Panda Power Funds closed a $372 million financing for its 758MW Sherman merchant combined-cycle project on 14 September. The deal asked lenders to take construction risk, on a plant without a physical offtaker. Yet Panda closed two such deals in the third quarter, capitalising on an expected need for baseload power in the Electric Reliability Council of Texas. The deals mark a rebirth of sorts for Panda Energy, a one-time major player in independent power.

Goldman Sachs and Credit Suisse were the lead arrangers of the Sherman deal, while Ares Capital, an asset manager with a private debt business, was the documentation agent. The Sherman deal was oversubscribed, prompting Panda and the leads to increase it to $372 million from $353 million. The deal ultimately comprised a $342 million first-lien, senior secured term loan B and a $30 million letter of credit. The Sherman financing has a significant equity contribution – $360 million, or 49.2% of project costs. Institutional investors are not clamouring for highly leveraged merchant greenfield deals, though they are usually more generous to projects with formal power purchase agreements.

But the slight increase in leverage from the size increased spurred Standard & Poor’s to downgrade Sherman’s rating to B from a preliminary B+. The credit agency, attributed the downgrade to a tight debt service coverage ratio – between 1-1.1x in 2015 – and greater refinancing risk than it had previously assumed. Sherman features a financial hedge in the form of a four-year put option, which gives the project some protection against unfavourable movements in gas prices.

While the leverage inched up, the pricing fell to 750bp over Libor from an initial 800bp. The original issue discount also dropped, from 2% to 1.5%. The debt has a tenor of construction plus four years (expected at six years total).

Sherman is believed to be only the second merchant greenfield deal financed in the institutional market since 2007. That year, Longview Power closed a $1.1 billion financing for its principally merchant, 769MW coal-fired project in West Virginia, which has since suffered a series of technical mishaps. The other deal was the $330 million financing for Panda’s 758MW Temple combined-cycle project.

Temple and Sherman were not pure merchant deals, however, given the hedging. Pure merchant deals have been scarce since the meltdown of the California power market in 2000. Since then, several investment banks stepped in to offer financial hedges to nominally merchant plants, usually brownfield ones, but as restrictions on their trading activities have taken hold, they have scaled back their offerings.

With Sherman and Temple, Panda took the view that ERCOT would need baseload power, thereby easing concerns of the quasi-merchant nature of the projects. ERCOT, Panda says, forecasts capacity reserve margins slipping to 9.8% in 2014 and 6.9% in 2015. Temple and Sherman are expected to be operational in 2014, possibly in time for the peak summer period. Concurrently, wind’s share of electric generation is rising. It surged to 10.2% during the first six months of 2012 from 2.9% in 2007, but is a volatile resource. With retirements of coal-fired projects looming amid a prolonged period of cheap gas, Panda anticipates a ready market for gas-fired capacity.

Panda’s projects are close to the Dallas load centre – Sherman is 95km north, while Temple is roughly 190km south – and will not face much immediate competition from other new projects. “A core group of institutional investors had a strong view of what’s going to happen in Texas,” says a banker of the oversubscribed Sherman deal.

The Sherman deal largely scored better terms than its predecessor. Compared to Temple, Sherman benefited from a wider syndication, slightly lower construction costs, a simpler structure and lower upfront fees.

Morgan Stanley and Ares led the Temple deal, which closed in July after being increased from a proposed $305 million. The Temple deal, unlike Sherman, features multiple tranches. The six-year (non-call for two years) Temple package consists of a $75 million term loan A priced at 700bp over Libor, a $255 million term loan B priced at 1,000bp with a payment-in-kind feature, a $10.16 million letter of credit facility and $5 million in working capital. The A and B loans are pari passu and features cross-acceleration provisions. 3M Employee Retirement Income Plan, an equity investor in Panda Temple and Panda Power Funds, provided a four-year, 600MW hedge and provided a similar enhancement on Sherman.

The two-tranche Temple deal had a specific spread-difference of 250-300bp, per Panda’s agreement with Ares. About six participants – mostly hedge funds – joined Temple, some in both tranches. Panda used a different syndication strategy on Sherman than it did with Temple. Sherman was conceived as a single-tranche deal, which observers say proved easier to explain to investors than the more complex Temple.

Sherman was marketed to a wider audience, including collateralised loan obligations and business development companies, which tend to be play smaller roles in deals, at least compared to hedge funds. Sherman attracted more than 30 investors, some of which had looked at Temple deal, but wanted to see whether the structure was successful first. Yet, Temple added some complexity to Sherman, including on pricing. Some investors perceived Temple and Sherman as essentially the same deal, despite the structural differences, and as such expected comparable spreads. Fidelity and Siemens were among the investors in Sherman. 

Panda Sherman Power LLC

STATUS
Closed 18 September 2012

SIZE
$732 million

DESCRIPTION
758MW merchant gas-fired project in Sherman, Texas, dispatching into the ERCOT market.

SPONSOR
Panda Power Funds

LEAD ARRANGERS
Goldman Sachs and Credit Suisse

DOCUMENTATION AGENT
Ares Capital

SPONSOR LEGAL COUNSEL
Haynes and Boone

LENDER LEGAL COUNSEL
White & Case