Fitch Expects to Rate Caithness Coso 'BBB-' & 'BB-'.

NEW YORK -- Fitch Ratings expects to assign ratings of 'BBB-' and 'BB-' to Caithness Coso Funding Corp.'s (Coso) proposed issuance of $375 million senior secured bonds due 2019 and $90 million subordinated secured notes due 2014, respectively. The primary purpose of the proposed financing is to repay existing indebtedness and provide a distribution to the sponsors.

Coso is a special-purpose company formed to issue debt on behalf of the Coso partnerships, the owners of the Coso projects and the guarantors of the proposed issuance. The Coso projects consist of three interlinked 80MW geothermal power plants and their transmission lines, steam gathering systems, and other related facilities located at the Navy Weapons Center in Inyo County, CA. Electric energy and capacity are sold to Southern California Edison (SCE) under separate Standard Offer No. 4 (SO4) contracts expiring in 2010, 2011, and 2019. Coso provides royalty payments to the U.S. Navy and the Bureau of Land Management for use of the geothermal resource.

The SO4 contracts provide Coso with fixed-price capacity payments and energy payments indexed monthly to the price of natural gas. After expiry of the SO4 contracts, Coso expects to continue selling its output to SCE under SO1 contracts. The price structure of SO4 and SO1 contracts is similar, although capacity payments are substantially lower in SO1.

Fitch has evaluated Coso's credit quality on a stand-alone basis, independent of the credit quality of its owners. The expected ratings reflect Coso's credit quality from 2007-2011, when debt service obligations peak and projected debt service coverage ratios (DSCRs) reach their lowest point. Fitch believes that Coso's long-term credit fundamentals are stronger than typical for the rating category.

Fitch views the subordinated notes as deeply subordinated to the senior bonds. Fitch's policy for deeply subordinated debt requires a three-notch differential between the ratings of the senior and subordinate debt unless other circumstances suggest greater notching. The financial results and protections provided to the senior bondholders support the minimum three-notch differential. Note that even though the subordinated notes mature before the senior bonds, the term of the subordinated notes overlaps with the period of Coso's weakest financial performance due to the substantial debt service due on the senior bonds. The subordinated notes benefit from the presence of a separate debt service reserve established for the exclusive benefit of the subordinated noteholders.

SCE's counterparty rating is considered a constraint on the ratings of Coso, which relies on SCE as its sole source of contractual revenue. This constraint is not currently active, as the expected ratings reflect Coso's financial performance on a stand-alone basis. In the event that SCE's credit quality falls below Coso's stand-alone credit quality, it is likely that Coso's ratings would be downgraded accordingly. It is important to note that SCE's credit quality may not be a constraint in the long term, as Coso's reliance on SCE will diminish as the PPAs expire. Fitch rates SCE's senior unsecured debt 'BBB' with a Stable Outlook.

Primary credit strengths include the following:

-- History of strong operational performance;

-- Stable geothermal resource;

-- Competitive cost structure;

-- Low volumetric risk;

-- Experienced and committed sponsor.

Primary credit concerns include the following:

-- Exposure to market price volatility;

-- Potential revision of the short-run avoided cost (SRAC) calculation;

-- Reliance on Hay Ranch augmentation program.

The Fitch base case employs Fitch's natural gas pricing assumptions in the calculation of SRAC prices. Senior DSCRs are projected to average 1.6 times (x) from 2007-2009 with a minimum of 1.5x in 2008. Senior DSCRs increase to approximately 2.5x by 2012 and remain above that level until maturity in 2019. Consolidated DSCRs average 1.3x through 2011 with a minimum of 1.2x in 2008. Consolidated DSCRs increase to approximately 1.9x between 2012 and the maturity of the subordinated debt in 2014. The pattern in coverage is largely due to the rate of principal amortization rather than the expectation of increasing cash flow.

To assess Coso's vulnerability to market conditions, Fitch considered several scenarios, which could result in different energy prices:

The low gas scenario reflects SRAC prices that would occur if natural gas prices fall to $3.35/MMBtu (in 2005, escalating at 2.5%) at the Malin trading hub, the index currently used in SRAC calculations. Senior DSCRs fall to a minimum of 1.35x in 2007 and 2008 and are generally greater than 2.50x from 2012 onward. Consolidated DSCRs average 1.1x from 2007 to 2011 and 1.5x between 2012 and the maturity of the subordinate debt.

The market energy scenario assumes that after the expiry of the SO4 contracts, the output is sold into the wholesale energy market at prevailing market prices, rather than to SCE under SO1 contracts at SRAC prices. Senior and consolidated DSCRs from 2011 onward are approximately 0.1x to 0.2x lower than in the Fitch base case.

The breakeven scenarios reflect the energy prices that result in coverage ratios of 1.0x on the senior debt and total debt in each year. SRAC prices would need to fall to approximately $38/MWh for a payment default on the subordinate debt and $30/MWh on the senior debt.

To assess the importance of the Hay Ranch supplemental injection program, Fitch considered a scenario that assumes the Hay Ranch program proves ineffective. Senior DSCRs fall to 1.25x in 2008, gradually increase to 1.8x in 2012, and then gradually decline to 1.5x at maturity. Consolidated DSCRs are at breakeven levels until 2011 and approximately 1.3x thereafter.

Fitch has published a presale report with a detailed discussion of the transaction and rating rationale. The presale report Caithness Coso Funding Corp. is available on the Fitch Ratings web site at 'www.fitchratings.com' under 'Project Finance' and 'Corporate Finance' or by contacting the ratings desk at 800-893-4824.

Fitch's rating definitions are available on the agency's public web site, 'www.fitchratings.com'. Published ratings, criteria and methodologies, and relevant policies and procedures are also available from this site, at all times. This document will remain on the public site for seven days.