Palo Verde Sale Leaseback Variable Interest Entities

9 Months Ended

Sep. 30, 2011

Palo Verde Sale Leaseback Variable Interest Entities

Palo Verde Sale Leaseback Variable Interest Entities

7. Palo Verde Sale Leaseback Variable Interest Entities

In 1986, APS entered into agreements with three separate VIE lessor trusts in order to sell and lease back interests in Palo Verde Unit 2 and related common facilities.  The VIE lessor trusts are single-asset leasing entities.  APS will pay approximately $49 million per year for the years 2011 to 2015 related to these leases.  The leases do not contain fixed price purchase options or residual value guarantees.  However, the lease agreements include fixed rate renewal periods which may have a significant impact on the VIEs’ economic performance.  We have concluded that these fixed rate renewal periods may give APS the ability to utilize the asset for a significant portion of the asset’s economic life, and therefore provide APS with the power to direct activities of the VIEs that most significantly impact the VIEs’ economic performance.  In addition to the fixed rate renewal periods, our primary beneficiary analysis also considered that APS is the operating agent for Palo Verde, has fair value purchase options, and is obligated to decommission the leased assets.

For the reasons discussed above, APS consolidates these VIEs.  Assets of the VIEs are restricted and may only be used to settle the VIEs’ debt obligations and for payment to the noncontrolling interest holders.  Other than the VIEs’ assets reported on our consolidated financial statements, the creditors of the VIEs have no other recourse to the assets of APS or Pinnacle West, except in certain circumstances such as a default by APS under the lease.  As a result of consolidation we eliminate rent expense and recognize depreciation and interest expense, resulting in an increase in net income for the three and nine months ended September 30, 2011 of $7 million and of $20 million respectively, entirely attributable to the noncontrolling interests.  Income attributable to Pinnacle West shareholders remains the same.  Consolidation of these VIEs also results in changes to our Condensed Consolidated Statements of Cash Flows, but does not impact net cash flows.

Our Condensed Consolidated Balance Sheets at September 30, 2011 and December 31, 2010 include the following amounts relating to the VIEs (in millions):

	September 30, 2011		December 31, 2010
Property plant and equipment, net of accumulated depreciation	$	134	$	138
Current maturities of long-term debt	30		29
Long-term debt less current maturities	83		97
Equity- Noncontrolling interests	109		91

For regulatory ratemaking purposes the agreements are treated as operating leases and, as a result, we have recorded a regulatory asset of $34 million as of September 30, 2011 and $33 million as of December 31, 2010.

APS is exposed to losses relating to these lessor trust VIEs upon the occurrence of certain events that APS does not consider to be reasonably likely to occur.  Under certain circumstances (for example, the United States Nuclear Regulatory Commission (“NRC”) issuing specified violation orders with respect to Palo Verde or the occurrence of specified nuclear events), APS would be required to make specified payments to the VIEs’ noncontrolling equity participants, assume the VIEs’ debt, and take title to the leased Unit 2 interests, which, if appropriate, may be required to be written down in value.  If such an event had occurred as of September 30, 2011, APS would have been required to pay the noncontrolling equity participants approximately $145 million and assume $113 million of debt.  Since APS consolidates the VIEs, the debt APS would be required to assume is already reflected in our Condensed Consolidated Balance Sheets.