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Announcement:

Entergy's Transmission Spin-Off Is Neutral to Metrics, But Not Without Risks

06 Dec 2011

New York, December 06, 2011 -- Entergy Corp. (ETR, Baa3 Senior Unsecured, Stable Outlook) and ITC Holdings Corp. (ITC, Baa2 Senior Unsecured, Stable Outlook) announced on December 5, 2011 that they have entered into an agreement under which ETR's utility operating companies will spin off all of their transmission assets to shareholders and merge them with ITC, using a tax-efficient Reverse Morris Trust structure. ETR shareholders will own over 50% of the post-merger ITC. The value of the transaction, in terms of book value of assets transferred, is estimated at approximately $3.2 billion, or approximately 13% of ETR's consolidated net property plant and equipment. Target closing is 2013.

Moody's views the transaction as essentially neutral from a metrics perspective, but it has the potential to increase regulatory risks and certain operating risks at ETR and its subsidiaries. We are maintaining the stable rating outlook for ETR and its utility operating companies (see list below) at this time.

ETR has stated that its operating subsidiaries would reduce their debt by approximately $1.7 billion upon closing and that ETR would reduce parent debt by approximately $100 million, such that cash flow coverage of debt and interest ratios would remain essentially unchanged (both on a consolidated basis and at the utility operating companies) as a result of the transaction after adjusting for the lost transmission revenues. In addition, ETR would be able to forego substantial Capex needed on the transmission system and avoid the associated regulatory lag with such intrastate investments. Currently, the transmission assets owned by each utility operating company are regulated by the respective local regulators, and ETR has transmission cost recovery rider only in Texas. Under ITC, the assets would be regulated by the Federal Energy Regulatory Commission (FERC), which has forward looking rate-making, generally higher Allowed ROEs and Incentive ROEs, and which permits a capital structure with 60% debt, as opposed to 45-50% for ETR's utility operating companies. Investments are needed to harden ETR's system along the Gulf coast, to meet NERC requirements and for system upgrades so that ETR can join a regional transmission organization (RTO -- ETR has proposed to join MISO).

The transaction will require a long list of approvals, including FERC and the public service commissions of Arkansas (AR), Louisiana (LA), Mississippi (MS), Texas (TX) and New Orleans (NO). Moody's views the outcome of the state approvals in AR (crucial due to its geographic position and size) and LA (crucial due to its size) as the most uncertain. However, the transaction terms would require the regulator in each jurisdiction to cede control over the transmission network (including the timing and prioritization of investment projects) to FERC and to accept incrementally higher costs for ratepayers (the transmission portion of rates would likely increase due to FERC's more generous rate-making). In addition, the transaction agreement would require all of the jurisdictions to accept joining MISO, whereas SPP (which is based in Little Rock) has been lobbying for Entergy Arkansas to join SPP. We note that, irrespective of the spin-off, the same regulators would have to approve ETR's joining an RTO, and control over transmission would migrate to FERC in that scenario.

One area of potential concern is that ETR's relationships with its various regulators could be damaged during the approval negotiations, which will undoubtedly be complex. Whether or not the transaction is ultimately successful, ETR will have to live with any ill will that might be created, whereas ITC will not be regulated by these commissions.

Another area of concern is the potential impact on future storm recovery. ITC will acquire a substantial number of ETR's storm response personnel with the merger. Moody's believes that coordination of any recovery effort would be more difficult when physically interconnected transmission and distribution assets are owned by unrelated entities, especially when those entities are likely to have different priorities regarding the order for repairing assets and restoring service. Moody's has observed a general improvement in the regulatory relations of ETR's utility operating companies after hurricanes Katrina and Rita, which we believe was caused in part by storm restoration that was viewed as effective given the difficult circumstances. We believe that storm recovery that is ineffective or lacking in coordination would have negative implications for regulatory relations.

Moody's observes that the sale will incrementally reduce the regulated portion of ETR's business mix. In addition, the asset mix of the operating utility companies will be marginally weighted toward higher risk generation and less toward lower risk transmission and distribution. However, we do not view these changes as material to the business profile, given reduced expectations of unregulated cash flows from the northeast nuclear fleet.

In summary, the transaction appears to be neutral to metrics, but in order to mitigate the potential business risks, we believe that ETR will need to manage the regulatory approval process carefully and plan for operating a previously integrated transmission and distribution system with an unrelated partner, including a storm response protocol.

Entergy Corporation - Baa3 Senior Unsecured, Stable Outlook

Entergy Arkansas, Inc. - Baa2 Senior Unsecured, Stable Outlook

Entergy Gulf States Louisiana, LLC - Baa2 Senior Unsecured, Stable Outlook

Entergy Louisiana, LLC - Baa2 Senior Unsecured, Stable Outlook

Entergy Mississippi, Inc. - Baa3 Senior Unsecured, Stable Outlook

Entergy New Orleans, Inc. - Ba2 Senior Unsecured, Stable Outlook

Entergy Texas, Inc. - Ba1 Senior Unsecured, Stable Outlook

System Energy Resources, Inc. - (P)Ba1 Senior Unsecured, Stable Outlook

William Hunter
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

William L. Hess
MD - Utilities
Corporate Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
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JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Entergy's Transmission Spin-Off Is Neutral to Metrics, But Not Without Risks
No Related Data.
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