Leasing Activities

12 Months Ended

Dec. 31, 2011

Leasing Activities

(8) LEASING ACTIVITIES

Investment in Finance Leases Held in Trust

As of December 31, 2011 and 2010, Pepco Holdings had cross-border energy lease investments of $1.3 billion and $1.4 billion, respectively, consisting of hydroelectric generation and coal-fired electric generation facilities and natural gas distribution networks located outside of the United States.

During 2011, PHI modified its tax cash flow assumptions under its cross-border energy lease investments for the periods 2011-2016, to reflect the anticipated timing of potential litigation with the IRS and to reflect the change in tax laws in the District of Columbia as further discussed in Note (17), "Commitments and Contingencies – District of Columbia Tax Legislation." Accordingly, PHI recalculated the equity investment and recorded a $7 million pre-tax ($3 million after-tax) charge.

During 2010 and 2009, PHI reassessed the sustainability of its tax position and revised its assumptions regarding the estimated timing of tax benefits generated from its cross-border energy lease investments. Based on these reassessments, PHI recorded a reduction in its cross-border energy lease investment revenue of $2 million and $3 million in 2010 and 2009, respectively. For additional discussion, see Note (17), "Commitments and Contingencies—PHI's Cross-Border Energy Lease Investments."

During 2011, PHI entered into early termination agreements with two lessees involving all of the leases comprising one of the eight lease investments and a small portion of the leases comprising a second lease investment. The early terminations of the leases were negotiated at the request of the lessees. PHI received net cash proceeds of $161 million (net of a termination payment of $423 million used to retire the non-recourse debt associated with the terminated leases) and recorded a pre-tax gain of $39 million, representing the excess of the net cash proceeds over the carrying value of the lease investments.

With respect to the terminated leases, PHI had previously made certain business assumptions regarding foreign investment opportunities available at the end of the full lease terms. Because the leases were terminated prior to the end of the stated term, management decided not to pursue these opportunities and $22 million in certain Federal income tax benefits recognized previously were reversed. The after-tax gain on the lease terminations was $3 million, reflecting an income tax provision at the statutory federal rate of $14 million and the income tax benefit reversal. PHI has no intent to terminate early any other leases in the lease portfolio. With respect to certain of these remaining leases, management's assumption continues to be that the foreign earnings recognized at the end of the lease term will remain invested abroad.

The components of the cross-border energy lease investments, as of December 31, are summarized below:

	2011			2010
	(millions of dollars)
Scheduled lease payments to PHI, net of non-recourse debt	$	2,120		$	2,265
Less: Unearned and deferred income		(771	)		(842	)
Investment in finance leases held in trust		1,349			1,423
Less: Deferred income tax liabilities		(793	)		(816	)
Net investment in finance leases held in trust	$	556		$	607

Income recognized from cross-border energy lease investments, excluding the gain on the terminated leases discussed above, is comprised of the following for the years ended December 31:

	2011			2010			2009
	(millions of dollars)
Pre-tax income from PHI's cross-border energy lease investments (included in Other Revenue)	$	55		$	55		$	54
Non-cash charge to reduce equity value of PHI's cross-border energy lease investments		(7	)		(2	)		(3	)
Pre-tax income from PHI's cross-border energy lease investments after adjustment		48			53			51
Income tax expense		10			14			16
Net income from PHI's cross-border energy lease investments	$	38		$	39		$	35

Scheduled lease payments from the cross-border energy lease investments are net of non-recourse debt. Minimum lease payments receivable from the cross-border energy lease investments are zero for each year 2012 through 2016, and $1,349 million thereafter.

To ensure credit quality, PHI regularly monitors the financial performance and condition of the lessees under its cross-border energy lease investments. Changes in credit quality are also assessed to determine if they should be reflected in the carrying value of the leases. PHI reviews each lessee's performance versus annual compliance requirements set by the terms and conditions of the leases. This includes a comparison of published credit ratings to minimum credit rating requirements in the leases for lessees with public credit ratings. In addition, PHI routinely meets with senior executives of the lessees to discuss their company and asset performance. If the annual compliance requirements or minimum credit ratings are not met, remedies are available under the leases. At December 31, 2011, all lessees were in compliance with the terms and conditions of their lease agreements.

The table below shows PHI's net investment in these leases by the published credit ratings of the lessees as of December 31:

Lessee Rating (a)	2011		2010
	(millions of dollars)
Rated Entities
AA/Aa and above	$	737	$	709
A		612		549
Total		1,349		1,258
Non Rated Entities		—		165
Total	$	1,349	$	1,423

(a) Excludes the credit ratings of collateral posted by the lessees in these transactions.

Lease Commitments

Pepco leases its consolidated control center, which is an integrated energy management center used by Pepco to centrally control the operation of its transmission and distribution systems. This lease is accounted for as a capital lease and was initially recorded at the present value of future lease payments, which totaled $152 million. The lease requires semi-annual payments of approximately $8 million over a 25-year period that began in December 1994, and provides for transfer of ownership of the system to Pepco for $1 at the end of the lease term. Under FASB guidance on regulated operations, the amortization of leased assets is modified so that the total interest expense charged on the obligation and amortization expense of the leased asset is equal to the rental expense allowed for rate-making purposes. The amortization expense is included within Depreciation and amortization in the consolidated statements of income. This lease is treated as an operating lease for rate-making purposes.

Capital lease assets recorded within Property, Plant and Equipment at December 31, 2011 and 2010, in millions of dollars, are comprised of the following:

	Original Cost		Accumulated Amortization		Net Book Value
At December 31, 2011
Transmission	$	76	$	33	$	43
Distribution		76		33		43
General		3		3		—
Total	$	155	$	69	$	86
At December 31, 2010
Transmission	$	76	$	29	$	47
Distribution		76		29		47
General		3		3		—
Total	$	155	$	61	$	94

The approximate annual commitments under all capital leases are $15 million for each year 2012 through 2016, and $46 million thereafter.

Rental expense for operating leases was $46 million, $45 million, and $45 million for the years ended December 31, 2011, 2010, and 2009, respectively.

Total future minimum operating lease payments for Pepco Holdings as of December 31, 2011, are $39 million in 2012, $36 million in 2013, $35 million in 2014, $32 million in 2015, $29 million in 2016 and $359 million thereafter.

Potomac Electric Power Co [Member]

Leasing Activities

(7) LEASING ACTIVITIES

Pepco leases its consolidated control center, which is an integrated energy management center used by Pepco to centrally control the operation of its transmission and distribution systems. This lease is accounted for as a capital lease and was initially recorded at the present value of future lease payments. The lease requires semi-annual payments of approximately $8 million over a 25-year period that began in December 1994, and provides for transfer of ownership of the system to Pepco for $1 at the end of the lease term. Under FASB guidance on regulated operations, the amortization of leased assets is modified so that the total interest expense charged on the obligation and amortization expense of the leased asset is equal to the rental expense allowed for rate-making purposes. The amortization expense is included within Depreciation and amortization in the statements of income. This lease is treated as an operating lease for rate-making purposes.

Capital lease assets recorded within Property, Plant and Equipment at December 31, 2011 and 2010 are comprised of the following:

	Original Cost		Accumulated Amortization		Net Book Value
	(millions of dollars)
At December 31, 2011
Transmission	$	76	$	33	$	43
Distribution		76		33		43
Other		3		3		—
Total	$	155	$	69	$	86
At December 31, 2010
Transmission	$	76	$	29	$	47
Distribution		76		29		47
Other		3		3		—
Total	$	155	$	61	$	94

The approximate annual commitments under capital leases are $15 million for each year 2012 through 2016, and $46 million thereafter.

Rental expense for operating leases was $4 million, $4 million and $3 million for the years ended December 31, 2011, 2010 and 2009, respectively.

Total future minimum operating lease payments for Pepco as of December 31, 2011 are $5 million in 2012, $5 million in 2013, $5 million in 2014, $4 million in 2015, $4 million in 2016, and $16 million thereafter.

Delmarva Power & Light Co/De [Member]

Leasing Activities

(8) LEASING ACTIVITIES

DPL leases an 11.9% interest in the Merrill Creek Reservoir. The lease is an operating lease and payments over the remaining lease term, which ends in 2032, are $93 million in the aggregate. DPL also has long-term leases for certain other facilities and equipment. Total future minimum operating lease payments for DPL, including the Merrill Creek Reservoir lease, as of December 31, 2011, are $12 million in 2012, $11 million in each of the years 2013 through 2015, $9 million in 2016, and $108 million thereafter.

Rental expense for operating leases, including the Merrill Creek Reservoir lease, was $11 million, $10 million and $9 million for the years ended December 31, 2011, 2010 and 2009, respectively.

Atlantic City Electric Co [Member]

Leasing Activities

(7) LEASING ACTIVITIES

ACE leases certain types of property and equipment for use in its operations. Rental expense for operating leases was $10 million, $9 million and $9 million for the years ended December 31, 2011, 2010 and 2009, respectively.

Total future minimum operating lease payments for ACE as of December 31, 2011 are $5 million in 2012, $4 million in each of the years 2013 through 2015, $3 million in 2016 and $25 million thereafter.