Fitch Affirms Duke Energy and its Subsidiaries Ratings

NEW YORK--()--Fitch Ratings has affirmed the existing Issuer Default Ratings (IDR) and instrument ratings of Duke Energy Corp. (DUK) and its subsidiaries. A full list of the ratings is provided at the end of this release. The Rating Outlook for Duke Energy Carolinas, LLC (DEC) is revised to Positive from Stable. The Rating Outlook for all other entities is Stable.

The rating affirmations reflect the sound financial performance of each entity in 2013 that was in line with expectations, further improvements expected in 2014 due to the residual impact of 2013 rate increases and on-going productivity gains following the 2012 merger with Progress Energy, Inc. (PGN). The recommendation also considers the financial flexibility afforded by DUK's size and scale and the geographic and regulatory diversity of its utility operations. With total assets of approximately $115 billion and a market cap of over $50 billion, DUK is the largest company in the utility sector with a diverse revenue stream from six utility subsidiaries operating across a six state service territory extending from the Southeast to the Midwest regions.

Duke Energy Corp.

KEY RATING DRIVERS

Conservative Business Model: DUK owns six regulated utilities operating in six states that provide a relatively predictable and diverse cash flow stream. The six regulated utilities are expected to provide approximately 85%-90% of consolidated earnings and cash flow over the next several years. Each of the utilities has a solid credit profile and is well positioned within their respective rating levels. Contracted renewables and international power generation account for the remaining earnings and cash flow contributions.

Solid Financial Profile: Consolidated credit metrics are expected to remain sound over the forecast period. Over the next two years Fitch forecasts funds from operations (FFO) fixed charge coverage and FFO lease-adjusted leverage will average about 4.9x and 4.2x, respectively which are supportive of current ratings. Projected adjusted debt/EBITDAR over the same period of 4.2x is moderately high for the rating category, but more than offset by the financial flexibility afforded by DUK's size and scale and the diverse cash flow stream. Each of the utility operating subsidiaries has a financial profile that is consistent with the current ratings.

High Parent Leverage: The percentage of parent level debt (intermediate holding company PGN plus DUK) is relatively high. Parent debt accounted for approximately 30% of adjusted debt in 2013 trending down to about 27% over the next few years. The acquisition of the more levered PGN in 2012 and the recapitalization plan for Duke Energy Ohio (DEO) described below accounts for the high proportion of parent debt.

Capital and Operating Cost Recovery: Tariff increases implemented in 2013 are expected by Fitch to strengthen 2014 earnings and cash flow measures for five of the six operating utilities and on a consolidated basis. Base rate increases were implemented in each of DUK's two North Carolina territories, as well as in South Carolina, Florida, and Ohio following regulatory approval of settlement agreements. Duke Energy Indiana, LLC (DEI) also increased rates in January 2013 through a rider mechanism to reflect the full recovery of approved construction work in progress (CWIP) related to its Edwardsport Integrated Gasification Combined Cycle (IGCC) plant. Only Duke Energy Kentucky, Inc. (DEK), DUK's smallest subsidiary did not raise rates in 2013.

Key Issues Resolved: Business risk was lowered in 2013 by the constructive resolution of several key issues. DUK made the decision to retire the Crystal River Unit 3 (CR3) nuclear plant which had been out of service since late 2009, resolved related insurance claims with its insurance provider, Nuclear Electric Insured Limited (NEIL) and obtained approval of a comprehensive settlement agreement with the Florida Public Service Commission (FPSC) that provides recovery of CR3. The settlement also provided cost recovery of Duke Energy Florida's (DEF) investment in the proposed Levy nuclear plant. The final rate treatment of the Edwardsport IGCC plant was also concluded in 2013.

Dan River Ash Basin Spill: The current ratings assume the cost of repair and clean up and any potential penalties following a coal ash spill at Duke Energy Carolina's Dan River coal plant will be manageable within the current ratings. Fitch expects the event will require additional investment over the next several years to remediate other coal ash ponds throughout the DUK system, but should be recoverable in rates.

Cost Control: Efficiency improvements and work force reductions mostly related to the PGN merger and the proposed sale of the Midwest generating portfolio are expected to keep O&M expense relatively flat at about $6 billion annually over the next several years.

Constructive Regulation: Regulation in DUK's six state service territory, particularly the three largest jurisdictions, North Carolina, Florida and Indiana is considered constructive by Fitch.

RATING SENSITIVITIES

Positive Rating Action: Positive rating action is not likely given the current ratings and leverage measures, including the significant parent level debt.

Negative Rating Action: Ratings could be downgraded if parent leverage exceeds the current 30% level, adjusted debt/EBITDAR exceeds 4.50x on a sustained basis or if one of its larger utility subsidiaries is downgraded.

Duke Energy Carolinas. LLC (DEC)

Strong Credit Profile: DEC's credit metrics are consistent with an 'A' rating and are expected to improve due to rate increases implemented in North and South Carolina in September 2013. The 2013 rate increase includes an additional rate boost in 2014. The rate increases provided recovery of investment in two new generating plants completed in 2012. Over the next two years, Fitch expects FFO fixed charge coverage, FFO lease-adjusted leverage and adjusted debt/EBITDAR to average approximately 6.0x, 3.0x and 2.75x, respectively. In each case the metrics are in excess of Fitch's target ratios for the current rating level.

Constructive Regulation: The regulatory environment in both North Carolina (DEC's primary regulatory jurisdiction) and South Carolina is constructive. North Carolina state regulation permits annual tariff adjustments to recover fuel, demand side management, energy efficiency and certain renewable costs. SC has similar rules. Authorized ROEs are generally at or above the industry average. Moreover, the North Carolina Utilities Commission (NCUC) may pre-approve the prudence and projected cost of new base load generating projects, which meaningfully reduces the risk of cost recovery, and has adopted policies that permitted the timely recovery of a significant portion of legislatively mandated emission reductions over the past few years at coal-fired generating stations (i.e. allowed DEC to continue the amortization of regulatory assets that were scheduled to expire).

Recent Rate Increases: DEC implemented rate increases in both North and South Carolina in September 2013 aggregating $353.1 million. The increases provided recovery of capital investments in new electric generation facilities and environmental controls. The increase in South Carolina will be phased in over two years including $80.4 million effective Sept. 18, 2013 and an additional $38.2 million the following September. The increase in North Carolina includes a provision to amortize a regulatory liability that will reduce the cash flow impact by $30 million in each of the first two years the new rates are in effect. Both North and South Carolina approved levelization accounting for nuclear refueling costs, which smoothes the earnings impact of refuelling outages, but has no effect on cash flow.

RATING SENSITIVITIES

Positive Rating Action: DEC's currently sound credit profile could support higher ratings once there is clarity surrounding the timing and cost of pending coal ash legislation in North Carolina and all related investigations are settled.

Negative Rating Action: Given the current headroom in credit quality measures a downgrade is not expected, but could occur if there is an unexpected significant penalty or unrecoverable cost related to the Dan River ash pond spill.

An increase in parent company DUK leverage or risk profile material or adverse change in the constructive regulatory environment in North Carolina could also adversely affect ratings.

Duke Energy Progress, Inc. (DEP)

Improving Credit Profile: Credit metrics improved meaningfully in 2013 and are expected by Fitch to continue to strengthen in 2014. The realized and expected financial improvement reflects higher rates, cost control measures and moderating capital requirements. Over the next two years, Fitch expects FFO fixed charge coverage to average approximately 5.75x and both FFO lease-adjusted leverage and adjusted debt/EBITDAR 3.5x, each of which is supportive of the current rating level.

Rate Support: In May 2013, DEP was authorized a two-step tariff increase that will bolster earnings and cash flow through 2015. The base rate increase, which followed a settlement agreement approved by the NCUC, aggregates $178.7 million (5.5%) premised on a 10.2% return on equity (ROE) and a 53% equity ratio. A $147.4 million base rate increase became effective June 1, 2013 and an additional $31.3 million was implemented on June 1, 2014. Prior to the 2013 increase, DEP had not raised base rates since 1988.

Constructive Regulatory Environment: Fitch considers regulation in North Carolina, DEP's primary regulatory jurisdiction, to be constructive. North Carolina state regulation permits annual tariff adjustments to recover fuel, demand side management, energy efficiency and certain renewable costs. Moreover, the NCUC may pre-approve the prudence and projected cost of new base load generating projects, which meaningfully reduces the risk of cost recovery and has adopted policies that permitted the timely recovery of a significant portion of legislatively mandated emission reductions at coal-fired generating stations.

Moderating Capex: Capex is expected to moderate over the next two years, alleviating external financing requirements and pressure on credit metrics. Over the 2014-2015 periods estimated capex is approximately $2.7 billion, about 14% less than the prior two year period of $3.1 billion. The lower capex follows the completion of a fleet modernization program designed to retire all of DEP's coal fired generating facilities in North Carolina that do not have scrubbers and to add new gas fired generation. The 920 MW Lee natural gas combined cycle plant was completed in late 2012 and the 625 MW L.V. Sutton combined cycle natural gas plant in 2013. After 2015, capex trends upward largely for new gas-fired generation needed later in this decade.

RATING SENSITIVITIES

Positive Rating Action: Achieving adjusted debt/EBITDAR and FFO lease adjusted leverage below 3.25x and 3.50x, respectively, could lead to an upgrade, but is not likely given that capex is expected to trend upward beginning in 2015 to address a capacity need in the 2016-2017 time frame.

Negative Rating Action: Ratings could be lowered if debt/EBITDAR and FFO lease adjusted leverage increased above 3.65x and 4.0x, respectively, on a sustained basis.

High unrecoverable costs related to potential ash pond legislation, an increase in parent company DUK leverage or risk profile or a material adverse change in the constructive regulatory policies for timely recovery of capital investments and fuel costs in North Carolina could adversely affect ratings.

Duke Energy Florida, Inc. (DEF)

Sound Credit Profile: As expected, credit metrics strengthened considerably in 2013 due to a Jan. 1, 2013 rate increase ($150 million), lower CR3 related O&M expense and the retirement of $435 million of debt. Over the next two years, Fitch expects FFO fixed charge coverage, FFO lease-adjusted leverage and adjusted debt/EBITDAR to average approximately 5.75x, 3.80x and 3.30x, respectively. Each of these financial measures is in line with Fitch's target ratios for the rating level. Beyond 2014 credit metrics benefit from a decline in CR3 related fuel cost refunds required as part of the 2012 settlement agreement. The agreement required rate refunds of $129 million of CR3 replacement power costs in both 2013 and 2014, and $10 million annually in 2014-2016. As per the agreement the decision to retire CR3 requires additional rate refunds of $40 million in 2015 and $60 million in 2016.

Constructive Regulatory Environment: Fitch considers regulation in Florida to be constructive. The FPSC employs several tariff adjustment mechanisms that benefit cash flow. In addition to a fuel adjustment clause, energy conservation expenses, specified environmental compliance costs and qualified nuclear costs are recoverable outside of base rate cases. Moreover, the settlement agreement addressing the rate treatment of CR3 was considered credit supportive by Fitch.

Base Rate Increase: A $150 million rate increase implemented in January 2013 has strengthened earnings and cash flow measures.

Base Rate Freeze: As part of the 2013 revised settlement agreement, DEF agreed to extend a previously agreed upon rate freeze two years through 2018, but importantly, is permitted to file a rate case if it's earned ROE falls below 9.5%. DEF is also permitted to accrue, for future rate setting purposes, a carrying charge on the CR3 investment until cost recovery begins.

Manageable Capital Program: Capital expenditures are moderate through 2015, easing external financing needs and pressure on financial metrics. Expenditures pick up beginning in 2016 for new capacity needed in the 2017-2018 period.

RATING SENSITIVITIES

Positive Rating Action: Ratings could be upgraded if the ratios of adjusted debt/EBITDAR and FFO lease adjusted leverage fall below 3.40x and 3.75x, respectively.

Negative Rating Action: Ratings could be lowered if debt/EBITDAR and FFO lease adjusted leverage increased above 3.65x and 4.0x, respectively, on a sustained basis.

An increase in parent company DUK leverage or risk profile or a material adverse change in the constructive regulatory policies for timely recovery of capital investments and fuel costs in Florida could adversely affect ratings.

Duke Energy Indiana, Inc.

Strong Credit Metrics: Credit metrics improved substantially in 2013 due in large measure to a $155 million tariff increase through a rider mechanism to reflect the remaining construction work in progress (CWIP) related to its Edwardsport Integrated Gasification Combined Cycle (IGCC) plant. Over the next two years, Fitch expects FFO fixed charge coverage to average approximately 5.75x, and both FFO lease-adjusted leverage and adjusted debt/EBITDAR about 3.5x, each of which is supportive of the current rating level.

Balanced Regulatory Environment: Fitch considers regulation in Indiana to be constructive. Indiana statutes permit the timely recovery of fuel and purchased power costs, environmental expenditures, energy efficiency programs, pipeline safety and bad debts. Although CWIP is not generally included in rate base, it is allowed and the Indiana Regulatory Commission (IURC) has permitted a cash return on pollution control equipment and allowed CWIP for DEI's Edwardsport IGCC plant through the IGCC rider.

Manageable Capital Program: DEI has no plans for new generation and accordingly capex is moderate over the next several years. In fact capex has been trending downward since peaking in 2011. Of the $1.85 billion capex planned over the next three years, approximately 25% ($440 million) is for environmental controls.

RATING SENSITIVITIES

Positive Rating Action: Ratings could be upgraded if the Edwardsport IGCC successfully completes its performance testing and the ratios of adjusted debt/EBITDAR and FFO lease adjusted leverage fall below 3.40x and 3.75x, respectively, on a sustained basis.

Negative Rating Action: Ratings could be lowered if debt/EBITDAR and FFO lease adjusted leverage increased above 3.65x and 4.0x, respectively, on a sustained basis.

An increase in parent company DUK leverage or risk profile or a material adverse change in the constructive regulatory policies in Indiana for timely recovery of invested capital, including environmental and fuel costs could adversely affect ratings.

Duke Energy Ohio, Inc. (DEO)

Strong Credit Profile: Despite some weakening in recent periods, credit quality measures are well positioned within the current rating level and should strengthen in 2014 and beyond due to a planned debt reduction and asset sale (described below). Over the next two years, Fitch expects FFO fixed charge coverage, FFO lease-adjusted leverage and adjusted debt/EBITDAR (normalized for the impact of asset sales) to average approximately 4.37x, 3.97x and 3.48x, respectively, each of which is in line with the current ratings.

Asset Dispositions Recapitalization Plan: DEO is in the process of exiting its non-regulated Midwest generation business. As a result DEO recorded a $1.4 billion pre-tax impairment in the first quarter of 2014 (1Q'14). After the write-down the remaining fair value is $2.2 billion. The sale is expected to close in early 2015. In anticipation of the asset divestiture management has recapitalized DEO. Earlier this month, $400 million of auction rate tax-exempt bonds was repurchased using proceeds from a DUK debt financing. Previously (late 2012), $500 million of DEO debt was retired in a similar fashion. The recapitalization plan will maintain leverage and coverage ratios that are appropriate for the revised earnings power, lower business risk and current ratings.

Rate Increase: On May 1, 2013 the Ohio Public Utilities Commission (PUC) approved a settlement agreement that provides DEO a $49 million (2.9%) increase in electric rates. The settlement is based on a 9.84% ROE and a 53.3% equity ratio. DEO originally requested an $86.6 million (5.1%) electric increase. Subsequently, in November 2013, the PUC adopted a settlement in the gas distribution proceeding that kept gas rates unchanged, but allowed $55.5 million of manufactured gas plant remediation costs to be recovered through a rider over five years.

RATING SENSITIVITIES

Positive Rating Action: Ratings could be upgraded if the ratios of adjusted debt/EBITDAR and FFO lease adjusted leverage fall below 3.40x and 3.75x, respectively, on a sustained basis.

Negative Rating Action: Ratings could be lowered if debt/EBITDAR and FFO lease adjusted leverage increased above 3.65x and 4.0x, respectively, on a sustained basis.

Ratings could also be lowered in the event of an increase in parent company DUK leverage or risk profile or a change in the fuel cost recovery provisions in Ohio.

Duke Energy Kentucky, Inc. (DEK)

Strong Credit Metrics: Credit metrics are strongly positioned in the 'BBB+' rating category. Over the next two years, Fitch expects FFO fixed charge coverage, FFO lease-adjusted leverage and adjusted debt/EBITDAR to average approximately 6.50x, 2.80x and 2.50x, respectively, each of which is strong for the current ratings.

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.

RATING SENSITIVITIES

Positive Rating Action: DEK's credit metrics are strong for the current rating, but positive rating action is not likely given the company's relatively small size and the significant impact of minor changes in cash flow and/or earnings on credit ratios.

Negative rating Action: Given the current headroom in credit quality measures a downgrade is not expected, but could occur if there is a delay in cost recovery of the company's significant environmental expenditures.

An increase in parent company DUK leverage or risk profile or a material adverse change in the constructive regulatory policies allowing for timely recovery of environmental and fuel costs could adversely affect ratings.

Fitch has affirmed the following ratings with a Stable Outlook:

Duke Energy Corp.

--Long-term IDR at 'BBB+';

--Senior unsecured debt at 'BBB+';

--Junior subordinated notes at'BBB-';

--Short-term IDR at 'F2';

--Commercial paper at 'F2'

Duke Energy Progress, Inc.

--Long-term IDR at 'A-';

--First mortgage bonds at 'A+';

--Secured pollution control bonds at 'A+';

--Senior unsecured debt at 'A';

--Short-term IDR at 'F2'.

Duke Energy Florida, Inc.

--Long-term IDR at 'BBB+';

--First mortgage bonds at 'A';

--Senior unsecured debt at 'A-';

--Short-term IDR at 'F2'.

Duke Energy Indiana, Inc.

--Long-term IDR at 'BBB+';

--First mortgage bonds at 'A';

--Senior unsecured debt at 'A-';

--Short-term IDR at 'F2'.

Duke Energy Ohio, Inc.

--Long-term IDR at 'BBB+';

--First mortgage bonds at 'A';

--Senior unsecured debt at 'A-';

--Short-term IDR at 'F2'.

Duke Energy Kentucky, Inc.

--Long-term IDR at 'BBB+';

--First mortgage bonds at 'A';

--Senior unsecured debt at 'A-';

--Short-term IDR at 'F2'

Progress Energy, Inc.

--Long-term IDR at 'BBB';

--Senior unsecured debt at 'BBB';

--Short-term IDR at 'F2'.

Fitch has affirmed the following ratings with a Positive Outlook:

Duke Energy Carolinas, LLC

--Long-term IDR at 'A-';

--First mortgage bonds at 'A+';

--Senior unsecured debt at 'A';

--Short-term IDR at 'F2'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014);

--'Recovery Ratings and Notching Criteria for Utilities' (Nov. 19, 2013);

--'Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)' (March 11, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Recovery Ratings and Notching Criteria for Utilities

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722085

Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735155

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=835035

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings, Inc.
Primary Analyst
Robert Hornick, +1-212-908-0523
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Philip Smyth, CFA, +1-212-908-0331
Senior Director
or
Committee Chairperson
Glen Grabelsky, +1-212-908-0577
Managing Director
or
Media Relations
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com

Contacts

Fitch Ratings, Inc.
Primary Analyst
Robert Hornick, +1-212-908-0523
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Philip Smyth, CFA, +1-212-908-0331
Senior Director
or
Committee Chairperson
Glen Grabelsky, +1-212-908-0577
Managing Director
or
Media Relations
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com