility that are not identified at that moment in time. The first one is Audrain projects which we've already funded, and Gilla Bend, which is another unidentified project we'd like to bring into the facility. As for what we've got done, Nelson is in, then the turbines for Pike and Gilla Bend are in and Audrain. What we're looking to put in beyond that is Pike, Gilla Bend, and Meriden, in Connecticut.
You recently made some acquisitions from Indeck. Are they under consideration?
No. We'll probably look at a standalone financing for those. The question's come up about whether we should use another construction revolver, but if we were to do it we'd have to do a large one and I'm not sure if that would be the best way because we'd have too much capacity available to us. We'll have to round out the edges with single-asset or portfolio standalone financings.
Overseas you have the oft-stated goal to be in the top three producers in any market where you work. So far you've done some deals in the UK, Australia and Latin America. Do you think these countries bring with them different financing approaches?
We find that for our assets in the UK and Australia that we can get very long tenors in the bank market, unlike the US right now. And so the financing strategy is somewhat different, because those markets are easier to operate in, from a financing standpoint. That could change, but right now, that's the case. The premise is still to use project finance debt.
These are two markets that showed a lot of promise in 1999, and since then a lot of people have found it really difficult to work there. Have your assets been operating well?
Certainly NETA has not provided the pricing expectations that anyone's had in the UK, but we have been able to get better performance out of our assets than Fiddler's Ferry, Ferrybridge and Drax, because we purchased Killingholme after that. During the whole purchase process the power price curve had stepped down, and continued to go down. So versus our competitors we weren't in too terrible shape. In fact, the UK market might be an attractive market to buy assets in right now, because I don't know if the current prices are sustainable.
You've been working on developing the Langage plant in south west England for a while. With the gas-fired moratorium lifted are you hoping to move that along now?
We will continue to evaluate the marketplace, and Langage is still in our sights, but we won't pull the trigger until were comfortable with how the marketplace is going and how NETA will work.
Do you anticipate expanding your trading operations in the region? Attention has shifted on the part of US firms from the distribution end to the generating and trading end.
What we do is we buy the generation and once we have significant critical mass then we provide the trading expertise behind it, not the other way around. I think you'll see us bulk up our trading operations there. We certainly have traders for our Killingholme facility, but in the rest of Europe our assets aren't 100% owned so it's difficult when we don't have complete control to provide our own trading.
The two plants that you've financed recently have been with outside partners. Is that for historical reasons, or to share a little risk? Would you be looking at getting 100% control eventually?
For international assets local partners have been preferred because they understand the marketplace and operating environment and also we are entering the marketplace to share the risk with third parties. We'll continue to use partnerships in new markets, but once we're established we'll move to 100% ownership.
You've developed Brazos Valley with Steag and Avista...
We bought them out and so, by the time we brought it to the marketplace it was 100% owed by NRG. We financed it on a single asset basis because we initially had partners and we'd made a commitment to the lead bank to do it. We had enough assets lined up for the construction revolver. That's a construction that rolls into a five-year financing. It would be easy to refinance, and that would be the structure that we'd want to use on our standalone financings.
Do you have any problems with the miniperm. It's presented as a flexible tool, but often represents the limit of bank appetite.
We're taking what the market will provide and since we believe that the best long-term solution lies in the capital markets, then the miniperm makes sense.
On the McClain financing, you have another partner...
Yes, that's the Oklahoma municipal utility. What happened was that this was a Duke Energy project that we acquired. They had worked on it with the municipality and put that structure in place, and we bought out their 77% stake. It's got planned commercial operation on June 15.
Is the output contracted?
It's 100% merchant but we will layer in contracts in the financing structure so that the leverage will increase according to the proportion of contracted output. In the revolver the coverages rely on the leverage we put on each asset, and contracts affect that. The McClain structure is very similar to a borrowing base approach. It's a $100 million non-recourse facility, assuming the contracted output happens. This is a five-year deal, led by WestLB, and the asset is already running.
One criticism that has come up is that you bid very aggressively for assets. Is that a product of your search for critical mass or do you feel that the quality of the assets justifies your approach?
Our strategy has been relatively consistent in terms of how we develop. It's done on a return basis ? when we believe that we can pay for these plants and that dictates the price. In the US, for instance, we believe that we've acquired assets at a lower price per kW than our competitors, particularly looking at our assets in California and our assets in New York. We believe that the prices we paid for these assets was very reasonable. Most of that is driven by return thresholds that we believe we can maintain.
The other big area where you've had a lot of development activity is Latin America, with the winding up of the joint venture with Vattenfall. How do think you'll go about supporting those?
I think you'll continue to see NRG being a small player here relative to the competition, in the near term. This is because of our investment criteria, which use our Euromoney-based risk ranking. The US, for instance, is a 94. On a MW average basis we have to have a score of 90 or higher. That requires us to have investments in very strong, westernised countries ? the US, Australia, the UK, Germany. That's why you'll see 90% of our assets in places like that, and that's why I don't see Latin America being a significant contributor to NRG in the short term.
You did recently buy an equity stake in TermoRio. What was the reason behind that stake?
That particular opportunity allows us to take a look at the Brazilian marketplace and understand that marketplace before we do anything in a major way there. The financing is still at an early stage.
One popular strategy is the so-called NAFTA approach, with the US, Mexico and Canada. You haven't yet done much north or south of the borders.
We're certainly intrigued with Canada. Mexico we're just observing right now.
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