On November 8, Southern Energy closed interim financing of $3.17 billion for its newly acquired PEPCO assets - and held out the possibility of the largest lease trust financing to date. The last such transaction, the $1 billion Reliant/Sithe deal, attracted high pricing and adverse comment on its structuring.

At least part of the difference between the Reliant deal and the more favourably priced Edison Midwest deal, which closed at the same time, was the absence of a corporate guarantee on the lease payments. Southern and its mandated lead arranger Credit Suisse First Boston will want to achieve pricing on the assets closer to the latter.

Southern's main aim is to grow a large generating vehicle that would not affect its balance sheet but would still attract cost-effective funding. Southern is still sitting on a $1.45 billion bridge facility that it put in place last year to fund its merchant assets. The new deal should put in place a long-term package that the ratings agencies will learn to love.

A constant theme of recent acquisition deals has been a chorus of warnings (usually, it must be said, from defeated bidders) that the prices paid by sponsors are fast becoming unsustainable. Even if they have not yet been able to tap the bond market as cheaply as they would have wished, 2000 has been a good year for the GenCo builders. Few markets have yet been ravaged by surplus capacity and coal generators in particular have been able to make a killing.

The Pennsylvania-New Jersey-Maryland (PJM) and mid-Atlantic markets have been the centre for most of the acquisition activity, spurred by deregulation and the wish of local utilities to exploit their stranded cost entitlements. Orion Power, Reliant/Sithe and now Southern/PEPCO have all been centred upon the region. Coal assets still dominate the region and are holding on to a sizeable marginal cost advantage as gas prices increase. The PEPCO assets are dominated by coal and oil-fired facilities, and with the exception of a couple of peaking units operate in a baseload capacity.
The explicit aim of the interim package is to prepare the way for an eventual lease trust take-out, probably as soon as the purchase is closed with the seller, the Potomac Electric Power Company. This candour is in marked contrast to earlier deals where sponsors have been reluctant to give a signal as to where earnings will be heading. Southern Energy, however, views the deal as a major shift in focus and wants to create a good relationship with the future bankers of its generating business. The major players have been called upon to commit to the majority of the bridge on a club basis.

The package has four elements, secured at various levels between Southern Energy and the assets. The first is a $650 million one-year revolving credit secured on the Southern Energy Generating parent company, and the second is a $870 million revolver with the same term secured at the Southern Energy North America level. Both of these have been syndicated down to retail institutions

The two other portions are a working capital facility of $150 million and a $1.5 billion bridge at the Southern Energy Mid-Atlantic (SEMA) level, which have been confined to eight institutions. The second of these facilities will be retired as soon as the lease trust transaction has closed. However, ideally the bridge should not fund, so that the assets do not touch the Southern Energy balance sheet at any time and therefore avoid any impact upon corporate earnings.

Joining CSFB as co-lead arrangers are Commerzbank (syndication agent), Bank of Tokyo-Mitsubishi and Citibank (co-documentation agents), Bayerische Landesbank, Bank of America, Chase Manhattan and UBS. These banks supported the SEMA facilities, with CSFB taking the administrative agent title.

In retail senior managing agents were Industrial Bank of Japan and Morgan Guaranty Trust; managing agents were ABN Amro, Deutsche Bank, Fuji Bank, Bank of Nova Scotia, Royal Bank of Scotland, Toronto-Dominion Bank and Wachovia Bank; co-agents were Barclays Bank and Fleet Bank, with ING, CIBC and Landesbank Rhineland as participants.

All facilities have a one-year term-out option, bearing in mind the competition in the bond market that will exist come maturity. Pricing on the bridge facilities is close to that found at the Southern Energy Generating level - 125bp over Libor drawn and 20bp undrawn. The top two facilities have been placed where they have for simplicity, according to the arrangers, although a wider collateralisation base presents obvious advantages for the lenders. Moreover, the output of the plants will still be contracted to PEPCO the utility through to 2004.

The issue of sale-lease-back obligation bonds (SLOBs) now waits upon final approval at the PEPCO end for the sale. There have been some obstacles to the completion of the sale, including a complaint from Panda Energy that the Power Purchase Agreement (PPA) on the Brandywine power plant requires its approval before any change in obligor. This is not believed, however, to be an obstacle to conclusion, but any delays could force the drawing down of the bridge.