Fitch Affirms Kern River Funding Corp Ratings; Outlook Stable

Business Wire, Feb 27, 2007

CHICAGO -- Fitch has affirmed the Issuer Default Rating (IDR) and Senior Unsecured Debt ratings for Kern River Funding Corp. (KRFC) at 'A-'. The Rating Outlook is Stable. KRGT has two debt issuances outstanding: $699 million of 4.893% amortizing senior notes due April 2018, and $387 million of 6.676% amortizing senior notes due June 2016.

KRFC serves as a special purpose financing vehicle for Kern River Gas Transmission Corp. (KRGT), one of two FERC-regulated natural gas interstate pipelines wholly owned by MidAmerican Energy Holdings Co. (MEHC; IDR rated 'BBB ' by Fitch). KRFC's debt obligations are unconditionally guaranteed by KRGT. The 'A-' rating reflects KRFC/KRGT on a stand-alone basis, separate from MEHC, due to the specific legal and financial structuring of KRGT and KRFC's corporate structure and debt obligations.

The ratings for KRGT reflect the company's portfolio of binding long-term transportation contracts, access to abundant natural gas supplies and its solid operating track record. In addition, KRGT benefits from a strong competitive position as the only interstate system which provides a direct interconnection between Rocky Mountain gas production basins to end use Southern California markets. KRGT also provides low-cost transportation to other attractive markets along its system including Las Vegas and Salt Lake City. These factors combined have enabled KRGT to operate at or above design capacity since 1993. KRGT continues to generate predictable cash flows and solid debt service coverage (DSCR) measures, with the ratio of EBITDA to DSCR projected to be slightly above 2 times (x) over the next five years. Fitch expects project economics to remain relatively consistent with historical levels over the life of the debt.

Currently, the blended credit quality of KRGT shippers approximates 'BBB', and includes several sub-investment grade energy merchant companies that signed on following KRGT's 2003 expansion. As a result, non-investment grade or unrated entities now account for 38% of all shippers by volume of total capacity. The company's credit policy requires that sub-investment grade shippers post either letters of credit ($89.3 million) or cash collateral ($26.2 million) equal to one year's reservation charge. This is somewhat atypical for project financing and provides significant creditor protection in a downside scenario. Around 95% of KRGT's revenues are from firm transportation customers under long-dated contracts, with 14% of contracts maturing between 2011-2013, 37% in 2016-2017 and 49% after 2018. The ability to have higher contracted levels in the latter years of the project debt would be viewed favorably by Fitch.

Rating concerns facing the company primarily relate to ongoing issues with certain shippers, in particular Calpine Energy Services and Reliant Energy Services, as well as competitive risks surrounding the potential for the development of competing pipeline systems and/or LNG import terminals serving the California market. Calpine Energy Services is a subsidiary of Calpine Corp., which has been operating under bankruptcy protection since December 2005, and has two 15-year firm transportation agreements with the pipeline. At this time, Calpine has posted cash collateral with KRGT but has not yet determined whether or not it will accept or reject the two contracts. Reliant Energy Services, a subsidiary of Reliant Energy Inc. (IDR Rated 'B', Rating Watch Positive by Fitch), and CenterPoint Energy Resources Corp. filed a joint complaint against KRGT with the FERC in mid-2006. CenterPoint Energy Resources Corp. is a subsidiary of CenterPoint Energy (IDR rated 'BBB-'), which secures Reliant's obligation under the shipping agreement, requested KRGT to allow Reliant to replace the CenterPoint guarantee with the conventional collateral required for non-investment grade shippers. Reliant is KRGT's biggest customer by volume, and the loss of the CenterPoint guarantee would deteriorate KRGT's shipper profile. In a distress scenario, whereby KRGT were to lose the Calpine and Reliant volumes, Fitch would expect that the pipeline would be able to remarket a portion of the capacity, albeit at a discount, in the interruptible market. Under these circumstances, it is anticipated that debt service coverage would remain comfortably above 1.0x over the life of the project debt.

In October 2006, the Federal Energy Regulatory Commission (FERC) issued an order modifying an earlier administrative law judge's (ALJ) initial decision on KRGT's 2004 rate case allowing a return on equity (ROE) of 11.2%, an increase from the ALJ's initial 9.34% ruling. The FERC's order also rejected several provisions of the rate case, including features of the load factor calculation and the inflation adjustment factor, that may not allow KRGT to achieve an 11.2% ROE. Kern River has filed a request for rehearing with the FERC, and a rehearing is expected to occur sometime in the first half of 2007. Fitch projections indicate that KRGT's credit metrics will not be significantly impacted under a situation with an effective 11.2% ROE.