Utility Fights $120M SILO Termination Fee

CHICAGO - An appeals court in Chicago is expected to rule within the next 60 days on Indiana-based Hoosier Energy Electric Cooperative Inc.'s efforts to stall a demand for a $120 million termination payment on a lease transaction triggered by the downgrade of the transaction's insurer.

The outcome of the case could set a precedent for other nonprofit entities involved in sale-in/lease-out, or SILO, transactions, or lease-in/lease-out, known as LILO, transactions where the guarantors' ratings have been downgraded.

Similar deals have captured the attention of U.S. lawmakers, who are considering providing federal guarantees on leaseback transactions. The legislation would particularly benefit transit agencies, many of which entered into SILO or LILO deals with private investors for equipment and rails that technically defaulted when the ratings of the insurers that guaranteed the deals were downgraded.

Citing the case, Standard & Poor's last week downgraded to BBB-minus from A-minus its issuer credit rating on Hoosier Energy and put the rating on negative CreditWatch pending the outcome of the court case. An adverse ruling could force the utility into bankruptcy.

The U.S. Court of Appeals for the Seventh Circuit on Jan. 5 heard oral arguments on the case between Hoosier Energy and Boston-based John Hancock Life Insurance Co., an equity investor in a SILO transaction involving a Merom, Ind.-based power station. In its ruling, the appeals court will decide whether to maintain or lift an existing injunction blocking the termination payment that a federal court in Indiana imposed in December. Further litigation is likely in either case, said an attorney involved in the case.

In the $300 million leveraged lease deal, John Hancock in 2002 bought the power station from Hoosier and leased it back to the utility for 30 years. Hoosier kept about $21 million and gave the remaining $279 million to Ambac Assurance Corp. to make lease payments to John Hancock on Hoosier's behalf.

The contract terms also required Hoosier to obtain a credit default swap from Ambac to give John Hancock further assurance it would receive the lease payments. Last summer, Ambac, like many other monoline bond insurers, was downgraded. The downgrade triggered a technical default in the lease deal, and John Hancock demanded a $120 million termination payment. Hoosier responded by asking an Indiana court to grant a restraining order and later a preliminary injunction.

In its downgrade, Standard & Poor's noted that Hoosier does not have sufficient liquidity to make the termination payment while addressing operating needs.

Analysts said the utility could be further stressed if cross-default provisions are exercised on more than $400 million in credit lines, bridge loans, and fuel and power purchase agreements that have collateral requirements tied to the termination of the lease agreement. Analysts noted that the federal court in Indiana held that lifting the temporary restraining order would likely force the utility into bankruptcy.

"We believe that the CreditWatch placement recognizes the potential for further significant downgrades should Hoosier suffer an adverse ruling that results in lease termination, or should cross defaults and/or bankruptcy filing be exercised," wrote Standard & Poor's credit analyst Jeffrey Panger. "Resolution of the litigation in favor of Hoosier might lead to stronger credit quality."

If the appeals court leaves the injunction in place, the parties will return to federal court in Indianapolis to litigate the case, according to Hoosier's attorney, Reed Oslan, a partner at Chicago-based Kirkland & Ellis LLP. If the appeals court rules to lift the injunction, allowing the termination payment demand to go forward, the case will again head to litigation as Hoosier has no intention of making the payment, Olson said.

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