D Duke Energy Carolinas coal Spill - A1 Rating

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1 Credit Opinion: Duke Energy Carolinas, LLC Global Credit Research - 25 Sep 2015 Charlotte, North Carolina, United States Ratings Category Moody's Rating Outlook Stable Issuer Rating A1 First Mortgage Bonds Aa2 Senior Secured MTN (P)Aa2 Senior Unsecured A1 Subordinate Shelf (P)A2 Parent: Duke Energy Corporation Outlook Negative Issuer Rating Sr Unsec Bank Credit Facility A3 A3 Senior Unsecured A3 Jr Subordinate Commercial Paper Baa1 P-2 Contacts Analyst Phone Michael G. Haggarty/New York City William L. Hess/New York City Key Indicators [1]Duke Energy Carolinas, LLC CFO pre-wc + Interest / Interest 6/30/2015(L) 6.7x 12/31/ x 12/31/ x 12/31/ x 12/31/ x CFO pre-wc / Debt 28.2% 30.1% 27.5% 23.4% 19.4% CFO pre-wc - Dividends / Debt 24.4% 24.4% 21.9% 18.3% 16.2% Debt / Capitalization 34.9% 34.5% 35.7% 37.3% 40.4% [1] All ratios are based on 'Adjusted' financial data and incorporate Moody's Global Standard Adjustments for Non- Financial Corporations. Source: Moody's Financial Metrics Note: For definitions of Moody's most common ratio terms please see the accompanying User's Guide. Opinion Rating Drivers - Credit supportive regulatory environments despite scrutiny over coal ash spill - Strong financial coverage metrics are appropriate for its A1 rating but could decline without near term rate case filing

2 - Higher capital expenditures for new generation, T&D upgrades, environmental compliance, and coal ash basin closure and remediation - Regulatory lag in the recovery of coal ash spending will pressure coverage metrics - Adequate liquidity from Duke parent company commercial paper program, bank credit agreement, and money pool access Corporate Profile Duke Energy Carolinas, LLC is a vertically integrated electric utility serving approximately 2.5 million customers in North Carolina and South Carolina. Duke Carolinas is the largest subsidiary of Duke Energy Corporation (Duke). On 2 September 2014, Duke announced that it will take a 40% ownership interest in a new $4.5 to $5 billion, 550- mile interstate natural gas pipeline to be built by Dominion Resources (Baa2 stable) from West Virginia to eastern North Carolina. The pipeline will supply natural gas from the Utica and Marcellus shale basins to generation plants at Duke Energy Carolinas and affiliate utility Duke Energy Progress. SUMMARY RATING RATIONALE Duke Energy Carolinas' rating reflects its low business and operating risk profile, above average regulatory environments in both North and South Carolina despite scrutiny over a coal ash spill in 2014, and financial metrics that are strong for its rating. The rating considers its position as part of the Duke corporate family which includes the largest utility system in the Carolinas, benefitting from fuel purchasing power and joint generation dispatch synergies with affiliate Duke Energy Progress. The rating also considers relatively high parent company leverage that amounts to approximately 30% of the consolidated organization debt. On 5 June 2015, the rating outlook of parent company Duke was changed to negative from stable while the rating of Duke Energy Carolinas was affirmed with a stable outlook. DETAILED RATING CONSIDERATIONS - Credit supportive regulatory environments despite scrutiny over coal ash spill Duke Carolinas has service territories in both North and South Carolina, two fully regulated states with credit supportive regulatory environments. In North Carolina, the utility is operating under a settlement agreement reached with the North Carolina Utilities Commission (NCUC) in September 2013 following the filing of its last general rate case. The settlement agreement authorized a $234 million electric base rate increase over the three year period based on a 10.2% ROE and a 53% equity ratio. Duke Energy Carolinas agreed to file no new general base rate case before September 2015 with exceptions for new generation or new government regulations and it has no plans to file for a base rate increase until 2017 at the earliest. In South Carolina, the company is operating under a similar settlement agreement approved by the Public Service Commission of South Carolina (PSCSC) related to the company's general electric rate case filed in Based on the settlement, the PSCSC authorized a total rate increase of $118 million, to be implemented over two years. The rate increase is based on a 10.2% ROE with a 53% equity ratio. We view the rate settlements reached in both North and South Carolina as credit supportive since they provided a degree of regulatory clarity for several years, despite scrutiny over last year's coal ash spill as is discussed below. North Carolina law also authorizes the NCUC to allow annual prudence reviews of baseload generating plant construction costs and the inclusion of construction work in progress (CWIP) in rate base with corresponding rate adjustments in a general rate case while a baseload generating plant is under construction. - Strong financial coverage metrics are appropriate for its A1 rating but could decline without near term rate case filings Duke Energy Carolina's financial coverage metrics are strong and stable after improving between 2011 and 2014, benefitting from rate relief implemented in 2013 and limited long-term debt issuance. As of LTM 30 June 2015, the company's CFO pre working capital to debt was 28.2%, compared to 30.1% at 12/31/2014 and 27.5% at 12/31/2013. Similarly, the company's retained cash flow to debt exhibited a similar trend at 24.4% for the twelve months ending 30 June 2015, compared to 30.1% in 2014 and 27.5% in These cash flow coverage metrics are at the high end of the A rating category in accordance with the financial ratio scoring grid under our Regulated Electric and Gas Utilities rating methodology. They could decline from these levels over the next several years as the utility increases capital spending but delays filing for rate relief until 2017 or 2018.

3 - Capital expenditures expected to increase for new generation needs, T&D system upgrades and environmental compliance After declining between 2011 and 2013, capital expenditures at Duke Energy Carolinas increased to $1.9 billion in 2014 and are projected to be in the $2.3 to $2.4 billion range in both 2015 and 2016 before leveling off to the $2.1 to $2.2 billion range from 2017 through Much of the increase in spending can be attributed to higher new generation expenditures, environmental compliance spending, grid modernization, and other transmission and distribution projects. In terms of new generation, the utility is currently in the process of building the new 750 MW Lee combined cycle natural gas plant in South Carolina, which was approved by the Public Service Commission of South Carolina (PSCSC) in April Construction was begun in the summer of 2015 and the plant will become operational by late 2017 at an estimated capital cost of $600 million (for Duke Energy Carolina's share). Duke Energy Carolina will own 87% of the plant, while the electric cooperative North Carolina Electric Membership Corporation will own 13%. Duke Energy Carolinas will continue to experience high maintenance capital expenditures of around $1 billion per year in 2015 and 2016, in addition to potentially higher expenditures related to the final EPA carbon rules. We believe regulated utilities will fare better than unregulated coal generators in meeting these environmental compliance obligations, and Duke Energy Carolina's current rating and outlook incorporate the expectation that the utility will continue to recover its environmental expenditures as part of its rate proceedings, although there could be some regulatory lag, particularly with regard to coal ash, discussed below. - Regulatory lag in the recovery of coal ash spending will modestly impact credit metrics Duke Energy Carolinas continues to be affected by repercussions from a February 2014 storm water pipe break beneath a coal ash basin at one of its retired power plants. The break resulted in the spill of 30,000-39,000 tons of coal ash into the Dan River and has subjected all of Duke's North Carolina coal ash storage basins to scrutiny. In 2014, North Carolina lawmakers overwhelmingly passed the Coal Ash Management Act of 2014, which regulates and requires the closure of coal ash basins at Duke's coal plant sites throughout the state. The legislation requires Duke to take costly, immediate action to excavate and close ash basins at three of its highest risk sites (including the Duke Energy Carolinas Dan River and Riverbend plants) by August 2019 and a fourth by August Duke's current capital expenditure plan for the next five years includes $1.3 billion to excavate and close the five highest priority coal ash sites. Duke has estimated that incremental cash expenditures of $700 million to $1 billion will be required for the next 12 North Carolina coal ash basins recommended for excavation, although the time frame must still be determined. In 2014, Duke recognized a $3.5 billion Asset Retirement Obligation (ARO) for its estimated obligations to close its North Carolina coal ash basins. In the second quarter of 2015, after publication of the EPA's final Coal Combustion Rules, Duke incrementally increased the ARO by $1 billion as it created additional obligations for the company in South Carolina, Indiana, and Kentucky, putting its total ARO at $4.5 billion. Duke Energy Carolina's coal ash basin closure and remediation spending is not recovered via trackers or other automatic cost recovery provisions and must be recovered via base rate case filings. As result, there is likely to be significant regulatory lag in the recovery of these costs, particularly with the utility not planning any rate cases until 2017 at the earliest, which will modestly affect credit metrics. Liquidity Duke Energy Carolinas maintains an adequate liquidity profile with access to funding from the parent company's commercial paper program through the Duke system money pool, and through direct borrowings from the money pool. The utility has $1.2 billion of borrowing capacity as of 30 June 2015 under the parent company's $7.5 billion credit facility due to expire in January 2020, which does not contain a material adverse change clause for new borrowings. The facility contains a single financial covenant requiring that Duke and its utility subsidiaries each maintain a consolidated debt to capitalization ratio of no more than 65% and at 30 June 2015, each company was in compliance with this covenant. As of 30 June 2015, Duke Energy Carolinas had a cash balance of approximately $28 million and $300 million of commercial paper outstanding, part of a permanent layer of commercial paper outstanding that is classified as long-term debt on the balance sheet. In addition, the utility is required to set-aside $250 million of its credit facility capacity to meet its obligations related to a 14 May 2015 Plea Agreement with the US Department of Justice related to coal ash. The utility also had $35 million of tax-exempt bonds with put features and $4 million of letters of

4 credit outstanding as of 30 June 2015, leaving $611 million of available capacity for Duke Energy Carolinas under the credit facility. The utility has $506 million of long-term debt due within the twelve months ending 30 June 2016, including $500 million of first mortgage bonds that are due 1 October Moody's expects the utility to generate between $2.5 billion and $3 billion of cash flow from operations in 2016 and, with capital expenditures expected to be close to $2.4 billion, it will likely continue to generate negative free cash flow depending on the level of dividends distributed to the parent. As of 30 June 2015, Duke Carolinas distributed dividends of $100 million to Duke Energy for the first six months of the year after distributing $500 million in Rating Outlook The stable rating outlook reflects the utility's relatively low business risk profile, credit supportive regulatory frameworks in both North and South Carolina, and strong financial metrics for its rating. It reflects our expectation that its growing capital expenditure program will remain manageable and financed with a balanced mix of debt and equity. The stable outlook also reflects our expectation that the company will be able to fully recover all of coal ash closure and remediation costs in rates, although regulatory lag in this recovery will likely modestly pressure metrics. What Could Change the Rating - Up An upgrade could be considered if there are credit positive changes in the utility's regulatory environment, including more real time recovery of coal ash closure and remediation costs, or if cash flow coverage metrics remain at levels that are strong for its current rating as it enters some high capital spending years, including if cash flow pre-working capital to debt is above 30% on a sustained basis. What Could Change the Rating - Down The rating could be downgraded if there is a decline in the credit supportiveness of the regulatory environments in North or South Carolina, if additional capital expenditures or other capital needs result in a material increase in debt levels or are not recoverable, or if financial metrics fall to levels that would be considered weak for its rating, including cash flow pre-working capital to debt below 25% on a sustained basis. Rating Factors Duke Energy Carolinas, LLC Regulated Electric and Gas Utilities Industry Current LTM [3]Moody's Month Grid [1][2] 6/30/2015 Forward ViewAs of 9/2015 Factor 1 : Regulatory Framework (25%) Measure Score Measure Score a) Legislative and Judicial Underpinnings of A A A A the Regulatory Framework b) Consistency and Predictability of Aa Aa Aa Aa Regulation Factor 2 : Ability to Recover Costs and Earn Returns (25%) a) Timeliness of Recovery of Operating and A A A A Capital Costs b) Sufficiency of Rates and Returns Baa Baa Baa Baa Factor 3 : Diversification (10%) a) Market Position Baa Baa Baa Baa b) Generation and Fuel Diversity A A A A Factor 4 : Financial Strength (40%) a) CFO pre-wc + Interest / Interest (3 Year 6.6x Aa 6x - 7x Aa Avg) b) CFO pre-wc / Debt (3 Year Avg) 27.4% A 25% - 30% A c) CFO pre-wc - Dividends / Debt (3 Year 21.7% A 12% - 17% Baa Avg) d) Debt / Capitalization (3 Year Avg) 35.5% A 35% - 37% A

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