The Prospectus says the notes
- will rank equally and ratably with all other unsecured and non-subordinated indebtedness of Duke Energy, of which approximately $3.3 billion was outstanding at December 31, 2010
- are structurally subordinated to the indebtedness and other liabilities of Duke Energy’s subsidiaries. As of December 31, 2010, there were $15.1 billion of indebtedness and other liabilities of Duke Energy’s subsidiaries
What does this mean? Does this mean that investors in the notes are treated equally with investors in Duke's corporate bonds? Or does it mean the bondholders have priority over holders of these notes?
Where do these notes fit in the hierarchy of bonds, preferred stock, common stock?
I notice Wikipedia says
"subordinated debt (also known as subordinated loan, subordinated bond, subordinated debenture or junior debt) is debt which ranks after other debts should a company fall into liquidation or bankruptcy."
These are essentially corporate bonds. The first bullet tells you that they are senior unsecured obligations of Duke Energy, which is the parent/holding company. This means that it ranks the same as any loan, bond, or other debt obligation to that entity -- i.e. ahead of equity and preferred stock.
What the second bullet tells you is some semi-sophisticated corporate finance/corporate structuring. Although the bonds are "senior" obligations of Duke Energy, they are *structurally* subordinated to debt or other obligations at Duke Energy's subsidiaries. This is very common for a corporate bond. The idea is that Duke Energy Inc. or whatnot likely does not own any assets other than the stock of its "operating subsidiaries". The operating subsidiaries themselves own things like plants, machines, equipment, and so on. So if there is any debt of, say, Duke Energy Carolinas, an operating subsidiary of Duke Energy, and the whole shebang goes bankrupt, the people who lent money to Duke Energy Carolinas will get paid before you get paid anything as a lender to Duke Energy.
The reason is again the only thing Duke Energy likely owns is the stock of its subsidiaries, so it can only pay you out of the residual value of those operating subsidiaries. Although this is somewhat complicated this is exactly how essentially every corporate bond in existence works, so if you own any IBM bonds or Total Bond Market, pretty much all of your bond holdings work that way.
To do some overkill, most companies have both unsecured bonds and a secured credit facility. They are both "senior" obligations, usually of the parent holding company entity (like Duke Energy), but the secured credit facility loaned by a bank or banking syndicate takes as collateral the assets (and stock) of all of those operating subsidiaries as well as guarantees from those entities, which are senior obligations of *those operating subsidiaries*. Below is an image I pulled from google:
It's not a great image, but in it the lender to Company A is structurally subordinated to the lender to Company B, because the lender to Company B will be paid off before any proceeds are distributed upstream to Company A. (Ignore the "intercompany loan" part of the diagram.)
Finally, regarding the point about credit ratings, I know nisi you're upset about them not disclosing the rating but it's actually become a pretty big issue. Someone can correct me if I am wrong but the SEC had a ruling I believe that said you needed consent from the rating agency to disclose your credit rating, and those credit rating agencies almost never provide consent because they are worried about liability. So it's my understanding -- and it's been a couple of years since I did a securities offering -- but I don't think anyone puts their rating in their offering documents anymore. (Also, there is no way these notes would be registered under the 1940 Act, and that would be a huge issue for Duke Energy.)
However, you can find the credit ratings for Duke Energy on their website, here (go figure):http://www.duke-energy.com/investors/fi ... atings.asp
Consistent with what I said above, the operating subsidiaries carry higher credit ratings than the parent company, Duke Energy. BB+ and lower are considered junk bonds; BBB+, the rating for Duke Energy, is considered "investment grade," FWIW.
The upshot is that I think you picked a couple of points that aren't as negative as you are making them, at least if you consider these things corporate bonds which is what they look, smell, and taste like. But I will wholeheartedly agree with you here:
My impression is that they've taken a sophisticated financial instrument and packaged it up to look and feel like just like a familiar money market deposit account.
And that is always a good reason to be wary.