New York, December 30, 2002 — Moody’s Investors Service lowered its ratings on Duke Energy’s senior secured first mortgage bonds to A2 from Aa3, its senior unsecured bonds to A3 from A1, and lowered its ratings on Duke Capital’s senior unsecured debt to Baa2 from A3.
Moody’s also lowered PanEnergy Corp.’s debt ratings to Baa2 from A3 and Texas Eastern Gas Transmission’s debt ratings to Baa1 from A2. Moody’s also lowered the rating for commercial paper of Duke Energy to Prime-2. The short-term Prime-2 rating for commercial paper rating of Duke Capital was not on review and is confirmed.
The outlooks for Duke Energy, Duke Capital, Texas Eastern and PanEnergy ratings are negative. Ratings assigned to Duke Energy Field Services (Baa2/P-2) and Maritimes and Northeast (A1 sec.) were not on review. This concludes a review initiated September 20, 2002.
Moody’s lowered Duke Capital’s ratings in response to lower actual and anticipated earnings and cash flow as a result of continued weakness in wholesale energy markets both in the U.S. and abroad. This has resulted in a reduction in debt protection measures for bondholders. In particular, Duke Capital has taken on substantial amounts of leverage in order to build out its merchant energy subsidiary, Duke Energy North America (DENA) and now faces diminishing cash flow to service that debt.
Since Duke Capital’s credit profile dominates the business and financial risks of its parent, Duke Energy, Moody’s also lowered the parent’s ratings. Duke Energy houses a vertically integrated, regulated utility, Duke Power Company. Moody’s notes that on a stand-alone basis, Duke Power’s financial measures are more consistent with its revised rating.
Regulators in North Carolina protect Duke Power’s debt protection measurements by prohibiting the utility from downstreaming proceeds of debt offerings to Duke Capital. As a result, Moody’s feels the two notch spread between securities issued by Duke Energy and Duke Capital remains appropriate. Although approximately one fourth of Duke Power’s outstanding bonds are secured first mortgage bonds rated A2, Moody’s views the benchmark rating for Duke Energy to be A3. As a result, Moody’s does not intend to upgrade the unsecured debt to A2 if and when the first mortgage bonds mature or are called.
The negative outlook reflects execution risk in Duke Capital’s program to strengthen its balance sheet. To compensate for reduced cash flows, Duke has embarked upon a debt reduction program aided by capital expenditure reductions and asset sales. The revised capital expenditure program detailed in September totals $3.5 bn for 2003, all but $1.5-$2 billion of which is discretionary. Duke anticipates selling non-core assets of about $1 billion in 2003 to reduce its debt balance. In addition, investigations by various government agencies into trading activities at DENA continue despite recent retrenchment there. In addition to monitoring developments in this area, Moody’s will follow Duke’s progress in curtailing spending without inhibiting cash generating capabilities. The negative outlook extends to Duke Energy as further ratings deterioration at Duke Capital would pressure Duke Energy’s ratings.
Moody’s believes the company’s credit profile is bolstered by the strength of its core regulated businesses and by reasonable liquidity throughout the system. On a consolidated basis, Duke Energy’s regulated businesses mitigate the weakness and volatility exhibited in the merchant energy sector. These businesses include gas transmission (the Texas Eastern, Algonquin, East Tennessee Natural Gas, Market Hub Partners and WestCoast Energy assets) a 35% EBIT contributor for the first nine months of 2002, and franchised electric (Duke Power), a 55% EBIT contributor.
The company had approximately $3.6 billion of commercial paper outstanding at September 30 with $6.6 billion of various bank lines. On October 1, Duke successfully closed on $1 billion of common equity reducing its commercial paper and bank lines by commensurate amounts resulting in approximately $2.8 billion of unused bank line capacity. While Duke Energy intends to access the capital markets in 2003 to refinance maturing debt, Duke Capital has pre-funded a significant portion of its maturing debt. With one exception, domestic bank facilities which mature in 2003 contain one-year term outs.