Fitch assigns initial ratings to Duke Energy and subs

NEW YORK–(BUSINESS WIRE)–Fitch Ratings has assigned initial Issuer Default Ratings (IDR) and instrument ratings to Duke Energy Corp. (DUK) and its operating subsidiaries as follows:


–IDR ‘BBB+’;

–Senior unsecured debt ‘BBB+’.

Duke Energy Carolinas, LLC (DEC)

–IDR ‘A-‘;

–Secured debt ‘A+’.

Duke Energy Indiana, Inc. (DEI)

Duke Energy Ohio, Inc. (DEO)

Duke Energy Kentucky, Inc. (DEK)

–IDR ‘BBB+’;

–Secured debt ‘A’.

The Rating Outlook for all entities is Stable. A detailed list of rating actions appears at the end of this release.

The existing ratings of recently acquired Progress Energy, Inc. (PGN, ‘BBB’ IDR) and its operating subsidiaries Carolina Power & Light Co. (PEC, d/b/a Progress Energy Carolinas, Inc.; ‘A-‘ IDR) and Florida Power Corp. (PEF, d/b/a Progress Energy Florida; ‘BBB+’ IDR) are unchanged.

Key Rating Drivers

PGN merger: The ratings incorporate DUK’s increased scale and enhanced financial flexibility as a result of the merger with PGN. Longer-term, economies of scale and the geographic proximity of the service territories should create synergy opportunities that strengthen credit quality measures. The recently announced resignation of the Chief Executive Officer did not affect the ratings.

Utility Operations: The consolidated ratings are supported by the credit strength and cash flow diversity of six regulated utility subsidiaries operating in six states. Post-merger, utility operations will provide approximately 85% of consolidated earnings and cash flow. DUK’s two largest and financially sound utility subsidiaries, DEC and PEC (IDR ‘A-‘ for both companies), will account for approximately 55% – 60% of utility earnings.

Credit Metrics: In 2013, the first full year of operation for the combined entity Fitch estimates consolidated EBITDA/interest, FFO/interest and FFO/debt of approximately 4.75 times (x), 5.0x, and 20% respectively, which is consistent with Fitch’s target ratios for ‘BBB+’ issuers and DUK’s peer group of utility parent companies. Debt/EBITDA, however, will be somewhat weak for the rating category with 2013 Debt/EBITDA projected by Fitch to be about 4.25x, trending down to about 4.0x over the next two years.

Construction Expenditures: Consolidated capital expenditures for the merged entity trend downward through 2013, as current modernization projects come on line through 2012. Expenditures then begin to increase in 2014 reflecting environmental expenditures, an expected increase in customer connections relative to recent years, potential new generation and discretionary expenditures.

Liquidity: DUK has sufficient liquidity to meet its operational needs and debt refinancing requirements, but will require continued capital market access. In November 2011, the company entered into a new $6 billion, five-year master credit facility; $4 billion became available at closing and the remaining $2 billion became available following the completion of the PGN merger.

Rating Concerns

Consolidated Leverage: The acquisition of the more levered PGN increases the proportion of debt at the parent level (DUK plus PGN). Pre-merger, Duke had approximately 20% of its $23 billion consolidated debt at the parent level, compared to about 33% for PGN. Post-merger parent debt (DUK plus PGN) is expected to approximate 25% – 27% of total debt.

Achieving synergies: DUK is at risk for system fuel savings included as part of the merger settlement agreement with the North and South Carolina Commission’s. The companies agreed to guarantee $650 million in system fuel savings for Carolina retail customers over the next five years (plus an additional 18 months if coal consumption at certain plants is less than originally forecast due to low gas prices).

Environmental Exposure: Pre-merger, DUK (excluding PGN) derived approximately 60% of its electric generation from coal-fired facilities and Fitch expects environmental spending to increase over the five-year period 2012-2016. DEI and DEK are authorized to recover environmental spending through tracker mechanisms. Both PEC and PEF are relatively well positioned to meet environmental compliance regulations and have more modest capital investment requirements.

What would lead to consideration of a negative rating action?

–Adverse regulatory outcomes;

–An increase in the percentage of parent level debt.

What would lead to consideration of a positive rating action?

–Not likely at parent or Duke Carolinas;

–Ratings of DEI could improve with continued rate support, while any improvement in the DEO ratings would be dependent on more clarity with respect to the proposed asset transfer and regulatory environment in Ohio.

Duke Energy Carolinas, LLC

Key Rating Drivers

Credit metrics: Credit metrics are strong and should improve in 2012, due to rate increases implemented in North and South Carolina effective January 2012. Fitch expects EBITDA/interest and FFO/interest coverage measures to approximate 5.5x and 6.0x, respectively in 2012 and debt to EBITDA roughly 3.5x.

Constructive regulatory environment: Fitch considers regulation in North Carolina, DEC’s primary regulatory jurisdiction, to be constructive. NC state regulation permits annual tariff adjustments to recover fuel, demand side management, energy efficiency and certain renewable costs.

Capital expenditures: DEC is nearing the end of a major construction cycle with the expected completion in 2012 of two major projects. Both the 825 MW Cliffside coal-fired unit and the 620 MW Dan River combined cycle gas-fired unit are expected to enter commercial operation before year-end. Capex is expected to ramp up after 2013 primarily due to environmental spending.

Rate support: Continued rate support is critical for maintenance of existing ratings. Duke Carolinas expects to file a rate case in North Carolina in 2012 with rates to be effective in 2013. The 2012 filing is the last of a three-year plan (2009, 2011 and 2013) to recover modernization investments.

Duke Energy Indiana

Key Rating Drivers

Credit metrics: Credit metrics are strong and should begin to trend upward following the expected recovery of additional Edwardsport financing costs later this year. Fitch expects EBITDA/interest and FFO/interest coverage measures to approximate 5.5x and 5.0x, respectively in 2012. Leverage is moderately high with 2012 debt to EBITDA and FFO/debt projected at approximately 4.0x and 17%, respectively.

Regulatory environment: Fitch considers regulation in Indiana to be constructive. Favorably Indiana statutes permit recovery of environmental costs.

Settlement Agreement: In April 2012, DEI entered into a settlement agreement that largely resolves the regulatory treatment of the company’s investment in the Edwardsport integrated gasification combined cycle (IGCC) plant. The agreement establishes a $2.59 billion cap on costs to be reflected in customer rates compared to a final estimated cost of $3.3 billion. The company also agreed not to request a retail base rate increase prior to March 2013, with rates in effect no earlier than April 1, 2014.

However, due to the settlement, customer rates will increase approximately 9.6% above the approximately 5% impact already in rates through a rider mechanism. Due to the settlement agreement, DEI wrote-off $420 million, in addition to previous write downs of $222 million and $44 million. To restore DEI’s balance sheet and achieve its authorized regulatory equity ratio of 51%, DUK is foregoing dividends from DEI in 2012.

Duke Energy Ohio

Key Rating Drivers

Credit metrics: Credit metrics are very strong but will trend downward due to the new electric security plan (ESP) implemented Jan. 1, 2012. The ESP effectively moved all generation to market based rates effective Jan. 1, 2012. The current market price for energy is well below the power prices embedded in its previous ESP.

ESP: The ESP provides for competitive auctions to supply the load obligations of customers that do not choose an alternative energy supplier. Supply costs are recovered from rate payers. The ESP requires DEO to transfer its generating assets at net book value to an affiliate by Dec. 31, 2014 and establishes a non-bypassable charge of $110 million per year for the three-year period 2012 – 2014 that will mitigate the impact of losing the above market margins on retail supply under the previous ESP. The ESP stipulates that the transferred generation cannot receive credit support from Duke Ohio. DUK will provide credit support, if needed, through an inter-company loan agreement.

Recapitalization: To reflect the higher merchant risk of the generating assets and to maintain credit quality, DEO will be recapitalized by refinancing approximately $900 million of debt at DUK. The debt transfer will be accomplished by refinancing $500 million of maturing debt (Sept. 15, 2012) with new parent debt and remarketing $400 million of tax-exempt debt at the parent thereby avoiding any make-whole premiums.

Duke Energy Kentucky

Key Rating Drivers

Credit metrics: Credit metrics are strongly positioned in the ‘BBB+’ rating category. In the near term, credit metrics are expected by Fitch to trend downward but remain supportive of the current ratings, due to high capex and a two year rate freeze agreed to as part of the settlement agreement approving the merger with PGN. Fitch expects EBITDA/interest and FFO/interest coverage measures to approximate 6.0x in 2012 and to trend moderately downward in 2013.

Regulatory environment: Fitch considers regulation in Kentucky to be constructive. Regulatory statutes permit recovery of environmental costs, which is particularly important given the company’s reliance on coal-fired generation.

Environmental exposure: Relatively large capital expenditures are required to comply with environmental regulations. Fitch expects the financial impact to be mitigated by the environmental cost recovery clause in Kentucky, but credit metrics are expected to trend down from currently very strong levels.

Fitch has assigned the following ratings with a Stable Outlook:

Duke Energy Corp.

–Long-term IDR ‘BBB+’;

–Senior unsecured debt ‘BBB+’;

–Short-term IDR ‘F2’;

–Commercial paper ‘F2’

Duke Energy Carolinas, LLC

–Long-term IDR ‘A-‘;

–First mortgage bonds ‘A+’;

–Senior unsecured debt ‘A’;

–Short-term IDR ‘F2’

Duke Energy Indiana, LLC

–Long-term IDR ‘BBB+’;

–First mortgage bonds ‘A’;

–Senior unsecured debt ‘A-‘;

–Short-term IDR ‘F2’

Duke Energy Ohio, LLC

–Long-term IDR ‘BBB+’;

–First mortgage bonds ‘A’;

–Senior unsecured debt ‘A-‘;

–Short-term IDR ‘F2’

Duke Energy Kentucky, LLC

–Long-term IDR ‘BBB+’;

–First mortgage bonds ‘A’;

–Senior unsecured debt ‘A-‘;

–Short-term IDR ‘F2’