Moody's Lowers Outlook on Duke Energy (DUK) to Negative; Financial Metrics Weak for Current Rating

Moody's Investors Service affirmed the ratings of Duke Energy Corporation (NYSE: DUK) (Duke, A3 senior unsecured), Progress Energy, Inc. (Baa1 senior unsecured), and Duke Energy Progress, Inc. (A1 senior unsecured) and changed their rating outlooks to negative from stable. Moody's affirmed the ratings of Duke Energy Carolinas, LLC (A1 senior unsecured), Duke Energy Florida, Inc. (A3 senior unsecured), Duke Energy Indiana, Inc. (A2 senior unsecured), Duke Energy Ohio, Inc. (Baa1 senior unsecured), and Duke Energy Kentucky, Inc. (Baa1 senior unsecured) with stable outlooks.

RATING RATIONALE

"The negative outlook on Duke's rating reflects consolidated financial metrics that are weak for its current A3 rating and likely to decline slightly over the next few years, persistently high levels of debt at the holding company level, future financing needs for pipeline and other parent company investments, and challenges at some of its international businesses, which the company has decided to retain," said Michael G. Haggarty, Associate Managing Director. The negative outlook on Duke also considers the negative outlook on one of its two largest utility subsidiaries, Duke Energy Progress, which reflects financial coverage metrics that we expect to decline materially due to increased O&M expenses and as a result of higher debt incurred for coal ash basin remediation and other capital expenditures. The negative outlook on intermediate holding company Progress Energy considers both the negative outlook on its largest utility subsidiary, Duke Energy Progress, as well as the high level of debt that remains at the Progress Energy level.

Consolidated financial metrics at Duke have been in the 17% to 18% range (CFO pre-working capital to debt) over the two years since the 2012 acquisition of Progress Energy, lower than historical levels, below the thresholds for A rated regulated utilities in our Regulated Electric and Gas Utilities rating methodology, and below most of our A3 rated regulated utility holding company peers. This is largely due to the large amount of debt at both the Duke Energy and Progress Energy holding companies, which totaled approximately $13 billion or 30% of total consolidated debt at the end of 2014. This level of debt has persisted despite the receipt of a higher than expected $2.8 billion of proceeds in April from the sale of the company's Ohio competitive generating assets and the company's plans to access between $1.2 and $1.4 billion of offshore cash. Moody's notes that Duke Energy initiated a $1.5 billion accelerated stock repurchase plan in April of this year.

The negative outlook also considers the substantial investments being made by the company, including nearly $2 billion in the Atlantic Coast Pipeline and a smaller $250 million investment in the Sabal Trail Pipeline. Although Duke may finance these pipelines in a separate legal entity, with each pipeline providing essential gas needs to its major utility subsidiaries and because of the strategic importance to the pipelines to these utilities, we will treat any debt associated with these investments as fully recourse to Duke. These and other potential Duke parent company investments going forward will continue to put pressure on both Duke's consolidated financial metrics and holding company debt levels and, as a result, we expect consolidated financial metrics to decline slightly from recent levels. If current trends with regard to financial metrics and debt levels continue, Duke's overall risk profile would likely be more appropriately reflected in a Baa1 rating.

Duke's rating is also pressured by its decision to retain its higher risk international businesses after a year-long strategic review of this business segment in 2014. Although the businesses account for only 10% of its total operations, they are being challenged by severe drought conditions and the strengthening of the US dollar compared to the Brazilian real in Brazil, while low oil prices have negatively impacted the performance of its Saudi Arabian methanol business.

The negative outlook on Duke Energy Progress, one of Duke's two largest utilities, reflects our expectation that its credit metrics will deteriorate from currently high levels (24.6% CFO pre-working capital to debt in 2014) to below 20% due to higher O&M expenses and as the utility incurs debt for coal ash basin remediation and other capital expenditures. The negative outlook also reflects the intention of Duke Energy Progress to not file for base rate relief through 2017, limiting the ability of the utility to reverse the anticipated decline in financial coverage metrics.

The negative outlook on Progress Energy is prompted by the negative outlook on Duke Energy Progress, the larger of its two operating utility subsidiaries, as well as consolidated financial metrics that are expected to remain weak for its current Baa1 rating. This is largely due to the high $2.7 billion of debt at the Progress Energy intermediate holding company level. Any negative rating action on utility subsidiary Duke Energy Progress would likely result in a negative rating action on Progress Energy.

The affirmation of the ratings and stable outlook of Duke's largest utility subsidiary, Duke Energy Carolinas, reflects the utility's credit supportive regulatory environments in North and South Carolina despite scrutiny over the coal ash spill at its Dan River coal ash basin in 2014. It also reflects improving financial metrics that are expected to remain robust for the rating going forward, including CFO pre-working capital to debt of nearly 30% in 2014. Although operating under largely the same regulatory framework as affiliate utility Duke Energy Progress, Duke Energy Carolinas exhibits better cash flow coverage metrics, more resilient retail sales volumes, proportionally lower coal ash remediation costs, and is not undertaking any significant generating asset purchases.

The affirmation of the ratings and stable outlook of Duke Energy Florida considers the credit supportive Florida regulatory framework and improving financial coverage metrics over the last three years (26.7% CFO pre-working capital to debt in 2014) despite some regulatory lag and a base rate freeze in place related to its retired Crystal River 3 (CR3) nuclear plant. Legislation was recently passed in Florida to permit the securitization of CR3 costs, which will weaken cash flow to debt metrics if undertaken, but will also reduce the pressure from CR3 on customer rates, which are among the highest among the state's investor owned utilities.

The affirmation of the ratings and stable outlook of Duke Energy Indiana reflects the completion and operation of the Edwardsport IGCC plant, a regulatory settlement reached in 2012 that provides clarity on the recovery of Edwardsport plant costs, a credit supportive regulatory framework in Indiana, and improving financial metrics (CFO pre-working capital to debt of 26.2% in 2014) as a result of declining capital expenditures and the implementation of IGCC rider recovery mechanisms. Although regulatory proceedings continue on IGCC plant cost recovery and the company's grid modernization plan was recently declined by Indiana regulators, we do not expect these developments to negatively impact the utility's rating or rating outlook.

The affirmation of the ratings and stable outlook of Duke Energy Ohio considers its lower business and operating risk profile following the sale of its generating assets, which has transformed the utility into a fully regulated transmission and distribution utility. Although business risk has diminished, we expect financial metrics (23.2% CFO pre-working capital to debt in 2014) to remain at levels appropriate for high Baa-rated transmission and distribution utilities considering the key financial metrics in our Regulated Electric and Gas Utilities rating methodology, including CFO pre-working capital to debt in the 17% to 18% range over the next several years.

The affirmation of the ratings and stable outlook of Duke Energy Kentucky considers its historically credit supportive regulation and declining cash flow generation and financial coverage metrics that remain adequate for its Baa1 rating (20.7% CFO pre-working capital to debt in 2014). The utility's rating is constrained by its small size and position as a wholly-owned subsidiary of Duke Energy Ohio, as well as the base rate freeze in place for the remainder of this year.

Duke Energy Corporation is a holding company for intermediate holding company Progress Energy, Inc., and regulated utilities Duke Energy Carolinas, LLC, Duke Energy Progress, Inc., Duke Energy Florida, Inc., Duke Energy Indiana,

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