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Rating Action:

MOODY'S INVESTORS SERVICE ISSUES RATES CAITHNESS COSO FUNDING CORP. SENIOR SECURED NOTES Ba1 AND Ba2

07 May 1999
MOODY'S INVESTORS SERVICE ISSUES RATES CAITHNESS COSO FUNDING CORP. SENIOR SECURED NOTES Ba1 AND Ba2 Moody's Investors Service assigned a Ba1 long term debt rating to $110 million of senior secured notes of Caithness Coso Funding Corp. (CCFC) due 2001 (the Short Notes) and a Ba2 long term debt rating to $303 million of senior secured notes of CCFC due 2009 (the Long Notes, together, the Notes). CCFC plans to sell the notes during the coming weeks. As discussed below, the Notes sales proceeds, together with other sources of funds, will repay the currently outstanding Coso Funding Corp. notes due 1999 and 2001.


The new Notes will be repaid out of operating cash flow from three geothermal projects located in the Mojave Desert 150 miles northeast of Los Angeles. The three projects-Navy I, Navy II and BLM (the Projects)-have been operating successfully for nine years and sell energy and capacity to Southern California Edison (SCE) pursuant to long term power purchase agreements (PPA's).


Moody's ratings reflect the Projects' experienced management, successful operating histories, the portions of the revenues under the SCE PPA's which are fixed and the very slowly declining geothermal resource. However, the ratings also reflect the portions of revenues under the SCE PPA's which will move at market power rates, the fact that projected operating costs are somewhat lower than past operating costs, the current litigation between SCE and the Projects, and the debt burden, which is significantly higher than the outstanding Coso Funding Corp. bonds being refinanced.


Notes Present Different Risk Profiles


The Short Notes and the Long Notes present somewhat different risk profiles. The Short Notes will be outstanding during a period of fixed or regulatorily supported PPA revenues. Two-thirds of the revenues during much of the term of the Long Notes, however, will be subject to market prices. In addition, although the geothermal resource appears to be declining in a slow, stable manner, any geothermal resource is ultimately a dwindling resource, a greater concern for the Long Notes than for the Short Notes.


The Projects were originally developed in the 1980's by Caithness Energy and CalEnergy. Caithness Energy, through affiliates, owns interests in seven US geothermal projects and several other power projects as well as investments in other industries. The Company invests money for a large number of private clients. In addition, Florida Power & Light Company (FP&L) owns a small portion of Navy I, and Dominion Resources Inc. owns a portion of Navy II and BLM.


In August 1998, CalEnergy announced its MidAmerican merger. In late February, CalEnergy sold its interests in the Projects to Caithness both to raise funds for the MidAmerican acquisition and to allow the Projects to keep their utility ownership beneath 50%, thereby keeping the Projects in compliance with the PURPA requirements. The Projects' power contracts require PURPA compliance.


Caithness paid for CalEnergy's Project interests with the proceeds of a $214 MM bridge loan. The Projects were each originally financed at the project level with bank debt. The project financings were then taken out in 1992 with the Coso Funding Corp. notes. Moody's currently rates the Coso Funding Corp. notes Baa2. That financing, however, was characterized by significantly lower leverage and significantly greater reliance on set-in-stone power rates. Caithness now plans to refinance both the bridge loan and the 1992 funding corp financing.


The refinancing needs total $501 MM. The $501 MM sources of funds comprise $413 MM of debt (the debt being rated), $30 MM of cash equity from Caithness Energy and $58 MM of cash on the balance sheet. The uses of funds comprise-aside from the debt refinancing described above--$74 MM in distributions to minority shareholders, $50 MM funding of the debt reserve and $10 MM of fees.


Structure of the Notes


Caithness will issue the Notes in two tranches-the Short Notes and the Long Notes. Both tranches rank pari passu with regard to cash flow and both share ratably in the security. The Short Notes' maturity coincides with the end of the fixed price and regulatorily supported periods under the Projects' power contracts (see below); the Long Notes' maturities slightly precede the first possible termination date of a necessary contract not resulting in compensation to the Projects-the ground lease for both Navy I and Navy II.


Caithness will take the Notes proceeds along with the remaining uses of funds and (1) repay the bridge loan and fund the debt service reserve at the funding corp level, (2) downstream funds to the Project partnerships to repay existing notes evidencing the 1992 financing and (3) pay fees and expenses.


The Notes will be secured by (1) a pledge of the notes from each of the Project partnerships to the funding corp, (2) liens on the assets and stock of the funding corp, (3) pledges of the partnership interests in the Project partnerships (which are held by other parties than the funding corp) and (4) guaranties of the Project partnerships. After repaying the existing Project partnership notes, the Project partnerships will be debt free besides (1) the new notes to the funding corp and (2) permitted debt. The Project partnerships have also been restricted with regard to permitted liens.


The Notes have been straightforwardly structured. The Notes amortize throughout their term. Of note: (1) Power contract buyouts materially affecting revenues require bondholder approval; (2) Power contract buyout proceeds above a minimal amount will be used to redeem bonds; (3) Bondholder put upon change of control; (4) Capital expenditure reserve account; (5) Six-month debt service reserve account; (6) 1.25x required DSCR test during the term of the Short Notes (through 2001) and 1.40x thereafter--one year look-back and one year look-forward; (7) Annual budget and geothermal adequacy certifications; (8) Limitations on indebtedness (including the same prospective DSCR tests as above); (9) permitted liens; (10) provision of financials and (11) a requirement to file exchange offer with the SEC within 90 days.


Projects Comprise Resource, Piping and Power Plants


The Projects comprise geothermal resource, piping and power plants. The Projects have run well for ten years and should operate well through the ten year life of the Notes. Each Project has three turbines. Certain of the turbines have experienced cracking problems, but the Projects have been methodically addressing those problems and plan to continue to do so. All other operating issues appear manageable.


The Projects have been granted rights to the land and the geothermal resource variously by the US Navy and the Bureau of Land Management. In addition, the Projects have recently leased additional adjacent land from the Los Angeles Department of Water and Power. The Navy can terminate its land arrangements early for several reasons, but only upon making a cash payment well in excess of the debt which would need to be retired upon such contract termination. The Notes require the Issuer to prepay debt with any such proceeds. The Project makes lease and/or royalty payments based on revenues to the landowners.


The resource consists of steam and hot water. Assuming the Projects continue to work the resource as planned, the Projects should continue to meet their power contracts' capacity requirements and to generate the projected energy. Although the resource appears to be declining, the decline appears to be slow and consistent.


Affiliates Will Manage the Projects


A Caithness affiliate will manage the resource. An FP&L subsidiary will manage all above-ground plant. Both are well-experienced in their roles. The Issuer projects operating costs going forward to be significantly below past operating costs. Much of this reduction results from O&M contractual cost reductions.


The Projects Will Sell Energy and Capacity to SCE pursuant to PPA's


All three Projects sell capacity and energy to SCE pursuant to PPA's which terminate after the Long Notes' maturity. The PPA capacity payments are set subject to the Projects' meeting achievable capacity tests. Energy revenues under two of the PPA's equal SCE's avoided cost of power. In its analysis, Moody's has assumed that SCE's avoided cost of power going forward will equal Southern California market clearing wholesale electricity prices. Although energy revenues under the third PPA currently is set, energy revenues under that PPA will also begin equaling SCE's avoided cost of power within the next year and a half. California law, however, tops off the energy payments under all three PPA's to 3 cents/kwh until the end of 2001. Moody's therefore assumes energy payments at the higher of the contracted amount or 3 cents/kwh until the end of 2001 and at California market clearing prices thereafter. After 2001, capacity payments account for one-third and (market-determined) energy payments account for two-thirds of revenues.


The Projects and SCE are currently in litigation over the Projects' alleged venting of gases in violation of its air permits several years ago. Moody's has considered the litigation issues and related issues and believes the debt ratings reflect the risks associated with that litigation and the related issues.


Financial Projections


The Issuer projects debt service coverage ratios averaging approximately 1.35x during the term of the Short Notes and 1.62x thereafter. While Moody's financial projections predict debt service coverage ratios generally in agreement with the Issuer during the initial years, Moody's stress assumptions with regard to future California market clearing electricity prices result in debt service coverage ratios of between 1.3x and 1.4x thereafter-a twenty to thirty basis point difference. Moody's power market stress assumptions address, among other factors, projected fuel prices, overbuilding, nuclear plant retirement and must-run contract termination dates. Moody's base stress case assumes that projected power rates could drop an average of 30% and still yield-with all other things being equal-break even debt service coverage ratios. Moody's also notes that the debt structure's debt service coverage ratio cash trap mechanisms have the potential to build up significant cash reserves.


Caithness Energy is based in New York City, New York. Florida Power & Light Company is located in Juno Beach, Florida. Dominion Resources Inc. is located in Richmond, Virginia.

No Related Data.
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