Texas regulators declined on Sept. 22 to address a key question inSharyland UtilitiesLP's pending ratecase, which could put InfraREIT Inc.'s future as a real estate investmenttrust, or REIT, in doubt.

InfraREIT is the publicly traded REIT that owns Sharyland'stransmission and distribution assets. InfraREIT is externally managed by On Aug.30, Sharyland reached amilestone in the rate case when it submitted to the Public UtilityCommission of Texas a joint proposal, along with PUCT staff and severalintervenors addressing "threshold legal issues," previously raised bythe commission.

In the filing, the parties noted the process was intendedto, "allow for the preservation of the REIT status," of InfraREIT. Atthat time, Evercore ISI analyst Greg Gordon called the joint proposalsignificant because it seemed to mark a decision to avoid imposing terms onSharyland that could result in InfraREIT generating insufficient qualifyingincome to maintain its REIT status.

But the PUCT declined to approve Sharyland's joint proposalat its Sept. 22 open meeting, with the commission deferring to a later time adecision on the "true lease" requirement that would allow InfraREITto retain its REIT status. The PUCT did direct staff to draft a revisedpreliminary order that would require Sharyland to file an amended rate filingby the end of 2016. This makes it unlikely the commission will make a finaldecision on Sharyland's rate case until mid-2017 at the earliest. The outcomeof this rate case is widely seen as having an impact on whether other utilitiesor power companies may ever electto restructure as a REIT.

"The bottom line is that this puts our down side casevaluation scenario — in which we assume [InfraREIT] loses its REIT status andconverts back to a traditional utility holding company — back in play, as wethought that it would be eliminated by the PUCT approving the jointproposal," Gordon wrote Sept. 26.

At issue are the leases between the entities underInfraREIT, such as regulated subsidiary Sharyland Distribution & Transmission Services LLC,or SDTS, which owns and leases the assets to Sharyland Utilities. The jointproposal classified those leases as a tariff, and reduces the number of leasesto two.

The parties supporting the joint proposal suggestedcontinuing the current lease structure, where the lease payments are calculatedso SDTS receives 97% of the projected regulated return on rate base investmenton its assets that it would be entitled to if it owned and operated the assets,instead of leasing them to Sharyland Utilities. Several groups oppose the jointproposal, including the Texas Industrial Energy Consumers, the Office of PublicUtility Counsel and the Texas Cotton Ginners' Association. The joint proposalalso does not address issues related to how federal income tax benefits shouldbe treated, as a result of the structure between Sharyland, SDTS and InfraREIT.

Gordon noted the PUCT and other parties involved in the rateproceeding appear to have an agreement on all other threshold legal issuesexcept for the joint proposal provision on leases that would allow InfraREIT tomaintain REIT status. Despite the setback, Evercore ISI still regards theinvestment risk and reward proposition of InfraREIT shares as"palatable," and reiterated a "buy" rating with a $20 pricetarget. (Texas Docket No. 45414)