EXPLORING THE CAPITAL MARKETS AND

SECURITISATION
FOR RENEWABLE ENERGY PROJECTS

ETSU K/BD/00215/REP

Contractor
Impax Capital Corporation Ltd

Prepared by
M E Haggard
M A Thompson
S Colonna

The work described in this report was

carried out under contract as part of the
New and Renewable Energy
Programme, managed by ETSU on
behalf of the Department of Trade and
Industry. The views and judgements
expressed in this report are those of the
contractor and do not necessarily reflect
those of ETSU or the Department of
Trade and Industry.

First published 2000

© Crown copyright 2000
 Limitation of Responsibility
This document has been prepared by Imp ax Capital Corporation Ltd (“Impax Capital”) with support
from CMS Cameron McKenna based on materials and information supplied by various sources believed to
be reliable. Impax Capital has made limited independent investigation of such information and makes no
representation or warranty (express or implied) as to the accuracy, completeness or fairness of the
information, opinions or projections herein. Nevertheless, additional information is available on request.

Recipients of this report are not to construe the contents of this report as investment, legal or tax advice.
Each recipient should consult its own counsel, accountant, independent adviser or other advisers as to
legal, tax, business, financial and related aspects of this report.

Except where otherwise indicated, this report speaks as of the date hereof. The delivery of this report shall
not under any circumstances, create any implication that there has been no change in the rules or activities
of the subjects contained herein since the report’s date. In furnishing this report Impax Capital undertakes
no obligation to update any of the information contained herein.

----- Acknowledgements------

Written with support from CMS Cameron McKenna

The capital markets are a large and constantly evolving arena. Without the participation and support of
many highly skilled practitioners in the market, the value of this report would be significantly diminished.
It is only by working closely with people actively involved in the market, that a reasonable assessment of
investment potential is possible. The following companies were particularly generous with their time and
support:
Barclays Capital Financial Security Assurance (UK)
Greenwich Natwest Fitch IBCA
HSBC Investment Bank Standard & Poor’s
Prudential Portfolio Managers UK
J Henry Schroder & Co

ii
1. Executive Summary
> Availability of finance is a function of the renewable energy framework and commercially
sound projects;
> Capital markets provide a large, long term and liquid source of finance for infrastructure;
> Capital markets can be flexible and offer looser covenants than commercial bank debt,
however, credit quality of the sponsors in conjunction with the main agreements (EPC, fuel
supply, PPA and O&M) is paramount;
> Green credentials are not bankable in isolation;
> Minimum transaction size for public markets is £100 million; therefore,

r- Capital markets/securitisation is most appropriate for the refinancing of renewable energy

portfolios owned by a single company.

1.1 Introduction
The UK’s renewable energy industry has grown significantly over the last decade, due
in large part to NFFO providing a long term bankable contract. As the industry grows,
the need for financing also grows and like any infrastructure project, renewable energy
needs to raise long term finance economically and with tenors that reflect the asset's life.
This becomes even more important when the relatively high costs of renewable energy
and the new support regime, which is economically less robust, are considered.

1.2 Task
This study looks at the opportunities for renewable energy projects to access the bond
market to finance projects or refinance existing projects, and what, if anything, is
required to facilitate this. In addition, the study looks at the possible use of
securitisation to group projects together as a means of dealing with some of the
challenges faced by renewables, such as small size relative to most bond issues and the
transaction costs.

1.3 Capital Markets and Securitisation

The capital markets provide the largest global source of finance (global bond turnover is
over $600 billion per day), they are generally very liquid and constantly increasing the
range of deals considered. Finance is provided as debt (bonds) and equity raised in the
form of tradable securities principally from non-bank sources, such as pension and life
companies, insurance companies, corporate investors and private accounts.
Securitisation is a process under which pools of future receivables - that is, contractual
entitlements to receive amounts of money - are packaged into tradable securities, usually
in the form of bonds. In economic terms, an investor buys a share of the cash flows
generated by a specific pool of assets and takes the risk that the assets will not generate
the expected cash flows. Diversification of the pool and credit enhancement may allow
the owner of the assets to reduce their average total borrowing cost.

1.4 Risks and Constraints

Capital markets financing exposes the transaction to global market risk, where appetite
for certain tenors, asset classes or credits may change unpredictably, with no obvious
link to a project’s specific merits. Therefore, prudent sponsors will run capital market
and commercial bank financing options in parallel for as long as practicable, to provide
some protection against this.
When developing a project the financing options need factoring in at an early stage,
particularly if a capital markets option is to remain available. This includes issues of
legal structure, credit profile and disclosure requirements. Securitisation provides one
potential route for a company. However, it is expensive in terms of transaction costs
and management time, therefore suitable professional advice is required before
embarking on this and other options considered.

1.5 Bank v. Bond

In general, the capital markets are better than the commercial bank debt markets at
providing:
> longer tenors;
> fixed and/or indexed rates;
> third-party credit enhancement;
> softer covenant packages;
> less stringent monitoring.
However, the commercial bank debt markets is usually better at:
> managing construction/completion risk and post-financial close variations;
> offering reasonable certainty (price and completion) when raising finance;
> managing proprietary or confidential information (controlled disclosure);
> dealing with complex or unusual transactions, or sub-investment grade risks.

1.6 Renewable Energy and the Capital Markets

The capital markets will consider renewable energy projects, provided fundamental size
and credit quality issues are met:
> a liquidity minimum for public placements in the secondary market is £100 million.
Less than this and the markets impose a ‘liquidity premium’. Private placements can
be much smaller and are only limited by the economics of the transaction costs
relative to the deal size;

IV
> quality requirements are the same for any technology: a proven technology, strong
EPC, bankable fuel supply, PPA and O&M agreements;
> ‘green’ credentials do not translate into a pricing advantage and may even discourage
investors on the basis that “fundamental economics are not viable without subsidy”.
Complex deals, whether renewable energy or fossil fuel plants, may be difficult to place
into the primary bond market. Few investors, including large institutional investors,
maintain the resources to conduct due diligence that goes much beyond a project’s credit
rating and its core report from a rating agency. This means that investors often avoid
overly complex or unfamiliar transactions. The degree of sensitivity to these factors
also depends on the overall level of market appetite at the time. For renewable energy,
complexity may come from unfamiliar technologies, fuel supply issues, green
certificates or just the number or diversity of assets to be included.

1.7 Credit Quality and the Percentage Obligation

While some renewable technologies are approaching a market price based on the recent
NFFO-5 bidding, such as energy from waste (2.39-2.49 p/kWh), this does not
convincingly demonstrate market convergence or the ability to compete on a standalone
basis with fossil fuel generators. Rather, the prices reflect NFPA’s credit strength, the
market’s comfort and understanding ofNFFO, its 15-year term, plus improvements in
technology - remove NFFO and renewable electricity prices will increase for three
reasons:
> capital costs need covering within the shorter power contract time frames (most
PPAs are too short and offtakers have little incentive to provide them for third
parties);
> lower gearing and higher equity is needed, with the associated cost;
> higher debt coverage ratios are required in order to deal with increased risk.
Renewable generators under the Percentage Obligation face four new risks that NFFO
generators did not:
> power market risk (price, volume and balancing charges);
> term/renegotiation risk (arms length market contracts rarely exceed 10 years);
> green premium risk;
> off-taker credit risk.
An effective and reliable legislative framework is required for a renewables market to
work efficiently. Once this is established, it takes a considerable period for investors to
research, understand and become comfortable with (or not, as the case may be) the new
arrangements. Further legislative intervention also needs minimising, to ensure prices
reflect economic drivers rather than expectations of political action. The NETA process

v
has caused a material slow-down in the UK renewable energy industry and this is likely
to exacerbate the process of implementing projects within the percentage obligation.
The debt market invested significant effort in assessing the NFFO framework and
educating credit committees on the risks involved. The new percentage obligation will
require more due diligence, due to its increased complexity and lack of standardisation.
This will take time and raising debt finance will be curtailed until this process is
completed. It is unlikely that bond finance will be accessible for individual projects,
until the new market has established a significant track record and a number of bank
financed deals have proved successful. However, refinancing of a renewable energy
portfolio with the support of strong corporate covenants is possible.

1.8 The Future

A framework that encourages economically rational behaviour is not in itself sufficient
to ensure access to long term capital. The markets will need convincing that the risks
under the percentage obligation are reasonable over the long time frame required for
infrastructure debt. This is particularly the case when other less risky projects are
competing for capital (cash and management time), such as PFI projects, with high
quality, predictable terms and contracts in excess of 20 years.
Therefore, it is likely that renewable energy projects will need significantly greater
levels of equity, supported by creditworthy sponsor guarantees. Necessarily this moves
the market structure towards consolidation and domination by larger corporates,
particularly the power utilities that have an existing generation profile that is able to
manage any new variable output.
A number of misconceptions exist within the renewable energy community that require
correction:
> merchant renewable power is not at present a bankable proposition - for the capital
markets or the bank markets - well tried and reliable conventional generation has
sufficient difficulty in raising finance, even when backed by large, multi-national
sponsors;
> there are no shortcuts when raising infrastructure finance - green credentials alone
do not make a project bankable. The core commercial structure must be sound;
> the main task is to look forward and encourage new renewable capacity -
securitisation provides a funding method primarily for projects that would receive
finance anyway. The challenge is to provide sensible instruments that will
encourage future projects.

VI
1.9 Summary
Bond finance and as a subset of this, securitisation, provide a source of finance for
renewable energy projects. However, commercial bank debt also provides a readily
available, large source of finance. The availability of finance per se is not restricting the
growth of renewable energy in the UK since there is no shortage of liquidity in the bank
or capital markets. Availability of finance is simply a function of the renewable energy
framework and access to commercially sound projects.

VII
viii
2. Contents
1. Executive Summary iii
2. Contents ix
3. Introduction 1
3.1 Outline......................................................................................................... 1
3.2 Objectives................................................................................................... 1
3.3 Context......................................................................................................... 2
3.4 Securitisation................................................................................................ 3
3.5 Research Methodology.............................................................................. 5
3.6 The Project Team....................................................................................... 5
3.7 Professional Advice.................................................................................... 5
3.8 Report Structure.......................................................................................... 6
4. Capital Markets 7
4.1 Outline......................................................................................................... 7
4.2 Bond Financing Process.............................................................................. 8
4.3 Supply and Demand.................................................................................... 9
4.4 Rating Agencies.......................................................................................... 11
4.5 Monoline Insurance.................................................................................... 11
4.6 Pooled Securities.......................................................................................... 11
4.7 Bond Pricing................................................................................................ 12
4.8 Repayment................................................................................................... 14
4.9 Secondary Market....................................................................................... 15
5. Financing Projects 17
5.1 Outline......................................................................................................... 17
5.2 On and Off Balance Sheet Summary......................................................... 17
5.3 Sponsor Strength.......................................................................................... 18
5.4 Size............................................................................................................ 19
5.5 Gearing...................................................................................................... 19
5.6 Documentation............................................................................................. 20
5.7 Transaction Cost.......................................................................................... 20
5.8 Interest Cost................................................................................................ 20
5.9 Confidentiality............................................................................................. 20
5.10 Replicability................................................................................................ 21
5.11 Insolvency................................................................................................... 21
5.12 Presentation................................................................................................ 22
5.13 Global Risk................................................................................................. 22
5.14 Bankability................................................................................................... 23
5.15 Use of Funds................................................................................................ 23
5.16 Summary...................................................................................................... 23
6. Non Recourse Financing 25
6.1 Objective...................................................................................................... 25
6.2 Non-recourse Bond and Commercial Bank Debt Summary........................ 25
6.3 Decision Process.......................................................................................... 26

IX
 6.4 Sponsor Strength.......................................................................................... 27
6.5 Size............................................................................................................... 27
6.6 Documentation............................................................................................. 28
6.7 Transaction Costs....................................................................................... 28
6.8 Interest Cost................................................................................................ 29
6.9 Transaction Risk.......................................................................................... 29
6.10 Confidentiality............................................................................................. 30
6.11 Insolvency................................................................................................... 30
6.12 Presentation................................................................................................ 30
6.13 Source ......................................................................................................... 31
6.14 Investor Flexibility....................................................................................... 31
6.15 Transaction Flexibility................................................................................. 31
6.16 Ongoing Monitoring .................................................................................... 31
6.17 Tenor ............................................................................................................ 32
6.18 Investors ...................................................................................................... 32
6.19 Summary ...................................................................................................... 32
7. Securitisation 35
7.1 Outline ...................................................................................................... 35
7.2 History.......................................................................................................... 35
7.3 Definitions ................................................................................................... 35
7.4 Securitisable Assets................................................................................... 36
7.5 Securitisation Types .................................................................................... 37
7.6 Issue ............................................................................................................ 37
7.7 Transaction Process ..................................................................................... 38
7.8 Sponsor Process.......................................................................................... 40
7.9 Confidentiality ............................................................................................. 41
7.10 Bond Rating................................................................................................ 44
7.11 Credit Enhancement.................................................................................... 48
7.12 Monoline Wraps .......................................................................................... 49
7.13 Capital Market Transaction Costs............................................................... 50
7.14 Fund Raising Options................................................................................. 50
7.15 Bridge Finance .......................................................................................... 50
7.16 Impact of the Basle Accord........................................................................ 51
7.17 Private Placements....................................................................................... 52
7.18 Green Premium .......................................................................................... 52
7.19 Schroders PFI Fund.................................................................................... 52
7.20 Recent Developments ................................................................................. 53

8. Support Mechanisms 55
8.1 Background ................................................................................................ 55
8.2 Auction of Renewables Contracts............................................................... 58
8.3 Fixed Tariff ................................................................................................ 61
8.4 Net Metering................................................................................................ 63
8.5 Renewable PortfolioStandard ...................................................................... 63
8.6 Voluntary Green Premium/Certificate ......................................................... 68
8.7 Conclusion................................................................................................... 68

x
9. UK Implications 71
9.1 Outline ......................................................................................................... 71
9.2 Capital Market Advantages........................................................................ 71
9.3 Capital Market Disadvantages..................................................................... 71
9.4 Plants Operating Under NFFO ..................................................................... 71
9.5 Pre-construction NFFO Contracts ............................................................... 72
9.6 Ex-NFFO Plants .......................................................................................... 72
9.7 New Build under the Percentage Obligation ................................................ 72
9.8 Conclusion ................................................................................................... 72
10. Alternatives 75
10.1 Outline ......................................................................................................... 75
10.2 Pre-prepared Portfolio ................................................................................. 75
10.3 Capital Markets Incentive ........................................................................... 75
10.4 Securitise Green Premiums........................................................................... 76
10.5 Weather Derivatives Hedge ........................................................................ 76
10.6 Stranded Asset Approach ........................................................................... 76
10.7 Government Sponsored Wrap ..................................................................... 77
11. Conclusionsand Recommendations 79
11.1 Context ......................................................................................................... 79
11.2 NFFO ....................................................................................................... 79
11.3 Percentage Obligation ................................................................................. 80
11.4 Refinancing ................................................................................................ 80
11.5 Other Frameworks ....................................................................................... 81
11.6 Summary ...................................................................................................... 81 12

12. Appendices 83
A. Glossary
B. Credit Ratings
C. Sovereign Credit Ratings
D. UK Power Company Credit Ratings
E. NFFO and the Fossil Fuel Levy
F. Financial Times Bond Table
G. Case Study in Bond Financing: Sutton Bridge Power
H. Deal List

xi
xii
3. Introduction
3.1 Outline
The UK renewable energy industry has grown significantly over the last 10 years, due in
large part to the Non Fossil Fuel Orders (“iVFFO”) that provided long term bankable
power contracts for developers to raise finance on. Progress in other parts of Europe
and the US has been equally swift, although the industry is still some way from
maturity. As the industry grows, the need for financing also grows and like any
infrastructure project, renewable energy needs to raise long term finance economically
and with tenors that reflect the asset's life. International capital markets have played a
growing role in infrastructure finance, with the City of London at the centre of this
development. This report examines capital market financing routes potentially open to
renewable energy projects and considers some alternatives.

3.2 Objectives
This report compares on and off balance sheet methods of financing renewable energy
projects before looking at ways in which securitisation through the capital markets could
provide benefits for the financing (or refinancing) of these projects. The increasing use
of capital market products for infrastructure deals is reviewed, before considering how
renewable energy project sponsors might use these. In selecting a financing option,
sponsors should consider many factors and this report highlights the following:
> The advantages, disadvantages and costs of different financing options and
securitisation in particular;
> The feasibility of securitisation within the legal and regulatory constraints of
investors and the London Market;
> Investor requirements and the investment profile of renewable energy;
> The experience of securitisation of power projects in general and renewable energy
projects in particular in Europe and North America;
> The possibility of grouping projects to be financed as a portfolio;
> The suitability of securitisation for renewable energy in the UK and, if it is feasible
and advantageous, identifying what the appropriate next steps would be. If it does
not appear feasible, identifying the reasons why this is the case.
This report was commissioned by ETSU to highlight the issues facing sponsors and
assist the Government’s decisions for the future of renewable energy support. A by­
product of this work is various recommendations and suggestions for further work by
ETSU, which builds on these results and may help the Government achieve its targets
for renewable energy resources. These are covered in Chapters 10 and 11.

1
3.3 Context
The world's electricity markets have liberalised over the last decade and many
independent power producers have come into existence as a result. The privatisation of
the electricity supply industry has led to large, private sector conventional generation
projects and the development of innovative financing packages, both on and off balance
sheet, to meet the increased need for funds.
In parallel, the generation of energy from renewable resources has rapidly developed.
As concerns over diversified energy supplies and global warming grow, the European
Commission and Member States have introduced policies and programmes that actively
support the expansion of these emerging technologies for cleaner, sustainable energy.
Many of these programmes mitigate part of the commercial risk inherent in such
innovative activity and provide bankable power contracts, which encourage private
developers to take the lead in establishing renewable energy capacity. Countries such as
Denmark have demonstrated the benefits of focused government support, which
catalysed domestic projects to underpin export growth, such that Danish wind turbines
now account for around half of all new turbines installed.
Despite local regulatory uncertainty, growth in the renewables sector has continued
across Europe as a whole. However, large-scale investment is still required if the
Commission’s objective of 12% primary energy from renewables by 2010 is to be
achieved. A direct consequence of the increase in project development activity is an
increase in the demand for finance, both debt and equity. The Commission's White
Paper on renewable energy predicted an investment requirement of approximately £100
billion between 1997 and 2010 if this target is to be met. In other words, an average of
£20 million per day needs investing across Europe in renewable energy projects until
2010.

With the release of the paper "Renewable Energy: Prospects for the 21st Century" by the
DTI in March 1999, the UK Government reconfirmed that it is working towards a target
of 5% of electricity from renewable resources, by the year 2003 and 10% hopefully by
2010. Once the target is reached, it is expected that renewable energy capacity will
continue to increase, encouraged by the Kyoto Accords and the need to maintain
diversity of energy supply.
In the UK, energy production has changed markedly since privatisation of the electricity
industry, primarily through the advent of very advanced gas-fired generation. The
Electricity Act of 1989 made provision for the respective Secretaries of State to mandate
that Public Electricity Suppliers obtain specified amounts of energy from renewable
energy resources, in order to achieve a target of 1,500MW of new renewable energy
capacity in place by 2000. This led to NFFO in England & Wales, and equivalent
orders in Scotland and Northern Ireland, which in turn have resulted in approximately
3,800MW of contracts for new nameplate capacity since 1991. The NFFO process

2
achieved remarkable reductions in price, with NFFO-1 awarding contracts in the range
3.6-lOp/kWh compared to NFFO-5 with contracts in the range 2.34-4.60p/kWh.
However, at the end of December 1999 only 747MW, or 20%, of that capacity was
commissioned and operating.
The UK currently obtains approximately 2.5% of its electricity (1998 figures) from
renewable energy, mainly large hydro1 resources. To reach the target of 10% by 2010,
it is estimated that approximately 8,000MW of new generating capacity will be
required, at a capital cost of £5-8 billion. This represents both a considerable challenge
and opportunity for developers and financiers. Long term assets need long term finance,
which applies particularly to renewable energy's cost profile when compared to some
alternatives.
Until now, the majority of debt finance has been provided by commercial banks, which
have become familiar with some of the sector’s technologies and commercial risks.
However, the capital markets provide the largest source of long term debt and may also
bring cost benefits to sponsors. To date, most of the UK's renewable energy projects
have divided into relatively large projects2 (10MW - 50MW) or very small projects
(<2MW). Most large renewable energy projects have been financed on balance sheet by
large companies, or have been project financed using commercial bank debt. This
report looks at securitisation as a possible means of increasing the options for project
sponsors to access finance in an efficient and competitive manner.

3.4 Securitisation
Securitisation is the process under which pools of receivables - that is, contractual
entitlements to receive amounts of money - are packaged into marketable, transferable,
investment grade securities, which are distributed to investors. The entitlements to
receive money could comprise mortgage loans, credit card receivables, lease
receivables, hire purchase contracts, trade receivables, project receivables or corporate
loans. The securities are collateralised by, amongst other things, the assets that are
being securitised.
In economic terms, an investor is buying a share of the projected cash flows - both
principal and income - generated by a specific pool of assets and is taking the risk that
the assets will not generate the expected cash flows. The originator - that is the original
owner of the receivables - is financing or refinancing the assets. Securitisation may also
eliminate some of the risks of owning those assets, whilst retaining some of the
economic benefits of the assets, such as fees for the provision of certain services in
relation to the assets, equity participation or in the case of over-collateralisation, the

1 Considered here as greater than 50MW.

2 These are small compared to fossil-fuel stations that typically run into many hundreds of MWs.

3
residual value. However, securitisation as a means of financing should be viewed in the
context of the wider capital market as shown in the diagram overleaf.

Commercial Capital Markets

Bank Debt Debt

Project Corporate Project Corporate Securitisation

Risk Risk Bond Bonds Issue

Private Placement; Public Placement;

Bi-lateral; Club; Syndication
(Domestic; Rule 144A; Eurobond)

Providers of commercial bank debt are typically the major commercial bank lenders.
Borrowers can obtain commercial bank debt from:
> a single bank via a ‘bilateral loan’;
> a small group of banks where each bank commits a given amount via a ‘club loan’;
> a large group or syndicate of banks after formal syndication following underwriting
by a lead bank or lead group of banks.
Capital Markets, on the other hand, is a broad term used to describe both debt and equity
raised in the form of negotiable (ie easily traded) securities from pension and life
companies, insurance companies, corporate investors and private accounts. Debt raised
in the capital markets is evidenced by a bond, which is a legal promise by the issuer
(borrower) to pay the investor (lender) on declared terms. Bonds are usually negotiable
and customarily longer-term obligations (5-25 years, or over). Short-term bonds are
referred to as Notes.
Bonds are raised through a number of mechanisms and markets:
> public listing on a stock exchange, with full disclosure and application of exchange
rules;
> a Rule 144A bond, which is issued in the US but not registered with the SEC and
only marketed to a limited number of qualified investors;
> private placement bonds which are negotiated with a small number of institutions
and often held to maturity.
The diagram above shows the types of debt instrument and illustrates some of the
options a sponsor needs to consider, often early in a project's development. The

4
development process should consider both sides of the tree until near to financial close.
Premature decisions may reduce the financing options available, which usually results in
greater cost or the project becoming uneconomic. The trade-offs between each option
are covered in more detail in Chapters 4 to 6, with a decision tree for commercial bank
debt versus capital markets debt in Section 6.3.

3.5 Research Methodology

The research was based on Impax Capital's extensive knowledge of raising finance for
the renewable energy industry supported by Cameron McKenna’s wide transaction
experience both inside and outside of the renewable energy field. This was
supplemented by extensive discussions, both formal and informal, with a wide variety of
market participants in the City of London.
At the outset, a list of recent power plant securitisation deals (see Appendix H) in
Europe and North America was established with particular regard to renewable energy
deals or deals that were similar in nature to renewable energy, such as small embedded
conventional plant. Attention was paid to the differing technology types: given the
extent of the UK wind energy resource, any securitisation of intermittent and non-
dispatchable plant with variable output (such as CHP) was carefully examined. The
survey of “done deals” was based on historical information and used to derive
conclusions on the advantages and disadvantages of different financing alternatives.

3.6 The Project Team

The Project Team was led and co-ordinated by Impax Capital of the UK, Europe’s
leading independent adviser to the renewable energy sector. Impax Capital has
successfully raised over $330 million in debt and equity capital from third parties for a
wide range of renewable energy projects. Supporting the research was Cameron
McKenna a highly respected City law firm with extensive project finance and capital
markets expertise that has worked with Impax Capital on a number of cutting edge
transactions in the renewable energy field.

3.7 Professional Advice

The content of this report derives in part from information provided voluntarily by third
parties that is not in the public domain, and against a background of changing financial
markets. The market is complex and little allowance is made for inexperienced
investors or sponsors. As such the methods described should not be considered the only
approach to securitisation, or that securitisation is the best way of freeing up equity for
further projects or broadening the range of investors for renewable energy projects.
Also, this report cannot provide a firm indication of how every investor, underwriter or
rating agency would price the risks involved. The process and assessment of the
benefits of securitisation is complex and expensive. Sponsors considering securitisation

5
as a means of raising finance are strongly advised to obtain independent advice relevant
to their particular needs before undertaking substantial work or expenditure.

3.8 Report Structure

The report initially compares and contrasts the differences between using on and off
balance sheet financing, before moving to a more detailed consideration of the
differences between the bond and commercial bank debt markets. Parts of this section
apply equally to on and off balance sheet financing, although the emphasis is on the off
balance sheet, or limited recourse route. Having laid the foundations for bond
financing, securitisation is examined in greater detail along with some specific issues
relating to bond finance. These include the rating agencies, disclosure issues and
insurance products.
Based on the above, a number of different renewable energy incentive schemes are
examined and their ability to provide bankable contracts for bond financing is
considered. The issues in particular for the UK market are subsequently highlighted,
before a number of alternative incentive structures are briefly touched upon, before the
report is concluded.

6
4. Capital Markets
4.1 Outline
'Capital Market' is a generic name that describes debt (bond) and equity raised in the
form of tradable securities from non-bank sources, principally pension and life
companies, insurance companies, corporate investors and private accounts. The main
features of a bond are relatively simple: the issuer, (ie borrower/sponsor), promises to
pay a specified percentage of par value on designated dates (the coupon payments) and
to repay the par (principal) value of the bond at maturity.
Bondholders, as creditors, have a prior legal claim over ordinary and preferred
shareholders on the income and assets of the company for the principal and interest due
to them. Bonds are customarily long-term obligations and are negotiable, that is they
are easily traded. Failure to pay the principal or interest normally constitutes a legal
default and investors can then go to court to enforce the contract. The obligations of the
issuer and investors are set out in great detail in a bond indenture or trust deed.
Generally a corporate trustee is employed to ensure the detailed stipulations of the
indenture are adhered to and the indenture is made out to the trustee, who is appointed to
act in a fiduciary capacity for the investors.
New bonds are originated in the primary market, where the money raised flows directly
to the issuers. However, most capital market trading takes place directly between
investors and this is known as the secondary market, since it does not directly involve
the issuer. This illustrates one of the main differences between bond finance and
commercial bank finance: a bond investor can usually sell a bond even if the underlying
characteristics change and can therefore adapt their portfolio’s risk profile3. A bank
usually holds commercial debt4 to maturity, post syndication, although Credit Suisse
First Boston (CSFB) recently securitised part of its project finance debt portfolio.
The market price of a bond changes over time due to several factors: expected inflation,
interest rates on competing investments and the creditworthiness of the borrower5.
However, price in isolation (ie spread over the benchmark) does not guarantee
saleability - this remains a function of the market’s capacity and liquidity at the time the
bond is issued, plus its appetite for:
> risk and tenor;
> that particular credit rating;
> the sector.

3 This rarely applies in the private placement market, where trading is limited or impossible and investors usually want
to hold the asset to maturity in order to cover a particular exposure.
4 There is some trading of debt between banks, but this does not provide ready access to liquidity.
5 Most bonds have a fixed rate, but some are issued with a floating rate or more recently, with index linking.

7
Bonds are issued across a wide risk spectrum ranging from sovereigns at one extreme to
sub-investment grade corporate or project risks, often referred to as ‘junk bonds’ or
‘high yield bonds’, at the other. An explanation of the different risk ratings is at
Appendix B, with a list of sovereign ratings at Appendix C and UK power company
ratings at Appendix D.
Normally a project will not receive a higher rating than its main sponsor, rather like
companies usually being unable to receive a higher rating than their home country. Due
to the ability to ‘ring fence’ an off balance sheet project from the sponsor it may be
possible for a project to achieve a higher credit rating than its sponsor in certain
circumstances and hence improve its borrowing capacity.
Capital market fund raisings may be issued by:
> a special purpose project company raising finance for a single activity (e g. a power
station, road, hospital etc.) the revenues from which will be the sole means of
meeting bond interest and principal payments as they fall due;
> a borrowing entity seeking to raise finance against a pool of receivables. This is
often referred to as securitisation;
> large and medium sized corporate issuers requiring finance for general corporate
purposes. In these cases, bondholders are secured on the corporate assets of the
issuer and not just the revenues from a single activity.

4.2 Bond Financing Process

The diagram overleaf outlines the main participants in a bond Global Non-Recourse
Bond Issue -$bn
financing and their roles are described in greater detail in
1994 3.9
subsequent sections. A bond issue can be distributed as a
1995 3.8
public issue or a private placement. Public issues are normally
1996 4.8
large liquid issues (at least £100 million), which can be easily
1997 7.5
traded. Private placements are distributed to smaller groups of
1998 9.8
institutions and are more likely to be held to maturity
1999 19.97
especially where the characteristics of the bond (an asset) have
Source: IFR PFI
been designed to meet the particular liability profile of an
investor. The growth in non-recourse bonds is shown opposite, with the jump in 1999
due primarily to activity in the US.

8
 Sponsor decides to Core Financial Model Bond v. Bank
raise finance. Appoint (Cash flow, construction,
(see Section 6.3)
Financial Adviser operations, B/S, P&L, tax)

Review Market Conditions

Structure model accordingly. ;
and Investor Appetite

Select and appoint sponsor's Structure Infomation

lawyers (usually on financial Memorandum, Model and
advisers recommendation). Due Diligence Pack

Bank that will market the bonds, inform

sponsor on price and guarantee take-up
Select Lead Underwriter
through the underwritingcommitment.

Independent review of risk - analysis

(made public with sponsor's agreement) Select and retain Rating
Required before many investors are Agency
allowed to consider the bonds.

Insure payments to \ Select Monoline Insurer

V bond holders. (if applicable)

Series of presentations from sponsor,

rating agency, underwriter and financial Roadshow for Investors
adviser to potential investors.

Complete documentation. Sell \

bonds. Sponsor receives funds.
Primary market placement £££

Underwriter provides trading liquidity and

undertakes always to buy/sell the bonds Market Making
(not always guaranteed).

4.3 Supply and Demand

The bond markets play an essential role in raising finance for
Project Bonds by
companies and governments. The largest sector of the market in Country ($m) 1999
1997 was dollar denominated bonds, which was worth over $11 USA 11,944
trillion, based on publicly traded debt outstanding6. Most of this Canada 1,863
is traded by institutions, and total daily bond turnover was UK 1,212
estimated to be around $600 billion in 19987. In the US, Puerto Rico 1,000
institutional funds were worth three times the assets in the Mexico 892
banking system, which reflects a growing trend towards capital Spain 728
market financing as a cheaper, more liquid source of funds8 (see Australia 492
table opposite for the country split in project bonds). Source : IFR PFI

0 US$ bonds account for approximately 47% of the market, Euro area bonds 25%, Yen 15%, Sterling and others the
remaining 13%.
7 The Economist, November 1999.
8 Financial assets held by commercial banks in the US have fallen from around 35% of total financial assets to 20%,
with pension funds and mutual funds being the main recipients of the switch in assets.

9
Over the long term, bonds could increase substantially as a source of project debt from
the current 10% in 1997 and 1998. This is mainly due to bonds representing funds from
the largest source of capital in the world - institutionally managed funds such as pension
funds, insurance companies and mutual funds. McKinsey recently estimated that in
2000, global savings would be close to $90 trillion - a large proportion of which is
under institutional management and theoretically available for long term debt financing.
This represents a substantial excess over the funds available for bank lending. To put
this in context, in 1997 US institutional investors controlled the equivalent of 227% of
US GDP, and UK institutional investors controlled the equivalent of 193% of UK GDP9.
With the amount of capital involved, institutions are constantly
Project Bonds by
searching for new instruments that meet their investment profile. Sector ($m) 1999
This need is exacerbated by the reduction in national debt for the Power 7,270
US and UK, whose long term sovereign bonds were traditional Telecoms 5,227
cornerstones of institutional portfolios. Both countries have Infrastructure 3,676
markedly reduced the proportion of long dated bonds issued. This Oil and Gas 2,822
results in “hunting down the yield curve10” and suggests that Petrochem 672
appetite for less conventional offerings, such as single asset project Leisure 299
bonds, within the capital markets may increase. At the same time,
the movement of infrastructure finance from the public to the Source: IFR PFI

private sector has also increased demand for long term finance.
Changes in investor demand amongst pension and life companies (in particular for
higher yielding assets), the increasing availability of private equity and the emergence of
large infrastructure funds suggests the need for debt instruments that will appeal to a
broad range of capital market investors. These include single asset bond issues and
securitisations, provided such products meet market requirements for credit, price,
liquidity and size. The above table provides a snap shot of demand in this area.
For private sector businesses, taking on debt can be Leading bookrunners of asset-
backed Euromarket issues $bn
risky. If their income fluctuates and they are unable
Credit Suisse First Boston 12.7
to meet the repayments, bankruptcy can ensue. Deutsche Bank
Therefore, in general the more financially sound an Lehman Brothers 39
issuer of debt is, the lower the spread achieved over Merrill Lynch 3.0
Goldman Sachs 2-6
the benchmark. Professional money managers use 24
HypoVereinsbank 19
various techniques to analyse information on Nomura 1.7
companies and bond issuers in order to estimate the Societe Generale L1
Morgan Stanley
ability of the issuer to live up to its obligations. This
JP Morgan
activity is known as credit analysis. Source: Capital Data Bondware, 1-6/99

9 The Economist, November 1999.

10 A colloquialism for looking for a higher yield at the expense of accepting greater risk. This usually occurs when
market sentiment is positive and sovereign risk provides insufficient return.

10
4.4 Rating Agencies
Some institutional investors rely on in-house credit analysts to determine the
creditworthiness of an issue; however, it is costly and time consuming for an individual
to monitor all the bonds held in their portfolio. Rating agencies reduce this cost by
assessing a company’s financial condition (usually by reference to its ability to repay
long-term debt and the likelihood of default) and publishing their conclusions.
Therefore, for most bond debt, sponsors will have to involve a rating agency and even
with some private placements, pension fund trustees will require a rating.
Ratings offer an independent assessment of credit risk and allow investors to compare
the risk and return characteristics of any instrument across global lines. Ratings are a
blend of qualitative and quantitative factors and by expressing an opinion on the future,
they are necessarily subjective. Nevertheless, they have generally correlated quite well
with subsequent default statistics.
Ratings are usually issued for bonds, companies and countries. However, recently bank
loan ratings have also occurred for specific project debt, as this may improve the
potential to access the capital markets when refinancing or as a means of demonstrating
to a bank the potential for refinancing. In part, this type of financing acts as a bridge to
the capital markets, whereby banks recognise that a major proportion of their loan will
be removed from their books within a relatively short period. This has in instances
allowed the banks to hold much higher positions than they would otherwise consider.
The leading internationally recognised rating companies are Standard & Poor’s,
Fitch/IBCA, Moody’s and Duff & Phelps. Their rating systems use similar symbols and
a description of these is in Appendix B. This report uses Standard & Poor’s
nomenclature throughout.

4.5 Monoline Insurance

A small number of companies offer monoline insurance, which may be used to improve
the credit rating of a bond to ‘ triple A ’, which lowers the interest cost and makes it
attractive to a wider or different pool of investors. Monolines are primarily active in the
US, but three monolines have offices in the UK. They effectively insert themselves in
the security chain between investors and the assets and guarantee the bond payments to
the investors. However, they impose tight credit criteria and covenants separate to the
bond holders’ trustee, in order to ensure the required credit quality. The role of
monolines is discussed in more detail in Section 7.12.

4.6 Pooled Securities

Issuers are now looking at pooling assets into securitised collateralised loan obligations
(CLOs) or collateralised bond obligations (CBOs). Bonds are being issued for closed-
end defined pools of loans made by banks and the first open-ended deals have recently

11
occurred11. Several types of structure now exist, but these remain variants of the
structures already extensively used for asset-backed bonds secured by mortgage
receivables, other consumer receivables and mid-market corporate loans.
Under a pool structure, bonds are serviced by the cash flow generated by a pool of
project loans. The credit strength of the bond should be stronger than the strength of an
individual loan, which results in cheaper borrowing costs, as the pooled cash flows
diversify the default risk inherent in the loans making up the pool. In addition the bonds
may be strengthened by over-collateralisation of loans and loan cash flows. Typically,
CLO bond issues are also issued in tranches to give different risk profiles and priority
claims on cash flows.

4.7 Bond Pricing

Simple bond pricing is made up of two components: a benchmark interest rate and a
spread, usually quoted in basis points (one-hundredths of a percentage point), on top of
the benchmark. The benchmark is either a government bond with a similar maturity12 to
the expected bond financing or the appropriate LIBOR rate. In the UK, Gilts are used
and in the US, the Treasury Bill rate is used, as these effectively represent a ‘risk free’
rate. The spread over the benchmark is an amalgam of factors that are primarily driven
by market sentiment. The factors include the project risk (represented by the bond
rating), the tenor of the bond, the repayment profile, the expected secondary market
liquidity, the appetite for exposure to the underlying assets, the spread achieved by
similar bonds and any special features in the bond13. The weighting of each factor
varies depending on market sentiment and the bond underwriters will be able to give an
indication of the expected rates at the time.
An example of the impact that market appetite can have on pricing is the spread
achieved by two PFI hospital deals. In 1998 the Queen Elizabeth Hospital (Deal 24 in
Appendix H) was rated BBB+ and priced at 160bp over the 2016 indexed linked Gilt.
In 1999 the South Tees hospital (Deal 23 in Appendix H) was rated AAA through a
monoline wrap and priced at 130bp also over the 2016 index linked Gilt. Both use the
same benchmark but a spread of 30bp between AAA and BBB+ is unusually small. The
South Tees deal spread was quite high due to the lack of market appetite at that time for
wrapped paper, compared to the 40+bp difference seen between BBB+ and A+ bonds in

11 An open ended fund is effectively a line of credit, where a number of projects are put in the pool, but the lenders
also agree to fund future, as yet undefined, projects. Typically these future projects must either pass a set of objective
quality criteria before being allowed into the pool, or they must be compared to the pool ‘under stress’ to ensure the
addition does not lower the overall credit quality of the pool.
12 The benchmark might have a similar ‘average life’ to the bond being issued, which takes into account different
coupon sizes, rather than simply matching the tenor.
13 These features might include call options, interest payment through ‘payment in kind’ bonds (usually only a feature
of highly leveraged buy-outs in the US), convertibility, index linking and the ability to change between principal
repayment methods (usually lottery versus market purchase). The pricing calculation for these is complex and beyond
the scope of this report.

12
Appendix D for UK Utility borrowings. Section 6.9 on capital market transaction risk
gives another example of how spreads may vary due to external economic shocks, such
as the Russian debt default in 1998.
Appendix F shows an extract from the Financial Times with a typical daily report on the
bond market and the spreads achieved, while the graphs below were compiled by

Utilities A v BBB (Syr modified duration, bp)

BBB

Source HSBC Investment Bank

HSBC Investment Bank based on utility bonds of different credit quality and maturities.
These demonstrate the significant changes in bond pricing over the last year and how

Utilities A v BBB (15yr modified duration, bp)

BBB

o o

Source: HSBC Investment Bank

13
spreads have tightened substantially for lower grade bonds in January 2000. This
resulted from a general lack of bonds available in the secondary market, which
increased demand for the lower grades and less popular bonds. Thus a bond issued over
the last year might have achieved a difference in spread of almost 20bp, depending on
when it was issued. It should be noted that the above graphs show modified duration
and not tenor. Modified duration is (simplistically) a weighted average of the bond’s
repayments that depends on coupon level and tenor.

4.8 Repayment
There are a number of ways a bond is repaid, which are partially a function of market
practise and partly of investor appetite. Typically, the coupon is paid quarterly, semi­
annually or annually and the standard varies from Gilts to corporates and from country
to country.
The principal repayment may be by a number of methods:
> Straight Amortisation - equal repayments are made throughout the life of the bond.
This is simple, common on tax-exempt infrastructure bonds in the US and gives
bond holders confidence in the repayments. However, it maximises investors’
exposure to reinvestment risk.
> Limited Amortisation - This is similar to straight amortisation, but occurs typically
over the last few years of the bond’s life. It is now also being seen over the initial
part of a bond’s life as a method to limit exposure in conjunction with some form of
credit enhancement.
> Sinking Fund - This is a fund often held by the trustee into which principal
repayments are made. This is used to redeem the bond at certain pre-agreed times,
sometimes only at maturity. It gives the bond holders confidence in the repayment
but does not expose them to as much reinvestment risk. Typically, the sinking fund
is invested in risk free bonds (ie sovereigns) and any interest rate differential (the
difference between the interest rate earned on the Sinking Fund balances and the
interest rate paid to bond holders) is borne by the issuer. Typically, sinking funds
that redeem bonds during the bond’s life are used to purchase bonds in the open
market, or by a lottery that selects bonds for redemption.
> Bullet Payment- A bullet payment refers to all the principal being repaid at the end
of the bond’s term. This is frequently supported by a sinking fund and is often the
preferred method for pension companies, due to the lack of reinvestment risk and
ability to plan their cash flows.
> Profiled Repayment - This usually only occurs in private placements where the
repayment profile is agreed on a financial base case model that reflects the
anticipated revenue flows from the assets. This is particularly useful for certain
renewable energy technologies (such as wind and biomass) that have seasonal

14
 performance differences. A variation on the profiled repayment is the Batesville
CCGT project (Deal 15 in Appendix H) where the senior bond debt had two
tranches: the first bond was a straight amortisation over 14 years and the second
bond with similar seniority amortised from years 14 to 26. This allowed different
investor appetites to be satisfied on tenor, without sacrificing security. Issues
regarding repayment are usually developed by the sponsor and their financial
adviser, based on the market and cash flow profile.
> Grace Period - Principal and interest payments may include grace periods and one
example of this is Dam Head Creek (Deal 10 in Appendix H) where the senior debt
had a 5 year grace period. This is similar to limited amortisation, but without any
repayments.

4.9 Secondary Market

The secondary market represents one of the main advantages for bond investors over
commercial bank debt investors, as this is a mechanism that allows investors to
efficiently trade their holdings14. The secondary market in bonds is primarily for listed
bonds, as private placements and Rule 144 A bonds have the number of investors
restricted by quantity and qualification. The secondary market operates in a similar
manner to a stock exchange and allows investors to buy and sell their investment,
thereby changing their risk profile with relative ease compared to commercial bank
syndicated debt. To generate sufficient liquidity in the secondary market, an issue of at
least £100 million is typically needed. Without this level investors in the primary
market are liable to require a greater spread to compensate them for the expected
difficulty in achieving a ‘fair’ price due to thin trading. Some corporates have over­
issued bonds to achieve this target level, and avoid penalisation in the primary market
issue.

14 There is a growing secondary market in bank debt that is being assisted by increasing standardisation of
documentation. However, this provides insignificant liquidity when compared to bond secondary trading.

15
16
5. Financing Projects
5.1. Outline
Power projects have generally raised finance by two main methods: loans to a developer
backed by the cash flow from ownership of a number of assets, or project loans backed
by the revenue of individual generating plant. This section compares these two
financing routes for renewable energy - on balance sheet and off balance sheet financing
- as the first step in the decision process for funding a project. Both have advantages
and disadvantages, and within this comparison, some of the issues between bank finance
and bond finance are touched on. A more detailed analysis of off-balance sheet bonds
versus commercial bank financing - the second step in the process - follows in Chapter
6, before Chapter 7 looks at securitisation and the issues it raises for renewable energy.

5.2. On and Off Balance Sheet Financing Summary

The following table summarises the main differences between on balance sheet and off
balance sheet financing. These differences are then amplified in the text, with specific
reference to the list of deals in Appendix H. The relative importance of each item can
only be judged in the context of a sponsor’s own circumstances and there is no attempt
to prioritise these here. This is a matter for the sponsor and their advisers.
On balance sheet financing is considered debt raised that has recourse to the sponsor’s
other assets. Off balance sheet financing is considered debt raised that only has recourse
to the specific assets it is financing and there is no recourse to the sponsor, beyond the
sponsor’s equity contribution. True non-recourse financing is very rare and limited
recourse financing more commonly occurs, with investors looking to maximise the
number of risks borne by the sponsor. The Tyseley waste to energy plant (Deal 12 in
Appendix H) shows the level of guarantee and support required by investors, in this case
represented by a monoline insurer, even from large, highly respectable sponsors, if an
investment grade rating is to be achieved.

On Balance Sheet Off-Balance Sheet

Sponsor Affects ability to raise finance on
Strength favourable terms.
Size Linked to balance sheet strength and
level of existing debt.
Gearing Moderate amount possible, but limited
by previous debt covenants.
Documentation Comparatively limited, often able to
duplicate previous debt funding.
Transaction Relatively cheap, especially if the
Costs sponsor has a good track record and
previous transactions can be duplicated.
Theoretically, allows financing of
projects unrelated to sponsor strength.
Constrained only by the economics of
the underlying assets.
Much higher than on-balance sheet with
correspondingly higher equity returns.
Complex, expensive and transaction
specific.
Relatively high, due to complexity.
Securitisation costs are substantially
higher than most single asset project
finance.

17
 On Balance Sheet Off-Balance Sheet

Interest Cost Linked to the quality of the sponsor, size
of their balance sheet, business
relationship, plus existing debt level.
Confidentiality Good, with limited requirement to
disclose sensitive project specific data.
Replicability Easy and cheap if loans can be
replicated. (Note with bonds, similar
covenants are required between issues,
otherwise earlier bonds are adversely
affected.)
Insolvency Harder to become insolvent due to the
variety of income generating assets and
the relatively lower gearing.
Presentation Equity analysts interpret debt positively
provided gearing is not excessive.
Debt fully recorded on balance sheet.
Source Bank or capital markets possible, but
linked to existing level of debt.
Global Risk Entire business at risk if the loan
defaults.
Sponsor able to take more market risk
and rely on asymmetry of information.
Bankability Not directly relevant - see sponsor
strength.
Use of Funds Can be very flexible, with few
restrictions, but depends on the
borrower.
Reflects only the risk of the project and
any credit enhancement,
Variable, depending on route taken.
Public debt placements may require
substantial disclosure.
Difficult, but see Chapter 10.
Well structured deals are designed to be
self-correcting, with numerous objective
indicators of performance. Insolvency
action is relatively simple, as priorities
and values are extensively documented.
Equity market signal can be mixed.
May move debt off balance sheet if less
than 50% of the SPV is owned.
Bank or capital markets possible.
Avoids tripping loan covenants or ratios
imposed by sponsor's other debt.
Sponsor's risk limited to equity paid in
and any other support, but see Chptr 9.
All risks need defining and allocating -
a costly and time consuming process
that may impact the sponsor's returns.
Extensive work to check contracts and
ensuring an appropriate structure.
Highly constrained with draw downs
linked to set milestones.

5.3. Sponsor Strength

Sponsor strength will always be a factor in the ability to raise finance, if only for the
perceived quality, a “halo effect”, that certain names may bring, plus the potential that
name recognition brings to assist the decision process. This is particularly relevant for
on-balance sheet financing where a good track record will lower borrowing costs and
provide a wider range of lenders competing for the business. Impax Capital has noticed
changes in attitude from finance providers when small developers attract a large, well
capitalised shareholder.

18
For non-recourse finance, the transaction is based purely on the economics of the assets
to be financed and the amount of equity and other support, such as performance
guarantees, provided. However, investors usually take comfort from having a large
sponsor and the expectation that they can afford to behave ‘responsibly’ if the assets
under perform. This might imply a slight shading in interest rates, of around 5-15bp.

5.4. Size
Funds raised are initially a function of the cost effectiveness of the fund raising in terms
of fees and time. Thereafter, the amount that can be raised, is dependent on the
following factors.
> The amount that can be borrowed through the balance sheet is directly linked to the
size of that balance sheet and the existing level of borrowing, which may often have
covenants restricting the level of additional borrowing. For a large utility, the
additional debt required for most renewable energy projects would amount to around
2% of their existing borrowing15, which may be sufficiently material to move it off
balance sheet when renewable energy is not considered a ‘core business’.
> Off-balance sheet funds are in theory a function of the credit quality of the
underlying cash flows and the coverage ratios required, therefore size is rarely
constrained per se, other than by the transaction’s cost. Minimum sizes are often
required to attract investors and compete for management time with larger projects.

5.5. Gearing
On-balance sheet gearing is usually kept below 60% and in many cases below 30%.
This is due to the less well-defined nature of the supporting cash flows and the freedom
the company has to apply those cash flows in any area of the business. In contrast, most
non-recourse financing starts at 70% gearing (for merchant power type projects using
state of the art technology) and may achieve up to 95% gearing. This is due to long
term contracts that match the financing tenor and provide predictable revenue flows that
are only linked to operating efficiency. The result of higher gearing is improved returns
to equity holders.
In practice, gearing ratios are applied as a ‘rule of thumb’ assessment and the finance
provider’s preference for sponsor’s cash, in the form of equity, at risk in the project
vehicle. The credit quality of the underlying cash flows is directly linked to the quality
of the off-take contracts: if price and volume are contracted, then the levels of gearing
seen in the early ‘dash to gas’ in the UK are possible. Subsequent deals, where volume
but not price was contracted saw significantly lower levels of gearing and this is touched
on in the Sutton Bridge case study in Appendix G.

15 PowerGen has approximately £2.5bn of debt and an average large renewable energy project costs about £50m,
hence 2%.

19
5.6. Documentation
Documentation is an issue of cost and complexity. Cost is a function of the legal fees,
which are directly related to transaction complexity. Complexity also impacts on the
sponsor’s management time, both while negotiating the transaction and afterwards while
trying to ensure that all the covenants and stipulations are adhered to.
Off-balance sheet financing as a rule has far more complex documentation as it seeks to
constrain and allocate risk. Some attempts have been made to standardise
documentation (such as turnkey construction contracts - the Model Forms), but this has
had limited success. Section 7.19 looks at Schraders’ PFI fund that uses standardised
documentation to ‘shoe-horn’ sponsors into a predetermined set of contracts. On-
balance sheet financing usually has simpler documentation and subsequent rounds of
fund raising can often use existing documentation.

5.7. Transaction Costs

Costs for on balance sheet financing are generally much lower than off-balance sheet
financing due to the simpler debt structures and the ability to use more boiler plate' in
the legal agreements. In the case of bonds, the underwriting cost depends on the
anticipated rating, on the basis that it is easier to market a high grade security than a
lower grade security. Thereafter the difference is primarily due to legal and
accountancy fees, particularly as off-balance sheet transactions are more contractually
intensive. In addition, raising finance for renewable energy typically faces increased
costs due to the fuel supply risk inherent in most projects and the lack of market
comparators. Section 7.13 gives an indication of the actual costs involved for off-
balance sheet transactions.

5.8. Interest Cost

On balance sheet financing is concerned with the credit standing of the entire corporate
entity and as a result, this tends to favour established, large companies. A list of major
UK power company ratings is at Appendix D which shows interest costs standing in the
35-60bp range today, but this was much lower before the Asian debt crisis and the
Russian default. This contrasts markedly with the non-recourse transactions in
Appendix H that mainly cost more than lOObp over LIBOR. In contrast, off balance
sheet funding costs are strictly a function of the project’s credibility and the availability
of funds for project transactions at the time. However, there is a material difference in
this regard between the capital markets and commercial bank market, which is dealt
with in Chapter 6.

5.9. Confidentiality
On balance sheet funding rarely requires a sponsor to divulge the detailed uses of the
funds received, which may provide it with a commercial advantage. Off-balance sheet

20
funding requires a greater level of disclosure, but this varies significantly between the
options selected. This is covered in more detail in Section 7.9.

5.10. Replicability
Replicability refers to the ability of work from one fund raising to be readily adapted to
a subsequent fund raising and thereby reduce the transaction costs. This is less
applicable to the commercial bank market than the bond market. However, within the
capital markets this can restrict the issuer in the type of financing raised and it is
generally considered desirable that any bonds raised through the balance sheet are
fundamentally similar to previous financings, otherwise it is likely to affect existing
issues.
The cost in management time is particularly high for any bond debut issue although
there are speed and cost benefits to be derived subsequently from having established
“template” documentation. Establishing the right structure for (especially) a debut
corporate bond issue is important, as any subsequent variation in structure or quality
will affect pricing.

5.11. Insolvency
If funds raised through the balance sheet are defaulted on, the debt provider has recourse
to all the issuer's balance sheet up to the value of the debt. The recent losses by MEG
Micon demonstrate the risks faced by a company and MEG Micon only survived as a
company due to its shareholders’ willingness to stand behind the debts and provide
additional capital injections. This is one reason that the rates achieved by corporate
borrowers are substantially lower than project specific debt, as there are more assets to
call on. Equally, few companies have leverage much over 50%, which means that more
equity is available to 'cover' the debt16. In contrast, most off balance sheet financing
achieves debt in the range of 70-95% of the project's cost, which reduces the absolute
amount of equity the sponsor must subscribe17 and maximises the return on equity.
In theory, with non-recourse financing the sponsor is only exposed up to the amount of
equity subscribed, subject to completion/performance guarantees in connection with the
sub-contracts. In practice, true non-recourse financing is rare and sponsors will often
find themselves under considerable pressure from their lenders to support a project,
particularly if they wish to access the market again. In this context, failure of non­
recourse financing in the bank or capital market would restrict access to both sources of
funds in the future. The support provided by Foster Wheeler for the Robbins waste to

10 This simplifies a complex issue and in practise, the level of cash, amongst other tilings, is also a vital factor.
17 In one unusual case, the sponsor raised 140% of tire project's value in debt. This was partially due to tire
relationship existing, but also demonstrates the nature of non-recourse financing which is secured on tire value of
future cash flows, not the project's asset value.

21
energy plant in Illinois clearly demonstrates the pressure sponsors can be under18.
Conversely, problems with wind farms built by small developers in California in the
1970s have made many investors wary of investing in wind power even today.
An absolute requirement for any off-balance sheet fundraising is that it is 'bankruptcy
remote' from the sponsor. This means that any problems with the sponsor cannot affect
the cash flows to debt providers and other investors in the off-balance sheet vehicle and
vice versa. This is a potentially complex area, depending on the SPV jurisdiction of
incorporation. For the UK, where the legal concept of fixed and floating charges is well
established, this is less problematical than in the US.

5.12. Presentation
Within reason, equity markets look favourably at a degree of gearing and the debt is
fully recorded on the balance sheet. This may have implications for future lending, as
some debt covenants are linked to balance sheet ratios. Off balance sheet debt should
have little or no impact, although FRS 519 may require consolidation that could trip
other borrowing ratios.
A strong sponsor may not wish to consolidate the debt for several reasons, even if it
would still benefit from limiting liability by using a subsidiary:
> the project is not in its core area of business;
> a joint venture partner is exposed to a similar risk profile (such as the PowerGen
renewables refinancing with Abbot - Deal 1 in Appendix H);
> in politically sensitive projects, it may bring the additional support of the
international finance community.

5.13. Global Risk

Off balance sheet financing seeks to isolate the assets from the sponsor and ensure the
funder’s only risk is linked to the underlying asset performance. Therefore, this does
not expose the entire sponsor to risk.
A major benefit of on-balance sheet debt financing is that it permits the sponsor to take
equity type risks with debt funds. This is relevant where the sponsor believes it has a
better understanding of the market risks (information asymmetry) than the banks or
rating agency and is unlikely to be able to convince them that the risk is acceptable. An
example of this are certain Italian CIP6 (see Section 8.2) contracts where sponsors are
beginning work on balance sheet due to the complex contracting process of some of the
main contracts. This approach would be virtually impossible for a bank or rating agency
to accept in an off-balance sheet funding. Similarly, a number of the NFFO 1 and 2

18 The Robbins plant had its power tariff and gate fee cut significantly by the local government and as a result, Foster
Wheeler paid hundreds of millions of dollars to keep the plant going until it could be sold. Walking away from the
deal was, apparently, considered impossible if Foster Wheeler were to retain its reputation and ability to raise finance.

22
biomass plants were obliged to lock in a substantial portion of their fuel supply with
long term contracts, although macro indicators suggested that the fuel prices would fall
and remain low. This indeed proved the case and at the end of the debt period, these
plants were able to purchase fuel in the spot market and switch between fuel types
depending on the respective prices, in order to boost their returns.

5.14. Bankability
Bankability is not directly an issue for debt issued through the balance sheet, as in this
context it refers to the sponsor’s size and balance sheet strength. For projects, it refers
to the creditworthiness of each party and the contractual links of those parties to the
project. These are subject to individual and careful scrutiny. Debt providers also look
through the contractual agreements to the underlying economic incentives, to ensure the
SPV and its shareholders are incentivised to meet its debt covenants.
However, all the cash traps, tight covenants and clever structuring will not work if the
fundamental building blocks of a project (PPA, EPC/construction guarantees, fuel
contracts) are not of the appropriate credit quality or duration. These must also inter­
relate, such that any risks left in the project company are acceptable. This is particularly
relevant for renewable energy post META and NFFO-5. A fundamental building block
remains the PPA and without it, green certificates or carbon credits will not be
considered bankable.

5.15. Use of Funds

As described above, on balance sheet funds usually give the management great leeway
in how the funds are used. This allows greater commercial judgement to be exercised
and fewer constraints on the riskiness of those investments. Off-balance sheet finance
typically constrains the use of funds for strictly defined purposes. However, the recent
emergence of open-ended securitisations and the Schroders PFI fund (see section 7.19),
have demonstrated more funding options for sponsors. In these instances, provided
projects meet certain very tight credit criteria and can comply with pre-defined
documentation, they may be subsequently added to the pool.

5.16. Summary
On-balance sheet financing often achieves a lower interest cost and greater flexibility.
Off-balance sheet financing allows the merits of a project to drive the amount of funds
raised with higher levels of gearing possible. However, this is only due to revenues
being contracted and specifically committed to debt service, or the market risk for spot
revenue being considered acceptable, because the product is a basic commodity and the
supply/demand balance is well understood. For the UK power sector and renewables in
particular, NETA may change this. Nonetheless, investors’ demand for long term debt19

19 Financial Reporting Standard - rules governing accounting in the UK.

23
in infrastructure is growing and the investor base is increasing. Both methods provide
advantages and disadvantages, which need assessrng agamstthe specific circumstances
for which funds are required.

24
6. Non Recourse Financing
6.1 Objective
Assuming a sponsor has decided to raise finance through a non-recourse structure, this
section examines some of the issues involved in choosing between the project bond and
commercial bank financing. Chapter 7 then looks in more detail at the securitisation
process and some of the specific factors that apply.

6.2 Non-Recourse Bond versus Commercial Bank Debt Summary

The following table summarises the main differences between capital markets debt and
commercial bank debt for an off balance sheet financing. These differences are
amplified in the text and referenced to the deal list in Appendix H. The relative
importance of each factor should only be judged in the context of a sponsor’s own
circumstances and there is no attempt to prioritise the factors. This is a matter for the
sponsor and their advisers.
Commercial bank debt is self-explanatory and for the purposes of this section, capital
markets debt will be primarily considered in the context of the public markets. Options
such as Rule 144A or private placements are considered in Chapter 7. These provide
some additional features that might benefit certain sponsors.

Commercial Bank Debt Capital Market Debt

Sponsor Less important, but may influence Helps primary market placement and
Strength spread achieved. may improve credit rating one notch.
Size Large (no minimum) but rarely cost Very large (minimum £100+ million)
effective below £10-20 million.
Gearing High gearing accepted, tied to DSCR. High gearing accepted, tied to DSCR.
Documentation Transaction specific but can be more Fairly standardised for public markets,
flexible as a result. otherwise complexity may be an issue.
Transaction Negotiable, but subject to market norms. See section 7.13.
Costs
Interest Cost Usually over lOObp, rarely over 250bp, Depends on market conditions. Material
as higher risk projects simply not variation can occur not linked to project
accepted. May step down post quality. Access to monolines and other
completion. enhancement possible.
Transaction Limited, as negotiated process. High, as market conditions may change.
Risk
Confidentiality Good - information kept within the Limited in public placements by need to
lending syndicate. disclose material contracts and the level
of rating agency comment.
Insolvency Flexible approach to refinancing and Inflexible and more likely to initiate
workouts possible. insolvency proceedings.

25
 Commercial Bank Debt Capital Market Debt
Presentation Limited. Demonstrates sophistication and rating
may have a 'halo' effect.
Source Large market with many experienced Large market. US market is more
participants. complete with contiguous pricing along
the risk curve - less so in Europe.
Investor Flexible, able to cope with complex Inflexible once issued. Relatively
Flexibility structures and deal with variations in simple story needed in primary
performance once debt drawn. placement (but see Section 7.17 on
private placements).
Transaction Complex documentation, but some Issue follows a necessarily standardised
Complexity standardisation possible. approach but is inherently more
complex.
Ongoing Significant. Limited, unless monoline involved.
Monitoring
Tenor Usually under 15 years, but some PFI Long tenors, often 20-30 years, some
loans now reaching 30 years. out to 40 years.
Investors Relatively small number of investors, Large number of investors with small
often holding sizeable participations. investments relative to their portfolio2".

6.3 Decision Process

The diagram overleaf outlines the main considerations for sponsors in deciding between
a bond and commercial bank financing. Some are empirical, while others necessitate a
more subjective approach, such as that taken by Enron in Sutton Bridge Power (Case
study in Appendix G and Deal 14 in Appendix H), when the ability to raise its corporate
profile in the wider market was also significant. These factors are explained in more
detail later on and in this diagram they set out in the approximate decision order.20

20 Less so in the Eurobond primary market.

26
 Amount Bank

>£60-80m

Confidentiality Bank

Sufficient disclosure possible

Flexibility
- Ease of refinancing
- Additional projects (portfolio additions)
- Changes to existing project
- Re-negotiation of terms
- Drawdown flexibility.
Degree of flexibility required shades
between bond and bank/private placement.

Rating Bank

Investment grade likely

Complexity Bank

Complexity shades between bond

and bank/private placement.

Tenor

Longer tenor shades

towards bonds.

Other
- Diversify source of borrowing
- Relationship with lenders

All in Cost
- Wrap Final decision Market Status/
- Legals Sentiment
- Spread

6.4 Sponsor Strength

Sponsor strength provides similar benefits to the commercial bank debt and capital
market debt routes. For capital market investors, a strong sponsor may bring ‘name
recognition’ benefits that are particularly useful in the primary market. For commercial
debt lenders, there may be ‘relationship benefits’ in supporting a large core client.

6.5 Size
Bank financings are usually able to cope with most transaction sizes and loans are often
widely syndicated. In the context of renewable energy this is unlikely to prove a barrier.

27
For the largest transactions the bond markets are often chosen, as these provide the
greatest breadth and liquidity. The Orchid securitisation (Appendix H, Deal 18) of
nuclear credits demonstrates the need to move outside of a relatively small domestic
market, as well as the advantages of a currency that appeals to the widest variety of
investors, in this case US$.

6.6 Documentation
Various bond underwriters contacted believed that negotiating and structuring a bond
financing is easier and quicker than a commercial debt financing. The sponsor will only
deal with the bond underwriter (rather than a number of commercial bank arrangers); or,
in a wrapped deal, with a monoline insurer (with reduced input from the bond
underwriter). However, monolines are likely to negotiate a tougher covenant package
than commercial lenders, which may work in favour of investors but against issuers.
Major project loans are increasingly being structured with common documentation for
PFI style projects or export credit agencies (Common Terms Agreements and Common
Security Agreements) as an alternative to more cumbersome inter-creditor agreements.
For these transactions, the additional flexibility also means that the question of finance
from a bond or loan may be deferred until closer to launch when the market appetite is
best assessed. However, this structure is yet to gain acceptance in the wider project
finance market.

6.7 Transaction Costs

In comparing transaction costs between the two fund raising methods it is difficult to
draw meaningful conclusions for renewable energy projects, as costs are generally
transaction specific and partly a function of the level of competition for business at the
time. In general, bond under writing costs are higher than a bank’s equivalent charges,
while the ancillary transaction costs might be lower and more open to adaptation.
However, one of the largest costs, the legal fees, are a function of deal complexity.
Section 7.13 provides some indication of the costs associated with a capital market
transaction and where several projects are involved, for instance in a securitisation, the
structuring costs will materially outweigh any differences between commercial debt and
bonds.
One transaction ‘cost’ unique to the capital markets is the uncertainty over the final
spread achieved, until the bond is launched. Under certain market conditions, this may
result in an inability to place the bond at all - an example being the withdrawal of the
Dam Head Creek bond financing (Deal 10 in Appendix H) due to market problems and
META uncertainty. Conversely, better terms than expected may be achieved, such as
for Sutton Bridge (Deal 14 in Appendix H).

28
6.8 Interest Cost
Interest rates are broadly similar for most types of deal when considered on an
unwrapped basis and commercial bank financings are often hedged with fixed rate
swaps, the cost of which are rarely public information. The relative market appetite in
the bond market often drives the advantage of one method over another. In particular,
the Treasury 6% 2028 Gilt stood at a yield of 4.52% on 4th February 2000, illustrating
that fixed rate, long-term sterling is available at historically low rates and coincidentally
lower than medium term rates.
Monoline wrapped bonds may often have an interest cost advantage over the bank
market, as the monoline will adjust its pricing to compete with the current bank market,
within the monoline’s own pricing envelope, which is dictated by their need to fulfil
their own capital adequacy requirements. Bonds may also offer more innovative
structures, such as index linking, which fills a particular need in the market and thereby
achieves a better credit rating.

6.9 Transaction Risk

Access to capital markets is prone to interruption as project sponsors discovered during
the second half of 1998. In the US market, for example, infrastructure bond spreads
over US Treasuries widened from around 200bp to 600bp and above. Yields increased
from 8-10% to 11-13%. In the UK, investors in triple A rated PFI bonds enhanced by
insurance from one of the US monoline agencies have seen spreads increase from a low
of 50bp in the summer of 1998 to more than lOObp over their equivalent Gilt bench
mark after the Russian debt default later that year. The hiatus forced sponsors to run
with both commercial debt and capital market solutions to guard against future
uncertainty.
A bond’s actual spread is uncertain until the bond is launched. This may be due to
many factors, some economic, and others due to activity in other parts of the world or
even a lack of market appetite for a certain asset class due to many similar issues having
reached the market in the preceding months.
Bonds typically provide fixed rates although a number of recent issues have had floating
tranches (see the PECO Energy securitisation - Deal 19 in Appendix H) or the index
linked bonds for PFI deals such as the Queen Elizabeth Hospital deal (Deal 24 in
Appendix H) have been very well received and achieved exceptional pricing as a result.
Index linked bonds would be an attractive route for NFFO based renewable generators
due to the NFFO contract’s index linking and provided that the basis risk of the
operating costs is not substantial.

29
6.10 Confidentiality
There is little or no confidentiality in bond transactions, other than private placements.
The activities of rating agencies and the requirement of exchange listing rules ensures
that there is far greater transparency of information in the bond market than with the
commercial debt market. This may exclude the bond route, other than for private
placements, as many key contracts in a power financing have confidentiality clauses
built in. This aspect is covered in greater detail in Section 7.9. Commercial bank
financing is capable of far greater confidentiality and the sponsor’s banking
relationships are often included in third-party confidentiality agreements as standard.

6.11 Insolvency
Default to a bond investor means that a payment has been missed and the cure
provisions built into the funding structure have failed. It is then probable that the issuer
will be placed in administration, as it may be difficult for a large number of bond
holders to agree terms, amongst themselves or with the sponsor(s)21. In contrast, banks
are usually able to take a more flexible approach for the following reasons:
> there may be a relationship factor with the borrower/sponsor(s);
> syndication loan participation amounts are normally larger (£5 million is at the lower
end of the participation scale in a syndicated loan) than a bond investor’s final take
(bonds are usually sold in lots of £10,000 or £100,000), hence a greater incentive to
resolve the problem;
> the role of an Agent Bank for a syndicated credit is to co-ordinate the response of
other syndicate banks in such circumstances;
> the number of banks in a syndicate is small relative to the individual bondholders in
an issue, making agreement and action easier.

6.12 Presentation
Issuing a bond and the subsequent publication of a rating can have a halo effect for the
sponsor outside the capital markets. To an extent, it demonstrates that the sponsor has
‘come of age’ and even if the ‘triple A’ is due to a monoline, this may help credibility
areas outside the debt market.
For instance, PSEG is building a number of pure merchant power plants in Texas
through the bank market, rather than issue high yield bonds that would not achieve
investment grade. They plan to pool the current plant under construction (Guadalupe -

21 UK exchange rules allow a ‘cram down’ whereby once 75% of bond holders agree tire terms of a restructuring they
can then force the remaining bond holders to accept them. This is not possible under US exchange rules and small
bondholders are often involved in ‘greenmail’ where they negotiate an early take out of their bonds so that large bond
holders can agree a restructuring.

30
1,000MW, $320 million senior debt) with a number of other assets in that region to
achieve an investment grade rating22.

6.13 Source
The commercial banking market is easily large enough to cope with any renewable
energy based transaction. However, banks do have sector lending limits that may
constrain their ability to lend to projects. In London, a number of banks have a good
level of experience in certain sectors of renewable energy project finance and are willing
to look at a great variety of deals. However, the level of risk accepted by commercial
banks is quite low (compared to the risk of many single asset projects) and cannot be
increased merely by increasing the interest rate paid.
The bond market is very large, although this may also suffer from over issuance of
certain types of paper. A good example of the effect of over issuance is the South Tees
PFI hospital deal (Deal 23 in Appendix H). In the US and to a growing extent in
Continental Europe, a high yield (junk bond) market is growing that offers financing
instruments along the entire risk spectrum and certainly beyond what most commercial
bank credit committees would accept.

6.14 Investor Flexibility

Bond investors are usually passive and only interested in receiving their interest and
principal repayments. Indeed, the large number of investors usually precludes any
restructuring or adaptation of terms. It is here that the commercial banks have the
greatest advantage, as a syndicate can usually come to a collective agreement on dealing
with major changes in the transaction. However, the difficulty of this should still not be
underestimated.

6.15 Transaction Complexity

Both routes are complex due to the nature of the non-recourse structure. To the extent
that listed bonds require certain documentation, this may appear a slightly simpler route,
but counteracted by the complexity of listing rules. With competent advice, neither
route should provide most sponsors with an insurmountable hurdle.

6.16 Ongoing Monitoring

Bond structures typically adopt a very limited level of monitoring compared to
commercial bank debt and although rating agencies continue to report on a bond, the
level of interaction is still relatively low. However, monoline insurers will usually adopt
the same degree of monitoring as the commercial banks as do many private placement
investors.

22 This also reflects the current view that in the US power market participants need large diversified portfolios to
succeed in a deregulated market, which coincides with the forecasts for the UK power market made by Fitch IBCA.

31
6.17 Tenor
Bonds traditionally offer long tenors and fixed rates, compared to banks that tend to
offer shorter tenors and floating rates, with the option of swapping (at a cost) floating
for fixed. De-mutualisation of the larger building societies and the arrival of continental
municipal lenders have brought tough new competition as these institutions can start to
match bond market tenors with lending commitments of up to 30 years23. This has
helped increase the tenor offered by the commercial bank market and narrowed some of
the difference between bonds and bank lending. However, the bond markets still offer
consistently longer tenors and a number of financings (eg South Tees Hospital PFI (Deal
23 in Appendix H) and Sutton Bridge Power (Deal 14 in Appendix H)) have been
strongly influenced by the relative ease with which these are obtained compared to the
bank market.

6.18 Investors
Deal complexity has a strong influence on the financing route chosen due to the level of
interaction expected or required between sponsors and investors. In this context, private
placement bonds and bank financing are similar, in that with a small investor audience,
it is possible to educate them on the project’s unique features. In comparison, most
investors in listed bonds do not have the resources or inclination to understand the
nuances of a deal, which was one reason cited for the withdrawal of the bond financing
for Dam Head Creek (Deal 10 in Appendix H).

6.19 Summary
Apart from any price or tenor advantages over commercial bank debt, positive features
of the bond route generally include documentation with a greater degree of
standardisation; a “hands-off’ covenant package; and a less intrusive post-signature
monitoring and surveillance regime. However, the greater disclosure requirements and
the listing obligations plus a difficult restructuring process that tends to favour
administration or insolvency in preference to a work out counters this. In addition,
commercial bank debt and private placements are better able to accept complex deals or
unusual technologies.
There are disadvantages to the bond market for issuers regarding negative arbitrage
during construction, penalties for pre-payment and less flexibility in restructuring.
Similarly, the liquidity of the project bond market is still poor compared to government
bonds and most corporate bonds, which means investors are not always able to exit the
bonds at a price they accept as realistically reflective of the value, which implies higher
pricing.

23 Some PFI deals have recently had 27 year loans from UK clearing banks as a result of this competition and the
credit quality/tenor of the underlying contracts.

32
In practice, sponsors are usually recommended to retain the flexibility in choosing
between bond and commercial bank finance for as long as possible, such that any short­
term capital market issues will not prevent the project going ahead. In the end, pricing
is usually the absolute determining factor.

33
34
7. Securitisation
7.1. Outline
This section looks specifically at the requirements of securitisation compared to single
asset bond finance. It also considers some issues that are common to any capital market
instrument in greater depth, such as monoline insurance and disclosure rules.
Corporate finance techniques are being increasingly applied to financing power
transactions, especially when buying groups of generating assets that have a greater
diversity of risk. An example is the US Gen financing24 of the New England Electric
System generating assets used a borrowing vehicle that had an investment grade rating
to issue commercial paper supported by revolving credit commitments, which resulted
in a significant saving in borrowing cost. This implies an increasing willingness of
investors to look at innovative ideas and not be put off by unfamiliar asset bases.

7.2. History
Securitisation first appeared in the 1880s when New York trust companies sold
debenture bonds secured by groups of mortgages to the public. The large growth in
securitisation began in the 1970s as the US Government sought to create liquidity in the
secondary mortgage market. This allowed mortgage lenders to move large parts of their
debt portfolios off balance sheet, in order to improve their central bank imposed capital
adequacy ratios. This freed up lenders’ capital to make new loans, without the costs of
raising new funds and still being able to retain an interest in the profits derived from the
securitised assets. The growth of securitisation outside the US has been concentrated in
the last 10 years and was also dictated by the economic needs of particular areas plus the
ability of the local legal system to accommodate securitisation.

7.3. Definitions
Securitisation is one possible route for opening the capital markets to finance renewable
energy projects. In this context, securitisation is considered the financing or refinancing
of income generating assets in the form of tradable debt instruments sold to investors
which are secured on the assets and which are serviced from the cash flow the assets
yield. It could also be considered to be the transformation of an illiquid asset into a
tradable security with a secondary market.
A securitisation typically involves the following steps:
> assets are pooled;

24 US Gen is the unregulated subsidiary of PG&E, the 3rd largest utility in the US by assets and market capitalization.
US Gen issued $417 million of bonds and $900 million of bank debt for this transaction. This should not be confused
with National Grid Company’s purchase of the New England Electric System’s transmission assets.

35
> a special purpose company is set up that accesses or acquires and then administers
the assets;
> securities are issued by the special purpose company based on the ability of the
company to generate income from the pooled assets, together with any supporting
insurance proceeds, guarantees or other forms of credit enhancement;
> typically the special purpose company then obtains a credit rating for its securities,
which facilitates trading on the secondary market and qualifies them as suitable
investments for pension funds and other institutional money.
One motivation for segregating assets and using them as collateral for a security offering
is that it can result in lower funding costs. This is because investors look to the credit
quality of the underlying pool of assets rather than the credit quality of the issuer of the
asset-backed securities. The first ever asset-backed security was issued by Sperry Lease
Financial Corporation and was backed by lease receivables. The issue was structured
such that the cash flow from the underlying leases was clearly sufficient to satisfy the
interest and principal payments for the bond and as a result, it received a AAA rating,
which was substantially higher than Sperry’s own rating. This structuring is particularly
important for small companies that do not have the track record or access to sufficient
capital through their balance sheet to compete with larger developers.
Securitisation brings significant advantages to borrowers, capital market investors and
bank lenders:
> if the international capital markets are accessed, the financing of existing assets at
better rates than the originator would be able to obtain through a more
straightforward secured borrowing. By putting together a transaction which enables
the issue of investment grade paper, it is possible to benefit from cheaper funding
costs and access to a wider range of investors; and
> if an off balance sheet structure is used, the removal of the underlying assets from
the originator’s balance sheet and the consequent freeing up of capital for use in
writing new business. This is possible through a special purpose vehicle.
> bank lenders are able to liquefy one of their major illiquid assets and benefit from
regulatory capital relief, as well as coping with single country, technology or sponsor
limits;
> investors are offered an efficient way to diversify risks and invest in potentially more
liquid assets, with an attractive return;

7.4. Securitisable Assets

Virtually any asset producing a fairly stable and predictable cashflow can in theory be
securitised. Examples of assets which have to date been securitised in Europe include
mortgage loans, lease payments, consumer loans, conditional sale and hire purchase
receivables and revolving credits such as credit card receivables and corporate loans. In

36
theory any renewable energy project capable of being project financed could be grouped
into an asset pool suitable for securitisation.

7.5. Securitisation Types

A securitisation of the revenue streams from groups of renewable energy projects might
be possible as part of a re-financing of debt in projects that had been commissioned and
had achieved an operating track record. The following scenarios are theoretically
possible although the first of these is the most likely from a practical standpoint, as there
may be difficulties in taking security under multiple jurisdictions in a single finance and
security package:
> projects with a single owner in a single jurisdiction;
> projects with a single owner in multiple jurisdictions;
> projects with multiple owners in a single jurisdiction;
> projects with multiple owners in multiple jurisdictions.
Within this mix, projects might be single or multiple technologies and the benefits of
diversification are discussed in Section 7.10.
The re-financing of portfolios is the most likely way in which securitisation could be
applied to the renewable energy sector given the small size of projects, potentially
variable income stream and the technology, construction and operating risks attending
such projects. However, capital markets practitioners indicated that the bond market
would accept some construction risk, depending on the technology and the quality of the
EPC contract.

7.6. Issues
A number of issues need consideration in connection with any proposed securitisation.
The solutions to the problems posed will vary for different asset types or different
issuers in the same jurisdiction.
A number of the issues are:
> what structure is required to achieve the commercial objectives of the originator and
to satisfy investor expectations?
> what are the assets and what are their characteristics?
> what is the most appropriate mechanism for transferring the assets (assuming a
transfer is necessary)?
> how do credit and securities regulations impact on the structure?
> how do insolvency considerations impact on the structure?
> what are the arrangements for obtaining security and for collecting the moneys?

37
7.7. Transaction Process
Securitised transactions come in many forms and structures, but there are four basic
elements common to all transactions:

a. Sale
The owner of the assets to be securitised sells the assets25 to a special purpose
vehicle (SPV) established either by the originator specifically for the purpose of
acquiring those assets (ie a clean company) or by a third party as a conduit to
acquire the assets of originators in general. The SPV is often ‘orphaned’, so
that it need not be consolidated as a subsidiary or subsidiary undertaking under
the relevant statutory regime. In the UK, FRS 5 has limited the opportunities to
do this, although there may still be ‘quasi subsidiaries’, to deal with regulatory
concerns or financing restrictions on risk asset ratios and the like. Although the
SPV acquires the assets, the originator will normally retain a participation in the
profits of the assets (approximately the income less the financing and
administrative costs), particularly where the project is over-collateralised,

Typical Structure of a Securitisation

Administrator
Swap/liquidity
Originator Residual
providers
Value Services
T ransfer assets/
liabilities
Receivables

Project Assets Security Trustee

Security
Purchase Price

Trust

Receivables Trust

Enhancement
Investors Construction Lender
(monoline etc)

such as the PECO securitisation (Deal 19 in Appendix H). There are several
ways of achieving this, but in the UK the preferred method is a ‘receivables
trust’ whereby a trustee holds the assets for the benefit of both the SPV and the
originator, with the originator being limited to the residual profits arising. The

25 There will be tax and other issues to consider - suitable professional advice is required.

38
 security trustee represents the interests of the bond holders and will not
necessarily be the same as the receivables trustee.

b. Secured Borrowing
The SPV raises funds to pay for the assets, usually in the form of bond
financing, either public or private placement, but occasionally by syndicated
loan facilities. The SPV then creates fixed and floating charges over the assets
and all of the SPV’s other property, undertaking and assets to secure its
obligations to repay the finance raised. This security will be granted to the
bond security trustee, for the lenders, the provider of any credit enhancement
and the originators.

c. Enhancement
As the SPV is a shell holding only restricted assets, some enhancement is
required to protect it from various risks, including:
> credit risk (default by the debtor projects);
> liquidity risk (receipts delayed/payments accelerated);
> currency risk (movements in exchange rates where several currencies are
used - see the Sutton Bridge case study in Appendix G);
> market risk (covers reinvestment risk and market rates moving differently to
income returns).
Enhancement can take many forms and might include the SPV issuing several
tranches of debt (see Deal 16 in Appendix H) with different seniorities, loan
facilities, letters of credit, insurance, contingency funds, swaps, guaranteed
investment contracts and top slice agreements26. The type of securitised asset
and its cash profile will determine the nature of the enhancement, along with
the negotiating skills of the originator. Bond underwriters and monoline
insurers in particular, will look to constrain the sponsor’s freedom and try to
design a structure that is self-correcting if there is a problem with one of the
asset cash flows. Thus the level of enhancement will be set by the expected
demands of investors and this will relate to previous investment performance of
similar deals and the market appetite at the time.

d. Servicing
The originator will usually continue to service the assets in the portfolio as the
agent of the SPV for a management fee and deal with the day to day
administration. It will also transact the daily business of the SPV (which will
rarely have assets of its own) and be responsible for the fulfilment of any
statutory duties of the SPV.

20 A tiering of risk that allocates risk in a set order to investors. Tins is often seen indirectly in bond tranches, but for
it to work effectively, there needs to be a sufficiently large deal to provide liquidity in each tranche.

39
7.8. Sponsor Process
Planning, structuring and bringing a securitisation to fruition is inevitably a challenging
and time consuming exercise, particularly for first time sponsors or for new assets. The
process can take many months and requires considerable forward planning and
commitment on the part of the originator. It requires a substantial degree of investment,
both in adviser’s fees and management time, as well as modifications to the sponsor’s
existing systems and procedures. Sponsors that have completed a securitisation report
levels of due diligence and legal structuring that make an audit or a project financing
appear simple in comparison. Therefore, sponsors may well find that timely
professional advice can help achieve a similar aim in a more cost-effective
manner by

> straightforward asset sales;

> renegotiating loan covenants;
> use of hedging instruments;
> refinancing existing borrowings on a different basis.
If securitisation still appears an attractive alternative, a detailed feasibility study
covering the economics and practicalities is then advisable. The first questions to be
posed are:
> are the assets genetically suitable?
> are the particular originator’s assets suitable?
Generic suitability refers to the degree of stability in the cash flows provided by the
assets and how easy it will be for external due diligence, be it by a private placement or
a rating agency or monoline insurer, to understand the risks involved. This area is of
particular significance for renewable energy generators, where the capital markets are
less familiar with the technology and fuel risks of renewable energy technologies. For
most wind farms, hydro, land fill gas and waste to energy plants this process is relatively
easy, as there is substantial historic performance data to support underlying cash flow
assumptions. Biomass based combustion may have a slightly more challenging time,
depending on the technology used, the fuel risk profile and the country the project is
based in27. Technologies that are less proven, or with a more chequered track record,
such as anaerobic digestion, wave power and some photo voltaics, will find it difficult to
provide the level of investor comfort required. The stage that finance is raised is also an
influence, as proven technologies provided by quality EPC providers and sponsors can
attract financing during construction, as demonstrated by PowerGen’s recent £48
million re-financing at favourable rates for its wind farms (Deal 1 in Appendix H).

27 In the US, biomass has in many instances a better track record than waste to energy, while in Scandinavia, biomass
is considered a main stream fuel source.

40
The suitability of the originator’s assets for securitisation needs establishing as early as
possible. Suitability not only depends on technology, as above, but on whether the
assets are capable of securitisation. This may be influenced by:
> confidentiality clauses in material contracts;
> existing documentation that has fundamental flaws that would render the assets
unenforceable;
> contractual prohibitions on transferring the assets.
The asset mix is also important at this stage, depending on the power marketing
strategy. Where assets are supported by a government sponsored power contract for the
term of the proposed debt, this is less important and Appendix E discusses the benefits
of the NFFO contract as a financeable instrument. However, if assets will be selling
power into the open market, be it on a merchant basis, into the balancing market or
through a mix of bilateral contracts, then sponsors will need to ensure that their mix is
credit worthy. A recent report by Fitch IBCA highlighted the potential changes in credit
worthiness that different generating portfolios will attract, and this will influence the
financeabiltiy of the eventual portfolio.
However, there are a number of uncertainties derived from the nature of project bonds,
the lumpiness of the transactions and the unproven default remediation history within
the capital markets, such that sponsors considering securitisation need to focus on the
specific pool of assets planned to go into the pool. In assessing a pool, it is the credit
profile of the receivables supporting a given asset backed debt issue rather than any
generic rules or assumptions about global asset performance that counts.

7.9. Confidentiality
Confidentiality concerns have prevented a number of capital market transactions, due to
the need to disclose information on all material contracts. An example of this is the Salt
End power plant28 sponsored by Entergy: BP as gas supplier objected to the disclosure
requirements (that included its contracts) and as a result, Entergy had to cancel the bond
issue.
Many contracts signed in financing a renewable energy project have confidentiality
clauses, be this fuel prices, turnkey contract clauses or performance guarantees that the
counter-party will not wish disclosed for various commercial reasons, other than under
appropriate and controlled confidentiality agreements. With a public placement, this is
more difficult unless the capital market financing option is factored in to the negotiation
of these contracts, or appropriate representations and warranties can be obtained from
sponsors on which investors can rely29. However, Rule 144A and private placements

28 The UK’s largest IPP merchant plant: £722 million project for a 1,200MW CCGT. Gas supply contract was 15
years and construction started -06/98.
29 This reinforces the advantage a large, reputable sponsor has over some of the smaller IPPs. Clearly tills method
would only work where a reasonable number of contracts can be covered by tire proviso.

41
may still be possible, as access to information can usually be controlled appropriately.
Some banks have even been prevented from pooling their project exposure to launch
notes collateralised by project revenues as a result of this. Sponsors who borrowed from
banks found the bank wanted their consent to a collateralised loan obligation issue using
their project as part of the collateral pool. Many sponsors proved unwilling to agree to
the required disclosures without some benefit to them in return.
Disclosure, being the flip side of confidentiality, is particularly an issue of investor
protection in the US market, which is more litigious. Market worries over bondholders
accepting construction risk have been overcome using proven technologies and high
quality EPC contractors. Sutton Bridge30 in the UK was the first unwrapped deal on
which investors took construction risk, and the $1 billion Petrozuata Rule 144A issue in
Venezuela even happened without political risk cover. But even with strong investor
appetite, matters on project bonds are still largely uncharted and highly sensitive areas.
Finance is still being raised on the basis of dealings with rating agencies, stock
exchanges, government agencies and general commercial awareness rather than any
long-term reliable precedent or legal ruling. With projects under development or
construction, bank loans are heavily structured, with experienced lenders sophisticated
enough to gauge and allocate risk in order to protect themselves through detailed
covenants against any setbacks affecting the repayment schedule. Eurobond or Rule
144A placements are sold into a market without significant investor input or negotiation.
Regulations exist to protect the potential investor, but how much suppliers or off-takers
will allow to be revealed is unclear. It is difficult to objectively define what must be
disclosed to satisfy regulators without divulging too much to competitors, as it remains a
skill based on experience. In the absence of specific project bond regulation, sponsors
and advisors need to balance confidentiality with due diligence.
Rule 144A Offerings - Information provided in a US bond offering is far more
detailed than a Eurobond offering, (although European market practice has been
influenced by US requirements) partially as a result of US legal practices. Rule 144 A
offerings are designed to avoid registration with the SEC and as such, can only be sold
to approved investors. With some exceptions, there is little difference in Rule 144A
requirements and those internationally reputable firms would require. There are minor
differences of form, such as a Rule 144A issue usually lists risk factors as a separate
heading, while the international market traditionally does not need this. This is changing
as the market moves towards a ‘mid-Atlantic’ standard. However, on project bonds, risk
factors are standard even when they are not going into the US. Rule 144A technical
requirements require less disclosure than is customary, but due to industry practise, it is
generally necessary to disclose a similar level as for public deals.

30 £285 million raised - see Deal 14 in Appendix H.

42
London Offering - When structuring a Eurobond issue, the London listing rules need
considering, as this is now the preferred exchange for project debt and structured debt.
The earliest deals were unrated sterling issues, but Sutton Bridge (Deal 14 in Appendix
H) was an important development as the first Eurobond with a Rule 144A placement
which was London-listed and where investors also bore construction risk. In this
transaction bonds were placed simultaneously in the UK and US.
London-listed deals need to display contracts, which is one of the peculiarities of the
London exchange and a material difference from Rule 144A placements. For Rule
144A deals, issuers do not file contracts with the SEC - which would be obliged to
make that information available to the public - and therefore better confidentiality is a
major advantage of this type of issue. With a listed Eurobond, the documents go on
display and are available for inspection but in contrast, in the US far more detail is
required in the offering circular. It is then up to the issuer if copies of contracts are
distributed to prospective purchasers and if they are distributed, this can be under
appropriate confidentiality restrictions.
However, third party contracts may be material to the investor’s decision and contract
summaries are included in Rule 144 A circulars. For Eurobonds, if a provision of the
contract is material it must be disclosed in the offer document, whether or not the
exchange requires its display for 14 days. If a large pool of assets is being securitised
then diversity and size of the collateral pool determines the amount that must be
disclosed about individual projects. Rating agencies typically expect to examine all
material contracts if there are 20 or less projects in the pool, with 30 or more projects
within a pool then selective sampling occurs and this approach might also be acceptable
for bond prospectuses.
Exemptions from disclosure rules on the London exchange, have rarely been given.
There are three possible reasons for exemption from disclosure:
> the information is minor;
> the information has national security implications;
> disclosure is detrimental to the issuer.
The third option gives the most opportunity for a sponsor, but even this has had limited
success. The best example was the £165 million PFI deal issue for Road Management
Consolidated. The Highways Agency was reluctant to disclose anything that would
have allowed another consortium to gain a competitive advantage over the Government
for subsequent deals. Given the difficulties of getting a derogation and a more flexible
attitude from the Government, subsequent deals, such as the M6 Autolink
Concessionaires (see Deal 22 in Appendix H) have not had waivers. Even the presence
of a monoline insurer has been tried unsuccessfully as a reason for minimising, or

43
avoiding, disclosure on the basis that investors could rely on the triple A rated monoline
to conduct the necessary due diligence.
In summary, sponsors should consider in advance the different requirements for
fundraising and ensure that when negotiating contracts there is sufficient flexibility for
capital markets funding, if there is any chance of using that route. In practise, US and
European bond prospectuses are identical, with only a local regulatory wrap added at the
end.

7.10. Bond Rating

A rating is the rating agency’s opinion about the likelihood of full and timely payment
on a rated security. It is not a recommendation to buy or sell a security and gives no
indication of the aptness of a given security for any investor’s portfolio.
A bond rating represents the ability of a borrower to repay the principal and interest over
the long term. These crudely translate into probabilities of default, with a rating of ‘B’
signifying a 30% chance of default over a 10 year period and a rating of ‘BBB-‘ a 4%
chance of default over a 10 year period. In this instance default refers to a payment not
being met rather than complete non-payment of funds. It is very unusual for a
structured transaction to receive a bare (ie unenhanced) ‘AAA’ rating because of the
nature of the risks assumed. Most bank project financed deals could qualify for a rating
in the ‘BB’ to ‘A’ range, depending on the technology used and quality of the sponsor.
In bond ratings a high grade means low credit risk or conversely a high probability of
future payments. Bonds rated triple A (‘AAA’) are said to be prime, double A (‘AA’)
are of high quality; single A issues are upper medium grade and triple B are medium
grade. All lower grades are described as having speculative elements and are
considered sub-investment grade, or more colloquially 'high yield' or 'junk bonds'. All
bonds rated BBB or better are considered investment grade. The distinction has a
significant effect on the marketability of the bonds to investors, as many large
institutional funds are restricted to investment grade bonds. In the US there is a larger
market for sub-investment grade paper that is able to absorb new issues more easily than
low grade bonds issued elsewhere. The bond’s rating and the market’s appetite are
directly linked to the spread the bond will have to pay. Both factors are affected by
general economic conditions, which drive the benchmark pricing for a bond and its
credit spread. The benchmark is usually a highly liquid sovereign issue, such as a Gilt
in the UK, with a similar tenor to the proposed bond and the bond is then priced as a
number of basis points over that. However, this spread will vary depending on general
economic conditions, which may cause a ‘flight to quality’ or demand from institutions
‘hunting down the yield curve’.

44
A variety of research has been undertaken to develop a series of financial ratios that
objectively measure the credit risk of various businesses. The nature of the data means
that these are biased primarily towards whole businesses, rather than individual projects.
Nonetheless, these give a perspective on credit risk and may provide an indication for
highly leveraged capital market transactions. An example of this sort of date is shown
below.

Financial Ratios by Bond Rating (1990 - 1992)

AAA AA A BBB BB B CCC

Pre-tax interest 17.7 7.6 4.1 2.5 1.5 0.9 0.7 (Pre-tax Income from Continuing
coverage Operations + Interest Expense)/Gross
Interest
EBITDA* interest 21.0 10.5 6.2 4.2 2.6 1.9 1.2 EBITDA/Gross Interest
coverage
Funds from 120.1 65.3 37.0 26.3 15.5 9.8 5.5 (Net Income from Continuing Operations
operations / debt (%) + Depreciation)/Total Debt
Free operating cash 42.3 28.0 13.6 6.1 3.2 1.6 0.8 (Funds from Operations - Capital
flow / Total debt (%) Expenditures - Change in Working
Capital)/Total Debt
Pre-tax RoC* (%) 31.9 20.6 15.6 10.9 10.9 6.9 4.6 (Pre-tax Income from Continuing
Operations + Interest Expense) /
(Average long & short term debt +
minority interests + Shareholder Equity)
Operating income / 22.2 16.3 15.1 12.6 12.7 11.9 12.1 (Sales - COGS* - Selling Expenses -
Sales (%) Admin Expenses - R&D Expenses)/Sales
Long-term debt / 12.5 23.3 34.7 43.8 59.3 59.9 69.3 Long Term Debt/(Long Term Debt +
Capital (%) Equity)
Debt / Capital (%) 21.9 32.7 40.3 48.8 66.2 71.5 71.2 Total Debt/(Total Debt + Equity)

Source: Professor Damodaran (note rounding has occurred from the original research)

* EBITDA - earnings before interest tax depreciation and amortisation. RoC - return on capital. COGS -
cost of goods sold.

These results have been translated into spreads over the benchmark, to provide an
indication of what a different credit rating costs. The actual figures will vary depending
on market conditions and the phase of the economic cycle, plus in project finance other
covenants may impact the price compared to the general corporate market, as shown
overleaf:

45
Synthetic Rating Estimation: Premium over US Government bonds
Large Manufacturing Firms Smaller or Riskier Firms
If Interest Coverage If Interest Coverage
> To Rating Spread > To Rating Spread
-100 0.199 D 10.00% -100 0.499 D 10.00%
0.2 0.649 C 7.50% 0.5 0.799 C 7.50%
0.65 0.799 CC 6.00% 0.8 1.249 CC 6.00%
0.8 1.249 CCC 5.00% 1.25 1.499 CCC 5.00%
1.25 1.499 B- 4.25% 1.5 1.999 B- 4.25%
1.5 1.749 B 3.25% 2 2.499 B 3.25%
1.75 1.999 B+ 2.50% 2.5 2.999 B+ 2.50%
2 2.499 BB 2.00% 3 3.499 BB 2.00%
2.5 2.999 BBB 1.50% 3.5 4.499 BBB 1.50%
3 4.249 A- 1.25% 4.5 5.999 A- 1.25%
4.25 5.499 A 1.00% 6 7.499 A 1.00%
5.5 6.499 A+ 0.80% 7.5 9.499 A+ 0.80%
6.5 8.499 AA 0.50% 9.5 12.499 AA 0.50%
8.5 100 AAA 0.20% 12.5 100 AAA 0.20%
Source^pofessorDamodaranJhoteroundinghasoccurredjromtheoriginalresearch)^

The other significant variable is the markets appetite for specific asset classes and if
there have already been a number of similar bonds issued, investment managers may be
restricted in taking on any further exposure to that asset class. These factors insert a
substantial degree of uncertainty over a bond issue, that cannot be accurately quantified
until the actual issuance. A good example of this recently was Dam Head Creek (Deal
10 in Appendix H).
The rating process is based on five main components:
> Credit analysis of the underlying assets and/or underlying obligors.
> Payment analysis on the application of cash flows; monitoring and furnishing reports
on payments.
> Analysis of the characteristics of the investment pool for concentration and
correlation issues;
> Stress analysis of the default and loss characteristics of the portfolio.
> Analysis of the transaction structure both from a legal perspective such as accessing
and liquidating collateral; operational and administrative risks, and the ability of the
cash cascade to protect different investor tiers.
The rating process is very detailed and requires a significant amount of documentation
and information to be provided to the rating agency. The actual rating is only assigned
once documentation is complete, which is why a bond prospectus often states an
expected rating.

46
The chart below shows some of the processes that a rating agency will go through.

Initial Contact

Feasibility Industry
Analysis Review

Collateral Sovereign Risk Originator/

Legal Structure
Analysis Evaluation Servicer Review

Collateral Cash Flow Analysis

Financial Credit
Structure Enhancement

Preliminary Rating Final Legal Final Rating Financial

Pre-Sale Monitoring
Committee Review Committee Close

A portfolio is considered concentrated if the cash flows are highly reliant on a small
number of investments (generally one or two) and generally considered diversified if
there are 11 or more projects in the pool. An asset pool is also concentrated if a large
proportion of the portfolio will be simultaneously affected by any single factor. The
determination of the degree of correlation is important to the assessment of the
portfolio’s weighted average cash flow credit quality. Because most portfolios
anticipated under this study will typically not have a large number of investments and
will all be made up of infrastructure investments, some correlation is inevitable. For
portfolios with minimal correlation, the credit rating will be raised and hence the cost of
borrowing lowered.
It is worth noting that the rating agencies consider:
> a securitisation structure in general terms is only as strong as its weakest link;
> all unrated entities in the structure will become insolvent.
A significant point for originators is that the better the information provided the less
likely the rating agency is to make conservative assumptions. Rating agencies work
from the effect of a worst-case economic scenario affecting the assets and the effect this
would have on the ability to service the securities. The higher the level of rating sought

47
the greater the stress analysis applied to the assets. By changing the credit enhancement
it is possible to target a desired rating for a securitisation transaction.
The initial proposal to the rating agency is likely to include:
> a detailed description of the assets providing collateral, the originator’s underwriting
standards and collection procedures;
> a description of the originator’s views of credit and liquidity risks;
> a description of how any cash flow shortfalls will be covered;
> a description of how the structure ensures that investors will be paid in full and on
time under all circumstances;
> an explanation of the flow of funds and any liquidity shortfalls;
> the legal jurisdiction of the issuer and the assets.
The rating process will involve confidential discussions with the rating agencies to deal
with any issues that arise on the proposal; an indication is then given of the detailed
work necessary to assign a rating and the rating fee that would involve.
The quality of the sponsor influences the rating attributed to the project, even though
much of the financing done for renewables is on a limited-recourse basis. A sponsor’s
quality is often a highly subjective judgement based on balance sheet strength, track
record in projects and the quality of the management. In particular, a sponsor that is
highly regarded in the market and has been rated over several years at the corporate
level by one of the rating agencies, is able to lift the rating assigned to a project by
several notches, compared to a less well known sponsor. Although this apparently
contradicts the concept of non-recourse financing and assessing a project vehicle purely
on its merits, the reality is that few large companies have let limited-recourse projects
fail causing senior debt holders to suffer material losses.

7.11. Credit Enhancement

The main factors in assigning a rating to a bond are the type of underlying assets, the
type of loan, the leverage, the amount of seasoning and the credit quality of the contracts
and counter-parties. Typically a double A or triple A rating is sought, as this gives
access to the greatest pool of investors and hence the most liquid markets. The amount
of credit enhancement depends on what a rating agency requires to bring the receivables
pool up to that rating. This is open to limited negotiation and rating agencies are used to
making subjective judgements. However, they are unlikely to move far from industry
norms.
There are two general types of credit enhancement:
> External Credit Enhancement - This comes from third-party guarantees that
provide first loss protection against losses up to a specified level. The common

48
 types of external enhancement are (1) corporate guarantees; (2) letters of credit; (3)
pool insurance; (4) bond insurance and (5) monoline wraps. Pool insurance typically
only covers certain defined losses and may be linked to historical credit performance
and the degree of seasoning. Bond insurance typically is used to supplement other
forms of credit enhancement, rather than as a stand-alone enhancement. External
credit enhancement is also subject to the credit risk of the third-party providing the
enhancement.
> Internal Credit Enhancement - This is generally more complicated than external
enhancement and may alter the cash flow characteristics, even in the absence of
default. The most common forms are the tranching of bonds (so that a subordinated
series are issued which enables the first-ranking bonds to be rated higher), the
provision of a subordinated loan facility, cash traps, or over capitalisation.

7.12. Monoline Wraps

A “wrap” is credit enhancement provided by a monoline insurance company. The
insurer takes the credit risk of the project in return for a fee paid by the borrower thereby
enabling bond investors to look to the credit risk of the insurer (usually AAA rated)
rather than the project. The wrap helps to broaden the investor base by attracting
institutions that would not invest in project debt likely to carry a rating of BBB or lower.
Monoline insurers will not consider an underlying risk of less than ‘BBB’, in order to
avoid impairing their own ‘AAA’ status. However, they usually aim to price the wrap
so that the all-in cost of the bond is competitive with the pricing of a commercial bank
debt alternative. Section 7.16 covers some of the related changes to bank risk capital
allowances under the Basle Accord.
There are a limited number of monolines in the London market, as most concentrate
solely on the US market. Investors appear to retain an appetite for monoline paper,
although pricing of the wrap is a function of competition at the time and the credit
quality of the main underlying asset. For instance, monolines are keen to wrap NFFO
style contracts due to the government component, which reduces their capital weighting
to 20%, compared to 100% (see Section 7.16 for more details). The price of wrapped
paper can fluctuate considerably, despite the high credit ratings as AAA’ trades from
flat to lOObp over depending on perception of the underlying credit quality.

49
7.13. Capital Market Transaction Costs

Item Cost Remarks

Underwrite, structure and 62.5-75bp for AAA Success based fees payable at
distribute bond (calculated on 100-125bp for BBB financial close.
the face value of the bond) 200-300bp for sub-investment grade

Lawyers (issuer, monoline, >£400,000 and may easily exceed the For borrower’s account regardless
underwriter and trustee) underwriting fees on small complex of transaction outcome.
deals.

Rating Agency £50-100,000 For borrower’s account regardless

of transaction outcome. Typically
5bp for project finance and 3bp
for balance sheet debt, with a
minimum absolute level.

Accountants £25-50,000 For borrower’s account regardless

of transaction outcome.

Listing fees etc £10,000+ Success based

Registrars £10,000+ Success based
Trustees £10,000+ Success based

Typically the costs become prohibitive on a pro-rata basis when the size of the issue
falls below £60-80 million, both in terms of the fixed fees and the liquidity premium
charged by the market for small deals. Below this size the market is more limited and
tends towards private placements, with only a small number of investors purchasing the
bond. This effectively resembles the commercial bank market, with the loan differences
being primarily legal, rather than financial. Some corporate bonds have been issued at
£100 million even though the company required less than that, solely to achieve the
round number and avoid a premium to compensate an expected lack of liquidity.
Legal fees are a function of the time worked, which is based on the complexity of the
deal. Most capital market transactions are completed by a small number of legal firms
based in the City. Although these charge substantial fees compared to firms located
outside London, the in-house experience and credibility that the name brings generally
more than offsets the higher charge-out rates.

7.14. Fund Raising Options

Securities placed privately are exempt from registration, because they are issued in
transactions that do not involve a public offering. The private placement market in the
US has grown significantly due to the agreement of rule 144 A in 1990, which allows the
trading of private placement bonds between qualified institutional investors.

7.15. Bridge Finance

Bridge finance is usually provided by commercial banks or an investment bank to cover
a short term financing need, such as the construction period, prior to a take-out by the
main, longer term, financing through a bond issue. A good example of this was the

50
Italian Vento wind project (Deal 2 in Appendix H), where the sponsors financed their
equity stake through a bridge financing during construction. In theory this allows more
flexibility in financing, with covenants designed to cover the different risks that
construction and operation each have. However, bridge finance can be a risky
proposition for developers, as it is often time constrained or has a stepping up of interest
rates31. Before entering a bridge based transaction, sponsors should take appropriate
professional advice (not from the prospective finance provider) on the risks involved.

7.16. Impact of the Basle Accord

The Basle Committee has recently released its proposed risk capital weightings for
securitised assets held by banks. The Accord prescribes that external ratings should be
used as the basis for risk weighting and for securitised tranches, the weightings are as
shown overleaf.
Rating Risk Weighting32
AAA to AA- 20%
A+toA- 50%
BBB+ to BBB- 100%
BB+ to BB- 150%
B+ or below Deduction from capital

This new system differentiates between paper of different credit quality, compared to
the existing system that simply requires that all asset-backed securities be risk weighted
at 100%, unless they are mortgage backed, when it is 50%.
This suggests that banks will become more interested in investing in the paper of other
banks, especially as most banks tend to have a concentration in the exposure to a certain
domicile or customer. Banks will also find it attractive to invest in highly rated
securitised paper of corporates due to the lower risk weighting and this should result in
increased liquidity and volume. This should also have a material impact on the way
corporates raise funds, by making it more attractive to raise funds through a
securitisation. This should help move European corporate borrowing closer to the US
model, where over 60% of corporates raise funds via the issue of paper. This will help
renewable energy, as the market will become deeper for all risk bonds.

31 One of the basic challenges of project and infrastructure debt is achieving debt terms that match the asset lives of
the facilities being financed. With the exception of the US bond and bank debt markets, maturities rarely approach
infrastructure asset lives. Even in the US high yield market, investors tend to prefer the pricing simplicity of interest
only bullet bonds, which avoids re-investment risk. As a result, many infrastructure financings face major refinancing
risk in the form of large bullet and balloon payments. Some lenders argue that refinancing reduces credit risk, because
it gives lenders opportunity to reset debt terms and pricing. Elowever, maturity risk might be relatively small for
established credits in relatively liquid and continuous markets, but where the sponsor is not a well known name, or the
credit is less than AAA/AA, there remains a significant timing risk.
32 The amount of risk free capital required covering a particular risk that is being insured.

51
7.17. Private Placements
The process of issuing bonds through a private placement in the UK is very similar to
accessing the commercial bank debt market. The simplest reason that the debt is issued
as a bond stems from many of the investors not being banks and thus prohibited from
making loans. A further reason is that many large fund managers, such as Prudential,
which invested in the SELCHP plant (Deal 11 in Appendix H), find it administratively
easier to allocate bonds internally between different investment funds.
The private placement market compliments commercial bank debt and often is willing
to offer far longer tenors at fixed rates, particularly where these match annuity fund
liabilities. This provides some potential for sponsors to negotiate a slight improvement
in terms in return for tailoring the debt profile to the particular liability profile of the
investor. Private investors are often more willing to look at unusual projects, they will
consider smaller amounts (£10-20+ million) and prefer not to involve a monoline, as
they like the improved spread. Certain private placement investors can individually take
substantial amounts (around £75 million, where most banks would need to syndicate
that) or for larger amounts, they are able to create a club investment with similar
institutions. As with commercial bank debt, private placements can offer far higher
degrees of confidentiality than the public markets.
The private investors contacted expressed interest in the renewable energy sector, but
the provisos on underlying contract credit strength were no different to the public
markets. However, they tended to prefer well proven technologies, such as wind power
and waste to energy, rather than more cutting edge developments.

7.18. Green Premium

‘Green’ marketing often figures prominently in many renewable energy investment
proposals seen by the authors. Sponsors often consider this enhances the attractiveness
of such investments. However, with a few minor exceptions, investors only accept the
‘greenness’ of an investment as advantageous when the fundamental economics already
exist. Therefore, in the primary market the ‘green’ nature of the underlying assets might
prove advantageous in marketing the bond, but it will not improve the spread over the
benchmark bond. If anything, investors tend to be concerned about what they are giving
up, in order to do something for the environment. This is compounded by the
limitations imposed on most institutional investors by their fund trustees to invest only
at market rates. Therefore, renewable energy derived bonds will be assessed purely on
the quality of the supporting cash flows and assets, just like any other offering.

7.19. Schroders PFI Fund

Schroders has recently constructed a template fund for a PFI portfolio. It has agreed a
£1 billion wrap with FSA for an open-ended debt guarantee for pooling post­
construction PFI projects in conjunction with a construction period bridge facility from

52
an investment bank. The Fund is aimed at relatively small PFI projects (£5-20 million)
for which it would not otherwise be economic to raise money. Projects must comply
with the terms of the standardised documentation and they are financed through
construction by the bank bridging loan. Once sufficient projects have reached
operation, these are aggregated and the construction finance is then refinanced via the
bond market.
Schroders made a substantial investment in advance to prepare the documentation
templates that covers all the construction and refinancing documentation. The template
and quality thresholds for a project to be admitted were agreed with FSA in advance,
thereby insuring the FSA wrap would be available. The ability to take a project from
pre-construction to operation through this financing mechanism is partially dependent
on the project sponsor also being the contractor. Therefore, the restrictive covenants
provided for the construction phase are accepted by the sponsor as a ‘cost’ of financing
a relatively small project. It is unclear how well this might work with a third-party EPC
provider.
Schroders and the Rotch Group own the standard template and the contract with the
FSA. Their income is derived from the fees for structuring each PFI funding. The
actual interest rate achieved by the bond is passed through to the individual companies,
therefore, each participant benefits from the pooling of their assets with others to
achieve diversification for investors.
The covenants are tightly drawn, with little room for a sponsor to negotiate variations.
Schroders believes this will be acceptable, as these projects would not otherwise gain
finance. This application of this type of structure for the renewable energy market is
considered in Chapter 10.

7.20. Recent Developments

The securitisation market continues to develop and access an ever broader range of
markets. For instance, in 1997 a number of transactions used notes or certificates issued
out of US securitisation deals as the underlying assets for secured Euronotes, issued
with a ‘AAA’ rated swap. A variation on this was the issue by Westpac of Australian
mortgage-backed notes, with the transaction registered with the SEC, while using
identical documentation for the Eurobond and Australian markets. While in Latin
America securitisation of dollar denominated cash flows has served as a means for
issuers to access the capital markets at better rates than they could achieve by borrowing
on their own credits. The first transactions of this type included the monetization of
tourist credit card charges by banks in Mexico and future encashment of migrant worker
receivables.
Recently, originators of assets that have non-credit risks have used securitisation
techniques to transfer those assets along with the non-credit risk to the capital markets.

53
Risks normally underwritten by primary insurers are also being transferred to the capital
markets. In this instance, a SPV raises capital in the capital markets and reinsures a
catastrophic risk. Interest on the securities is funded out of the premiums paid by the
ceding insurer and investment earnings on the entity’s capital. Any claims on the
reinsurance causes investors to incur a loss on their investment.
This is complemented by work on the development of synthetic securitisations to
overcome some of the covenanted limitations that often exist on the underlying assets.
Synthetic transactions are now well established for currency and interest swaps. Rather
than exchanging economic assets, an agreement to exchange the economic difference at
set periods in the future occurs. If the originator is unable to transfer the assets to an
SPV, a synthetic securitisation might help in the form of a swap: a counter-party pays up
front for the right to enter the swap, whereby he receives a stream of income generated
by the inalienable assets.
In an attempt to broaden the market and access more investors, Enron has securitised its
dividend stream from the South Teesside power complex through a £110 million issue
of sterling bonds privately placed through Barclays Capital. The inherently
subordinated position of this sort of deal provides an interesting yield pick up, but the
investor base for such assets still remains limited.
From the above, it is unlikely that securitisation will provide a route to finance
renewable energy projects other than after construction. In order to access the capital
markets efficiently, a large proportion of the existing capacity built under NFFO would
need to be amalgamated into the portfolio. This might point to a portfolio approach as
used by Schroders in their PFI fund. Given the state of the renewables industry, it is
unlikely that any one participant could afford the risk associated with starting the up­
front work on this approach.

54
8. Support Mechanisms
8.1 Background
Across the developed world most renewable energy technologies have converged within
their band in terms of cost, competitiveness and technical development, such that the
costs for a wind farm at around £800/kW is roughly the same in California, as it is in
Minnesota, Scotland or Spain. While some countries retain an exceptional expertise in
certain niches for historic reasons, such as Denmark’s large-scale anaerobic digesters,
market penetration by renewables is primarily a function of economics and by direct
implication, the government driven incentive schemes. This is most noticeable in
Europe, where countries have very different profiles for renewable energy capacity
installed over the last 20 years. For instance the UK has around 2.1 GW of renewable
energy capacity, three-quarters of which is large hydro; Denmark has around 0.9GW of
renewable energy capacity, which is over 95% wind power; and Italy, has 22GW of
renewable energy capacity, 90% of which is large hydro. Inevitably this is partly due to
local peculiarities, such as the renewable resource and difficulty of getting planning
permission for wind turbines in the UK, but principally it is a direct result of the form of
incentive scheme available.
The shape of the renewable energy market in any country reflects a government’s
decisions on the political and market support provided. The one common factor
amongst (almost) all incentive schemes in the EU is the reliance on tariff subsidies
rather than investment grants. Unlike many other markets, where government imposes
generally negative covenants on a market in order to shape its function, the renewable
energy market requires positive covenants to develop. For the UK to achieve its targets
in renewable energy, the Government’s decisions on the form of the incentive scheme
directly impact the shape (and hence size) of the resulting market. To achieve larger
renewable energy projects (both to make accessing the capital markets possible and
achieve the overall quantum required by the EU) the system needs to encourage larger
projects. However, this should not be at the expense of the small innovative
technologies developed by entrepreneurs, who have generally demonstrated a degree of
nimbleness and risk acceptance that large companies still find hard to emulate.
Therefore, a balance is required between building capacity now, while encouraging
technologies that create tomorrow’s market, rather like Danish support for wind power
in the 1970s.
While some renewable technologies are approaching a market price based on the recent
NFFO-5 bidding, such as landfill gas (2.59-2.9 p/kWh), energy from waste (2.39-2.49
p/kWh) and wind (2.43-3.10 p/kWh), it is incorrect to assume this demonstrates market
convergence. The market rarely, if ever, provides triple A, 15-year, index linked
contracts without performance penalties. The prices reflect how bankable the contract
is, not merely an improvement in technology alone - remove NFFO and power prices

55
will jump, unless an equivalent tenor and credit quality contract is available, as capital
costs need covering within the power contract time frame. Therefore, this report
assumes that fundamentally the sector will need some form of incentive for many years
to come. This derives partially from the capital cost of renewables, but also the
difficulty of relatively small projects negotiating strong enough PPAs. For instance, one
of Europe’s largest biomass power stations had a construction cost of over £1200/kW
compared to large CCGT power stations with a cost approaching £280/kW. In
addition, some CCGTs are up and running within 14 months - hence lower construction
interest cost, which makes it hard for renewable energy to compete. In many renewable
energy project financings, the two largest costs are EPC followed by interest during
construction.
In addition, for small developers, any negotiation with a power marketer is strongly
weighed against them in terms of need, cost and expertise. Large utilities that construct
their own renewable capacity do not face the same problems. For them, the negotiating
process is limited only to defining the off-take terms in a manner acceptable to external
investors, if financing on a limited recourse basis. However, large utilities still need
sufficient economic incentive, both in rates of return and absolute quantum33, for a
project to compete internally for management resources against much larger fossil fuel
projects. An example of the benefits that a guaranteed PPA brings is demonstrated by
the NFFO-5 awards, where all the energy from waste projects bid for prices below the
current average pool price34.

This section looks at the bankability of a selection of renewable energy incentive

schemes being used or promoted at the moment. They are examined in the context of
the ability to provide investment grade levels of security35 and whether they are
bankable for the purpose of securing long term finance. These schemes are considered
in isolation, although in practise most countries offer other incentives, such as tax
allowances or grants that may encourage a renewable energy market.
For any PPA, the important variables are price, volume, term and off-taker credit
strength:
> Electricity Price may be fixed, indexed (to RPI or another benchmark, such as
average retail price), floating, or variable. The variability is usually a function of
embedded benefits, availability incentives and costs associated with non-contractual

33 For example a 3MW wind project with an all in cost of £8m that generates a (attractive) 25% rate of return for
shareholders will often still be too small to justify the management time required in a major utility.
34 The cost of accepting a bid below average pool price was probably offset by the ability to raise finance against a
known income profile, the indexed linked nature of NFFO, the removal of electricity market risk (ie price, charges and
uncertainty) and the simplification of the PPA arrangements. The tenor of the waste contract also plays a part, but this
alone does not explain a bid below pool price.
35 Investment grade ratings often depend on the weakest link in security chain being able to meet the stress testing
required by rating agencies or monoline insurers. Therefore, a PPA might be bankable, that is money can be raised
against it, while still not meeting the security level required for an investment grade rating.

56
 performance. The more confidently this can be predicted, the better the credit
quality of the financing.
> Volume is self-explanatory, although the period over which it is averaged, and the
incentives for meeting that amount, strongly impact the overall credit quality of the
PPA. In particular, the ability to vary volume without penalty is important,
otherwise it compounds the total penalty for non-base case performance36. If the
marginal cost of production is low enough the generator will almost always be able
to dispatch the volume profitably, assuming that the penalties for this variability do
not negate the benefit.
> Term is important when financing relatively expensive renewable energy plant. The
longer the term, the more predictable the average cash flows (ie a longer averaging
period) and hence, the cheaper the overall financing cost.
> Off-taker credit strength is the keystone to the Price/Volume/Term structure, as it
represents the ability of the contract counter-party to fulfil the contracted terms. For
most utilities, which have a published credit rating, this is a relatively straight
forward assessment by investors. Where the off-taker is a small company or does
not commission a credit rating, investors may never become comfortable with the
risk.
The above factors drive the credit risk of the PPA and these are examined in the context
of the different incentive mechanisms. However, the ultimate bankability depends on
the underlying reliability of the renewable technology to generate electricity. In this
chapter bankability of an incentive scheme is considered in isolation, while in practise
investors assess the incentive in the context of a particular technology/project.
A number of these incentive schemes are being changed, or have only recently been
introduced, therefore due caution is required before project specific assumptions are
made on the basis of the following commentary.
The incentive schemes examined are:
> Auction of Renewables Contracts (ie UK NFFO or Irish AER);
> Fixed Price Mechanism (ie Germany, Spain and the former Danish system);
> Net Metering (ie some parts of the US);
> Renewable Portfolio Standard (ie the new Danish System or UK Percentage
Obligation);
> Voluntary Green Premium/Certificate (ie California, the Netherlands or
Philadelphia).

36 An extreme example occurred in the US mid-West during 1999, when Cinergy was unable to meet its contract
obligations for a two hour period. This cost the company $79 million as a result.

57
8.2 Auction of Renewables Contracts
The main examples of this type of contract are the UK NFFO, Irish AER (which are
very similar to each other) and to a lesser extent, the Italian CIP6. All provide an index
linked price and a known term, however under NFFO, sponsors bid for prices, while
CIP6 prices are set by the government for each technology band and sponsors bid on a
technical basis for these contracts.
CIP6 Contracts are funded from the Cassa di Conguaglio, a tax account maintained for
all the energy companies at the government’s (Ministem del Tesoro) specific behest.
All consumers pay energy taxes (environment and nuclear taxes) on their bills. These
are remitted by the distributors to the generators and then into the Cassa di Conguaglio
to fund the nuclear levy (see Orchid Securities - Deal 18 Appendix H - for the notes on
its securitisation), government taxes and the renewable energy incentive paid through
CIP6. Bids for CIP6 used to be made to Enel, but after its privatisation this is handled
by MICA (Ministero dell’Industria Commercio e dell’Artigianato - the Italian
equivalent of the UK’s DTI). Unlike NFFO, the CIP6 pays a very high price (around
lOp/kWh) for the first eight years of its term and then a much lower price (around
3p/kWh) for the final seven years. These prices are index linked and paid fully from the
Cassa di Conguaglio unlike the NFFO, which is a mix of a reference price and a green
premium (albeit the difference is effectively transparent to the generator).
NFFO - in its most recent guise, provided a 15-year index linked contract for a power
price based on a competitive tendering process. The NFFO power price is a
combination of the market clearing price (ie pool price or post NETA, it is expected to
be the balancing market price) and a premium over this. However, the contract holder
and the financiers have no market exposure and receive a fixed price irrespective of the
actual level of pool price. The UK Government imposes a legal requirement for the
public electricity suppliers to collect this premium from all consumers’ bills. In practise
the percentage payment from consumers’ bills is reviewed at regular intervals and forms
a fund with sufficient capacity to meet all anticipated payments until the next review. A
more detailed description of the NFFO is in Appendix E.
This section will concentrate on the NFFO, as it provides a stronger credit and is
familiar to most readers. There are several reasons for the greater credit strength of the
NFFO compared to CIP6 - the two main ones being govemment/political risk and the
relatively short premium period for CIP6.
The main advantages of NFFO from a financing perspective are: a known price that is
index linked on an annual basis; reasonable length fixed term; very secure risk profile
(refer to Appendix E where the ‘quasi sovereign risk’ perception is discussed); a
standardised contract; and a set capacity. Taking each of these in turn:

58
> Risk Profile - NFFO achieves its strong risk rating due to the perception that the UK
government will not act arbitrarily by retroactively changing the Orders and that the
uplift in price is shared across all electricity consumers. This is not weakened by the
pool price component that is paid by a PES, as the market believes that the regulator
would not allow a PES to default, due to its national importance and they are
required by the regulator to maintain an investment grade rating. The value of this
risk perception is most noticeable in the way a monoline insurer allocates only a 20%
risk capital weighting to a NFFO backed project compared to a project with a
'normal' PPA37 This reduction in risk weighting means the monoline is able to offer
a more competitive price for a NFFO based project38.
> Price - The price achieved by a project is set in the NFFO bidding process, such that
if a bid is accepted, the bidder receives that price. When raising finance the sponsor
can model with reasonable confidence the price it will achieve, as this only varies
due to inflation. Income risk then becomes ‘merely’ a function of technology
performance risk, which most financiers will accept, particularly when coupled to
strong performance guarantees from the contractor/O&M supplier. With a project's
main income source index linked, this reduces exposure to interest rate changes and
reduces the need for an interest rate swap, thereby improving overall cost
effectiveness39.
> Term - As discussed earlier in this report, most infrastructure projects need long
term finance, often in the 10-25+ year range. The 15-year term for NFFO is
sufficient to allow a reasonable amortisation rate for the debt, while still giving a
PPA 'tail' at the end of the repayment period. Generally, it is easier to raise finance if
the repayment term is less than the PPA term, although some quasi-merchant plants,
such as Sutton Bridge (see the case study in Appendix G) have their financing
extending beyond this guaranteed term. However, these plants are usually state of
the art CCGT plants with amortising debt, which means that they will still be mid­
merit when their original PPA expires but have a substantially reduced debt burden.
It is most unlikely that a renewable energy plant would achieve a similar financing
due to differences in capital cost and performance certainty. Having a PPA 'tail' at
the end of the financing period provides substantial comfort to investors, as they can
see guaranteed revenue (subject to technology performance) still available to fund
their debt if the project under performs initially. Indeed, some financings now

37 Risk weighting in this instance would be 100% or possibly even more, depending on the level of perceived risk.
38 A quirky result of the NFFO structure is that its credit risk falls as the pool price falls, because a greater proportion
of the price is borne by the NFPA/sovereign component, although in practise this is unlikely to change the credit
rating.
39 The current market appetite for index linked bonds is strong, as evidenced by the new Treasury Building PFI
project under PFI which went to a bond financed solution due to the ability to provide an index linked 35 year bond.
Commercial debt providers also bid for the solution but were unable to match the indexing, without potentially costly
index linked swaps. This appetite means a better spread will be achieved, but it should be noted that the attraction of
an index linked investment is in proportion to its tenor, since inflation risk increases with time.

59
 provide a grace period at the beginning and end of the financing period (such as Dam
Head Creek - Deal 10 in Appendix H) to give sponsors leeway to deal with the
inevitable variations in performance, without needlessly triggering default
provisions.
> Standardised Contract - The NFFO PPA is standardised and as such, simplifies
the due diligence that an investor needs to conduct. Once investors have researched,
understood and accepted the NFFO risk, standardisation means that this work is
quickly replicated for future projects, with the associated economies of scale.
Therefore, uncertainty caused by the NETA process (and the delay in starting the
renewable energy percentage obligation) will slow the development of renewable
energy, even if it were to offer a similar credit risk to NFFO, because investors will
need to become familiar with it and understand the credit implications. The removal
of standardised power contracts under the percentage obligation only compounds the
problem.
> Capacity - A NFFO contract covers a set quantity of generation. If this quantity is
exceeded, the PES still has to purchase the excess power, but at the pool price rather
than the premium price, and no penalty is payable. Similarly, if the generator does
not achieve its NFFO output, it still receives the full NFFO price per kilowatt-hour
generated and no penalty under the contract. This system gives generators a
considerable margin for variation in their output, with no adverse consequences from
the PPA, when compared with many larger conventional plants that incur substantial
penalties if they cannot meet their contracted obligations. This simplifies the due
diligence process and risk. In particular it is very valuable for variable output
generators such as wind and CHP40.
Although there are a number of flaws with the NFFO process, these affect the
government’s objectives for renewable capacity rather than the credit strength of the
contract41. Thus, the NFFO contract forms an essential link in any financing
arrangement and would be advantageous in raising bond finance. In all the research
conducted with capital market practitioners, the NFFO contract was consistently highly
regarded. Its one weakness might be that infrastructure investments command longer
terms and investor appetite is particularly strong at the moment for long-term money.
The past 10 years demonstrate that NFFO is bankable and provides an investment grade
link in any financing.

40 A major strength of NFFO is that it allows averaging over a significant period (it varies between rounds) that is long
enough for variable output generators to smooth out and peaks or troughs. Conversely, this is why the balancing
market will be so detrimental for variable output generators under NETA.
41 These flaws include encouragement to game the system: the longer a prospective sponsor waits to build a project,
the higher the profit due to steadily falling production costs and there are no penalties for developers if they fail to
install the capacity, so that unprofitable bids are made that force out realistic bids.

60
8.3 Fixed Tariff
The German Renewable Energy Feed-In Tariff (REFIT) regulates public utility
companies’ purchase and reimbursement of electricity generated from renewable
resources. The legislation applies to hydro, wind, and solar energy, as well as landfill
gas, geothermal, sewage gas and agricultural and forestry products/waste, although it
excludes hydro, landfill gas, sewage gas and biomass plants with a generator rating
greater than 20MW. A new version of the law was introduced at the beginning of 2000
and its full implications are not yet clear.
The REFIT law obliges public utilities (operators of the grid) to purchase renewable
energy generated in their respective supply area, and to reimburse the fed-in electricity
at various rates depending on the technology used. Electricity generated from hydro,
biomass, landfill gas or sewage gas is reimbursed at 80% of the average electricity price
paid by domestic consumers, whilst wind and solar power are reimbursed at 90% of the
average consumer price (approximately 5.5 pence/kWh for wind). The new law gives
three ministries (environment, energy and industry) the right to re-examine the prices
paid biennially to check the level of market penetration and cost effectiveness of each
technology band. This may result in changes to the percentage awarded, or in the case
of wind, it has limited new projects to a maximum of 5 years of payments under REFIT.
The average consumer price is calculated across all Germany and recalculated
biennially42. The local utility that buys the power is able to pass the additional costs of
the REFIT price through to its own consumers. However, the old law included a
provision that ensured any generator starting up under the REFIT scheme will not
receive ‘worse terms’ if the law is subsequently changed, although this did not remove
price risk due to moves in the average price. This provision has not been noticeably
applied in practise yet, therefore it introduces a greater level of uncertainty. The benefit
of this clause was that it removed the requirement for investors to form a view of the
likelihood of the German government changing the incentive structure. Although the
current political climate in Germany is unlikely to materially change the support for
renewable energy, there is a risk that it might be adapted, especially as any government
will find it easier to change the terms of a scheme run on a biennial basis rather than
facing the political difficulties of retroactive changes.
A price calculated every two years that is based on average retail prices is hard to model
without the substantial expense of specialist power sector consultants, particularly in a
market being restructured. This exposes the income to reasonable variation and a
presumption of falling prices, which will add to investor concerns. It also exposes
sponsors to interest rate risk, as the retail power price will not necessarily track a change

42 New energy taxes were introduced in spring 1999 that significantly increased the retail price of electricity, and
hence, the subsidy paid to renewable energy generators. The European Commission had challenged the resulting
increased subsidy and this is still being negotiated.

61
in interest rates (ie basis risk). An interest rate swap is always possible, but this adds to
the cost of financing. For investors, the expectation of falling prices does not reduce the
bankability of renewable energy contracts, rather it makes them conservative in their
assumptions and the cover ratios required. Inevitably this biases towards the cheaper
technologies in each band and hence away from capital markets financing.
The contracts are generally very simple, as the local utility is obliged to accept
whatever power the renewable generator produces and there are no penalties for under
or over production (top-up and spill). As a result, little due diligence is required of an
investor. The lack of penalty is another advantage when it comes to modelling the
investment and narrows the income risk down to technology performance, which makes
the contract readily bankable.
The relatively high price and short duration of the tariff biases the incentive towards
proven, low cost technologies that will be able to repay their debt quickly and thereby
offset any longer term uncertainty. This explains the preponderance of wind power and
waste to energy renewable schemes in Germany compared to the greater diversity found
elsewhere. However, biomass may achieve a flat priced 20-year contract that would be
very attractive for bond style finance, assuming the 20MW limit did not preclude the
scale required.
It is unlikely that long term capital market financing (ie greater than 7 years) could be
raised against other renewables supported solely by a REFIT type incentive, unless
coverage ratios were satisfactory even with significant convergence of the incentive
price towards the wholesale market price after the first few years of the financing. This
sort of uncertainty is better borne by a private placement or commercial bank financing
where the ability to restructure the debt is easier. Although in practise, such investors
will still require significant credit protection.
Fixed prices tend not to reflect the true costs of generating electricity and one of the
difficulties of this system is setting the 'right' price. If wholesale power prices are
expected to fall substantially below retail prices there is a credit risk if renewables grow
to a material size and the cost of support becomes excessive. In that instance the utility
will pay a non-competitive price for a substantial portion of its power purchases and
may then be motivated to challenge the system and try to invalidate the grandfathered
rights. This has been seen to an extent in Germany with utilities in the north contesting
the REFIT due to the disproportionate cost borne by their consumers due to most wind
farms (approximately 3,000 MW nameplate capacity) being on the north coast.
Investors will consider this risk and it may limit their willingness to provide long term
finance.
The Spanish incentive scheme is similar to the former REFIT law, but the government
sets the price support each year. Despite this uncertainty, a substantial level of limited-
recourse finance has been raised. However, the level of sponsor guarantee is significant,

62
which may explain the preponderance of large energy companies and construction
companies in that market. Also, Spanish banks have dominated the financing (around
90%) as they have been more willing to take a positive view on regulatory, political and
sovereign risk. However, the Xistral project (Deal 3 in Appendix H) demonstrates the
benefits of a predictable power regime, not merely on price but the perception that the
government will live up to the spirit of its obligations.
In conclusion REFIT provides a bankable solution that may be considered Investment
Grade over the short to medium term and possibly long term for biomass.

8.4 Net Metering

Net metering is a system similar to the Fixed Tariff concept that is usually provided for
smaller generators (typically less than 1MW). It is found in parts of the US and certain
limited areas of the EU. In effect net metering allows a normal retail consumer’s
electricity meter to be ‘run backwards’. This type of incentive is aimed at small
generators, typically using an intermittent power source as it allows the generator to
draw power from the grid when their own generator is not running, while exporting any
excess power to the grid when it is running. By allowing the meter to run in reverse, it
effectively provides the local retail power rate to the generator.
For small generators this system has a number of important advantages, as it provides
access to the grid and power contracts on fair terms by removing the negotiations with a
large power company, which is often in a stronger position than a small generator. It
also helps the financial due diligence process, due to the very simple, standardised
contract used and limiting credit assessment to the off-taker, which by definition in the
UK is of investment grade for the retail market43. The credit risks are similar to those
for the Fixed Tariff scheme, although the size of project usually considered appropriate
for net metering is generally limited such that it is less likely to invite legal challenge
than fixed tariff schemes. This also means it is unlikely to make economic sense due to
transaction costs for non-recourse finance. Overall, net metering credit risk is lower
than the Fixed Tariff Scheme, therefore it may be considered bankable and investment
grade.

8.5 Renewable Portfolio Standard

A renewable portfolio standard aims to impose a market driven price on green power by
obliging a certain proportion of all electricity generated/consumed to come from a
renewable source. Typically a fungible certificate represents the green value and it can
usually be separated from the underlying electricity. Two main Renewable Portfolio
Standards are being introduced. The first system, in Denmark, was due to start at the
beginning of 2000, but it has been postponed without a new implementation date. The

43 Some of the smaller power marketers are able to post a bond instead of a credit rating. How tills will stand up to a
credit review is currently unclear.

63
UK system is due to start after the NETA process is complete (October 2000 in theory),
but no sooner than April 2001. The features of each system are:
Denmark should have moved from a fixed price mechanism to a new incentive for
renewable energy in order to ensure 20% of its power consumption is from renewable
sources by 200344 A purchase obligation was to be placed on every electricity
consumer - represented by their chosen supply company - that required them to buy
20% of their electricity from renewables. In parallel, rules were to be streamlined for
site permitting and grid access to minimise the opportunity for development bottlenecks.
The mechanism for recognising “green value” was a green certificate issued in
proportion to the volume of green kilowatt hours produced. It was planned that
certificates would be registered and held at a producer account with a bank or depository
trust company. These could then be traded in an open market (a derivatives market was
also planned45) and this should remove some of the price volatility and allow forward
sales.
UK electricity market arrangements are being replaced by NETA, which is being
reviewed and has undergone a number of iterations, which are not yet finalised. Current
proposals assume bilateral trading, with a balancing market and cost allocated to
generators out of balance against their contracted supply. Renewable resources will be
encouraged by the imposition of an obligation on Suppliers to take a percentage
(apparently 8%, but to be confirmed) of output from renewables, which will increase
over time to meet the government's target of 10% by 2010. Green certificates are
expected with a cap on green certificate prices. Trading will be based on a market
delivered mechanism and the exact form is correspondingly uncertain.
Green Certificates - superficially provide a sensible, market orientated approach that
will establish a clearing price for green power. A common currency for trading green
power comes into being and the supply of certificates depends on the volume of
renewable energy produced. If supply exceeds demand, the price will fall and thereby
discourage new entrants or penalise high cost producers. In theory a liquid market in
certificates removes wholesale electricity market price risk, as the green certificate price
should rise to off set any fall in wholesale price. However, this is only possible if
certificates are not capped like the proposed UK and Danish systems and if the price is
elastic. In an ideal market, the price of certificates plus the expected electricity price
will equal the marginal cost of green power. It appears that the certificates are not
linked to the source of production46, which means sufficient liquidity will be provided in
the market. Generators are not necessarily tied to selling certificates to a Supplier and

44 Currently it is 14% - ie renewable energy is expected to increase approximately 50% in three years.
45 The issue of counter-party risk for trading is not yet clear - ideally central clearing and standardisation are required,
where trade is facilitated and delivery guaranteed.
46 There had been discussion about issuing a greater number of certificates for the more expensive technologies -
which would move the system back to a fixed tariff problem of the 'right' price, or issuing different bands of
certificates, which would impact liquidity and remove a market driven system.

64
could contract with a creditworthy counter-party for its green certificates, thereby
rearranging the credit risk of power sales. This does not remove the credit risk, which
remains a function of the factors listed previously and the key determinant of access to
long term finance.
With green certificates, the cheaper technology bands will benefit initially as purchasers
seek to sign them up and there is a risk that 'non-convergent' technologies (such as
biomass and offshore wind) are 'squeezed out'. This risk is potentially magnified by the
fragmented nature of the industry and lack of transparent market pricing for green
benefits, which will be exacerbated by the needs of bilateral contracts47 introduced
under NETA.
Penalties - in the UK and Denmark, a transitional mechanism was proposed to limit the
cost of non-compliance. In Denmark the penalty is effectively capped at a rate close to
the maximum incentive price cap, which effectively removes much of its punitive nature
and turns it more into a price controlling mechanism, thereby reducing the bankability of
the system. In the UK, a cap on the green premium is also proposed, that will hinder
development of bankable contracts, as investors cannot form a reliable assessment of the
premium while it is distorted by an artificial limit and also exposed to political risk.
Access - arrangements in the UK for renewable energy developers that wish to use the
local distribution system are uncertain and characterised by long and expensive
negotiations, an uncertain basis for charging and occasionally disproportionate charges.
Work towards making aggregation of renewables easier as well as reducing the penalties
for being out of balance is ongoing. Current proposals include measures to ensure the
distribution companies, the National Grid and network planning documents consider
embedded generation, obtain system security services from embedded generators and
are incentivised to do so. This includes the publication of technical and commercial
information, plus transparency of the principles and rules for calculating connection and
DUoS48 charges. There are proposals to increase the scope and scale of non-licensed
generators and Suppliers to trade electricity in local markets without having to go
through the balancing market risks of NETA or the costs of licensing. These assist the
process of raising finance, as investors will be more comfortable that the costs represent
a true market price and that they are able to forecast with reasonable certainty any
charges. However, these do not in themselves make a project bankable.
The Climate Change Levy - will impose a tax on fossil fuel based generation supplied
to non-domestic customers from April 2001, while exempting energy from
renewables49. This makes the price target for convergence easier to reach, by effectively

47 The real difficulties faced by the Renewable Generators’ Consortium demonstrated the problems of getting the
industry to act cohesively, as has the response to NETA.
48 Distribution Use of System Charges.
49 The Levy was announced in the March 1999 Budget statement and exemption for renewables was announced in the
November 1999 pre-Budget statement.

65
raising the price of fossil fuel power by 0.43p/kWh (ignoring the offset from National
Insurance rebates). It is questionable whether the difference is sufficient to compensate
for the risks involved. Indeed, investors may consider that the Levy unduly susceptible
to political risk, given its high profile and overt impact on all sectors of industry, such
that they will only consider a portion of it in their assessment of future market prices.
Therefore, the Levy cannot be considered bankable in isolation.
Financing Risks - On the basis of the information currently available, the financing
risks for renewable generators under the percentage obligation are:
> Uncertainty - caused by NETA has impacted fossil fuel based projects (see Dam
Head Creek, Deal 10 in Appendix H), as well as renewables. Even when NETA is
implemented, the markets will take time to assess it and gain comfort in the ability to
model returns, which will impact renewables, where there is a higher degree of
perceived risk50 and output variability. In addition, investors will require substantial
evidence of the level of green premium achieved before committing any funds
against projections - until a strong market in green premiums is operating and
transparent, the premiums are probably unbankable. This suggests that only the most
competitively priced technologies will succeed.
> Compliance - is a key factor in the success of a percentage obligation and the level
of penalties imposed for not meeting the obligation. Unless penalties provide an
incentive (ie sufficiently punitive), the percentage will not be met if it proves cheaper
to ignore it. Investors need the confidence that the Government will enforce the
directive effectively and consistently, such that the market for green power remains
buoyant and a stable premium can be established. Equally, the assessment of what is
renewable needs complete transparency and contractual rigour, otherwise the
measurement of merit order51 will be impossible for investors, even assuming that
they are willing to consider this risk in the first place. It is unlikely that any but the
largest renewable energy projects will justify the cost of developing a merit order for
renewable energy generation.
A number of accreditation schemes are being advanced in the UK, but most lack the
credibility to enforce the measurement of renewable output. Any verification must
be able to demonstrate that the capacity existed and that the actual power produced
was green. OFGEM will be given the obligation to provide verification, although it
currently appears that only the Environment Agency has wherewithal to confirm
compliance and measure the output of different generators.

50 Perceived risk comes from the main risks faced by any power project financing: price, volume, off-taker credit,
sponsor credit, technology, political, construction and operating.
51 Merit order is refers to the competitiveness of a power plant in terms of cost and its ability to service a particular
demand profile. Fossil fuel powered merchant plants undergo substantial and costly assessment of their current and
anticipated position in the merit order such that price and volume risk can be assessed by investors. The concern for
investors with green certificates will also be the predictability of price and volume.

66
> Forecasting - of long term green certificate prices may be required in order to raise
long term finance. Forward sales covering that period provide one method of
forecasting, but the validity of these depends on sufficient purchasers being willing
to contract for a known price now, compared to taking future spot market risk. This
is unlikely. Alternatively, investors will need to assess the merit order of renewable
generators, (see the write up on Sutton Bridge in Appendix G) to be comfortable
with the level of anticipated green certificate price. It is almost impossible that
investors will consider this type of analysis (and associated cost) for other than the
largest transactions and then only if the enforcement mechanism is considered robust
enough to maintain demand. As a result, until the market establishes itself, investors
are unlikely to consider it bankable beyond the minimum certificate price and the
expected wholesale price. A forward market will develop, but it will be short-term
initially and may never achieve sufficient liquidity beyond 18-24 months.
> PPAs - will need to be negotiated for each project and the current market is not
providing the quality or duration required. In particular, under NETA the risk
sharing of balancing charges appears asymmetric. The one group that can achieve
good PPAs is the existing large energy companies, which can finance on-balance
sheet, with a vertically integrated portfolio that can absorb any variability. However,
the proviso made earlier still exists on the demands this would make on management
time and if this is overcome, it suggests that renewables will not be provided at fully
competitive prices. The alternative to a large energy company for most developers
will be a contract with an aggregator that can manage the variability and negotiate
better embedded generation provisions for its larger portfolio. However, many
aggregators advertising themselves for renewables do not provide the credit strength
needed for long term finance. Non-standardised PPAs will increase due diligence
costs and make it more difficult for developers without non-recourse finance
experience to agree bankable contracts.
In summary - a percentage obligation biases renewable generation towards large
integrated power companies that have the experience and financial strength to negotiate
suitable PPAs and provide some corporate support. Compared to NFFO, the percentage
obligation exposes generators to:
> whole sale power market risk (price, volume and balancing charges);
> term/renegotiation risk (arms length market contracts rarely exceed 10 years);
> green premium risk (price, volume, political and cap levels);
> off-taker credit risk (power off-taker and green certificate off-taker).
Even the provision of capital grants (possibly from the Climate Change Levy) as tax
allowances biases towards generators with large parent companies that can use the
credits elsewhere in their business. In practise, a PPA will not even be needed by the

67
large vertically integrated companies, as they can take the market risk of price and
volume through their balance sheet. Small generators and independent producers of
variable output generation will not achieve the quality of PPA required for long term
financing, until the cost of non-compliance outweighs the difficulty of a long term
obligation. As currently drafted, no renewable portfolio standard is likely to provide a
bankable contract.

8.6 Voluntary Green Premium/Certificates

A number of green certificate systems exist in the US based on one of three independent
verification systems. One of the higher profile systems has developed in California in
parallel with the Automated Power Exchange (APX). In this instance, there is no
obligation for consumers to buy clean power and renewables are sold to customers on a
voluntary basis.
Californian renewable energy producers receive three types of payment: the commodity
price of the power, a certificate and a subsidy. However, if the subsidy is removed, the
price of the green certificates should rise to compensate, assuming a steady level of
demand. In practise green certificate prices are unlikely to rise sufficiently (ie the
market is elastic) to fully compensate for the removed subsidy. Indeed, observation
suggests that the fall would be exponential, as most consumers will pay a small amount
extra for environmental benefits but will balk at paying large amounts, both for
affordability reasons and dislike of free-riders. Therefore, this system is unlikely to be
considered bankable until sufficient market pressure exists to persuade large numbers of
consumers to purchase green power. In reality this means regulatory compulsion, as
marketing alone is unlikely to achieve this and investors would require suitable
enforcement methods to encourage the market in green certificates in order to avoid
undue free riders.

8.7 Conclusion
It is clear from the above that the ideal system does not exist and it will remain a
balance between economic efficiency, bankability and the encouragement of different
technology bands. The UK Government has made a clear commitment to renewable
energy:
“Renewable sources of energy make an important contribution to secure, sustainable
and diverse energy supplies and are an essential element of a cost-effective climate
change programme52.”
However, legislation is required for a renewables market to work properly. Once a
framework has been established, legislative intervention should be minimised to ensure
prices do not reflect expectations of political action rather than pure economic drivers.

52 John Battle MP, Minister for Energy in New and Renewable Energy - Prospects fertile 21st Century, March 1999.

68
However, a framework designed to encourage economically rational behaviour is not in
itself sufficient to ensure access to long term capital.
For the purposes of raising large amounts of long term finance through the capital
markets, the ideal contract is one that provides a long term, predictable set of cash flows
that only depend on the project’s operational performance and off-taker’s effective
credit rating. Other incentives may be as effective in getting capacity built and ensuring
its debt is paid off, by providing relatively high, but short term payments, although this
will bias renewables towards wind due to its relatively low capital costs compared to
Waste to Energy. Therefore, it seems that technologies with costs converging towards a
wholesale power market price are best incentivised with long term, competitively bid
large contracts (ie 50 - 100+ MW) that do not penalise geographically dispersed
aggregation. Non-convergent technologies need similarly reliable incentives but with
less rigorous price competition but more rigorous commercial and technical assessment.
Conclusions that may be drawn from the case studies in Appendix H are:
> the provision of creditworthy long term power contracts greatly expands the range of
renewable energy projects that can be financed;
> the mitigation of power price risk for lenders, through a fixed pricing mechanism
enables senior debt gearing to be increased and the amount of truly subordinated
debt or equity to be decreased, with a resultant decrease in cost;
> long term bond financing keeps power prices low in the early years while
maintaining adequate debt service coverage ratios.

69
70
9. UK Application
9.1 Outline
This chapter provides a succinct review of the main issues regarding renewable energy
financing in the UK and the application of the capital markets, based on the more
detailed information contained in the preceding chapters. Due appreciation of the
complexity involved in any financing is required and an awareness of the often
unintended consequences certain decisions may have. Therefore it is always important
to obtain appropriate professional advice for the particular circumstances of the
transaction under consideration.
There are four elements of the UK market to consider:
> existing plants that are operating under NFFO-3, 4 and 5;
> the 2GW of NFFO-3, 4 and 5 capacity not yet constructed;
> the ex-NFFO-1 and 2 plants de facto under the percentage obligation;
> new build plants under the percentage obligation.

9.2 Capital Market Advantages

The main advantages of the capital markets are tenor, price (from time to time), the
ability to access a wide range of investors and the ability to benefit from innovative
features, such as index linking. Whether the underlying assets are green or not does not
affect in any material way the ability to raise finance - it is the underlying quality of the
cash flows that matters. This applies equally to all forms and sources of finance.
Grouping projects may help, as a more diversified pool of assets with some cross-
collateralisation will lower the risk profile. However, it is unlikely that the benefits of
grouping projects belonging to multiple owners will outweigh the associated transaction
costs.

9.3 Capital Market Disadvantages

For renewable energy the main disadvantage is the minimum size required for the public
markets, although private placements partially get around this. However, the probable
complexity of any renewables deal will make primary marketing challenging and the
relatively short duration of most renewable incentives limits access to the full tenors
possible in the bond markets. Other issues such as disclosure and complex structures
may impact the ability to access the market, unless allowance for a possible capital
markets financing was made when the project was first developed.

9.4 Plants Operating Under NFFO

Plants operating under NFFO are best placed to access the capital markets through
refinancing, which might release additional cash or reduce the cost of borrowing. These

71
plants have high quality power contracts, no construction risk and many have a
substantial operating track record. Opportunity exists for these to be grouped into a
portfolio and thereby achieve the necessary size to attract bond investors. However,
given the relatively short NFFO contract time left (when compared to PFI projects with
contracts of over 25 years), the advantages of the capital markets may be limited to price
indexing and intermittent price competitiveness as the non-NFFO period cashflow risk
will need support from strong corporate covenants. The benefit of longer tenors will not
apply as both sources of capital are easily able to provide this tenor.

9.5 Pre-construction NFFO Contracts

Pre-construction NFFO plants are unlikely to attract bond market finance, unless
supported by strong corporate covenants. Several would need to be grouped together to
achieve the requisite size. It is unlikely that the market will be interested in analysing a
complex construction package, particularly for several sites and technologies. The
inclusion of a small proportion of pre-construction projects within a portfolio has been
achieved with the banking market (but limited to simple, well proven technologies) and
is not ruled out for the capital markets.

9.6 Ex-NFFO Plants

Ex-NFFO plants are effectively under the percentage obligation but have the advantage
of good operating histories. Until the percentage obligation has established a substantial
track record and several commercial bank debt financed projects have proved
successful, it is unlikely that the capital markets will even consider these projects, if a
green premium is required to support the debt, unless supported by strong corporate
covenants. For those projects able to operate at a market price and not unduly exposed
to balancing charges, there is a possibility of accessing the capital markets to refinance a
large portfolio. However, this would only be possible if one company acquired a
substantial proportion of the existing projects, in order to reach a reasonable size. The
markets would not accept projects with multiple ownership and complex inter-creditor
agreements.

9.7 New Build under the Percentage Obligation

In a similar manner to the ex-NFFO generators, new build plants under the percentage
obligation will find it virtually impossible to access the capital markets in the short term.
The only exception is for very large single asset projects that are financed on a limited
recourse basis with strong parent guarantees. This limits the market to the very largest
utilities, such as Vivendi, National Power and PowerGen.

9.8 Conclusion
There are opportunities for renewable energy to access the capital markets, however this
will be primarily for refinancing. The intrinsically smaller size of most renewable

72
generation also limits its access to these markets, and to an extent, also the commercial
bank markets. Non-recourse financing is exceptionally complex and contractually
intensive, which imposes a minimum size due to economies of scale, whatever source of
funds eventually used. The most effective way for the government to open the capital
markets to renewable generators would be to simplify the transfer (ownership and site)
of pre-construction NFFO contracts. This will allow some contract consolidation and
hence larger project sizes.

73
74
10. Alternatives
10.1 Outline
This section highlights a number of alternative approaches to financing renewable
energy assets and means by which the industry can be encouraged. The ideas outlined
below represent a selection of some of the more innovative concepts that were discussed
as part of the research process for this report, although events in the UK market may
well overtake these. They are included here to stimulate discussion, rather than provide
solutions. Those concepts that merit further study and assessment may be selected for
subsequent development by the New and Renewable Energy Programme.

10.2 Pre-Prepared Portfolio

The Schroders’ PFI fund (see Section 7.19) with its generic documentation and bridging
loan for the construction period demonstrates a market based approach to help smaller
projects raise finance in a cost effective manner. However, the up-front costs of
establishing this fund were very substantial and it is considered unlikely that the
renewable energy sector would stimulate sufficient interest from a finance House for
this type of up-front investment due to its smaller size, lack of clear commercial
prospects and more uncertain future than PFI. Schroders’ judgement on PFI was
positive, but renewable energy without any clear framework available offers little
commercial incentive. Further study on this approach and the actual costs involved
might identify an opportunity for a portfolio structure to be created with or without
Government assistance, such that it can then operate on a commercial basis.

10.3 Capital Markets Incentive

Two principal attributes of the capital markets are the financing term offered and the
size of funds raised. Infrastructure projects are generally long-term assets that need long
term finance to maximise the economics. Renewable energy with its relatively high cost
structure needs term financing to an even greater extent, but to achieve this, senior debt
lenders (whether bond or bank markets) need certainty.
Therefore, based on the above considerations, a new incentive scheme might be run on
the following lines:
> Term of 20, 25 or 30 years, depending on the technology;
> A minimum contract size of 50MW and a maximum size of 100MW;
> The contract would be company (one contract per company per round) specific,
rather than site specific and not transferable until post-construction;
> Power price will be sufficient to ensure an average DSCR of 1.1, provided that third-
party senior debt is between 70-80% of the financing and that a minimum output
specification is achieved (for instance in terms of capital expenditure, operating

75
 expenditure, heat rate, availability and the like - ie technology performance risk
remains with the debt/equity investors);
> Power price will be adjusted downwards if the contracted amount is not achieved.
This system would encourage larger corporate involvement, while focussing on
technologies that offer scale and replicability and offer front-end economies due to the
use of long-term debt. A broadly similar concept is used in the PECO Energy
securitisation through the ‘Competitive Transition Charge’ mechanism (see Deal 19 in
Appendix H).

10.4 Securitise Green Premiums

As a market for green certificates or premiums develops, income to sponsors may come
from two separate sources: power sales and green premiums; which might not
necessarily be sold to the same purchaser. When a green obligation is imposed on an
annual basis, this improves the opportunity for variable output generators (eg wind and
CHP) to raise funds against the green premium sales. The longer averaging period
provides a lower risk and the green premium purchaser might be of higher credit quality
(ie an industrial customer rather than a small aggregator). Sponsors may also wish to
sell forward their premiums. Areas for further study include: the direct market for green
premiums (ie not through a Supplier); and the design of a trading exchange for green
premiums (rules, instruments and legal position).

10.5 Weather Derivative Hedge

A number of innovative capital market and derivative products have been successfully
marketed over the last two years. These include a bond with repayments dependent on
earthquake risk in Japan, weather derivatives traded on the Chicago Board of Trade and
the development of an OTC53 market for weather derivatives. There is potential for
certain technologies (such as wind power) to provide a quasi hedge for some of these
instruments, in that their revenues move inversely to some weather risk that the
underlying market may wish to hedge. This should probably be considered a revenue
enhancement tool for green power producers, rather a core financing method.

10.6 Stranded Asset Approach

Stranded assets in the power industry are typically assets that were built during
government ownership or control of utilities, but when deregulation occurred the costs
associated with those assets were unsustainable in an open market. A number of
examples are detailed by Deals 18 and 19 in Appendix H.
Stranded assets are generally funded by a set levy imposed on all consumers, agreed
with the regulator for a set number of years and protected from subsequent challenge.

53 Over the Counter.

76
This concept is widely found in the US power market and in the Italian and Spanish
securitisation of nuclear credits. The levy is securitised, the funds purchase the assets
and their future obligations ring-fenced from the main operating company. This might
provide a method of ensuring marginal assets continue to generate. The assets are
grouped and funds raised in different risk tranches, with Government support for the top
tranche (ie to guarantee marketability) and commercial finance raised for the remainder.
The Channel Tunnel Rail Link provided a unique example of the benefits of a
government guarantee in marketing the bonds, although the public sector test (the
guarantee would not be called in any reasonable scenario) may be harder to achieve in
this context.

10.7 Government Sponsored “Wrap”

Monoline insurers impose a tough and sometimes onerous covenant package on the
projects they sponsor. Given the uncertain nature of some renewable energy
technologies, it is unlikely that a monoline would accept sufficient of the risks to make
the insurance economic (particularly for non-NFFO projects, due to the change from
quasi-sovereign risk). The Tyseley Waste to Energy plant is a good example of the
credit strength required by a monoline insurer before its guarantee is committed (see
Deal 12 in Appendix H).
There are a number of market stimulation funds operating, such as the Photo Voltaic
Market Transformation Initiative sponsored by the IFC (ie World Bank) that work on a
semi-commercial basis to provide support and develop a market ahead of full scale
commercial acceptance. Another example is the Aqua Fund supported by OPIC (a US
Government Agency) that raises debt on the public market and lends it on to the Aqua
Fund. The public debt is guaranteed by OPIC and corporate investors fund around one-
third of the Aqua Fund. The fund then invests in water infrastructure projects, but due
to the low debt costs, the fund is able to generate higher returns for its commercial
investors than they would achieve through a straight investment and thereby allow a
greater number of projects to qualify for financing.
For renewable energy, the fund would be managed by a commercial organisation to
provide an insurance wrap to relevant projects. A commercial return would be possible
due to the fund manager’s detailed understanding of the renewable energy market
(because the contract makes it economic to develop the knowledge) and the ability to
accept risks that a monoline could not, due to its regulatory capital restrictions. Equity
investors in projects would still be exposed to risk and the wrap manager would be
incentivised through a mix of results from the number of projects supported and the
return made on the underwriting.

77
78
11. Conclusions and Recommendations
11.1 Context
The sterling capital markets provide a potentially deep, liquid pool of finance for
projects with a debt requirement in excess of £100 million; the underlying credit
strength of the project - prior to the involvement of a monoline insurer - is usually
around the BBB level; and direct or indirect support from a large corporate is often
required to give the credit the requisite strength.
Most renewable energy projects have not met these criteria, primarily on account of
size, but also because many project sponsors under NFFO 1 to 5 are small, financially
weak entities compared with companies like Vivendi and Enron whose support for
Tyseley and Sutton Bridge respectively was crucial for the bond issues attaching to
those transactions.
In contrast, the volume of bond issues emanating out of the PFI sector54 reflects:
> the availability of larger transaction sizes;
> financially more robust sponsors;
> agreements that provide long term, high quality contracted-for revenues streams,
contingent (only) upon performance.
We conclude that commercial bank debt continues to provide an effective and flexible
means of financing projects across all sectors. While there are pricing and term
advantages, from time to time, in using capital markets finance, the liquidity and
extended maturities available from some banks - particularly for PFI projects -
continues to make commercial debt a competitive option and, for most NFFO style
projects, the only option.

11.2 NFFO
The NFFO framework has been responsible for securing commercial bank support for
renewable energy projects. The certainty, credit quality and enhanced nature of the
NFPA contracts provided an “equity substitute” for an industry most of whose early
sponsors were small, undercapitalised companies. That phase of the industry’s
development is almost certainly drawing to a close following the publication in
February 2000 of the Government’s “Conclusions in Response to the Public
Consultation on New and Renewable Energy, Prospects for the 21st Century”.
The Government has announced its intention to move away from the existing NFFO
arrangements and adopt a percentage obligation on all electricity suppliers, as outlined
in that document. This is likely to steer future renewable energy development towards

54 In 1999, bond debt accounted for over 25% of all new PFI deals (31% if the Pay Water private placement is
included) compared to 10% in 1998. Total new PFI deals in that year were £1.97 billion.

79
the larger, financially robust corporates, capable of taking the electricity market price
risks inherent in the new scheme and largely absent from its NFFO predecessor. The
means of financing within this new framework will also change, as financiers will place
greater reliance on the credit strength and direct support from project sponsors, in the
absence of the predictable contracted-for cash flows obtainable under NFFO. A limited
recourse financing approach if pursued will need a greater proportion of equity and
subordinated debt (ie lower gearing) in conjunction with more robust shareholder
guarantees. Many of the smaller companies that originally started the UK renewables
business will not have the financial strength to provide such support and may need to
consider merging with larger organisations. Unless these smaller firms offer unique
skills, joint ventures are unlikely. From an industrial perspective, we view this as a
potentially positive development for the achievement of the Government’s renewable
energy targets for 2003 and 2010. However, the flexibility, willingness to take risk and
innovative approach deployed by many small companies provides a vital ingredient in
the sector’s ability to become a vibrant industry. It is unlikely that the pioneering work
achieved so far could be repeated under a grant based system.

11.3 Percentage Obligation

It is unrealistic at this early stage to expect financiers to make long term credit decisions
based on judgements of:
> the likely future price level of Green Certificates;
> the future supply / demand relationship for renewable energy, or
> the likely cost competitive position of one renewable energy technology over
another.
It remains to be seen whether large corporate sponsors are willing to take these risks
themselves. There is likely to be a lull in the development of renewable energy in the
UK (exacerbated by the gap between NFFO-5 and the start of the percentage obligation)
while all parties assess the new arrangements and this will impact all types of financing,
not just the bond markets. Financial institutions will need to embark on a detailed due
diligence exercise to understand the new order and to put the sunk costs of research into
the NFFO framework behind them. Further discouragement of a quick take up comes
from the relatively low cap on green certificates, which distorts the economic incentives.

11.4 Refinancing
In the short to medium term, the bond market and securitisation provide a potential
source of refinancing for NFFO based projects, which may release funds for further
project development. The 2GW of NFFO-3, 4 and 5 capacity still not yet built provides
ample size to access these markets, especially if additional flexibility is allowed in

80
relocating contracts. However, with a 15-year term, the capital markets provide no
consistent advantage over the commercial bank debt market.

11.5 Other Frameworks

Part of the remit of this study was to look at support mechanisms used in other markets
to see whether they offered any guidance for an alternative support framework in the
UK. We looked, therefore, at designing a scheme that maximised the advantages of
using capital markets finance whilst fulfilling the principal criteria for access, in
particular transaction size and credit strength.
Chapter 10 looks at support frameworks from a number of markets. From the
constituency of schemes described, we would recommend further study of the capital
markets incentive scheme described in Chapter 10.3, if the UK were ever to consider
adopting a successor to NFFO. This structure encourages the use of long term capital
market debt in order to optimise electricity price economics in the early years of a
project. The structure involves the recalculation of the electricity price each year to a
level sufficient to provide senior lenders with acceptable debt service cover, subject to
the plant meeting a minimum output specification. There are precedents for this
approach and one of them, PECO Energy Transition Trust (Transaction 19 in Appendix
H) incorporates a mechanism referred to as the Reconciliation of Competitive Charge.

11.6 Summary

In summary, bond finance and as a subset of this, securitisation, provide a

source of finance for renewable energy projects. However, commercial bank debt
also provides a readily available, large source of finance. In Impax Capital’s view,
the availability of finance per se is not restricting the growth of renewable energy
in the UK. Availability of finance is simply a function of the renewable energy
framework and access to commercially sound projects, as there is currently no
shortage of liquidity in the bank or capital markets.

81
82
12. Appendices

A Glossary

B Credit Ratings

C Sovereign Credit Ratings

D UK Power Company Credit Ratings

E NFFO and the Fossil Fuel Levy

F Financial Times Bond Table

G Case Study of a Bond Financing: Sutton Bridge Power

H Deal List

83
84
Appendix A - Glossary
Some of the terms in this Glossary have different meanings in contexts other than those
of the international markets and certain domestic markets.

Accrued Interest Interest earned but not collected. Interest due from the issue, or from the last coupon
date to the present on an interest-bearing security, or from the last payment due date
on a loan.
All-in Rate An interest rate on a loan that includes the funding cost, risk margin, cost of
compensating balances, commitment fees and any other charges.
Allotment The allocation of a new issue of securities by the lead-manager among members of
the syndicate. This normally takes place after the issue’s subscription period and
after its final terms have been fixed. The syndicate members in turn allocate the
securities to their investor clients.
Amortisation (1) The gradual reduction of any amount over a period of time. A general term
which includes practices such as depreciation depletion, write-off or intangibles,
prepaid expenses, and deferred charges; or general reduction of loan principal.
(2) Gradual repayment of a debt over time.
(3) Repayment through the operation of a sinking or purchase fund.
Annuity A level stream of cash flows for a limited number of years.
Arbitrage In theory it is the simultaneous purchase and sale of an asset (usually in different
markets) to take advantage of price anomalies. In practise it is far more complex, but
the intention is to take advantage of discrepancies in the market.
Arms Length A term referring to agreements made between unrelated parties or as if the parties
were unrelated. It implies open market rates/conditions.
Asset-backed Securities collateralised by a pool of assets. The process of creating securities
securities backed by assets is referred to as asset securitisation.
Association of An association of over 500 member firms from 30 countries. The main objective of
International Bond the AIBD is to provide a basis for examining the secondary market, issue rules
Dealers (AIBD) governing the markets and to maintain a close liaison between the primary and
secondary markets.
Balloon payment Where a term loan is amortised in equal periodic instalments except for the final
payment, which is substantially larger than the other payments, the final payment is
known as a balloon payment.
Base Rate Floating interest rates on bank loans are sometimes quoted on the basis of the prime
rate or the base rate of the lender.
Basis Point (bp) One one-hundredth of a percent (ie 0.01%), typically used in expressing rate or yield
differentials.
Bearer Bond A bond for which the only evidence of ownership is possession.
Benchmark In the context of a bond, this is typically a “risk free” bond (usually from the
government) that has a similar duration to the bond being raised that provides a base
interest rate, to which a risk related premium (the spread) is added to calculate the
bond’s coupon.
Bid and Offer Bid is the highest price a prospective buyer is prepared to pay at a given time for the
tradable unit of a specific security; Offer is the lowest acceptable price to a
prospective seller of the same security. Collectively, the two prices represent a
quotation and the difference between them is the spread.
Boiler Plate A colloquialism that refers either to standard terms and conditions in a contract, or
the level of protection/armour required in order to achieve a transaction.

A-1
Bond A bond is a negotiable note or certificate, which evidences indebtedness. It is a legal
contract sold by one party, the issuer, to another, the investor, promising to repay the
holder the face value of the bond plus interest at future dates. Bonds are also
referred to as notes or debentures. The term note usually implies a shorter maturity
than bond. Some bond issues are secured by a mortgage on a specific property,
plant, or piece of equipment.
In certain markets the terms “bond” and “debenture” refer to different levels of
security. In the UK a debenture is usually secured and a bond is unsecured, whereas
in the US, this is the opposite way around.
Bond House A firm which underwrites, distributes and deals in bonds as one of its primary
activities.
Bond Rating An appraisal by a recognised bond rating service of the soundness of a bond as an
investment.
Bought Deal A Eurobond issue that is fully underwritten on fixed terms and conditions by the
Lead Manager. A bought deal occurs when the Lead Manager offers to launch an
issue with a specified price and spread.
Bridge Financing Interim financing of one sort or another.
Broker Brokers are intermediaries who trade in a variety of financial instruments including
foreign exchange, equities, commodities, bullion or insurance on behalf of their
clients and who charge a fee-or commission-for this service and advice. Brokers
fulfil an important function in the market by bringing together buyers and sellers in
an efficient manner.
Capital Markets A broad term used to describe both debt and equity raised in the form of tradable
securities principally from non-bank sources, i.e. pension and life companies,
insurance companies, corporate investors and private accounts.
Cash Sweep A mechanism whereby post debt service cash flows can be redirected to pre-pay
certain obligations (usually senior debt principal).
Clip and Strip In this type of bond, the principal and coupon portion of the bonds may be split apart
Bonds and sold separately.
CLO Collateralised loan obligation. Payments to the CLO bond holders are derived from
the cash flows realised from the underlying pool of loans in the securitised portfolio
Co-financing Where the different lenders agree to fund under the same documentation and security
packages yet may have different interest rates, repayments, profiles and terms (e.g.
tranches A and B).
Collateral Assets pledged as security to assure payment.
Co-manager A member of the management group of a securities offering other than the lead
manager(s). A second-tier participant, ranked by size of participation.
Commitment Fee A per annum fee applied to the portion of the unused financing (the amount not yet
drawn down) until the end of the availability period.
Commercial Bank A bank that both accepts deposits and grants loans and, under certain stipulations in
some countries, pays interest on current accounts.
Commercial Paper An unsecured promissory note with fixed rate and fixed maturity of less than 270
days. Commercial paper is normally sold at a discount from face value.
Committed Loan A legal commitment undertaken by a bank to lend to a customer.
Facility
Consolidate The process of combining the accounts of a group of companies onto one set of
accounts. This may mean showing the combined debt of all group companies, even
though most of it is actually non-recourse to the parent’s balance sheet. This is a
presentation issue, rather than an economic issue.

A-2
Convertible Bond A bond containing a provision that permits conversion into other securities of the
issuing entity, typically ordinary equity at some fixed exchange ratio.
Convertible Debt Debt convertible to equity or debt issues of the issuer upon the happening of certain
events and/or at the option of the lender.
Coupon The annual rate of interest on the bond’s face value that a bond’s issuer promises to
pay the bondholder. One of a series of actual certificates attached to a bond, each
evidencing interest due on a payment date.
Coupon Rate The rate of interest received by a bondholder on an annual, bi-annual or quarterly
basis.
Covenant A loan covenant is agreement by a borrower to perform certain acts, such as the
timely providing of financial statements, or to refrain from certain acts such as
incurring further indebtedness beyond an agreed level. A breach of a covenant is a
Default.
Cover The amount above unity of a Debt Service Ratio.
Credit The issue of a Guarantee, L/C, or additional Collateral to reinforce the credit strength
Enhancement of a Project Financing.
Cross­ Project Participants agree to pool their Collateral (i.e. allow Recourse to each other’s
Collateralisation Collateral).
Cross-collaterised Pooled securities allowing recourse to other security interests in the pool.
pooled financing
Cure Making good a Default.
Current Yield The ratio of the coupon on a security to its market price, expressed as a percentage.
DCF Discounted Cash Flow where net cashflow is brought to a Present Value using a
given percentage Discount Rate.
Dealer A securities dealer, as opposed to a broker, acts as a principal in all transactions,
buying and selling for his own account.
Debt (Liability) An obligation to pay cash or other goods or to provide services to another.
Debt Capacity The total amount of debt a company can prudently support, given its earnings
expectations and equity base.
Debenture A legal security over the Issuer’s assets.
Debt Service Principal Repayments plus Interest Payable. Usually expressed as the annual
dollar/currency amount per year.
Default Failure to make timely payment of interest or principal on a debt security or to
otherwise comply with provisions of a bond indenture or loan agreement. A Money
Default means a repayment was not made on time. A Technical Default means a
Project parameter is outside defined/agreed limits or a legal matter is not yet
resolved.
Default Premium The increased return required to compensate investors for the risk the company will
default on its obligation.
Deferred Coupon Bonds in which the interest payment is postponed to some date prior to maturity.
Bonds
Discount Rate The annual percentage applied to NPV or PV calculations. The Discount Rate may
be a Weighted Average Cost of Capital.
Direct Placement Selling a new issue not by offering it for sale publicly but by placing it with one or
several institutional investors.
Discount Bond A bond selling below par.
Discount Non-interest-bearing money market instruments that are issued at a discount and
Securities redeemed at maturity for full face value; for example, US Treasury bills.

A-3
Disintermediation The investing of funds that would normally have been placed with a bank or other
financial intermediary directly into debt securities issued by ultimate borrowers; for
example, into bills or bonds.
Domestic Bonds Bonds issued by a borrower in its country’s own domestic bond market.
Drawdown The Borrower obtains some of the Project Financing, usually progressively
according to construction expenditures.
DSCR Debt Service Cover Ratio. The ratio of cash available to service the debt in a
specific period divided by that period’s debt service requirement.
Dun & Bradstreet A firm that rates the creditworthiness of many borrowers and generates financial
ratios for many industry groups.
ECGD Exports Credits Guarantee Department of the United Kingdom.
Efficient Market A market in which asset prices instantaneously reflect new information.
EIB European Investment Bank. An organisation owned by the governments of the EU
that lends at preferential rates to large infrastructure and similar projects that assist
economic development in Europe. It accepts very limited risks, will only fund a
portion of a project and often requires preference over other senior debt providers.
EIB won’t take construction risk and the technology needs a good operating history
and progressive release of bank guarantees. Its spread is typically flat to 5bp under
commercial banks.
EPC ‘Engineer Procure Construct’. A generic term used for a turnkey construction
contract where the contractor takes responsibility for all aspects of the construction
and provides (bankable) performance guarantees.
Equity Kicker A share of ownership interest in a company, project or property in consideration for
making a loan. The kicker may take the form of stock, stock warrants, purchase
options, a percentage of profits, or a percentage of ultimate ownership.
Eurobond A Eurobond is any bond in any currency issued outside a borrower’s domestic
market and sold to international banks. Eurobonds have no domestic market and are
often bearer instruments. Eurobonds are not registered in the United States and
therefore can not be originally sold to a US investor. They are genuinely
international instruments.
Face Value The maturity value of a bond or other debt instrument. Sometimes referred to as the
bond’s par value or nominal value.
Fiduciary An individual, corporation, or association, such as a bank or trust company, to which
assets are given to hold in trust, according to the trust agreement.
Fixed Rate Bond A fixed rate bond pays the same rate of interest to investors throughout its life and
has a final maturity date.
Floating Interest An interest rate which fluctuates during the term of a loan and which is adjusted
Rate upwards or downwards during the term of a loan in accordance with some index of
short-term rates.
Floating Rate A floating rate note issue has no fixed rate of interest. The coupon is set periodically
Notes according to a predetermined formula tied to short-term interest rates in the
appropriate market. Usually refers to floating rate notes issued in Europe, although
all kinds of floating rate instruments are issued in the United States. The holder may
have the right to demand redemption at par on specified dates.
Gearing The level of debt to enterprise value (ie debt plus equity). Alternatively the debt to
equity ratio (not used in this report).
Grace Period (1) The period between a primary market offering of an issue of securities and the
first operation of its sinking fund, and
(2) The period which may be allowed to the borrower to remedy an event of default.

A-4
Hell-or-High-Water A requirement that an obligation, such as rent payments, be carried out “come hell-
Clause or-high-water”. An unconditional, absolute obligation not subject to defence of non­
performance by the other party to the contract.
Illiquid A financial instrument not easily traded or converted to cash.
Indenture of a A legal statement spelling out the obligations of the bond issuer and the rights of the
Bond bondholder.
Indenture Trustee The holder of a security interest in property for the benefit of the lenders.
Indexed Loan A loan with debt service repayment tied to some standard which is calculated to
protect the lender against inflation and/or currency exchange risk.
Information A document detailing the Project and Project Financing.
Memorandum
International A group which endeavours to standardise the way which new Eurobond issues are
Primary Markets launched, encouraging common standards and greater disclosure. The London or
Association Luxembourg stock exchanges require the issuer to comply with its relevant listings
procedures.
Institutions Insurance companies, pension funds, trusts, foundations, mutual funds, funds
managers, bank investment departments.
Investment Bank A term applied to a financial institution engaged in the issue of new securities
including management and underwriting of issues as well as securities trading and
distribution. Investment banks engage in buying and selling securities, such as
stocks, bonds and mortgages. Investment banks also act as intermediaries between a
corporation that requires funds and investors.
Investment Grade For a rating, the rating value above which institutional investors have been
authorised to invest. Genetically, it is instruments rated BBB or higher.
IRR The Discount Rate making the NPV zero.
Junk Bond A sub-investment grade bond or unrated high-yield bonds.
Keep-Well Letter A form of guarantee in which the guarantor agrees to keep the recipient of the
guarantee well, by injecting capital as needed. Sometimes called a maintenance of
working capital guarantee. If properly worded, a keep well letter can be the
equivalent to a formal guarantee.
Lead Arranger The senior tier of Arranger.
Lead Bank A senior bank involved in the negotiations for a Project Financing. Subordinate to
an Arranger. Lead Manager.
Lead Manager Senior tier of lender in a loan Syndication.
Limited-Recourse Under certain conditions (legal or financial), there is access to the sponsor’s credit or
other legal security for repayment, besides the Project’s cashflow. There is usually
Recourse in the event of fraud or misrepresentation/non-disclosure - thus “Non­
recourse” is better described as “Limited Recourse”.
Liquid Easily traded or converted to cash.
Majority in The term typically used in loan indentures to indicate those persons that are titled to
Interest instruct the indenture of the trustee to take action under the indenture.
Manager A medium-level Participant established according to Final Take.
Margin The amount expressed in % p.a. above the interest rate basis or cost of funds. For
hedging and futures contracts, the cash collateral deposited with a trader or exchange
as insurance against default.
Market Risk Changes to amounts sold or the price received which impacts on gross revenue.
Sometimes called sales risk.
Maturity The final date a project finance loan is repayable. The end of the term.

A-5
Merchant Power A power plant that is exposed to full market risk for price and volume for its
electricity sales.
Mezzanine A generic term for finance subordinated to the senior debt but senior to ordinary
Finance equity and possibly preference equity.
Monetisation Securitisation of the gross revenues of a contract.
Moody’s A credit rating agency.
Mortgage A pledge or assignment of security of particular property for payment or debt or
performance of some other obligation. Similar to an indenture of trust or security
agreement.
Mortgage Bond A bond secured by a lien on property, equipment, or other real assets.
Negative Pledge Undertaking by a borrower not to offer improved security arrangements to other
lenders without offering the equivalent security to the instant lender.
Negotiable Any written evidence of a payment obligation which maybe transferred by
Instrument endorsement or by delivery, such as checks, bills of exchange, drafts, promissory
notes and some types of bonds or securitised assets of which the transferee may
become a holder in due course.
NETA New electricity trading arrangements.
NFFO Non Fossil Fuel Obligation
Over­ A transaction specific term. It is the allocation of ‘more’ assets to support a liability
Collateralisation than might other wise be required.
Participant A party to a Funding. It usually refers to the lowest rank/smallest level of funding.
Alternatively, it is one of the parties to the Project Documents.
Participation The amount of loan/bond issue taken directly or from another direct
lender/underwriter.
Pass-through A mortgage-backed security on which payment of interest and principal on the
underlying mortgages passed through to the security holder by an agent.
PPA Power Purchase Agreement, a long-term power supply contract.
Praecipium The amount of the front-end fee retained by the Arranger(s) and not distributed to the
joining members of a Syndication.
Prime Rate The rate at which banks lend to their best (prime) customers. The all-in cost of a
bank loan to a prime credit equals the prime rate plus the cost of holding
compensating balances.
Private Debt A placement of debt securities to a limited number of sophisticated investors, as
Placement opposed to a public placement. Registration requirements are simpler in a private
placement and greater disclosure is often possible through the use of confidentiality
agreements. However, the security might have a limited secondary market.
Pro rata Shared or divided according to a ratio or in proportion to participation.
Project Financing A loan structure, which relies for its repayment primarily on the project’s cashflow
with the project’s assets, rights, and interests, held as secondary security or
Collateral.
Project The Asset constructed with or owned via a Project Financing, which is expected to
produce cashflow at a debt service cover ratio sufficient to repay the Project
Financing.
Prospectus A formally approved document describing the business and affairs of the issuer and
the terms and conditions of the security. An offering Circular in the US filed with
the SEC, e.g. for an IPO or a rule 144a Bond Issue.
PV Present value where a stream of cash flows or accounting flows are discounted to the
present at a Discount rate.

A-6
Quality The degree of credit risk of a security or borrower. High quality borrowers are
perceived to have greater than average ability to make debt service payments and
hence offer less risk.
Rating Agencies Agencies that study the financial status of a company then assign a quality rating to
securities issued by that firm. Standard & Poors and Moody’s are leading rating
agencies.
Recourse In the event that the project (and its associated escrows, sinking funds, or cash
reserves/standby facilities) cannot service the financing or Completion can not be
achieved, then the Financiers have resource to either cash from other
Sponsors/corporate sources or other non-Project security.
Rule 144A A rule adopted by the US Securities and Exchange Commission that eliminates the
two year holding period of privately placed securities by permitting large institutions
to trade such securities among themselves without having to register them with the
SEC. Less stringent documentation and disclosure is permitted than for normal
securities.
Running the Book The manager who has total control over a debt syndication or bond offering (usually
appears on the upper left of the list of underwriters in a tombstone advertisement).
Seasoning The age of a loan portfolio. It is primarily used in the mortgage market where
defaults and redemption rates are a function of the age of the loans.
Secondary Market After the initial distribution of bonds or securities, secondary market trading begins.
New issue houses usually make a market in bonds or securities they have co­
managed. Other institutions, generally act as market makers in a wide range of
issues and instruments by quoting two-way prices and being prepared to deal at those
prices.
Secured Creditor A creditor whose obligation is backed by the pledge or some other security over
assets. In the event of a default, the secured creditor receives the cash from the sale
of the pledged asset to the extent of their debt and they are usually able to force the
sale of those assets to meet this obligation.
SEC Securities and Exchange Commission. An agency in the United States created by
congress to protect investors in securities transactions by administering securities
laws and regulations.
Security A legal right of access to value through mortgages, contracts, cash accounts,
guarantees, insurance’s, pledges, or cash flow including licenses, concessions and
other Assets. A negotiable certificate evidencing a debt or equity
obligation/shareholding.
Securitisation The process under which pools of receivables - that is, contractual entitlements to
receive amounts of money - are packaged into marketable, transferable, investment
grade securities that are distributed to investors.
Senior Creditor Any creditor with a claim on income or assets prior to that of general creditors.
Senior debt All debt, both short term and long term, which is not subordinated to any other
liability. In addition, most current liabilities such as accounts payable, accrued
expenses and taxes are usually considered senior debt. If the financial statements do
not specify whether the debt is senior or subordinated, conservative practice is to
assume it is senior.
Sinking fund A reserve of the sinking fund established or set aside for the purpose of payment of a
liability anticipated to become due at a later date.
Indentures on corporate issues often require the issuer to make payments into a
sinking fund. The proceeds are used to retire randomly selected bonds in the issue,
or in some instances by market purchase.
Sovereign risk The government’s part of political risk.

A-7
Special purpose An independent corporation with nominal capital which is a party to a project
corporation financing for purposes of holding title as a nominee or acting as a conduit of funds.
Sometimes known as an SPV - special purpose vehicle. The structure has
implications for security and bankruptcy remoteness in some jurisdictions.
Sponsor A party wishing to develop a Project. A developer.
Spread The risk related interest premium added to the benchmark rate to calculate a bond’s
coupon. This is usually measured in basis points.
SPV See special purpose corporation.
Strip Debt Debt arranged in tiers with different rates, maturities and amortisation to improve the
borrowers cost.
Syndicated Loan A commercial banking transaction in which a number of banks undertake to provide
a loan or other facility to a customer on a pro rata basis under identical terms and
conditions evidenced by a single credit agreement. The pricing will normally consist
of a fixed spread over a short term based rate with commitment fees, agency fees,
management fees, offsetting balances, security, etc, often included as well.
Subordinated The subordinated party accepts a lower priority of repayment and/or security than
Debt senior debt.
Takeout A financing is structured to refinance of take out another loan, such as a
construction loan.
Tap Basis In the Euro commercial paper market, the method of issuance where by the dealer
approaches the issuer for paper in direct response to particular investor demand
rather than the issuer seeking bids from the dealer.
Tenor The number of years a loan is made for.
Term loan A loan with an original or final maturity of more than one year, repayable according
to a specified schedule.
Tolling Agreement A long-term contract to make periodic payments over the life of the contract in
certain minimum amounts as payment for a service or a product.
Tombstone An announcement placed in a financial newspaper or journal which announces a
financing or performance of some financial service.
Treasury Bill A non-interest-bearing discount security issued by the US Treasury to finance the
national debt. Most bills are issued to mature in three months, six months or one
year.
Trustee An independent or nominated third party who administers corporate or financial
arrangement.
Underwriter A financial firm engaged in the business of underwriting securities issues.
A dealer who purchases new issues from the issuer and distributes them to investors.
In a Eurobond offering the Lead Managers and Co-managers act as underwriters for
the issue, taking on the risk of interest rates moving against them before they have
placed the bonds. Additional banks maybe invited to act as sub underwriters, so
forming a larger underwriting group.
Underwriting An arrangement under which a financial house agrees to buy a certain amount of
securities of a new issue on a given date and price, thereby assuring the issuer the
full proceeds of the financing. The commitment to fund is not contingent on
Syndication.
Unsecured Loan A loan made on the general credit of a borrower. The lender relies upon the borrows
balance sheet and the capability of the borrower’s management to manage its assets
and produce cash flows sufficient to repay the debt No assets are pledged.
Yield The financial return, usually expressed as an annual percentage.

A-8
Yield Curve The relation ship between yield and current maturity is depicted in graphic form as a
yield curve. This curve plots yield on the vertical axis and maturity on the horizontal
axis. A normal yield curve slopes upwards from left to right, from short maturities
to long maturities.
Yield to Maturity The rate of return from a debt security held to maturity when interest payments and
the investor’s capital gain or loss on the security are taken into account.
Zero Coupon A bond that pays no interest. The security is sold at a discount and its yield is
determined by a rise in value per unit of time. Its maturity value equals par.

A-9
A-10
 Appendix B - Credit Ratings

S&P Moody’s Fitch Duff & Description

IBCA Phelps
Gilt edge, prime securities, the highest debt rating assigned.
AAA Aaa AAA AAA
AA+ Aa1 AA+ AA+
Very high grade and quality. Capacity to repay is strong and
AA Aa2 AA AA
differs marginally from AAA.
High Creditworthiness
Investment Grade

AA- Aa3 AA- AA-

A+ A1 A+ A+
A A2 A A Upper medium grade, strong capacity to repay, but
susceptible to adverse economic conditions.
A- A3 A- A-
BBB+ Baal BBB+ BBB+
BBB Baa2 BBB BBB Lower Medimn Grade. Adequate capacity to repay, but
adverse economic conditions are more likely to lead to
risk.
BBB- Baa3 BBB- BBB-
BB+ Ba1 BB+ BB+
Low Creditworthiness

Low grade, speculative.

:

BB Ba2 BB BB
Speculative

BB- Ba3 BB- BB-

B+ B1 B+ B+
Highly speculative.
B B2 B B
B- B3 B- B-
CCC+
Substantial Risk or in Default

Substantial risk, in poor standing.

ccc C33 CCC CCC
:
Mainly Speculative

ccc-
cc Ca CC Extremely speculative, may be in default.

c C C
Cl Income bonds - no interest paid.

ODD
In default or with payment arrears.
DD DD
D D

B-l
B-2
Appendix C - Sovereign Credit Ratings
Ratings are the country’s credit rating or where applicable, the foreign currency rating.

Rating
Country Long Term Outlook Short
Debt Term
Austria AAA Stable A-1 +
Belgium AA+ Stable A-1 +
Bulgaria B Positive Positive
Denmark AA+ Positive A-1 +
Finland AA Positive A-1 +
France AAA Stable A-1 +
Germany AAA Stable A-1 +
Greece BBB Positive A-3
Hungary BBB Positive A-3
Iceland A+ Positive A-1 +
Ireland AA+ Stable A-1 +
Israel AA- Stable A-1
Italy AA Stable A-1 +
Liechtenstein AAA Stable A-1 +
Luxembourg AAA Stable A-1 +
Malta A Negative A-1 +
Norway AAA Stable A-1 +
Poland BBB Positive A-3
Portugal AA Stable A-1 +
Romania B- Negative C
Russia SD - SD
Slovak BB+ Negative B
Slovenia AA Stable A-1
Spain AA+ Stable A-1 +
Sweden AA+ Stable A-1 +
Switzerland AAA Stable A-1 +
United Kingdom AAA Stable A-1 +
Source: S&P Infrastructure Finance September 1999

C-1
C-2
Appendix D - UK Power Company Credit Ratings

S&P S&P Credit Spread over LIBOR

Company
Rating Outlook 5 Year 10 Year
Avon Energy A- Negative +65 +80
British Energy A- Negative +57 +70
CE Electric A- Negative +55 +69
CSW Invest. A- Negative +55 +69
Hyder BBB+ Negative +79 +95
National Grid AA+ CWD +17 +25
National Power A- Stable +37 +55
PowerGen A Stable +40 +55
Scottish & Southern Energy A+ Stable +17 +27
Scottish Power A+ CWD +22 +33
Southern Invest A- Negative +60 +80
TXU Eastern BBB+ Stable +75 +89
United Utilities A Negative +45 +60
Yorkshire Power BBB+ Negative +75 +95
Source: Chase, "International Fixed Income Credit Research", 29 June 1999

Highest and lowest spread for each maturity are in bold

Ranges:
A+: 17 - 33bp
A-: 37 - 80bp
BBB+: 75-95bp

D-1
D-2
APPENDIX E - NFFO AND THE FOSSIL FUEL LEVY
The Non-Fossil Fuel Obligation (NFFO) requires public electricity suppliers (PES) to
contract for renewable generating capacity. To achieve this, the Secretary of State for
Trade and Industry and the Secretary of State for Scotland are empowered under the
Electricity Act to ensure that each licensed supplier55 buys a certain amount of
generating capacity from non-fossil fuel sources.
Licensed suppliers are obliged, under the scrutiny of DTI and the Office of Electricity
Regulation, to run a competition where individual projects bid for a Power Purchase
Price (PPP56) within different technology bands. Each bid is examined by OF GEM on a
‘will secure’ basis57 and all projects that pass the test are included in the analysis by
OFGEM to recommend the capacity set for each technology band. The Secretary of
State then lays the Order before Parliament and licensed suppliers award sufficient
PPAs to meet the Order on the basis of price per kilowatt-hour generated.
In 1990 all the PESs set up one organisation, the Non-Fossil Purchasing Agency
(NFPA) to act as their agent and pool the obligations for running the competitions and
payments. To meet the NFFO, PESs have to enter into contracts with generators for an
aggregate amount of electricity, which complies with the Order. There are technology
bands for wind power, hydro, landfill gas, municipal and industrial waste, agricultural
waste and energy crops, although these are not always represented in each competition.
PESs purchase the electricity, which contributes to the NFFO through the NFPA.
To meet the higher cost of renewable generating stations, licensed suppliers pay a Fossil
Fuel Levy on their electricity sales revenue. The Levy is collected by OFGEM each
month through the Suppliers’ electricity bills and then given to the NFPA for it to pay
the renewable energy generators the difference between PPP and Contract Price. The
payments are then paid as an additional sum for every kilowatt-hour of electricity
generated by the generator.
Renewable generators are paid according to their bid price (index linked) and not
according to Pool price or any other mechanism. The Act foresaw the development of
the electricity market, a general downward movement of prices (all generation) and
therefore recognised a need to account for the difference between the price paid to the
renewable generators and the market price of electricity. The Act and secondary
legislation derived from it, permits PESs to recover the difference between the price

55 The obligation is on the distribution grid, therefore on the PES. Important when considering consequences of
market supply liberalisation. Suppliers need a licence when selling >500kW and can only obtain it if they are rated at
Investment Grade (no less than S&P’s BBB- or Moody’s Baa3). Some Suppliers are able to post a bond to achieve
this, but the impact on a credit assessment is not yet clear.
50 Fixed indexed price an RE generator would be guaranteed with a NFFO Purchase Power Agreement.
57 Projects are examined under technical, commercial and economic viability criteria in order to ensure that they "will
secure" the capacity specified in the Order.

E-1
paid to generators and the Reference Price. To date, the Reference Price has been set at
the price of electricity in the Pool. Some reference price will arise from NETA
(possibly the average Balancing Market price) although this is not yet certain.
The additional cost is passed through to customers and this is specifically allowed for in
supply price controls. At present the Levy accounts for less than 1% of a customer's
bill. The Fossil Fuel Levy for 1998/99 raised £117m from licensed electricity suppliers
and of this, £114m will fund renewable generation commitments with the remaining
£3m added to the existing £41m surplus from 1997/98. The resultant surplus, plus the
interest generated that has already been taken into account in setting the levy rate for
1999/2000, will be used to offset the amount of levy required in the next rate setting
exercise in spring 2000. The 1999/2000 levy, at 0.3% on the electricity bill, is
equivalent to less than £1 a year on the average domestic electricity bill of £27 558.
OFGEM has two main roles under NFFO. To advise the Secretary of State for Trade
and Industry and the Secretary of State for Scotland on the means of meeting proposed
Orders, and to examine the projects put forward by the RECs to ensure that they 1,1will
secure' the capacity to be specified in the Order. Contracts are awarded competitively
on the price per kWh bid by generators.
As the levy is spread across all consumers and is a statutory requirement on the
Suppliers to collect the funds, the market treats this as a de facto sovereign level of risk.
This comes from the cost being borne effectively by the whole nation and a strong
perception that the UK government will not act retrospectively to change contracts that
are in operation.
In Scotland generators are able to bid for contracts with the two Scottish public
electricity suppliers, Scottish Power and Hydro-Electric, in the same way that applicants
in England and Wales are able to apply for inclusion in the Non-Fossil Fuel Obligation.
Three Scottish Renewables Orders (SRO) have been made to date, the first in 1994,
second in 1997 and third in March 1999. In England and Wales five Non-Fossil Fuel
Orders have been made to date, in 1990, 1991, 1994, 1997 and in 1998.

58 Source: OFGEM.

E-2
 Appendix F - Financial Times Bond Table
EURO-ZONE BONDS
Red.* S&P Bid Bid Day’s Change Mth’s Spread v
15 December 1999 Coupon
date Rating Price Yield Yield Change Yield Govts
□ SOVEREIGNS
UK 01/01 4.250 AAA 100.665 3.62 -0.03 +.20 -0.43
Denmark 01/02 7.750 AA+ 100.908 4.28 +0.00 +0.22 -0.01
Sweden 02/01 5.000 AA+ 101.237 3.85 -0.0.3 +0.19 -0.20
Greece osms 5.750 A- 100.524 5.66 -0.07 +0.08 +0.72
□ SUPRANATIONALS
ADB“ 10/07 5.5000 AAA 101.309 5.29 -0.07 +0.07 +0.46
EIB“* 04/09 4.000 AAA 90.753 5.28 -0.05 +0.11 +0.25
Eurofima**** 12/09 5.625 AAA 100.954 5.50 -0.05 +0.12 +0.47
World Bank 04/05 7.125 AAA 110.520 4.82 -0.06 +0.06 +0.21
□ UTILITIES
EDF 01/09 5.000 AA+ 97.858 5.30 -0.04 +0.09 +0.27
TEPCO 02/03 4.750 AA 100.171 469 +0.00 +0.16 +0.27
Elydro-Quebec 03/08 5.375 A+ 98.680 5.57 -0.07 +0.07 +0.63
Powergen (UK) 07/09 5.000 A 93.540 5.90 -0.03 +0.10 +0.87
□ FINANCIALS
Bad Wurtt 02/10 5.375 AAA 98.744 5.54 -0.04 +0.11 +0.47
OKB 09/07 5.750 AAA 103.244 5.22 -0.05 -0.01 +0.39
Credit Local 04/09 4.750 N/A 95.381 5.39 -0.04 +0.10 +0.36
Abbey Natoional 01/09 5.000 AA- 94.323 5.82 -0.06 +0.10 +0.79
□ INDUSTRIALS
Unilever 05/04 6.500 AAA 106.335 4.85 -0.01 +0.11 +0.34
McDonalds 09/07 5.125 AA 98.324 5.38 -0.06 +0.08 +0.44
Philip Morris 04/09 5.625 A 97.413 6.02 -0.06 +0.09 +1.08
Bat Int Fin 01/09 5.375 A 97.753 5.75 -0.07 +0.05 +1.03
□ PFANDBRIEFE........
Rliein Elypo 12/01 5.500 AAA 102.133 4.33 +0.01 +0.24 +0.28
Euro Elypo 01/04 5.500 AAA 100.560 4.84 +0.03 +0.18 +0.33
Bayer Elypo 01/06 6.000 AAA 104.350 5.15 +0.03 +0.15 +0.43
Depfa 01/09 3.750 N/A 88.188 5.43 +0.02 +0.02 +0.40
□ HIGH YIELD
Ono Finance 05/09 13.000 CCC+ 112.055 10.67 -0.05 -1.08 +5.64
Colt Telecom 07/08 7.625 B 101.719 7.35 -0.05 +0.04 +2.41
Impress Metal 05/07 9.875 B 95.289 10.81 -0.05 +0.94 +5.98
Remy Cointreau 07/05 10.00 B+ 109.286 7.76 -0.03 -0.21 +3.15
^Redemption; **Asian Development Bank; ***European Investment Bank; ““European Company for the Financing of Railroad
Rolling Stock; “*“German Landesbank Mortgage Asset Backed Securities
Source: Financial Times 16 December 1999

New International bond issues |

„ Amount Coupon
Borrower Price Maturity Fees Spread bp Book-runner
m. %
□ US Dollars
Rep of the Philippines (a) 400 9.875# 98 625 Jan 2019 POOR +361(Feb29) Goldman Sachs
Banco Itau SA (b) -
(Brazilian private bank)
100 9.25# 100.432R Feb 2001 0.38R - Barclays Capital
□ EURO (e)
3CIFJ 200 (c) 99 998 Jan 2002 0.125 Deutsche Bank
TPS A Euro Finance (d) -
100 6.125 100.366 Oct 2004 0.325 +145(Jul04) Deutsche Bank/Salomon SB
Polish Telco
□ STERLING
Merchants Trust pic (g) -
30 5.875# 97.241R Dec 2029 0.625R 175(Dec28) Warbusrg Dillon Read
UK investment trust
Final terms, non-callable unless stated. Yield spread (over relevant government bond) at launch supplied by lead manager. J Floating rate
note. # semi-annual coupon. R: fixed re-offer price; fees shown at re-offer level., a) Fungible with $700m. Plus 157 days accrued, b) Fungible
with $100m. Plus 146 days accrued, c) 3-mth Euribor +10bp. d) Fungible with €400m. Plus 56days accrued, e) Spreads relate to German govt
bonds, g) Floating charge over property.
Source: Financial Times 16 December 1999

F-1
F-2
Appendix G - Case Study of a Bond Financing: Sutton Bridge

Deal Summary

Capacity: 790MW CCGT with three 260MW GE 9FA+ turbines.

Senior debt: 25 year BBB bonds, fully amortising from 2002 until maturity in 2022.
£195m 8.625% coupon and $150m Rule 144A 7.97% coupon.
Issued May 1997.

Equity: £42 m.

PPA: 15 year capacity and tolling agreement (CTA) with synthetic tolling agreement for
Eastern Electricity.

Site: South Lincolnshire, 85 miles north of London.

Introduction
Sutton Bridge Power (SBP) marked a ‘coming of age’ for UK IPP bond finance. Until
that deal, the sector had been considered a significant potential source of sterling bonds,
but one that had not fulfilled the capital market’s expectations. SBP was a significant
development in the sterling bond market for several reasons, not least of which was at
that stage only two other power project bonds59 had been issued and these were for post­
construction projects with power contracts covering the debt tenor.

Fund Raising
SBP raised finance pre-construction and against a tenor that included 8 years of
merchant exposure, with 30% of the debt still outstanding at the change over. Much of
the attraction of using the bond market was due to the particular needs of the sponsor,
which wanted a 25 year tenor (commercial bank debt was at that stage only achieving 18
years) and the consequential earlier availability of dividend flows. Market indications
were that institutional investors wanted to see more long-term paper to match their
liabilities, which made the potential to get the bonds away successfully far more likely.
Equally, the sponsor also considered that the strategic benefit of increased visibility
amongst a new pool of investors - the UK institutions - was important and not available
through the commercial debt route. Any sponsor the size of Enron has to regularly raise
finance from the capital markets and increasing its investor base through greater
visibility would assist in future approaches to the markets.
Unusually, the sponsor decided to offer the bonds in parallel to the UK and US market
in order to ensure there was sufficient market depth and appetite for the bonds. At the
same time, the underwriters split the placement equally between themselves, rather than
dividing it geographically by their home markets.

59 El98m Kilroot deal in 1994 and £4bn First Hydro acquisition in 1996.

G-1
Dividing the placement across the Atlantic introduced a further element of competition
that helped narrow the spread - a technique rarely possible in such a direct manner for
the commercial bank debt market. Indeed, it subsequently appeared that the full amount
of debt could have been placed in either market, which suggests that the element of
competition helped tighten the spread finally achieved. To deal with both markets, the
covenant package was based on a mix of US and UK market practice, which investors
were forced to come to terms with. A disadvantage of the split was the unusually long,
dollar bond, currency swap, which was arranged through Enron's risk management unit.

Risk Summary
With regard to the credit rating process of the issue, the project was considered to
expose lenders to the following risks:
> After 2014 or later if the CTA is extended, SBP is exposed to merchant risk until the
2022 bond maturity;
> UK and European gas markets were at an early stage of liberalisation and
deregulation, thus exposing SBP to an uncertain gas industry structure and its
attendant pricing and supply risks;
> Financial forecasts relied on natural gas supplies and transportation in the UK and
Continental Europe to be adequately balanced and below 44 pence per therm (1996
price) during the merchant period;
> Enron Corporation (BBB+), may own as little as 10% of the project's equity by 2014
and will therefore have limited incentive beyond its guarantees and commitments to
the project to provide support if the economics seriously deteriorate;
> UK electricity regulation or other public policy related activities might pass laws and
regulations that would lead to coal being favoured as a fuel stock over natural gas.
However, the following strengths offset the risks:
> Enron Capital & Trade Resources Ltd (ECTRL) a wholly owned subsidiary of
Enron Corporation, has guaranteed all fixed and most operating payments to SBP
with a CTA through May 2014 in exchange for supplying gas to the project;
> Enron Corporation and its subsidiary, Enron Power Corporation, substantially
guaranteed construction of the power plant, thus mitigating construction risk;
> Enron Engineering & Construction Services was a highly experienced contractor that
supervised the construction of the plant;
> General Electric (‘AAA’) supplied two frame 9 turbines and assumed virtually all
operating risk for 12 years (extendable for six years at SBP’s option under the same
terms and conditions). The assumption of risk was made through an Operation and

G-2
 Maintenance agreement (O&M) whereby it is responsible for all O&M costs in
return for a fixed management fee - thus greatly reducing technology risk;
> Gas reserve risk was very low, with British North Sea supplies alone capable of
providing gas at current consumption rates for almost 10 years and European
supplies sufficient for almost 85 years;
> CCGTs were quickly replacing coal-fired generation technology in the UK, a
situation that was expected to continue until most coal and oil-fired generation was
retired by 2014, thus helping CCGT technology remain competitive;
> Minimum debt service coverage ratios (DSCRs) during the CTA period were 1.34
for the base case and extremely robust under sensitivity analyses;
> Minimum forecast base case DSCR of over 2.50 during the merchant period, which
conservatively assumed that technology and gas prices would move SBP from a base
load plant to a peaker facility, and would only rely upon capacity payments from the
pool for coverage of fixed and operating expenses; and
> Financial covenants mirrored those typically found in most project finance
transactions, but also included a two-year forward looking DSCR test on
distribution60 during the merchant period.
The exceptionally strong construction arrangements, contractual allocation of
technology risk to General Electric, strongly supported revenue payments, which in
large part are virtually guaranteed by Enron through to 2014 and fundamentally sound
economics allowed a BBB rating. However, the eight-year tail merchant power period
with its complete exposure to fuel and electricity price/volume risk will limit any
upward ratings movement until the uncertain dynamics of the UK gas and electricity
markets stabilise and become more transparent.

Capacity and Tolling Agreement

The bonds have a three phase life: the first 19 months for construction, where risks were
mitigated through a fixed price engineering services contract with General Electric, the
second phase is a 15 year CTA and the final 8 years expose investors to merchant risk.
At the end of the CTA, some £90 million of debt will still be outstanding, although there
is an option for that phase of the contract to be extended. The arrangers argued that in
the last phase the plant will only be moderately geared and the plant's efficiency will
easily allow the bonds to be fully amortised.
In many respects, the CTA is analogous to a conventional PPA, however, ECTRL does
not directly take the electricity. ECTRL has an agreement with Eastern Electricity pic
which effectively provides Eastern with a synthetic tolling plant, since for certain

o0 Distribution refers to cash paid out of the project company that is not for operating expenses or for the senior debt.

G-3
regulatory reasons, Eastern may not directly own additional IPP capacity. The CTA
initially extends to 2014, after which ECTRL may elect to extend the contract in one-
year increments for 10 years with at least 24 months prior notice. However, the terms of
the CTA were not binding until construction was complete and the plant achieved
minimum performance criteria. Bondholders were at risk in that the terms of the
contract were subject to possible renegotiation if the station did not meet minimum
performance criteria. However, that risk was largely mitigated by liquidated damages
for delay and performance on construction of the station.
The CTA mitigates much of SBP’s business risk as the agreement controls fuel expenses
and eliminates electricity price and volume risk. Functionally, the CTA is an ECTRL
gas-put to SBP and ECTRL pays SBP a fixed sum and a variable sum based on every
fired gas turbine hour. In return, SBP remits all pool proceeds that it may earn to
ECTRL. Fuel costs largely determine SBP’s place on the merit order dispatch curve,
therefore the ability to mitigate fuel supply and price risk reduces its risk relative to its
competitors. SBP virtually eliminated fuel market risk in the early years of the project
by transferring that risk to Enron, which was better able and willing to absorb the risk.
In the latter years, several options may become available, although not as firm
contractually as in the early years, thus exposing the project to fuel market risk.
The CTA is a notable measure of Enron’s commitment and exposure to the SBP project,
as at financial close the present value of the CTA payment until 2014, before netting out
any pool proceeds, was about £500 million. In addition, the CTA insulated bondholders
from most changes in the law affecting the cost of gas-fired generation in England and
Wales. If SBP incurred additional costs or savings due to a change, those costs or
savings pass through to ECTRL.

Financial Structure
Senior creditors comprise the original bondholders and any further issues of these
bonds, plus debt raised to fund required modifications or improvements and a working
capital facility of up to £15 million. Subordinated secured creditors, comprised the
letter of credit facilities and the dollar bond swap provider (ECT) and had no rights of
acceleration, insolvency, etc. The security structure also provided for deeply
subordinated creditors - mainly cost overrun facilities provided by Barclays Bank,
unsecured, but guaranteed by Enron. Deeply subordinated creditors are paid out of
permitted distributions but with no rights of acceleration etc.
Enron structured SBP to provide as much financial flexibility as possible, particularly
during the potential merchant power years. The most important feature is that
approximately 70% of the senior debt will have been amortised by then, thus greatly
reducing the project’s leverage. According to the base case forecasts, which
conservatively assume that SBP will operate as a peaking facility, SBP should have a

G-4
minimum DSCR of 2.5 during the merchant years. During the CTA period, when Enron
has taken away the merchant risk, the projects base case minimum DSCR is 1.34. The
DSCR ratio does not drop below 1.0 until the station’s availability for the year drops to
66%, when the CTA would cause the fixed payments to be adjusted downward so that a
DSCR of less than 1.0 would result. Given the reliability of GE gas turbines and the
insurance in place, this risk was considered low.
The base case pro forma below shows how Enron designed the revenue structure and
bond amortisation to minimise default risk to bondholders. In the CTA period, the CTA
payments provide a quality and high-certainty revenue stream. Expenses are minimised
since Enron is supplying gas to the project. As a result, SBP is able to amortise its debt
quickly in the CTA period and during the merchant period, the bond amortisation
schedule lowers principal payment by about £6.8 million per year, reducing overall debt
service by £8.1 million. Variable O&M decreases to zero by 2014, the year in which no
dispatch is assumed and the project receives only loss-of-load probability (LOLP)
payments. Any dispatch, assuming that the project is bid at prices higher than gas
expenses, would only increase net operating income. Hence, even at no dispatch, SBP is
able to maintain a minimum DSCR of 2.48.
SBP Pro Forma -1996 £m 1999 2005 2010 2014 2019 2022
Revenues
Fixed payment 57.6 68 8 68 8 22.9 0.0 0.0
Variable payment 3.7 4.7 4.6 1.8 0.0 0.0
Pool proceeds 0.0 0.0 0.0 380 64.4 65 9
Total revenue 613 715 73.4 62.7 64.4 65 9
Expenses
Fixed O&M (5 2) (7.4) (8-5) (9.6) (H.l) (12.2)
Variable O&M (17) (4.7) (4.6) (18) 0.0 0.0
Miscellaneous expenses (7.2) (10.2) (118) (13.2) (15.2) (16.5)
Total expenses (16.1) (22.3) (24.9) (24.6) (26.3) (28.7)
Earnings Before Interest & Tax 45.2 51.2 48.5 38 1 38 1 37.2
Plus depreciation 7.2 8.7 8.7 8.7 8.7 8.7
Plus interest income 1.0 1.7 0.0 0.0 0.0 0.0
Pre-tax cash flow 53.4 616 57.2 46.8 46.8 45.9
Senior debt service
Principal 0.0 (16.3) (16.3) (7.5) (11.5) (7.3)
Interest (20.9) (20.4) (13.2) (7.7) (3.7) (0.3)
Total senior debt (20.9) (36.7) (29.5) (15.2) (15.2) (7.6)
Senior DSCR 2.56 168 1.94 3 08 3 08 6.04
Summary DSCRs Min Avg Max
CTA period 1.34 1.64 2.10
Merchant period 248 248 248
Pricing
At the time of the financing, the UK portion of the SBP bond was sold slightly below
par at 99.523 in order to achieve a spread of 135bp over its benchmark Gilt, the 9%
2011. The yield at issue was 8.66%. Approximately three months later AES Barry was
financed as a pre-construction merchant power plant through the bank market, using a

G-5
floating rate loan and interest rate at issue of 8.3%. This was based on a spread of
130bp over LIBOR, which then fell to 120bp for the first five years post-construction,
before slowly increasing to 134.5bp after the eleventh year of operation. However, the
loan was for 15 years and £91m. This demonstrates remarkable competitiveness in
pricing, when the tenor of the bond was 50% longer than the commercial debt and on a
fixed rate - the cost of a swap to fix the bank rate would have comfortably made up the
difference between implied yields and Enron achieved strategic benefits on top.

Legal and Contractual Structure

The following chart shows the project's structure. A more detailed explanation of it is
available from Standard & Poor’s:

Enron Corp
Enron
Engineering &
Construction

SB Investors Enron O&M

Ltd Ltd.

50% 150%
Enron SB Ltd.
A100%

Collateral
Intercreditor
Agent

Cayman Issuer
(Sutton Bridge
Finance)

(. .) Contract/Agreement CTA: Capacity & Tolling Agreement ECTRL: Enron Capital & Trading Resources Ltd

Participant DOI: Deed of Indemnity ESA: Engineer Service Agreement

ECT: Enron Capital & Trading Resources GEM: General Electric International Inc.

EES: Enron Engineering Services

----------Ownership

G-6
Appendix H - Deal List

Contents
1. Off Balance Sheet Commercial Bank Project Debt - Electricity.
2. Off Balance Sheet Bonds - Electricity.
3. Off Balance Sheet Bonds - Stranded Costs.
4. Off Balance Sheet Bonds - Infrastructure.
5. On Balance Sheet Commercial Bank Debt - Electricity.
6. On Balance Sheet Bond Debt - Electricity.

Notes:

1. Interest rates are expressed as basis points over LIBOR unless otherwise stated.
2. Exchange rates used are listed in the below table.
3. PFI Deals in Section 4 quote the debt raised, rather than total project cost.

Exchange Rates Used:

FX FX/£ £/FX
€ 0.632 1.582
$ 0.618 1.62
Dr 0.0018 543.8
FFr 0.096 10.42
ITL 0.000326 3,070
Pta 0.0038 263.2

H-1
H-2
 (1) Off Balance Sheet Commercial Bank Project Debt - Electricity
Project
1. PowerGen Renewables
(UK 1999)
Refinance existing loans for
10 operating wind farms & 2
under construction, plus the
development and construction
costs of wind farms in 2000.
Debt &
Sponsor Pricing and Structure Remarks
Arranger
PowerGen - 50% £48m Tranches: Placed to put funding needed for current and
(UK power utility) projected requirements under one facility and
ABN AMRO A. £22m - 15 years: refinance operational projects and fund projects move it off balance sheet. More financial
Abbot Group - 50% under construction in 1999; 80 - 125bp; autonomy/clarity for the new company,
(UK oil group) B. £2m - 17 years: development costs up to 2000; 100 - 125bp; although paying a higher interest rate than if
C. £24m - 17 years: projects in 2000; 100 - 125bp. financed on PowerGen’s balance sheet.
Tranche C will refinance drawings under Tranche B, once the wind farms Projects financed under NFFO
start construction. contracts with NFPA.
ABN AMRO brought Tranche A and B to
syndication. The deal was oversubscribed.
Abbot purchased 50% of PowerGen
Renewables on 31/12/98 for £5.71m. One of
the attractions of the partnership being Abbot’s
off-shore technology.
H-1
2. IVPC (Italian Vento
Power Corp)
(Italy 1998)
Project finance for a
169.2MW wind project to
refinance 59.4MW operating
sites and construct remaining
sites.
IVPC Energy - 50%
90% owned by US wind
developer UPC)
Tomen Power
Corporation - 50%
(US subsidiary of Tomen
Corporation, a Japanese
general trading and services
company)
ITL349bn Tenor: 13 years The five tranche facility is structured in line
(£113m) with the construction milestones of the project
Five loan tranches: ITL118bn (1st tranche) to refinance 59.4MW; (tranche A has already been drawn to refinance
Greenwich ITL228bn (4 tranches) to finance construction of 108.8MW: operating sites).
NatWest
A. ITL118bn, Years 1 to 7 - 105bp; Year 8 to 13 - increases up to 130bp; It refinanced a bridge loan on an existing asset
B. ITL44.9bn, Construction 120bp; Operation to Year 7 - 105bp; Year 8 and financing construction of new plants.
to 13 - increases up to 130bp;
C. ITL105.9bn, as B; Banks derived comfort from the existing
D. ITL62.5bn, as B; operation of 59MW, which allowed them to
E. ITL15m - VAT facility, 25bp. agree stepped finance for the remainder.
Underwriting fees: Senior lead managers, ITL50bn - 40bp; lead mangers, Project uses government
ITL35bn - 30bp; managers, ITL20bn - 20bp. guaranteed Renewable Energy
Debt/equity - 85/15. PPAs (CIP/6).
Eleven CIP6 PPAs (each 15 years). Base Tariff: ITL195.9/kWh (6p/kWh) Proven technology supplied by Vestas Multiple
- first 8 years; ITL98.3/KW (3p/kWh) - Years 8 to 15. lump sum EPC contracts.
Long term O&M contract with Vestas (turbine supplier). Tranche E finances VAT credits due from the
Government to allow for timing differences.
H-2
H-3
 Debt &
Project Sponsor Pricing and Structure Remarks
Arranger
3. Xistral Grupo Aciona - 90% Pta32bn Tenor: 19 years (3 years construction, 16 years operation) - 90bp. One of the largest wind farms deals in Europe.
(Spain 1999) (Spanish construction firm) (£122m)
Project finance for a 240MW Cash sweep mechanism to accelerate repayment up to year 14. No need for long-term PPA’s, as the local
wind farm. NEG Micon - 10% Banco Bilbao utility (Begasa) is obliged to buy the off-take
(Danish wind turbine Vizcaya Underwriting fees: senior lead managers, Pta1bn and above - 30bp; lead under Spain’s renewable energy legislation
manufacturer) managers, Pta500m to Pta999m - 22.5bp; managers, Pta350m to Pta499m
Chase - 15bp. The Renewable Energy tariff, which has
been set by law, is Pta 11.1/kW (4.2 p), which
Debt/equity - 85/15. will change each year.

PPA: 5 year rolling contract with Begasa, a local utility owned by Endesa
(55%) and Union Fenosa (45%).

4. Orisane Lyonnaise des Eaux FFr305m Tenor: 20 years (1.5 years construction, 18.5 years operation). France’s largest waste-to-energy deal in 1999.
(France 1999) (French utility) (£29m)
Waste-to-energy plant in Interest: 60bp. The plant will burn 110,000 tonnes of waste per
Mainvilliers, west of Credit annum.
Chartres. Agricole EIB provided FFr140m (£86.5m).
The plant will have two sources of
Natexis revenue: waste tip fees and
electricity sales.

EIB has contributed €1.6bn (£1bn) as part of

its infrastructure/environmental programme, to
waste processing plants in Europe, since 1993.

H-4
5. Rokas Rokas €70m Tenor: 11.5 years (3 years construction, 8.5 years operation). Different currencies used for refinancing and
(Greece 1999) (Greek construction firm) (£46m) development.
Project finance for 6 wind Three tranches for 3 construction phases:
farms on three islands Paribas A. €2.9m (£1.832m) (10 MW - completed); Greek Drachma has depreciated against the
totalling 104MW. B. Dr24bn (£45.6m) (50MW - in construction); Euro by 30% since debt issued (0.0027 to
C. Dr597m (£1.134m) (44MW - to be started). 0.0019). High currency risk for operating
projects.
Interest: 150bp pre-completion; 140 - 160bp post completion.
High level of grant funding allows low debt
Total Funding is £230m, structured as follows: 20% Debt, 40% EU grant, ratio. Equity levels are set by grant
40% Equity. requirements.

PPA with Public Power Corporation (Greek utility). Projects use government
guaranteed Renewable Energy
PPAs.

H-5
H-6
 Debt &
Project Sponsor Pricing and Structure Remarks
Arranger
6. API Energia API - 51% €648.5m €34.62m for an 18 month equity bridge: 35bp. One of Italy’s first project finances it has been
(Italy 1999) (Italian energy firm) (£410m) refinanced to increase D/E from 75/25 to 85/15.
Refinancing of a project €577.6m base facility €25.31m standby facility
finance for a cogeneration (to ABB - 24% ABN AMRO 0-1 year: 130bp 130bp Difficult refinancing process (fire accident at
a refinery) power plant using (Swiss engineering firm) 1-8 years: 115bp 125bp the refinery shortly before closing the deal).
tar refinery waste as fuel. BNL 9-12 years: 125bp 135bp Deal executed when 90% of the construction
Texaco - 21% 13-17 years: 140bp 150bp was completed.
(US energy firm) Greenwich
Natwest Underwriting fees: Senior lead managers, €30m - 42.5bp; lead mangers, Major risks are the tar gasification technology
€22.5m - 32.5bp; managers, €15m - 25bp. and new, stricter environmental regulations that
Mediocredito could be put in place following the fire at the
Centrale Debt/equity - 85/15. refinery.

20-year PPA with Enel (largest Italian utility). The PPA has an incentivised price for first
eight years of generation. Remaining years
API - tar supply contract guarantee. will be at market price (Italian pool price).

7. Gregory Cogeneration
(US 1999)
Project finance for a 550MW
merchant cogeneration gas-
fired power station.
G&E Power $257m A. $175m, 17 years (2 years construction + 15 years operation); Guaranteed revenues (5 years)
US power utility) (£159m) B. $10m Debt Reserve Letter of Credit (L/C); and fuel supply do not cover most
C. $7m Revolving Debt;
ING D. $65m Equity Bridge for construction period; of debt tenor.
Columbia Electricity
(US power utility) E. Small working capital facility.
Projections for average DSCR are high, but not
DSCR: 2.1 average, 1.76 minimum. unusual for merchant risk (effectively coverage
ratios are moving the financing closer to on-
10 year secured fuel supply; 5 year power offtake agreement (Reynolds for balance sheet type ratios).
the majority, Dynergy for the remainder) and heat (Reynolds Metals plant).

H-7
 Debt &
Project Sponsor Pricing and Structure Remarks
Arranger
8. Milford El Paso Energy - 95% $365m Five tranches: Senior Debt facility split into 4 tranches to meet
(US 1999) (US power utility) A. $156.25 bank loan (2 years construction, 15 years operation) to be different investor appetites.
Project finance for a 540MW (£226m) syndicated. Construction (2 years) - 112.5bp; Years 1 to 4 - 125bp; Years
merchant gas-fired power Power Development Corp 5 to 8 - 137.5bp; Years 9 to 12 - 162.5bp; Years 13 to 15 - 187.5bp. Note that two pension funds are taking
station. - 5% KBC Bank Underwriting fees: $25m - 62.5bp; $20m - 50bp ; $15m - 40bp. construction risk.
(US power utility)
B. $30m (2 years construction, 17 years operation) commercial bank The plant takes market risk. El
loan; Paso is taking fuel price and
C. $35m (2 years construction, 18 years operation) funded by Trust
Company of the West, a US investment fund; capacity risk.
D. $50m (2 years construction, 19 years operation) funded by pension
fund TIAA-CREF;
F. $15m working capital facility;
G. $78.75m equity bridge loan (2 years).

Cash Traps: if debt service cover ratio falls to 1:4:1, 50% of excess cash is
trapped or held in escrow for four quarters and only returned to the
sponsors if the project’s performance improves. The amount steps up as the
DSCR falls. The deal also features sweeps if the DSCR rises above a
threshold.

El Paso Natural Gas will provide fuel with 25% of fuel cost subordinated to
debt service. If the plant dispatches less than75% of the time, the % of fuel
subordinated to debt service increases.

The plant is scheduled for service in November 2000.

H-8
9. Tenaska Frontier Tenaska Frontier - 65% $380m Tenor: 19 years (2 years construction, 17 years operation): The plant’s market risk is dimished
(US 1998) (US power utility) (£235m) A. $295m construction and term loan: 100bp (construction), up to by Peco Energy taking capacity
Project finance for a 830 MW 212.5bp (operation);
gas-fired, combined cycle Montana Power - 25% Credit B. $42m equity bridge loan during the 2-year construction period; risk.
power station. (US power utility) Lyonnais C. $38m letters of credit;
D. $5m working capital credit. The project risk (for fuel) is linked to Peco &
Illinova - 10% Tenaska risk.
(US power utility) Debt/equity: 85/15.
Note lower interest rate in construction (100bp)
Well proven GE technology. than in operation (212.5bp). This suggests
either a very strong EPC or that the banks want
Tenaska Frontier has the O&M, as well as the supply contract. to encourage refinancing during operation.

Power Team (a division of PECO Energy) purchased the rights to

market 100% of electricity output.

H-9
H-10
 (2) Off Balance Sheet Bonds - Electricity
Project Sponsor Debt & Pricing and Structure Remarks

H-11
10. Dam Head Creek
(UK 1999)
Refinancing an 800MW
merchant gas-fired power
station 12 months in to a 25
month construction period.
The profile is based on the
proposed bond, which was
planned for 11/99 but
withdrawn.
Entergy Corporation £361m
US energy group)
Must maintain at least 50% Warburg
of the equity until start of Dillon Reed
commercial operations and
25% during the following
five years.
Rating: Senior BBB-; Subordinated debt BB-; Full electricity market price risk - currently
very competitive due to gas moratorium but
3 Facilities: expected to become mid-merit by 2015.
A. £271m senior bonds, tenor 24 years, 5 year principal grace period,
First public bond financed merchant plant in
average life 14.8 years; Europe - an indicator of market sentiment.
B. £54m subord. Bonds, tenor 19 years, 6 year principal grace period,
average life 12.8 years; Low projected market risk based on estimates
C. £123m ancillary credit facility (loan underwritten by banks, tenor 20 that the plant is still profitable running at 30%
years), consisting of: baseload.
- £20m cost overrun facility;
- £10m working capital facility (commissioning onwards); Complex off-shore structure for tax and
- £35m gas L/C - if drawn, repayment is senior to debt service; financing purposes.
- £18m National Grid Guarantee - covers equipment from NGC;
A long-term (although shorter than the debt
- £40m Hedging L/C for trading counterparty risk. tenor) fuel contract with price based on a basket
of indices. May be rebased if market price
Construction and Refinancing Fees are £14.5m (4% overall). moves by >20%.
Debt/sub debt/equity - 75/15/10 (£36m equity guaranteed by an ‘A' Minimised construction and maintenance
rated bank L/C; all equity must be fully subscribed by start of risk due to robust MHI guarantee.
operation).
High DSCR, especially first years due to
DSCR (Base Case): average 2.58, minimum 2.00; Aggregated Senior and principal repayment grace period.
Subordinated Cover Ratio: average 1.95, minimum 1.54; Aggregated Gas supplier required a LC to protect against
Senior and Subordinated Cover Ratio (Worst Case): 1.24. fluctuations in plant performance.
Reserve Accounts (6 month senior debt; 1 year subordinated debt).
S&P commented on a low equity (£36m)
Fuel: 15 year index linked (50% pool price, 30% PPI, 20% gas price) take level and sponsor is having £46m of its
or pay contract with Shell. Able to sell on into spot market. current finance repaid.

Construction Bonds: a) Performance (30% EPC), b) Ascending (in lieu of
retention of milestone payments; 10% EPC) and c) Availability and
Defects Liability issued at take-over (25% EPC). All bonds are issued by
Bank of Tokyo-Mitsubishi (Rating A-) on behalf of contractors.
Extraordinary Maintenance: 6 year agreement with MHI61 (provides
operational and financial guarantees in relation to the agreement), then
establishment of maintenance reserve account. O&M:15 year agreement
with Entergy (provides operational and financial guarantees in relation with
the agreement).
Risk Management: agreement with Entergy for hedging activities against
power and gas future prices and for credit support on market arrangements.
S&P constrained the rating due to NETA,
pool price and gas price risks.
Partial cram-down possible with 50% of all
senior creditors.
First attempt to raise bond funding at the start
of construction (—10/98) was withdrawn due to
turmoil in the market (Asia and Russian
default). Bank finance was £463m senior debt
and £36m sub-debt. Senior debt priced at 115-
145bp.

H-12
61 MHI: Mitsubishi Heavy Industries

H-13
 Debt &
Project Sponsor Pricing and Structure Remarks
Arranger

H-14
11. SELCHP Onyx
(UK 1999) (Vivendi - French multi­
Waste-to-energy plant utility)
refinancing of senior and
mezzanine debt. CNIM
(Constructions Industrielles
de la Mediterranee - French
construction firm)
£55m 22 year private placement to Prudential, that also removes some of the
shareholder guarantees.
Societe
Generale Working capital facilities provided by Societe Generale.
Refinancing a bank loan at 125-150bp, expiring in 2006
PPA: 3 year deal with London Electricity. Installed capacity of 32MW.
Fuel contracts with 7 municipalities to supply 400,000 tons p.a.
H-15
The plant was financed through a £95m
recourse financing arranged by BNP and Bank
of Scotland. It did not sell and had to wait for
syndication once construction was completed.
Outside NFFO (expired in 1998), short term
PPA with London Electricity. Operations
started in 1994. Project will be exposed to
merchant risk, although the main revenues are
from waste incineration gate fee payments.
A private placement to only one debt provider.
Structured as a bond to enable Prudential to
allocate the debt among its different funds.
Pru’s largest single investment in project
finance to date and the sponsors wanted a
private placement.
SocGen will provide ongoing working capital,
but is not linked to the senior debt.
12. Tyseley Waste Disposal
(UK 1998)
Project bond for a 28 MW
waste-to-energy incinerator.
62 Debt only
Onyx £95m62 Wrapped by Financial Security Assurance (FSA). Limited recourse financing.
(Vivendi - French multi - Rating AAA, £88m of debt at 6.675%, 2018, priced at par (spread at issue
utility) Paribas 80bp over 9% 2008 Gilt). Bond default risk linked to the ability of the
insurer FSA (AAA) to meet the bonds
Amortisation: front weighted to ensure that by the 15 year mark principal is obligations.
paid down to £18.3m (designed to protect FSA from a Vivendi default and
end of NFFO period). Project financed under NFFO contract with
NFPA.
Performance and regulatory risk guaranteed by Vivendi (BBB+),
through a L/C up to the full value of debt. Credit Commercial de Level of sponsor guarantees makes it a quasi
France (AA) issued £18.5m L/C designed to protect FSA in the corporate deal.
event of default by Vivendi.
FSA has not underwritten regulatory &
2 Reserve Accounts: both 6 months debt service coverage. One reserve performance risk (secured by Vivendi) nor fuel
account can be used to pay for unforeseen maintenance costs. risk (secured by Council guarantees). FSA has
recourse on both Vivendi and the City of
Main revenues are municipal waste incineration fees paid by Birmingham Birmingham for these.
City Council. Fees rise in line with a composite index, designed to reflect
Tysley’s costs. Electricity revenues, guaranteed with NFFO PPA and split
with Council.
H-16
H-17

Project
13. Kilroot Electric
(UK 1994)
Refinancing a non recourse
commercial debt transaction
by AES and Tractebel to
acquire the 520MW coal/oil
power station in Northern
Ireland.
14. Sutton Bridge Power
(UK 1997)
Project bond for a 790MW
gas combined cycle power
station.
Debt &
Sponsor Pricing and Structure Remarks
Arranger
NIGEN £198m Unrated. 9.50%, 17 years tenor, issue at 99.896. UK’s first non-recourse bond issue in the power
Joint venture formed in market.
1992 by AES and BZW Repayment: amortising from 2006-2010 (five equal instalments).
Tractebel) Sold to UK insurance and pension funds and
Salomon 13 year PPA contract with Northern Ireland Electricity (transmission and apparently no rating was required.
Brothers distribution company).
The project takes market risk. Operating
Proven and operating technology reduces generating risk. track record made financiers comfortable.
Enron - 50% $150m Rating BBB See Appendix G for more details.
(US energy firm) (£93m)
and A. US$ Tranche, Rule 144a, 7.97%, 25 year tenor, issued at par; Default risk linked to two large corporate
SB Investors Ltd - 50% £195m B. Sterling Tranche, Bond, 8.625%, 25 years tenor, issued at 99.523. risks. Market & fuel are Enron risk (BBB+)
(Private Investor Vehicle) up to year 2014.
BZW Debt/equity - 85/15; Equity of £42m.
DSCR: 2.5 to 1.00 during the merchant period (minimum DSCR forecast O&M linked risks are effectively GE risk
Merrill Lynch by S&P's analysis assuming the plant becoming a peaker). (AAA) up to 2012, or 2018 if O&M agreement
renewed.
Plant passed commissioning tests in May 1999;
Enron guarantees Capacity & Tolling agreement for input & output. Enron Bond riskier in the last years of its tenor due to
pays a fixed price for output that comprises cost of the gas supply in a tolling agreement shorter than bond terms.
exchange for all market proceeds. The agreement expires in 2014, if not
renewed Sutton Bridge becomes a merchant plant. Note that projections include periods where
available cash is just enough to service debt.
O&M Agreement: 12 year GE Agreement, where GE assumes virtually all
operating risks. Extendable for 6 years at Sutton Bridges' option
Swap agreements to hedge dollar payment obligation.
H-18
15. Batesville Cogentrix Energy $325m Rating BBB- Similar structure to Sutton Bridge. PPA
(US 1999) (US cogeneration project (£201m) default risk is Virginia (A-) and Aquila
Bond issue to refinance an developer) A. $155m tranche; 14 year amortising bond, issued at 165bp over 9 year (BBB) corporate risk.
837MW combined cycle CSFB Treasury (7.164%);
power station 60% into LS Power B. $170m tranche; 26 year tenor, issued at 230bp over 30 year Treasury Tolling agreements do not cover all 2nd tranche
construction period. (US power (8.16%); Amortises between 2013 and 2025 (years 14-26). tenor, projections estimate a 45% margin
between available cash flow and debt service
company) Debt/equity - 86/14; payments (ie effectively a DSCR of 1.8).
DSCR: 1.7 (average), 1.45 (minimum).
Note: tranche ‘B’ repayment is done after
2 Tolling Agreements: 13 years with Virginia Electric and Power Co (2/3 expiration of the Virginia tolling agreement and
of output, with a call option to extend to year 25); 15 years and 7 months repayment of tranche ‘A’. Risk is valued at
with Aquila Power Corp a subsidiary of Utilicorp United, (1/3 output, with 65bp higher than tranche ‘A’.
a call option for a further 5 years).

Construction Guarantee: BVZ (Black & Veatch and Zachry JV)

O&M: LS Power.

H-19
 Debt &
Project Sponsor Pricing and Structure Remarks
Arranger

H-20
16. Pacific Klamath
Energy
(US 1999)
Non recourse bond issue to
build a 484MW gas-fired
cogeneration power station.
City of Klamath Falls $308.6m Three tranches: Default risk linked to Pacificorp
(Oregon) (£190) (BBB+) ability to meet its 30 year
A. Unrated tax exempt senior - $220m: (all priced at par) - 25% placed
Lehman tolling agreement (47% electricity
to private entities and 75% placed to municipalities or non federal
Brothers government agencies, made up of: output, 100% gas input) and O&M
1. $22.6m, 5.5%, 2007; agreement obligations.
2. $44.9m, 5.75%, 2013; Finance cost is lowered by the use of tax
3. $28.9m, 5.875%, 2016; exempt bonds.
4. $123.6m, 6%, 2025;
Taxable senior debt unrated, as placed with a
B. Taxable senior, private placement to approved institutional investors - restricted number of institutional investors.
no SEC registration required: $28.6m, 10%, 2025, Yield 10.19%,
issued below par; Taxable subordinated debt yield lower than
taxable senior debt yield due to the Pacificorp
C. Taxable subordinated bond (Rating: BBB+): $60m, 8.2%, 2025, Yield guarantee (ie same credit rating).
8.34%, issued below par.
Tax exempt senior debt structured to meet
DSCR: Average 2.09, Minimum 1.74; Lehman Brothers received $4.2m.
needs of investors - presumably a negotiated
placement.
Tolling agreements (30 years, 47% of total off-take) signed by Pacific
Klamath Energy (subsidiary of Pacificorp).
Similar to PFI deals, due to public-private
“partnering”.
Steam sale agreement signed with local wood industry (no minimum
requirement).
Pacificorp guarantee for US$60m subordinated bond. Construction and
Performance guaranteed by Black & Veatch. O&M provided by
Pacificorp.
H-21
17. AES Eastern Energy AES Corp $550m Rating BBB-, $550m unsecured pass-through certificates, Rule144A Bond funds only two of the four power stations.
(US 1999) (US power company) (£340m)
Bonds non recourse to Two Tranches: No dividend distribution to AES unless
AES for the acquisition Morgan A. 350bp over Treasuries, 2017 (12.5 years average life); coverage debt equals or exceeds 1.7.
of four coal plants from Stanley B. 350bp over Treasuries, 2029 (22 years average life).
New York State Electric & Division of risk between AES and the
Gas. Forecasted DSCR: over 2.00; Two debt reserve accounts: 1 year. NYSEG (the off-taker): NYSEG assumes
capacity risk for 2 years, while AES Eastern
Two year (up to April 2001) capacity (representing ~10% of total Energy takes price risk.
revenues) agreement with NYSEG at spot market prices.

Two year contract with Merchant Energy Group of the America (MEGA)
to market the plants' energy.

Fuel supply: short-term contracts with 3 Pittsburgh coal suppliers.

H-22
H-23
 (3) Off Balance Sheet Bonds - Stranded Costs
Debt &
Project Sponsor Pricing and Structure Remarks
Arranger
18. Orchid Securities Finmeccanica SpA $335m Rating AAA - Recourse on the Republic of Italy. Collateral are receivables, no fixed assets.
(Italy 1996) (Italian manufacturing (£207m)
SPV securitising nuclear group - Seller of nuclear Amortised secured floating-rate notes due February 2008. The SPV Issue in US Dollars in order to access a larger
credits arising from the credits to SPV) Merrill Lynch incorporated in the Caymans (tax issues) and bought, with the proceeds of and more liquid market.
moratorium on nuclear the bonds, Finmeccanica’s nuclear credits. Credits are reimbursed through
construction in Italy. a “nuclear surcharge” paid by Italian electricity consumers, collected by the Nuclear credit agreement
electricity utility Enel and then distributed to nuclear creditors. These
guaranteed by Italian Government.
nuclear credits form the collateral for the bond issue. A currency swap is
used as payment of nuclear credits is denominated in Italian lire. The swap
Achieved higher rating than the Sovereign, due
also covers interest basis risk arising from the notes paying interest on
to the risk being spread across the economy,
three-month US dollar LIBOR and the nuclear credits paying interest at the
without ‘political’ risk interposed.
ABI (Italian Bank Association) prime rate.

H-24
19. PECO Energy
Transition Trust
(US 1999)
Securitisation of PECO
Energy stranded cost due to
market liberalisation.
PECO Energy
(US utility - seller of future
surcharge - income to SPV)
$4bn Rating AAA Unlike Orchid Securities, neither Pennsylvania
(£2.472bn) 7 separate classes with weighted average lives (AL) ranging from 1.3 to 8.9 State, nor the Federal authorities can abrogate
years; 2 classes have floating interest rate: PECO’s rights to its transition charges; i.e.
Salomon A. 244.3m, 5.502%, AL 1.3 years; removes regulatory risk.
Smith Barney B. 275.6m, 5.656%, AL 3.26 years;
C. 666.4m, 17bp over LIBOR-6m, AL 4.03 years; Credits guaranteed neither at
D. 459m, 5.83%, AL 5.37 years;
E. 464.2m, 23bp over LIBOR-6m, AL 6.28 years; federal level nor at the
F. 993.6m, 6.073%, AL 7.28 years; Pennsylvanian state, therefore over
G. 896.8m, 6.155%, AL 8.91 years. collateralisation was necessary.
Electricity price risk.
Stranded cost is recovered through a surcharge levied on retail electricity
bills, with the surcharge as the collateral to bond holders. The proceeds will be used to recover
investment made during the regulated period.
Two reserve accounts: Consequently proceeds will be used to reduce
Capital Account - 0.5% of principal fully funded at financial close, Over capitalisation on a pro rata basis.
Collateralization Account - 2% of principal to be funded throughout the
term of transaction.
Surcharge rates are variable. The Reconciliation of Competitive Transition
Charge (CTC) is the name of the mechanism that re-calculates every year
the necessary adjustments to the CTC rates, to recover the total CTC
Revenue Requirement.
H-25
H-26

Project
20. Stirling Water
(UK 1999)
PFI linked bonds for three
water projects (Seafield,
Almond Valley and Esk) in
Scotland.Two separate issues:
one for Seafield and Almond
Valley, the second for Esk
(delayed by planning
permission).
(4) Off Balance Sheet Bonds - Infrastructure
Debt &
Sponsor Pricing and Structure Remarks
Arranger
Thames Water - 49% £79m Rating AAA (Rating Fees: £18,000 pa.) Purchase of output by East
(UK water utility)
Scotland Water Authority, a
RBC Coupon: 5.822%, 27.5 years, yield at issue: 120bp over 8% 2015 Gilt.
MJ Gleeson - 41% Dominion creditworthy government owned
(contractor) Securities Wrapped by MBIA Ambac (unconditional and irrevocable guarantee of agency, hence low cover ratios.
(formerly payment of scheduled interest and principal); Wrapping fee: 45bp p.a. The projects credit profile is
Montgomery Watson - Hambros) equivalent to £4m up-front & £39,000 commitment fee. enhanced by MBIA’s wrap.
10%
(environmental engineering Lead Arranger underwriting fee: 1.25%. Experienced and high rated sponsor (Thames
and construction firm) Water) supporting the project.
Principal repayment grace period: 5.5 years;
Interest repayment grace period: 2.5 years. EPC firm committed as O&M provider and
shareholder, which is sometimes seen as a
Debt/Equity: 80/20; £14.835m Subdebt, £4.95m Equity. conflict of interest.
DSCR: 1.04 Minimum, 1.13 Average;
Debt Service Reserve Account: 1year during construction, 6 months Predictable business cycles, with reliable cash
during operation. flows.
Construction guarantee (Ml Gleeson): 100% initially during construction it
decreases to 50% of bonds drawn down towards completion. Guarantee Risks:
cost 90bp on amount, plus 50 bp commitment fee. Uncertainty on long term water flow
projections;
L/D's £120,000 week (£6.24m over lyear). Change in environmental regulations;
New Scottish Parliament’s level of support
Trustee: Prudential - £lk pa construction and £4k pa operation + £10k if for PFI.
wound up.
30-year purchase contract with the government-owned East Scotland Water
Authority (ESW) and 30-year service contract, which includes a number of
protective clauses against uncontrollable events (i.e. force majeure).
H-27
21. Stirling Water
(UK 1999)
PFI linked bonds for the Esk
water projects.
Thames Water - 49% £30m Bonds are part of the above issue (same documentation). Total debt issue is £108m.
(UK water utility) Same coupon 5.822% , but due to interest rate change bonds were issued
RBC under par at 94.308, giving an effective yield at issue of 6.376%.
MJ Gleeson - 41% Dominion
(contractor) Securities
Montgomery Watson -
10%
(environmental engineering
and construction firm)
H-28

Project
22. M6 Road
(UK 1997)
PFI DBFO road programme;
Issuer is Autolink
Concessionaires with a
concession period of 30 years.
Debt &
Sponsor Pricing and Structure Remarks
Arranger
Amey Construction 19.5% £250m FSA Wrapped Bond; Rating AAA; 8.39%; tenor 25 years. Payments due are UK Government risks.
(UK contractor) The projects credit profile is enhanced by
Morgan Debt/equity - 93/7. Debt subdivided as follows: FSA’s wrap. Note shadow toll agreement.
Sir Robert McAlpine Stanley A. £125m 25-year bonds;
19.5% B. £69m EIB loan facility; Payment projections structured on the basis of
(UK construction company) C. £19m of privately placed unrated subordinated bonds; an estimated flow of cars using the road.
D. £16m of sponsors equity and subordinated debt.
Taylor Woodrow Volume risk.
Construction 19.5% Shadow toll mechanism whereby the government pays variable fees based
(UK contractor) on the level of traffic.
Barr Holdings 6.5% £230m completion guarantee (5 years) arranged by IBJ; L/C commission;
private company 1.4% or 2.4% over LIBOR if L/C is exercised.
investor) Part of EIB loan facility provides various backup facilities: a cost overrun
facility, a maintenance reserve fund and some debt service reserves.
Innisfree PFI Fund 35%
(private equity investment
fund for PFI projects)
H-29
23. South Tees
(UK 1999)
PFI linked bonds for a 32 year
concession to build and
manage a hospital near
Middlesborough.
Endeavour Consortium:
John Mowlem - 19% Barclays
(contractor)
Innisfree Partners -
45.5%
(private equity investment
fund for PFI projects)
Barclays Infrastructure
Fund - 35.5%
£137m Rating AAA, 3.607% (first coupon), tenor 32 years, priced at 99.992, Yield
3.54% (130bp over index linked Gilt 2016).
Index Linked, FSA Wrapped Bond (wrapping fee: 35bp).
Senior Debt finance fees £6.6m, Arranging Fee: 65bp; Commitment Fee:
50bp.
Debt/equity - 83/17; DSCR: 1.265 Annual, 1.39 Average.
Expected RoE: 18.46%. Equity £7m; £5.5m equity from NHS.
Subordinated debt £20m (finance fees £630k), £10m repaid by year 10
(debt/equity ratio in year 10 will be 94/6), remaining £10m repaid as a
bullet one year after bond repayment;
Construction Period is 3.9 years, with a £42.7m performance bond backed
by Zurich Insurance.
Revenue is split between an availability fee (68% total revenue) and a
service fee.
H-30
Payments due are UK Government risks.
The projects credit profile is enhanced by
FSA’s wrap. Note quality indicators.
Largest UK hospital PFI deal.
NHS retained patient volume, revenue, medical
technology, health provision and some building
risks. Risk allocation for the sponsor made
easier as construction provided by the
consortium.
Bond selected due to longer tenor (banks only
offered 27 years) and wrapping gave certainty
of execution (as just post Russian default).
Sponsor exposed to basis risk between
operating cost inflation and RPI. Fee has two
components: a fixed availability fee linked to
RPI and a service fee linked to RPI but market
tested every 5 years. Fees are linked to quality
indicators and reduced if indicators deteriorate.
H-31

Project
24. Queen Elizabeth
Hospital
(UK 1998)
PFI linked bonds for a 32 year
(renewable for another 30)
concession from Greenwich
Healthcare NHS Trust, under
which it virtually demolishes
the existing Queen Elizabeth
Hospital in Greenwich.
Debt &
Sponsor Pricing and Structure Remarks
Arranger
Meridian Consortium: £119m Rating BBB+. Payments due are UK Government risks. No
wrap to guarantee project performance.
Kvaerner Construction Barclays Index Linked Eurobond. Note rate (160bp for BBB+) compared to
(Anglo-Norwegian South Tees (Deal 23 - 130bp for AAA).
engineering group) First coupon 4.1875%, tenor: 30 years, 17.5 year average life, spread at
issue: 160bp over 2016 index linked Gilt. Index linking removes mismatch between
Innisfree Partners assets and liabilities.
(private equity investment Amortised Principal Repayment end weighted.
fund for PFI projects) Note risk to Meridian if its costs rise faster than
Debt is divided between £86.2m (Original Budget - base case) and £5m the index payments they are linked to.
(Contingencies).
Service fee linked to quality indicators. If
Equity contributions: £5m Equity, £10.09m Subordinated Debt indicators deteriorate, fee is reduced.
Trust Contribution: £13.6m.
Part of the hospital belongs to the MoD.
DSCR: 1.31 (minimum); Debt Service Reserve Account: 6 months.
Concession for 32 years, covering building maintenance (main fee) and a
service fee for laundry, catering and other soft services. Fees agreed in
advanced but are index linked to PPI (Producer Price Index).
H-32
H-33
(5) On Balance Sheet Commercial Bank Debt - Electricity

H-34
 Sponsor, Date and Description Principal Terms Remarks
Country of Issue
25. National Grid Co Transmission system $2.75bn Rating: AA+ The purposes of the loan are:
(UK 04/99) owner - total assets of (£1.7bn)
£4.9bn (pre-acquisition) Four facilities: 1) To back the $3.2bn acquisition of New
£250m 1. $850m 5 year credit multicurrency 57.5bp; England Electric Systems and Eastern Utilities
2. $550m 5 year multicurrency revolving 57.5bp; Associates;
ABN AMRO 3. $1.35bn 364 day revolving (to be drawn no later than the 3rd 2) To refinance New England Electricity
Barclays anniversary from signing) 57.5bp; System’s debt;
Chase 4. £250m 5 year multicurrency revolving credit 57.2bp. 3) Other corporate purposes.
Deutsche
DKB Margin over Libor: Facilities ‘A’ to ‘C’ are for both National Grid
HSBC Facilities 1 to 3 can drop to 50bp and facility 4 to 45bp if less than and its subsidiaries. Facility ‘D’ is only for
$2.025bn is committed; parent use (sterling currency).
Facilities 1, 2, and 3 can drop to 42.5bp and facility 4 to 37.5bp if less than
$1.575bn is committed. S&P quote AA risk as: capacity to repay is
strong and differs from the highest quality
Commitment Fees: only by a very small amount.
Facilities 1 to 3 pay 25bp before the acquisition and the lower of 25bp and
half the margin thereafter;
Facility 4 pays 20bp before the acquisition and the lower of 22.5bp and
half its margin thereafter.

26. Scottish Power Integrated Utility - total £2.6bn Rating: A+ S&P - A+ risk: has strong capacity to
UK assets of £6.2bn repay; borrower is susceptible to adverse
Royal Bank of Facility ‘A’ - £2bn 2 years (matures 2001) term 45bp; effects of changes in circumstances and
(UK 03/98)
Scotland Facility ‘B’ - £0.6bn 2 year (matures 2001) revolving 45bp. economic conditions.

Commitment Fee fixed at 17.5bp. Refinancing a 5 year facility first arranged in

1996 to support a bid for Southern Water and
for other general purposes. The facility was
undrawn, although the bid was successful.

Proceeds used as a bridge financing to acquire

Pacificorp (US). The acquisition was done
through a share swap and made Scottish Power
do a $835m share buyback to support its price.

H-35
H-36
 Sponsor, Date and Description Principal Terms Remarks
Country of Issue
27. PowerGen UK Integrated Utility - total £2.4bn Rating: A S&P - A risk: capacity to repay is strong
(UK 07/98) assets of £5.9bn and differs from the Scottish Power (A+)
Deutsche Bank Three facilities: quality only by a very small amount.
Goldman Sachs 1. £500m 364 day revolver 50bp;
HSBC 2. £1bn 5 year revolver 50bp; Proceeds to:
3. £900m 5 year amortising term loan 50bp. - finance £1.9bn East Midland acquisition;
- refinance previous loan arranged in 1995.
Margin over Libor
Margin is adjusted in a 35bp to 55bp band subject to values of the debt to
EBITDA ratio.

Commitment Fees
Facility one: 12.5bp;
Facility two: 50% of applicable margin.

28. National Power Integrated Utility - Total £1.25bn Rating: A Same risk profile as PowerGen
(UK 12/98) assets of £6.9bn
Barclays Facility 'A' £500m 364 day facility 27.5bp; Working capital facility that will refinance a
Chase Facility 'B' £750m five year term loan 25bp. £500m revolver. The tenor was 5 years, a
Citibank margin of 17bp and a commitment fee of 8.5bp.
NatWest Margin over Libor
Facility ‘A’ additional 7.5bp if over 50% of facility is drawn; National Power had just undergone the
Facility ‘B’ additional 5bp if more over 50% of facility is drawn. acquisitions of the supply arm of Midland
Electricity (£300m) and 25% of the generating
Commitment Fees assets of Spanish Union Fenosa (£400m).
Facility ‘A’ 10bp;
Facility 'B' 5bp. Financing done shortly after the 1998 Russian
default.

H-37
29. Hyder Integrated Utility - total £450m Rating: BBB+ S&P - BBB risk: has adequate capacity to
(UK 09/97) assets of £3.9bn 5 year, pricing not disclosed by the borrower. repay, but adverse economic conditions or
ING Barings circumstances are more likely to lead to risk.
Ten banks providing debt, margin range (varies according to bidding) over
Libor between 15bp to maximum of 20bp. Facility replacing £750m revolver to finance
the acquisition of South Wales Electricity.

Facility reduces borrowing cost as well as

locking in a more favourable covenant package.

H-38
H-39
 (6) On Balance Sheet Bond Debt - Electricity
Sponsor, Date and Description Principal Terms Remarks
Country of Issue
30. National Power Integrated Utility - total £200m Rating A The issue was launched at a spread of 93bp
(UK 05/97) assets of £6.9bn Tenor: 25 years (matures 08/22) Coupon: 8.125% over the 8% 08/21 Gilt, pricing it 101.201
(indicative yield of 8.02%).

31. Hyder Integrated Utility - total £140m Rating BBB+ The issue was launched at a spread of
(UK 12/98) assets of £3.9bn Tenor: 22 years (matures 04/20) Coupon: 7.00% 235bp over the 8% 08/21 Gilt, pricing it at
99.151.
32. National Grid Co Transmission system owner £450m Rating: AA+ The issue was launched at a spread of
(UK 01/99) - total assets of £4.9bn Tenor: 25 years (matures 12/24) Coupon: 5.875% 140bp over the 8% 08/21 Gilt, pricing it
£99.076 (indicative yield of 5.9%).

33. PowerGen UK Integrated Utility - total £2 50m Rating A Marketed at 170bp over the 8% 06/21 Gilt,
(UK 03/99) assets of £5.9bn Tenor: 25 years (matures 04/24) Coupon: 6.250% pricing it £97.864 (indicative yield of 6.4%).
Price was based looking at National Power’s
yield of its £200m 25 year bond (93bp at
issue). The wider spread (opposed National
Power’s £250m issue) was due to the
moment of heavy supply of Sterling issues
(due to the end of the Russian and Asian
crisis) together with high interest swaps rates
(macro-economic uncertainties).

34. Northern States Power Minnesotan utility - 33rcl $150m Rating AA Indicative spread over US Treasuries 65bp
(US 03/98) largest US utility with Tenor: 30 years (matures 03/28) Coupon: 6.500%
assets of $7.4bn

35. Wisconsin Electric Wisconsin utility - 41st $150m Rating AA+ Indicative spread over US Treasuries 70bp.
Power largest US utility with Tenor: 30 years (matures 06/28) Coupon: 6.500%
(US 05/98) assets of $5.4bn

36. Duke Energy North Carolina based 4th $300m Rating AA+ Indicative spread over US Treasuries 100bp.
(US 12/98) largest US utility with Tenor: 30 years (matures 12/28) Coupon: 6.000%
assets of $26.8bn

H-40