Fitch Rates Duke Energy's Junior Subordinated Notes 'BBB-'
by Business Wire
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 redemption price.
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 utility earnings.
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 quality measures.
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 ratings.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Parent and Subsidiary Rating Linkage' (Aug. 12, 2011)
--'Recovery Ratings and Notching Criteria for Utilities' (May 3, 2012);
--'Rating North American Utilities, Power, Gas and Water Companies' (May 16, 2011).
-- 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 13, 2012)
Applicable Criteria and Related Research:
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Rating North American Utilities, Power, Gas, and Water Companies
Recovery Ratings and Notching Criteria for Utilities
Parent and Subsidiary Rating Linkage
Corporate Rating Methodology