NEW YORK--(BUSINESS WIRE)--
Fitch Ratings has assigned an 'A' rating to Duke Energy Ohio, Inc.'s (DEO)dual tranche debt offering consisting of $150 million first mortgage bonds, floating rate series, due March 6,2015 and $300 million, 3.8% series first mortgage bonds due Sept. 1, 2023. The Rating Outlook is Stable. Net proceeds will be used for general corporate purposes, including the repayment of short-term debt incurred to fund the retirement of $250 million of first mortgage bonds that matured in June 2013.
Key Rating Drivers
Strong Credit Profile: Despite a decline over the past 18-months, credit quality measures are well positioned within the rating category and should begin to trend upward beginning in the second half of 2013 due to a May 2013 rate increase and plans to reduce debt in 2014 in conjunction with a required asset transfer (described under corporate reorganization below). Fitch expects EBITDA/interest and funds from operations (FFO)/interest coverage measures to average about 7.0x and 6.0x, respectively over the next three years. Debt/EBITDA is expected to average approximately 3.2x in 2013 and then fall below 2.5x in 2014. Similarly, FFO/debt is expected to approximate 20% in 2013 and to range between 25%-30% in 2014.
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 and gas distribution rates. The settlement is based on a 9.84% return on equity (ROE) and a 53.3% equity ratio. The settlement agreement did not resolve DEO's request to recover $22 million of manufactured gas plant remediation costs and the issue remains pending. A decision on the gas case is expected late summer. DEO originally requested an $86.6 million (5.1%) electric increase and a $44.6 million natural gas rate increase.
ESP: The 2012 ESP shifted DEO's coal-fired electric generating capacity to market based rates effective Jan. 1, 2012, increasing merchant exposure and business risk. Since the prevailing energy price is well below the negotiated price embedded in the prior ESP, earnings and cash flow were lower in 2012. To mitigate the revenue loss, the new ESP established a non-bypassable stability charge that is designed to generate approximately $110 million annually through 2014. In addition, in September 2012 $500 million of maturing debt was refinanced with parent debt.
Capacity Rider Filing: In August 2012, DEO requested a cost based capacity charge to supplement the PJM Market based charge in current rates. DEO proposed to defer the difference between the two rates and to seek cash recovery of the deferral beginning in 2015. If approved in its entirety the new mechanism would provide approximately $728 million of incremental revenue over three-years. Ohio regulators previously approved a similar mechanism for AEP subsidiary Ohio Power Co. A decision is expected before year-end.
Corporate Reorganization: The ESP requires DEO to transfer its coal-fired generating assets (3,529 MW) to an affiliate at net book value by Dec. 31, 2014. Current ratings assume the assets will be transferred to Duke Energy Commercial Asset Management (DECAM), a direct subsidiary of DEO, in which case DEO retains the operating and financial risk. DECAM currently houses a portfolio of merchant natural gas plants aggregating approximately 3,752 MW. Under the ESP, DEO is prohibited from providing credit support to the merchant assets. As part of the reorganization plan, $500 million of DEO debt was refinanced with DUK debt in late 2012 and an additional $400 million of pollution control bonds are expected to be refinanced in a similar manner in conjunction with the asset transfer in 2014.
No rating changes are expected at this time; however, downward pressure could result from:
Merchant Exposure: Weaker than expected results in the merchant energy business due to a further decline in power prices, operational issues, or hedging strategies could adversely affect current ratings.
Asset Transfer: Transferring the generating assets to a separate DUK subsidiary in conjunction with the planned debt reduction could result in improved ratings.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 58, 2013);
--'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013);
--'Recovery Ratings and Notching Criteria for Utilities' (Nov. 13, 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);
--'Short-Term Ratings Criteria for Non-Financial Corporates', (Aug. 9, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Parent and Subsidiary Rating Linkage
Recovery Ratings and Notching Criteria for Utilities
Rating North American Utilities, Power, Gas, and Water Companies
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
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Robert Hornick, +1 212-908-0523
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Philip Smyth, CFA, +1 212-908-0531
Glen Grabelsky, +1 212-908-0577
Brian Bertsch, +1 212-908-0549