(8) LEASING ACTIVITIES

Investment in Finance Leases Held in Trust

PHI has a portfolio of cross-border energy lease investments (the lease portfolio) consisting of hydroelectric generation facilities, coal-fired electric generation facilities and natural gas distribution networks located outside of the United States. Each lease investment is comprised of a number of leases. As of September 30, 2012 and December 31, 2011, the lease portfolio consisted of six and seven investments with an aggregate book value of $1.2 billion and $1.3 billion, respectively.

During the third quarter of 2012, PHI entered into early termination agreements with two lessees involving all of the leases comprising one of the seven remaining lease investments. The early terminations of the leases were negotiated at the request of the lessees and were completed in September 2012. PHI received net cash proceeds of $202 million (net of a termination payment of $520 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.

During the second quarter of 2011, PHI entered into early termination agreements with two lessees involving all of the leases comprising one of the original 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 and were completed in June 2011. 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 in each case earlier than full term, management decided not to pursue these opportunities and certain income tax benefits recognized previously were reversed in the amounts of $16 million and $22 million for the nine months ended September 30, 2012 and 2011, respectively. The after-tax gain on the lease terminations was $9 million and $3 million for the nine months ended September 30, 2012 and 2011, respectively, including the income tax benefit reversal and an income tax provision at the statutory Federal rate of $14 million for each early lease termination. 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.

In the third quarter of 2011, PHI modified its tax cash flow assumptions for two of the investments in the lease portfolio associated with the change in tax laws in the District of Columbia. Accordingly, PHI recalculated the equity investment and recorded a non-cash $7 million pre-tax ($3 million after-tax) charge.

The components of the cross-border energy lease investments as of September 30, 2012 and December 31, 2011 are summarized below:


	September 30, 2012			December 31, 2011
	*(millions of dollars)*
Scheduled lease payments to PHI, net of non-recourse debt	$	1,852		$	2,120
Less: Unearned and deferred income		(626	)		(771	)

Investment in finance leases held in trust		1,226			1,349
Less: Deferred income tax liabilities		(738	)		(793	)

Net investment in finance leases held in trust	$	488		$	556

Income recognized from cross-border energy lease investments, excluding the gains on terminated leases discussed above, was comprised of the following for the three and nine months ended September 30, 2012 and 2011:


	Three Months Ended September 30,					Nine Months Ended September 30,
	2012		2011			2012		2011
	*(millions of dollars)*
Pre-tax income from PHI’s cross-border energy lease investments (included in Other Revenue)	$	13	$	7		$	39	$	35
Income tax expense (benefit) related to cross-border energy lease investments		3		(3	)		7		7

Net income from PHI’s cross-border energy lease investments	$	10	$	10		$	32	$	28

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 compares each lessee’s performance to 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 September 30, 2012, 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 September 30, 2012 and December 31, 2011:


Lessee Rating (a)	September 30, 2012		December 31, 2011
	*(millions of dollars)*
Rated Entities
AA/Aa and above	$	759	$	737
A		467		612

Total	$	1,226	$	1,349

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