Every single top-tier project finance bank will say that it can structure them, and several say that they have completed them. To date, however, one corporate and one bank has come forward with a completed, detailed template for a turbine warehousing facility ? PG&E and SG. The deal has ? justly ? been praised as groundbreaking, although there has been criticism from many institutions as to why PG&E decided to approach the bank market so publicly.

At the centre of this thinking is the new way in which deregulated power generators view their assets. Whilst the slow death of single-plant project finance has been long anticipated, what is less commonly appreciated in the financing community is that developers now view future plants as much as trading positions as bricks and mortar. In short, the development game is about to become as fraught as the gambit-riddled world of commodities.

The turbine market, however, is at present dreadfully one-sided. GE Power Systems, Alstom, Mitsubishi and their competitors are sitting on order books that stretch years into the future. And the best way to stay ahead of the competition is to front as much cash to the manufacturers as possible, preferably with a decent-sized management contract attached. One noticeable trend has been the decline in public announcements of turbine orders ? the energy traders in Houston like to arrange forward contracts without their competition knowing how much they might have online by then.

Banks that can carry out the warehouse facility on the quiet, therefore, can earn the gratitude of the client ? providing that their own accounting practices can hold up under the commitments. And the synthetic lease has yet to be accorded a standard treatment under US accounting rules. Indeed the new Basel rules, which have not yet been able to create any firm guidelines on risk treatments for project lending, may alter the situation still further.

The change in regulations that spurred the creation of the model was the Financial Accounting Standards Board's FAS 98, which appeared in the middle of 1999. This delivered the opinion that turbines, which can make up the majority of a power plant's costs, were to be considered as real estate. Previously the notion that turbines could be moved from plant to plant kept them out of this classification. Henceforth payments towards turbines, which would happen some time in advance of a plant's financing, would disqualify it from synthetic lease payment ? just as the structure began to find favour with energy players.

Synthetic leasing, which grew out of developments in the real estate industry, has gained a sizeable following because of the boost that it provides to earnings-per-share figures. This off-balance sheet loan allows the plant's operator to report different figures to the IRS and Wall Street ? the former treats it as a financing whilst the latter sees it as an operating lease not subject to depreciation. With the decrease in the size of the market for cross border leases ? especially the more aggressive tax plays ? leasing and asset finance groups at most energy banks have found that accounting plays are taking up a far greater share of their time and effort.

Process payments, however, even if they make up but a fraction of the cost of the turbine total, risk disqualifying this structure by triggering FAS 98. John Ryan, Managing Director for Contract-Based Structures at WestLB's Structured Finance Group, says that the issue of triggers exercised the minds of his team from the summer of 1999. ?FAS 98 hindered our clients'ability to do off-balance financing. But rather than put together a huge facility for small turbine payments we developed a stripped-down synthetic lease, and closed the first transaction in October 1999?. Around five more followed for three different clients, and Enron is believed to be among them.

A more complicated set of regulations began to evolve from the middle of 2000, concerning the terms of a construction agency agreement. The Emerging Issues Taskforce EITF 97-10 required that a new structure be constructed from the ground up to make possible a hassle-free take-out and construction period. The new template was snappily called the Collateralised Financing for Contracts Subject to FAS 98, or C 98 for short.

The main driver behind the new breed of synthetic warehouses is the requirement that the bank sponsor take on certain aspects of the construction risk, including condemnation and casualty. This risk transaction has brought the template far closer to the project finance idea of risk transfer, and has meant that some institutions are touting these transactions as a full financing product. The reality is that developers are more likely to want to transfer more risks that those currently included in the warehouse. According to Stacey Lefont, Associate at Jones, Day, Reavis & Pogue, which has represented clients on both sides on such transactions ?EITF 97-10 has changed the role of the construction agency agreement in synthetic lease trasactions. The sponsor has typically acted as construction agent in connection with synthetic lease construction projects but, in the past, the construction agency agreement was not very detailed. The new type of agreement is much more substantive, because it is used to accomplish two very different objectives ? the limitation on recourse to the construction agent required by the sponsor's accountants, and the restriction on the construction agent's independence required by the lessor in order to limit its risk in these transactions.?

The C 98's ideal feature is that it can be closed quickly and efficiently and does not immediately have to be syndicated, preserving the confidentiality that deregulated generating arms treasure. The warehouse facility is treated as a loan for German accounting purposes, but WestLB is not fully exposed to the commitments, most of which are smaller than their nominal values. Whilst unable to go into too much detail, Ryan says that a variety of instruments, including credit-linked notes, have been used to absorb the transactions.

The warehouse facility is not the whole answer to the corporates' development needs, partly because it is really designed to be a bridge loan with limited draw-downs. The warehouse, unless kept in place, is a good earner of structuring fees but brings in few long-term returns since it is largely undrawn. As such the warehouse should lead to a series of new construction facilities, possibly a construction revolver along the lines of Calpine's two recent deals.

PG&E's jumbo

SG's $7.8 billion warehouse deal for PG&E's National Energy Group is a tentative middle road towards the emergence of a fully-fledged accountant-friendly construction deal. Compared to the C 98 deals, which typically have a maturity of up to 24 months, this loan has a tenor of eight years, meaning that the trusts that hold the turbines are designed to be permanent vehicles that can hold turbines for the conceivable development horizon of PG&E.

Since it was pitched at the syndicated bank market and far more aggressively marketed as a project finance tool, this turbine warehouse has attracted the most comment. It probably represents the largest number of turbines covered by a warehouse, 44 units from GE and Mitsubishi. Whilst only around $300 million of the total will probably be used, with the remainder representing the requirements of accountants. The other $7.5 billion is collateralised by Treasuries, although because of EITF 97-10's stipulations there are certain (albeit limited) circumstances such as condemnation in which this would be forfeited.

A Master Trust acts as the lessor of each make of turbines, with PG&E Construction Agency Services LLC providing the necessary distance for synthetic lease treatment. As with most warehouse facilities, the corporate parent provides guarantees for the drawn portion of the debt, which has caused some nervousness on the part of PG&E's lenders. Since stabilising the ringfencing of Californian development subsidiaries this concern has faded, although the resultant standalone entities have generally had lower ratings than their previously solid utility parents.

Interestingly, SG has followed this up with a $956 million master turbine trust for Edison Mission Energy, covering nine recently purchased turbines. The deal has yet to reach the bank market, partly because the structure is fully collateralised, but also because SG may have found an alternative means of holding the debt. This warehouse backs Siemens Westinghouse 501F turbines to be installed at four sites, which have been selected but not disclosed. T-Bills back the entire facility, apparently for reasons of speed.

The long-term warehouse?

The warehouse deals can usually be used for the construction period, although the lease term does not start until the plant is in operation. The individual plants can then be taken out of the facility one by one, with few restrictions put in place on the replacement financing structure. The most obvious candidates would be single asset synthetic leases, possibly along the lines of the La Paloma or Lake Road financings, two deals done in 2000 and 1999 respectively which featured a hybrid synthetic/project financing structure.

However, there is an equally strong likelihood that the most popular replacement would be long-term, multiple asset vehicle along the lines of Calpine. Indeed the first example of this emerged at the start of the year. Enron completed a synthetic warehouse with WestLB in the first wave for around $600 million and this has been taken out by a CSFB-led portfolio financing, marking the first use of the construction facility by a corporate aside from Calpine. This deal has yet to enter syndication, which is slated for the middle of March, but is said by sources at the bank to be ?unique? and may feature a continuation of the warehouse's synthetic lease status.

The replacement is now the most eagerly-investigated avenue amongst those banks with good syndication abilities, their own project funds or a good institutional reach. The CSFB fund has already found favour with a number of lease transactions, and SG placed $325 million in senior notes to back construction of the Occidental Taft cogen facility. This featured a synthetic lease precompletion and a leveraged lease thereafter, and if applied to a series of plants for a more active developer. Oxy Taft also featured $183 million bank loan and $68 million in lease equity, and set a benchmark for tenor and speed.

WestLB's Ryan sees the need to adapt the warehouse for the more adventurous sponsors: ?right now synthetics are substantially corporate loans with regard to their risk profile, and for the moment that's fine. But we think that over the time the scale of developer's plans is such that they will be actively seeking risk transfer tranches. These could be in demand as soon as the next six months?. His group is already moving towards other markets, such as telecoms, where certain assets may get real estate treatment but QTE adaptations are not on the cards.

Current modifications of the structure include the use of the structure for overseas assets, with their higher due diligence requirements, a Euro-denominated facility and a revolving credit. Signs are however that the warehouse facility, at least at this stage in its evolution, will be primarily useful for corporates wishing to reserve their place in the turbine queue. Since these places in the queue are fairly valuable, and that a lucrative secondary market for turbines exists, credits are still an attractive option, although some leasing teams complain that the structure requires a large amount of time and effort given the returns involved. Greater economies of scale might change this view ? whilst CSFB and JP Morgan Chase have suggested that their combined deal book is probably still in single figures, WestLB claims more than 15 deals closed with a nominal value in excess of $3 billion.

Turbulence ahead?

Most market players say that whilst accounting structures have largely stabilised there remain a few looming issues that could force alterations. One is the Basel review of banks' capital allocations. One popular destination for warehouse debt is the commercial paper conduit, since this is fast means of placing debt that is well-rated. Citibank, the acknowledged leader in conduit use for the power industry has carried out a few transactions, and rival bankers suggest that its conduits might now be full of turbine-backed debt.

If true, this debt is probably going to get a little bit more expensive in the future, since 364-day commercial paper may lose its zero capital rating. Some predictions have put the weighting as high as 20%, and the corresponding premium would therefore increase. Banks could put in place derivative structures or risk monetisation structures such as those erected by Enron to transfer the limited default possibilities on turbine deals, provided the buyers exist.

There may also be changes to Special Purpose Vehicle rules that will require much more easily triggered consolidation on the part of financing entities, an issue that has been rumbling on for over five years. This could reduce the control over operations held by the energy giants or forces them back to balance sheet financing. As Bob Cunningham, Partner and head Jones Day's lending structured finance group says ?a number of warehouse facilities have been designed solely to take care of the construction period, with the project sponsor taking delivery of the turbine and putting it in place. At delivery, the project sponsor's decision as to the optimal long-term financing structure is based on the project sponsor's economics and rating agency, balance sheet and existing financial covenant considerations?. Changes in accounting rules and guidelines will not alter that impetus.