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Rating Action:

Moody's upgrades System Energy Resources, Inc. senior unsecured to Baa3; Outlook Stable

23 Aug 2012

Approximately $700 million of debt securities affected

New York, August 23, 2012 -- Moody's Investors Service today upgraded the senior unsecured debt of System Energy Resources, Inc.(SERI) to Baa3 from Ba1. Concurrently with this action, Moody's upgraded the secured lease obligation bonds (SLOBs) to Baa2 from Baa3 and the first mortgage bonds (FMBs) to Baa1 from Baa2.

"The 178 MW up-rate of the Grand Gulf nuclear unit licensed by the NRC in July enhances the value of its energy and capacity to the Entergy system, and the combined $874 million investment in the unit demonstrates the strategic nature of SERI to Entergy and the utilities that purchase its power," said Bill Hunter, Vice President and Senior Analyst. "Although SERI is a single asset nuclear power generator with some weaknesses in its contractual arrangements, it has an investment grade profile based on a power sales agreement that is regulated by FERC, a low cost of production, good operating record, declining leverage, and very strong financial metrics."

SERI, a wholly owned subsidiary of Entergy Corporation (Entergy, Baa3 Senior Unsecured, stable outlook), has a 90% combined ownership and leasehold interest in the Grand Gulf nuclear generating station located in Port Gibson, Mississippi. Once SERI completes testing on 178 MW up-rate that was completed in June 2012 and licensed in July 2012, Grand Gulf's net reliable capacity is expected to be 1,249 MW, making it one of the largest nuclear units in the US. SERI has filed with the Nuclear Regulatory Commission (NRC) for a 20 year extension of Grand Gulf's license from 2024 to 2044.

SERI's ratings reflect Grand Gulf's position as an attractive, low-cost generating asset, its strategic importance to the Entergy system as evidenced by its owners' recent $874 million up-rate investment. The ratings further consider SERI's FERC-regulated wholesale revenues that are generated under a US Supreme Court-tested power sales agreement with four utility affiliates, contractual support from the parent, a declining leverage profile as the SLOBs amortize, and consistently strong financial metrics. These credit strengths are balanced against SERI's asset concentration in a single nuclear power plant; the operating, regulatory and liability risks inherent to nuclear power; the fact that Grand Gulf must remain in commercial operation for SERI to earn any revenue under its main sales contract; and contractual complexities in the support agreement from the parent, which permit it to be terminated before the maturity of all of SERI's bonds and render it decidedly less secure than a guarantee from a creditor standpoint.

Under the Unit Power Sales Agreement (UPSA), SERI agreed to sell all of its owned and leased share of capacity and energy from Grand Gulf to the affiliated purchasers in accordance with the specified percentages ordered by the Federal Energy Regulatory Commission (FERC) in June 1985. The purchasers pay for the capacity and energy on a full cost-of-service basis irrespective of the quantity of energy delivered so long as Grand Gulf remains in commercial operation. The costs that SERI recovers in rates include its operating costs, fuel leasing costs, depreciation and accruals for plant de-commissioning and spent fuel disposal, as well as capital costs on its net investment -- both incurred debt costs and a return on equity (currently 10.94%). Monthly payments under the UPSA have been SERI's only source of operating revenues. The off-takers are of mixed credit quality - their ratings are 50% Baa2, 33% Baa3 and 17% Ba2, and their obligations under the UPSA are several, not joint. While the several nature of the purchasers' obligations exposes creditors to the weakest off-taker, comfort was gained by examining a sensitivity that eliminated cost recovery in its entirety from the weakest obligor (Entergy New Orleans, Inc., ENO, Ba2 Issuer Rating, stable), which today purchases 17% of SERI's capacity and energy. Moreover, this aspect of the USPA was tested during the bankruptcy of ENO, during which it obtained court approval to pay SERI for post-petition power through the term of the bankruptcy case.

Entergy provides a level of support to SERI in the Capital Funds Agreement (CFA), but the agreement can be terminated under certain conditions. Entergy has agreed to supply SERI with sufficient capital funds to (i) maintain SERI's ratio of equity/capitalization (excluding short term debt from the definition of capitalization) at a ratio of no less than 35%, (ii) permit the continued commercial operation of Grand Gulf and (iii) pay in full all indebtedness for borrowed money of SERI when due. The performance by Entergy under the CFA is not conditioned on Grand Gulf remaining in service. However, Entergy and SERI can agree to amend or terminate the CFA provided they obtain the consent of the banks providing the letters of credit (LCs) in favor of the owner lessors for SERI's sale-leaseback transactions. Although they currently expire in 2013, SERI is required to maintain these LCs during the lease term. However, the lease will expire in 2015 unless renewed. FMB-holders have pre-consented to termination of the CFA, and consent by holders of SLOBs and unsecured bonds is not required. While the CFA provides for a relatively clear level of support while it remains in effect, the treatment of tailored support agreements like the CFA in a bankruptcy is much less tested than the treatment of guarantees.

While the CFA has structural weaknesses, we believe there is a high likelihood that Entergy would continue to manage SERI's operations and finances in a manner supportive of its credit profile even in the absence of the CFA. This expectation is based on Grand Gulf's market position and its importance to the system, recently fortified by the $874 million up-rate investment, which was achieved with a minimal increase in total debt. SERI's value to Entergy is also based on a history of consistently upstreaming dividends - about $96 million on average from 2007-2011, which includes a period of higher than normal capital spending relating to the up-rate. Given SERI's likely net cash flow positive position in future years and its regulatory framework, we believe it is unlikely that market dynamics could materially alter SERI's value to Entergy. While an operational problem that caused Grand Gulf to cease commercial operation would negatively impact SERI's value to Entergy, we consider this to be a low probability event.

We view the Availability Agreement (AVA) between SERI and the purchasers as an important protection in the event that Grand Gulf were no longer in commercial operation. We view the AVA as a secondary sales agreement that would only come into effect if the revenues that SERI receives under the UPSA and any other sales agreements do not cover SERI's operating expenses, including depreciation, and interest and expenses incurred in a permanent shut down of Grand Gulf. The revenues due under the UPSA have always been greater than the revenues due under the AVA to date, primarily because the AVA does not include a return on equity. The AVA is thus untested, but, like the UPSA, it is regulated by FERC (which would have to approve any rate schedule before SERI could earn revenues under the agreement).

SERI's key cash flow metrics have been strong historically, generally scoring in the low Aa range. SERI's stable cash flows have enabled it to gradually amortize total debt from about $1.1 billion at 12/31/2004 to about $868 million at 12/31/2011, despite paying dividends to Entergy that have generally exceeded net income. Debt reduction will continue over the next several years as the SLOBs fully amortize by the end of 2015. For 2007-2011, cash from operations before changes in working capital (CFO Pre-WC) averaged $316 million, generally ranging from about $295 to $300 million, with one outlier of $387 million in 2009 year due to a $120 million tax refund (SERI has a tax sharing agreement with Entergy). For the 12 months ended 6/30/12, CFO Pre-WC + Interest / Interest was 8.0x and CFO Pre-WC to Debt was 39.6%. SERI's debt rose to $939 million at 6/30/12, but debt per KW of capacity remains reasonably low at about $800/KW.

Issuer: System Energy Resources, Inc.

Ratings Upgraded:

Senior Unsecured Rating: to Baa3 from Ba1

First Mortgage Bonds: to Baa1 from Baa2

Senior Secured Lease Obligation Bonds: to Baa2 from Baa3

Senior Secured Shelf: to (P) Baa1 from (P) Baa2

Senior Unsecured Shelf: to (P) Baa3 from (P) Ba1

Outlook: Stable

SERI's rating outlook is stable, reflecting the consistently strong cash flows that SERI generates under its FERC-regulated, court-tested primary sales contract, and the stable outlooks of the four purchasers.

SERI's ratings could be upgraded if the ratings of one or more of the purchasers were upgraded, or if Entergy's ratings were upgraded and the termination provisions of the Capital Funds Agreement were modified in a manner favorable to all bondholders.

SERI's ratings could be downgraded if the ratings of one or more of the purchasers were downgraded, if Grand Gulf ceased commercial operation for any reason and recovery under the Availability Agreement were materially delayed or challenged (a low-probability, high-severity event that could lead to a multi-notch downgrade), if contractual support from Entergy were made weaker, if SERI's cost structure changed so materially that its long-term value to the Entergy system were impaired, if dividends increased significantly relative to cash flow on a sustained basis, if SERI failed to receive a license renewal from the NRC and did not reduce dividends to assure that all debt could be repaid within the remaining license period, or if metrics declined precipitously, such that CFO Pre-WC to Debt were below 16% and CFO PRE-WC + Interest to Interest were below 3.3x, each on a sustained basis.

The principal methodology used in this rating was Regulated Electric and Gas Utilities published in August 2009. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

The Global Scale Credit Ratings on this press release that are issued by one of Moody's affiliates outside the EU are endorsed by Moody's Investors Service Ltd., One Canada Square, Canary Wharf, London E 14 5FA, UK, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that has issued a particular Credit Rating is available on www.moodys.com.

For ratings issued on a program, series or category/class of debt, this announcement provides relevant regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides relevant regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides relevant regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

Information sources used to prepare the rating are the following : parties involved in the ratings, parties not involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's considers the quality of information available on the rated entity, obligation or credit satisfactory for the purposes of issuing a rating.

Moody's adopts all necessary measures so that the information it uses in assigning a rating is of sufficient quality and from sources Moody's considers to be reliable including, when appropriate, independent third-party sources. However, Moody's is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

Please see the ratings disclosure page on www.moodys.com for information on (A) MCO's major shareholders (above 5%) and for (B) further information regarding certain affiliations that may exist between directors of MCO and rated entities as well as (C) the names of entities that hold ratings from MIS that have also publicly reported to the SEC an ownership interest in MCO of more than 5%. A member of the board of directors of this rated entity may also be a member of the board of directors of a shareholder of Moody's Corporation; however, Moody's has not independently verified this matter.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history.

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

William Hunter
Vice President - Senior Analyst
Infrastructure 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

A.J. Sabatelle
Senior Vice President
Infrastructure Finance Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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

Moody's upgrades System Energy Resources, Inc. senior unsecured to Baa3; Outlook Stable
No Related Data.
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