Fitch Rates Duke Energy Progress' FMBs 'A+'
KEY RATING DRIVERS
Credit Profile: Credit metrics are moderately weak for the rating level, but expected by Fitch to improve in 2016 and beyond due to a full year of contractual revenue from a wholesale power contract with the North Carolina Eastern Municipal Power Agency (NCEMPA), a pending request to increase base rates in Souh Carolina and recovery of energy efficiency costs through an annual rider in South Carolina with adjusted rates effective Jan. 1, 2017. Over the next three years, Fitch expects FFO lease-adjusted leverage to average about 4x and adjusted debt/EBITDAR 3.6x compared with 4.5x and 4x, respectively, in 2015.
Constructive Regulatory Environment: Regulation in North Carolina (NC), DEP's primary regulatory jurisdiction, and South Carolina (SC) is considered to be constructive by Fitch. Regulations in both states permit annual adjustments to recover fuel, demand side management, energy efficiency and certain renewable costs on a timely basis. Authorized returns are generally at or above the industry average. NC regulators may also pre-approve the prudence and projected cost of new base load generating projects, reducing cost recovery risk.
Substantial Capex Plan: Planned capex over the next five years of $8.5 billion is about $1 billion more than the prior five-year period. After maintenance capex, new generation needed later in this decade, environmental expenditures, including coal ash remediation, and nuclear fuel account for the largest share of the spending plan. The new generation includes two 280 MW combined-cycle natural gas plants that are part of a $1.1 billion plan to modernize DEP's electric system and retire the Asheville coal plant. Fitch expects the capex plan to be funded in a manner to support existing ratings.
Coal Ash Legislation: Coal ash remediation will require substantial capital investment over the next 15 years. Although the amount and timing of the expenditures remain uncertain, recently enacted legislation for dealing with coal ash ponds provides the NC Department of Environmental Quality (NCDEQ) more flexibility to establish the timing and closure options, which ultimately determines the cost. Although Fitch expects the costs to be recoverable from rate payers, an accelerated time-frame and higher cost could weaken credit metrics.
Rate Filing: DEP requested a $79 million (14.5%) rate increase in SC based on a 10.75% return on equity (ROE) and 53% equity ratio in July 2016. Major generation investments account for the majority of the rate filing. A final decision is expected by year-end with new rates effect Jan. 1, 2017. The rate filing is the first base rate increase in SC in 28 years. DEP also filed a request in SC to recover $39 million in energy efficiency and demand side management costs through an annual rider mechanism effective Jan. 1, 2017. The rider reflects approximately $8.5 million incurred during the 2015 test period and $30.8 million forecasted for the 2017 rate year. Previously, SC regulators approved DEP's request to recover $32 million for energy efficiency programs in 2015.
Fitch's key assumptions within the rating case for DEP include:
--Constructive outcome in pending SC rate case;
--Continued recovery of costs related to energy efficiency and demand side management;
--Retail sales growth of approximately 0.5% - 1.0% annually;
--Timely execution of $8.5 billion capex plan;
--Ash pond remediation costs are recoverable from ratepayers.
Positive Rating Action: Ratings could be upgraded should, on a sustained basis, adjusted debt/EBITDAR and FFO lease-adjusted leverage fall below 3.3x and 3.7x, respectively.
Negative Rating Action: Ratings could be downgraded should, on a sustained basis, FFO lease-adjusted leverage exceeds 4.3x and/or FFO fixed-charge coverage falls below 4.7x. Ratings could also be downgraded if there is a material adverse change in the constructive regulatory environment in NC or a significant increase in the cost of closing DEP's coal ash ponds.
Liquidity to supplement internal cash flow is provided primarily through a committed bank credit facility and participation in a corporate money pool. DEP has a $1.0 billion sub-borrowing limit as of June 30, 2016, in a $7.5 billion master credit facility shared with its corporate parent, Duke Energy Corp. (DUK) and its utility affiliates. DUK has the unilateral ability to increase DEP's sub-borrowing limit up to a maximum of $1.4 billion. DEP also participates in a corporate money pool. DUK's CP borrowings and excess utility affiliate cash are the primary source of funds for the money pool. The credit facility extends to January 2020.