MOODY'S ASSIGNS Baa3 RATING TO CAITHNESS COSO FUNDING CORP.'S (CAITHNESS COSO) PROPOSED ISSUE OF SENIOR SECURED BONDS AND ASSIGNS Ba2 RATING TO CAITHNESS COSO'S PROPOSED ISSUE OF SUBORDINATED SECURED NOTES; OUTLOOK STABLE
Approximately $465 Million of Debt Securities Affected
New York, July 21, 2005 -- Moody's Investors Service has assigned a Baa3 rating to approximately
$375 million of senior secured bonds due 2019 and assigned a Ba2
rating to $90 million of subordinated secured notes due 2014 to
be issued by Caithness Coso Funding Corp. (Caithness Coso).
The rating outlook is stable.
Proceeds from the offering, along with cash on hand of around $31
million, will be used to repay approximately $208 million
of existing Caithness Coso Series B 9.05% notes, rated
Baa3; to pay about $27.5 million of accrued interest
and the make-whole amount related to the existing Series B notes;
to fund about $27 million in debt service and capital expenditure
reserve accounts; to pay transaction costs of around $7 million
and to make distributions of about $230 million to the owners.
The Caithness Coso Baa3 rating considers the following supportive factors:
1. A high degree of cash flow predictability, as contracted
cash flows with Southern California Edison Company (SCE: Baa1 senior
unsecured debt: stable outlook) provide the primary source of debt
repayment through three separate power purchase agreements (PPA) that
expire at varying times through 2019;
2. While two of the PPA's with SCE expire before the term
of the bonds, contract extension risk is viewed as being low given
the relatively large size of this existing geothermal resource,
its successful operating history, its low operating costs,
the must-take requirement for a Qualifying Facility (QF) under
the Public Utility Regulatory Policies Act of 1978 (PURPA), and
the importance of renewable resources to California's energy policy;
3. Coso Operating Company (COC), the operator, has
a very strong track record in operating geothermal assets, as demonstrated
by a capacity factor of 102.4% for the five year period
4. Extension of the US Navy I and US Navy II resource contract
through 2034 lowers Caithness' cost structure, enhances the
long-term value of the plants, and provides greater incentive
for reinvestment of project cash flow back into the geothermal resource;
5. Historically, the Caithness Coso partnerships have demonstrated
very predictable financial metrics. For each of the 12-month
periods ending March 31, 2005, December 31, 2004 and
December 31, 2003, revenues, operating income,
and cash from operations were virtually unchanged at $153 million,
$66 million and $76 million, respectively.
Likewise, Caithness Coso's annual debt service coverage ratios
(DSCR) for these three periods were in excess of 1.60x;
6. Prospectively, the Caithness Coso partnerships are expected
to continue to demonstrate fairly robust and predictable DSCR.
Under the project's base case assumptions, DSCR for senior
debt is expected to average 2.41x, with a minimum DSCR of
1.55x, while the consolidated base case DSCR, which
incorporates annual debt service on the subordinated notes, is expected
to average 1.95x with a minimum of 1.27x. The minimum
DSCR for both senior debt and subordinated debt occurs in 2006,
when the potential for cash flow volatility will be low, since the
project is scheduled to receive fixed energy payments of 5.37 cents/kwh.
7. Low operating costs, as the average all-in breakeven
short run avoided cost (SRAC) rate needed to cover all costs, including
the payment of debt service on senior and subordinated debt, is
around 3.3 cents/kwh, which would be consistent with an average
natural gas price that is below $2.50/MMbtu;
8. According to reports prepared by the independent geothermal
engineer, the geothermal resource assets are expected to have a
reserve life that is well in excess of the term of the financing.
With effective stewardship of the resource and successful implementation
of various capital programs, the reservoir engineer believes that
the reserves should not experience a material decline over the period
of the financing.
The supportive factors are balanced against the following risks:
1. The proposed transaction will result in a substantial increase
in consolidated leverage. Total consolidated debt will increase
by around $257 million, the bulk of which will be returned
to the owners in the form of a dividend that may approximate $230
million and will result in negative shareholder's equity on a GAAP
balance sheet basis at closing;
2. Single resource risk and reliance upon one off-taker,
SCE as the source of revenue;
3. California regulatory decisions surrounding SRAC are likely
to be highly contentious;
4. While operating and financial results have been stable in recent
times, geothermal resources can experience greater year-over-year
changes in electric output, operating expenses and in capital expenditures
relative to other fuel sources;
5. The Caithness Coso partnerships' future revenues may exhibit
greater revenue volatility after April 2007 when the energy compensation
reverts to SRAC. This risk is significantly mitigated by Caithness'
low operating costs and an expectation that natural gas prices will remain
at levels that are well above the historic average.
The Baa3 Caithness Coso rating reflects the predictable source of cash
flow expected to be generated from energy and capacity payments received
under three PPAs that expire at varying times though 2019 with SCE,
an investment grade rated California based load-serving utility.
The rating also incorporates the strong operating history of these plants,
as demonstrated by the plants' average capacity factor of 102.4%
over the past five years and by the partnerships' stable financial
performance over the past few years as annual revenues, operating
income and cash from operations have been virtually unchanged since 2002.
The rating considers the experience of the operator, COC,
which has operated these plants since their inception in the 1980's
and the experience of Caithness Energy, COC's parent,
which obtained a controlling interest in these plants in 1999 and owns
other geothermal plants.
The rating also reflects the importance of these existing geothermal assets
to the California electric market, given the state's focus
on renewable resources as a core component of their energy policy.
The higher level of debt under the proposed financing is balanced against
the benefits resulting from the recent signing of a new agreement between
two of the Caithness Coso partnerships and the U.S. Navy,
which extended the partnerships' exclusive right to the geothermal
resources through October 31, 2034. This new agreement modestly
lowers the Caithness Coso partnerships' operating costs, reduces
uncertainties about future fuel supply, and provides the project
with a long-term incentive to continue exploring and developing
these geothermal resources and making the related capital investments.
The rating further considers the long-term favorable characteristics
of these geothermal resources, which are expected to have a reserve
life that is longer than the term of the financing, and have experienced
a relatively flat reserve decline, due in part, to a combination
of make-up drilling and improvements in surface facilities by COC.
Caithness Coso's plans to spend about $11.4 million
in capital expenditures during 2006 to build a system to supplement water
injection from the Hay Ranch that is part of a planned strategy to maintain
or increase reserve levels over an extended period of time.
The rating acknowledges the plants' very competitive operating cost
profile relative to other generating resources within the region.
Caithness Coso's variable costs of 1.4 cents/kwh are below
all fossil-fuel options in the western US, including base
load coal. This competitive position helps to mitigate future cash
flow concerns for the period when changes to the energy payment are expected
to occur. Under the current tariff arrangement with SCE,
the utility pays the Caithness Coso partnerships a capacity payment and
an energy payment of 5.37 cents/kWh. The energy payment
arrangement expires at the end of April 2007. Thereafter,
the Caithness Coso partnerships are expected to receive compensation for
energy based upon SCE's short-run avoided costs (SRAC), an
amount which is indexed to natural gas prices. While uncertainty
exists concerning the outcome of SRAC compensation, the Caithness
Coso partnerships' low operating costs, coupled with the expectation
of relatively high natural gas prices, position the Caithness Coso
partnership reasonably well to manage this risk. Break-even
analyses under assumptions that otherwise reflect the project's
base case conditions, indicate that the average SRAC energy price
could decline to around 2.8 cents/kwh and the Caithness partnerships
would have sufficient cash flow to service senior debt on a 1:1
Notwithstanding Caithness Coso's competitive position, Moody's
expects the SRAC process to be contentious, with the utilities seeking
to lower the compensation paid for energy under SRAC compensated contracts
to the lowest possible level and the QFs seeking to have an energy price
mechanism that minimizes any margin compression. An overriding
theme that should benefit the QFs position is the importance of QFs assets
to the overall resource supply mix in California, given the relatively
tight regional supply and the challenges to building additional energy
infrastructure in the state. However, Moody's believes that
the compensation scheme that ultimately results from the SRAC negotiations
is likely to compress over time as more efficient, lower heat rate
generating units are brought on-line.
The Baa3 rating incorporates the substantially higher leverage that will
exist at the Caithness Coso partnerships following the completion of this
financing. In addition to increasing total debt by about $257
million, approximately $230 million of the net proceeds will
be paid to the partners as a distribution at closing. As a result,
the Caithness Coso partnerships' balance sheet is expected to show
negative GAAP equity of approximately $7 million at closing.
The rating further incorporates the fact that two (Navy I partnership
and Navy II partnership) of the three PPA's with SCE expire in 2010
and 2011, respectively, well before the maturity date of the
senior bonds. This re-contracting risk is considered to
be low given the importance of this existing, dependable,
and low-cost renewable resource, the California PUC requirement
that renewable resources represent 20% of a utility's generation
resources by 2017, and the plants' status as a QF, which
under PURPA, requires SCE to take output from the Navy I and Navy
II partnerships at the utility's SRAC after the respective PPA expires.
Moreover, the debt and the amortization schedule have been sized
to try to address this risk, as the debt allocated to the Navy I
and Navy partnerships fully amortizes during the term of their PPAs expiring
in 2010 and 2011, respectively, resulting in the majority
of the debt being allocated to the BLM partnership, which has a
PPA expiry date of 2019.
While recent financial results have been stable, the rating also
considers the potential for greater year-over-year volatility
in financial results when operating a geothermal resource as compared
to other fuel sources, particularly natural gas-fired generation.
Given the possibility of year-over-year shifts in operating
expenses, the ongoing need to fund capital expenditures, the
ability to incur additional debt, and the uncertainty around future
SRAC revenues, the projected DSCR for the Caithness Coso partnerships
are appropriately stronger than most other investment grade power projects.
The base case DSCR for senior debt is expected to average 2.41x,
with a minimum DSCR of 1.55x, while the consolidated base
case DSCR, which incorporates annual debt service on the subordinated
notes, is expected to average 1.95x with a minimum of 1.27x.
The minimum DSCR for both senior debt and subordinated occurs in 2006,
when cash flow volatility is expected to be lowest as the project receives
fixed energy payments of 5.37 cents/kwh from SCE. While
the projected senior DSCR is substantially higher than is typically expected
in contracted power projects, the rating contemplates the flexibility
afforded to Caithness Coso through the financing documents, which
allows for the incurrence of additional senior secured bonds and additional
senior subordinated notes should the PPAs with the Navy I partnership
and Navy II partnership be extended. Under the terms of the indentures,
additional senior secured bonds and additional senior subordinated notes
can be incurred if the rating is affirmed by two rating agencies,
or if the minimum projected senior DSCR and consolidated DSCR for each
fiscal year, after taking into account the incremental debt,
is equal to or greater than 1.65x and 1.30x, respectively,
based upon contractual cash flows.
Caithness Coso, which is the issuer of the proposed bonds and notes
is a funding company without direct ownership of the physical assets.
However, each of the three partnerships, Coso Finance Partnership
(Navy I Partnership), Coso Energy Developers (BLM Partnership),
and Coso Power Developers (Navy II Partnership), will provide unconditional
upstream guarantees of the debt at Caithness Coso on a joint and several
basis. Caithness Coso's senior debt will be secured by a
first lien on all of its assets and its contracts, including the
three off-take PPAs with SCE. The transaction will feature
a waterfall structure for payment obligations, will require the
ongoing funding of a 12-month capital expenditure reserve,
and will have a six-month debt service reserve for the senior secured
notes. The debt service reserve will initially be provided by the
project in the form of a letter of credit available under a senior secured
five year letter of credit facility. Interest payments for draws
under the letter of credit reimbursement agreement will be paid on par
with senior debt service while principal payments of the letter of credit
reimbursement agreement will be paid after payment of senior debt service
in the waterfall.
The Ba2 rating for the senior subordinated notes incorporates the depth
of subordination of this debt relative to the senior debt. While
holders of the subordinated debt will have a second lien interest in the
collateral pledged to the senior debt, holders of the subordinated
notes lack rights to take action against Caithness Coso or its partnerships
if an event of default were to occur on the subordinated notes,
so long as there is any senior debt outstanding. The Ba2 rating
further considers the competitiveness of the Caithness parternships assets
as the average all-in breakeven SRAC price needed to cover all
costs, including the payment of debt service on senior and subordinated
debt, is around 3.3 cents/kwh which equates to an average
natural gas price that is below $2.50/MMbtu. The
principal on the subordinated notes will amortize over a nine year period
with final payment due in 2014, and the payment of interest and
principal on the secured subordinated notes is subject to a 1.30x
senior DSCR restricted payments test. Subordinated noteholders
benefit from a separate six month cash funded debt service reserve,
which provides some protection in the event that cash is trapped at the
senior debt level.
The rating outlook is stable and incorporates the expectation of a stable
operating and financial performance due to COC's history of being able
to effectively manage costs at this geothermal resource, the existence
of a predictable capacity payment through the life of the PPAs and a fixed
energy payment through April 2007, and the belief that the Caithness
Coso partnerships' exposure to SRAC risk is modest given the low operating
costs and the expectation for continued high natural gas prices,
a key determinant of the SRAC price. Limited upside rating potential
exists in the near-term given the single asset nature of this project
financing, the reliance on one source for all of Caithness Coso's
revenue stream, the expectation that the project's DSCR for
senior debt will remain in the 1.60x range in the near-term,
and the ability of the borrower to incur additional indebtedness under
both indentures. The rating could be downgraded should there be
a significant deterioration in the operating performance of the three
Caithness Coso partnerships or a substantial change in the credit quality
at SCE, which is the sole source of cash flow for the project.
The ratings are predicated upon review of final documentation and debt
sizing to meet projected debt service coverage ratios.
Caithness Coso is a special purpose corporation and a wholly owned subsidiary
of the Caithness Coso partnerships: Coso Finance Partners,
Coso Energy Developers, and Coso Power Developers. Caithness
Coso was formed for the purpose of issuing the senior secured notes on
behalf of the Coso partnerships who have jointly, severally,
and unconditionally guaranteed repayment of the senior secured notes.
The Coso partnerships and their affiliates own the exclusive right to
explore, develop, and use a portion of the Coso Known Geothermal
Resource Area in California.
Caithness Coso and the Caithness Coso partnerships are majority owned
by Caithness Energy, a project developer and sponsor with ownership
interest of approximately 2,500 MW of gross generating capacity
in geothermal, solar, wind, and natural gas.
Privately held, Caithness Energy is majority owned by Caithness
Equities, which is headquartered in New York City.
Corporate Finance Group
Moody's Investors Service
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service