Jan 9 - Fitch Ratings has assigned a 'BBB-' rating to Duke Energy Corp.'s
(DUK) new $500 million issue of 5.125% junior subordinated debentures
due Jan. 15, 2073. The Rating Outlook is Stable. The debentures will be
unsecured and will rank junior and be subordinated in right of payment and
upon liquidation to all senior indebtedness of DUK.
A portion of the proceeds will be used to fund the redemption of the $300
million of 7.1% Cumulative Quarterly Income Preferred Securities due 2039,
Series A, issued by DUK's indirect subsidiary FPC Capital I. The remaining net
proceeds will be used to repay commercial paper, fund capital expenditures of
DUK's unregulated businesses and for general corporate purposes.
So long as there is no event of default under the subordinated indenture, DUK
has the right to defer interest payments on the debentures for up to 10
consecutive years on more than one occasion. Deferred interest payments will
accumulate interest at a rate equal to the interest on the junior subordinated
debentures. DUK may redeem the debentures at any time at the applicable
The securities are eligible for 50% equity credit under Fitch's applicable
criteria 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT
Credit Analysis', dated Dec. 12. 2012. Key features supporting the equity credit
are the junior subordinated ranking, the option to defer interest payments on a
cumulative basis for up to 10-years on each occasion, and 60-year maturity.
Key Rating Drivers
Utility Operations: The ratings are supported by the credit strength and cash
flow diversity of DUK's six regulated utility subsidiaries operating in six
states. Utility operations are expected to provide approximately 85% of
consolidated earnings and cash flow. DUK's two largest and financially sound
utility subsidiaries, Duke Energy Carolinas and Progress Energy Carolinas (Fitch
IDR of 'A-' for both companies), will account for approximately 55% - 60% of
Financial Flexibility: The ratings incorporate DUK's increased scale and
enhanced financial flexibility following the 2012 merger with Progress Energy
Corp. (PGN). Longer term, economies of scale and the geographic proximity of the
service territories should create synergy opportunities that strengthen credit
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 4.75x, 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 should decline in
2013, as several electric generation modernization projects enter service.
Expenditures then begin to increase in 2014 due, in part, to rising
environmental expenditures and potential electric generation additions.
Capital and Operating Cost Recovery: Tariff increases are expected in several
jurisdictions in 2013 that should enhance consolidated earnings and cash flow
measures. Fitch expects tariff adjustments for Duke Energy Carolinas (DEC) and
Progress Energy Carolinas (PEC) in both their North Carolina and South Carolina
jurisdictions, primarily to recover capital investments. Electric and gas rate
increases are also expected for Duke Energy Ohio in 2013, while Progress Energy
Florida (PEF) raised electric rates effective Jan. 1, 2013.
Liquidity: DUK has ample liquidity to meet its operational needs and debt
refinancing requirements, but will require continued capital market access. A $6
billion, five-year master credit facility expires in November 2016. The credit
facility supports DUK's $2.2 billion commercial paper program.
Crystal River 3 Outage: Fitch believes it is unlikely management will elect to
repair Crystal River 3 (CR3) given the rising cost estimates, construction risks
and low gas-price environment, and instead will pursue the retirement option and
recovery of invested capital (see settlement agreement below). The unit has
been out of service since September 2009.
Florida Rate Settlement Agreement: A rate settlement agreement approved by the
Florida Public Service Commission (FPSC) establishes a framework for the
treatment of CR3 costs. Importantly, the agreement allows the recovery of
on-going replacement power costs. In addition, if PEF decides to retire CR3, the
parties to the settlement agreed not to challenge the full recovery of all plant
investment. Partly, offsetting the positive elements of the settlement agreement
are provisions for rate refunds of $388 million of CR3 replacement power costs
(primarily in 2013 and 2014), a lower than expected rate increase in 2013, a
rate freeze through 2016 and the removal of CR3 from rate base. The rate refunds
include $40 million in 2015 and $60 million in 2016 due to its inability to
start repairs in 2012.
High Parent 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 consolidated debt.
Achieving synergies: DUK is at risk for achieving system fuel savings included
as part of the PGN merger settlement agreement with the North Carolina Public
Service Commission. 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).
What Could Trigger a Rating Action
Adverse Regulatory Outcomes: Lack of rate support for DEC's fleet modernization
program poses the greatest downside risk to ratings. The company has invested
heavily to replace aging power plants and to comply with environmental
regulations and is dependent on continued rate support to maintain ratings
Crystal River 3 Repair: A decision to repair CR3 without assured regulatory
recovery would strain credit protection measures and could adversely affect