CENTERPOINT ENERGY HOUSTON ELECTRIC LLC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 1-3187

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC
(Exact name of registrant as specified in its charter)

TEXAS 22-3865106
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

1111 LOUISIANA
HOUSTON, TEXAS 77002 (713) 207-1111
(Address of principal executive offices) (Registrant's telephone number,
including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC MEETS THE CONDITIONS SET FORTH IN
GENERAL INSTRUCTION I(1)(a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS
FORM 10-K WITH THE REDUCED DISCLOSURE FORMAT.

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). Yes [ ] No [X]

The aggregate market value of the common equity held by non-affiliates as
of June 28, 2002: None
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TABLE OF CONTENTS

PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 17
Item 3. Legal Proceedings........................................... 18
Item 4. Submission of Matters to a Vote of Security Holders......... 18

PART II
Item 5. Market for Common Stock and Related Security Holder
Matters..................................................... 18
Item 6. Selected Financial Data..................................... 18
Item 7. Management's Narrative Analysis of Results of Operations.... 18
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 31
Item 8. Financial Statements and Supplementary Data................. 32
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 65

PART III
Item 10. Directors and Executive Officers............................ 65
Item 11. Executive Compensation...................................... 65
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Security Holder Matters.............. 65
Item 13. Certain Relationships and Related Transactions.............. 65

PART IV
Item 14. Controls and Procedures..................................... 65
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form
8-K......................................................... 65

1

We meet the conditions specified in General Instruction I (1)(a) and (b) to
Form 10-K and are thereby permitted to use the reduced disclosure format for
wholly owned subsidiaries of reporting companies specified therein. Accordingly,
we have omitted from this report the information called for by Item 4
(Submission of Matters to a Vote of Security Holders), Item 10 (Directors and
Executive Officers of the Registrant), Item 11 (Executive Compensation), Item 12
(Security Ownership of Certain Beneficial Owners and Management and Related
Security Holder Matters) and Item 13 (Certain Relationships and Related Party
Transactions) of Form 10-K. In lieu of the information called for by Item 6
(Selected Financial Data) and Item 7 (Management's Discussion and Analysis of
Financial Condition and Results of Operations) of Form 10-K, we have included
under Item 7 a Management's Narrative Analysis of Results of Operations to
explain material changes in the amount of revenue and expense items between
2000, 2001 and 2002.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

From time to time we make statements concerning our expectations, beliefs,
plans, objectives, goals, strategies, future events or performance and
underlying assumptions and other statements that are not historical facts. These
statements are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Actual results may differ materially
from those expressed or implied by these statements. You can generally identify
our forward-looking statements by the words "anticipate," "believe," "continue,"
"could," "estimate," "expect," "forecast," "goal," "intend," "may," "objective,"
"plan," "potential," "predict," "projection," "should," "will," or other similar
words.

We have based our forward-looking statements on our management's beliefs
and assumptions based on information available to our management at the time the
statements are made. We caution you that assumptions, beliefs, expectations,
intentions and projections about future events may and often do vary materially
from actual results. Therefore, we cannot assure you that actual results will
not differ materially from those expressed or implied by our forward-looking
statements.

Some of the factors that could cause actual results to differ from those
expressed or implied by our forward-looking statements are described under "Risk
Factors" beginning on page 12 of this report.

You should not place undue reliance on forward-looking statements. Each
forward-looking statement speaks only as of the date of the particular
statement, and we undertake no obligation to publicly update or revise any
forward-looking statements.

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PART I

ITEM 1. BUSINESS

OUR BUSINESS

GENERAL

We are a regulated utility engaged in the transmission and distribution of
electric energy in a 5,000-square mile area located along the Texas Gulf Coast,
including the City of Houston. We are an indirect wholly owned subsidiary of
CenterPoint Energy, Inc. (CenterPoint Energy), a new holding company whose
principal businesses are the regulated former businesses of Reliant Energy,
Incorporated (Reliant Energy) and its former subsidiaries. CenterPoint Energy
was created in 2002 as part of a corporate restructuring of Reliant Energy that
implemented certain requirements of the Texas electric restructuring law,
described below. In this report, unless the content indicates otherwise,
references to "CenterPoint Houston," "we," "us" or similar terms mean
CenterPoint Energy Houston Electric, LLC and its subsidiaries.

Our executive offices are at 1111 Louisiana, Houston, TX 77002 (telephone
number 713-207-1111).

THE RESTRUCTURING

Prior to August 31, 2002, our predecessor, Reliant Energy, a Texas
corporation incorporated in 1906, was:

- the parent company of a consolidated group of companies providing energy
and energy services primarily in North America and Western Europe;

- an operating integrated electric utility, providing generation,
transmission and distribution, and retail electric sales functions in a
5,000-square mile area located along the Texas Gulf Coast that includes
Houston; and

- a utility holding company, owning all of the common stock of CenterPoint
Energy Resources Corp. (CERC), which conducts natural gas distribution
and pipeline operations.

Reliant Energy's non-utility wholesale and retail energy operations were
conducted principally through its subsidiary, Reliant Resources, Inc. (Reliant
Resources).

Effective August 31, 2002, Reliant Energy completed the separation of the
generation, transmission and distribution, and retail sales functions of Reliant
Energy's Texas electric operations (referred to herein as the Restructuring) in
which it, among other things:

- conveyed its Texas electric generation assets to Texas Genco Holdings,
Inc. (Texas Genco);

- became an indirect, wholly owned subsidiary of a new utility holding
company, CenterPoint Energy;

- was converted into a Texas limited liability company named CenterPoint
Energy Houston Electric, LLC; and

- distributed the capital stock of its operating subsidiaries to
CenterPoint Energy.

As part of the Restructuring, each share of Reliant Energy common stock was
converted into one share of CenterPoint Energy common stock. Pursuant to the
provisions of certain of its existing debt agreements applicable when the
properties or assets of Reliant Energy were transferred to another entity
substantially as an entirety, CenterPoint Energy expressly assumed certain debt
and other obligations of Reliant Energy, and Reliant Energy was released as the
primary obligor on such debt. Immediately subsequent to the Restructuring, we
had outstanding (a) $614.7 million of first mortgage bonds issued directly to
third parties, (b) $546.5 million of first mortgage bonds that collateralized
medium-term notes and pollution control bonds of CenterPoint Energy (such
amounts are not reflected in our consolidated financial statements because of
the contingent nature of the obligations), (c) $300 million of notes issued by a
subsidiary, (d) $735.8 million of transition bonds issued by a subsidiary, and
(e) a $1.6 billion note issued to CenterPoint Energy. In addition, we had a $400
million credit facility. At December 31, 2002 we had $3.7 billion in outstanding
indebtedness

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and had issued $1.1 billion of first mortgage bonds and second mortgage bonds as
collateral for long-term debt of CenterPoint Energy.

Contemporaneous with the Restructuring, CenterPoint Energy registered and
became subject, with its subsidiaries, to regulation as a registered holding
company system under the Public Utility Holding Company Act of 1935 (1935 Act).
The 1935 Act directs the Securities and Exchange Commission (SEC) to regulate,
among other things, transactions among affiliates, sales or acquisitions of
assets, issuances of securities, distributions and permitted lines of business.

For additional information regarding the Restructuring and the
Distribution, please read Note 2 to our consolidated financial statements.

THE TEXAS ELECTRIC RESTRUCTURING LAW

In 1999, Texas adopted the Texas Electric Choice Plan (Texas electric
restructuring law), which substantially amended the regulatory structure
governing electric utilities in Texas in order to allow retail competition for
all customers. The Texas electric restructuring law required the separation of
the generation, transmission and distribution, and retail sales functions of
electric utilities into three different units. It also required each electric
utility to file a business separation plan with the Public Utility Commission of
Texas (Texas Utility Commission) detailing its plan to comply with the Texas
electric restructuring law. Under the law, neither the generation function nor
the retail function is subject to traditional cost of service regulation, and
the retail function has been opened to competition. The transmission and
distribution function we perform remains subject to traditional utility rate
regulation.

Under the Texas electric restructuring law, transmission and distribution
utilities in Texas whose generation assets were "unbundled" pursuant to the
Texas electric restructuring law, including us, may recover following a
regulatory proceeding to be held in 2004:

(i) "regulatory assets," which consist of the Texas jurisdictional amount
reported by the previously vertically integrated electric utilities
as regulatory assets and liabilities (offset and adjusted by
specified amounts) in their audited financial statements for 1998;

(ii) "stranded costs," which consist of the positive excess of the net
regulatory book value of generation assets over the market value of
the assets, taking specified factors into account; and

(iii) the ECOM True-Up, Fuel Over/Under Recovery and Price to Beat Clawback
components as further discussed in "Electric Transmission and
Distribution -- Stranded Costs and Regulatory Assets Recovery" below.

The Texas electric restructuring law permits transmission and distribution
utilities to recover regulatory assets and stranded costs through non-bypassable
charges authorized by the Texas Utility Commission to the extent that such
assets and costs are established in certain regulatory proceedings. The law also
authorizes the Texas Utility Commission to permit these utilities to issue
securitization bonds based on the securitization of the revenue associated with
that charge. The term "non-bypassable" refers to an element of a transmission
and distribution utility's rates that must be paid by essentially all customers
and that cannot, except in limited circumstances, be avoided by switching to
self-generation. For more information, please read "Electric Transmission and
Distribution -- Stranded Costs and Regulatory Assets Recovery" below.

For additional information regarding the Texas electric restructuring law,
please read "Regulation -- The Texas Electric Restructuring Law."

ERCOT MARKET FRAMEWORK

We are a member of the Electric Reliability Council of Texas, Inc. (ERCOT),
an intrastate network of retail customers, investor and municipally owned
electric utilities, rural electric co-operatives, river authorities, independent
generators, power marketers and retail electric providers, which serves as the
regional reliability coordinating council for member electric power systems in
Texas. The ERCOT market consists of the State of Texas, other than a portion of
the panhandle, a portion of the eastern part of the state bordering on Louisiana
and the area in and around El Paso. The ERCOT market represents approximately
85% of the demand for
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power in Texas and is one of the nation's largest power markets. The ERCOT
market includes an aggregate net generating capacity of approximately 70,000
megawatts (MW), approximately 14,000 MW of which are owned by our affiliate,
Texas Genco. There are only limited direct current interconnections between the
ERCOT market and other power markets in the United States.

The ERCOT market operates under the reliability standards set by the North
American Electric Reliability Council. The Texas Utility Commission has primary
jurisdiction over the ERCOT market to ensure the adequacy and reliability of
electricity supply across the state's main interconnected power transmission
grid. The ERCOT independent system operator (ERCOT ISO) is responsible for
maintaining reliable operations of the bulk electric power supply system in the
ERCOT market. Its responsibilities include ensuring that electricity production
and delivery are accurately accounted for among the generation resources and
wholesale buyers and sellers. Unlike independent system operators in other
regions of the country, the ERCOT market is not a centrally dispatched power
pool, and the ERCOT ISO does not procure energy on behalf of its members other
than to maintain the reliable operations of the transmission system. Members are
responsible for contracting sales and purchases of power bilaterally. The ERCOT
ISO also serves as agent for procuring ancillary services for those who elect
not to provide their own ancillary services.

Our electric transmission business supports the operation of the ERCOT ISO
and all ERCOT members. The transmission business has planning, design,
construction, operation and maintenance responsibility for the transmission grid
and for the load serving substations. The transmission business is participating
with the ERCOT ISO and other ERCOT utilities to plan, design, obtain regulatory
approval for and construct new transmission lines necessary to increase bulk
power transfer capability and to remove existing limitations on the ERCOT
transmission grid.

ELECTRIC TRANSMISSION AND DISTRIBUTION

SERVICE AREA

Our service area consists of a 5,000-square-mile area located along the
Texas Gulf Coast, with a population of approximately 4.7 million people.
Electric transmission and distribution service is provided to approximately 1.8
million metered customers in this area, which includes the City of Houston and
surrounding cities such as Galveston, Pasadena, Baytown, Bellaire, Freeport,
Humble, Katy and Sugar Land. With the exception of Texas City, we serve nearly
all of the Houston/Galveston metropolitan area. Effective January 2002, all
former electricity customers of Reliant Energy HL&P whose service was regulated
became free to choose to purchase their electricity from retail electric
providers who compete for their business. The competing retail electric
providers are now our primary customers. See " -- Customers" below.

ELECTRIC TRANSMISSION

We transport electricity from power plants to substations and from one
substation to another and to retail customers taking power above 69 kilovolts
(kV). Transmission services are provided under tariffs approved by the Texas
Utility Commission. Transmission service offers the use of the transmission
system for delivery of power over facilities operating at 69 kV and above.

ELECTRIC DISTRIBUTION

We distribute electricity for retail electric providers in our certificated
service area by carrying lower-voltage power from the substation to the retail
electric customer. Our distribution network consists of primary distribution
lines, transformers, secondary distribution lines and service wires. Operations
include construction and maintenance of facilities, metering services, outage
response services and other call center operations. As part of the Texas
electric restructuring law, metering service was to be provided on a competitive
basis for commercial and industrial electric customers beginning January 1, 2004
and for residential retail electric customers in each service area on the later
of September 1, 2005, or the date when 40% of the residential retail electric
customers in that service area are taking service from unaffiliated or not
formerly affiliated retail electric providers. However, the Texas Utility
Commission has determined that the market is not yet ready for

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all metering services to be made competitive and has begun a rulemaking
proceeding to decide when and what type of metering services will be opened to
competition.

Our distribution network receives electricity from the transmission grid
through power distribution substations and distributes electricity to end users
through our distribution feeders.

Distribution services are provided under tariffs approved by the Texas
Utility Commission. New Texas Utility Commission rules and market protocols
govern the commercial retail operations of distribution companies and other
market participants.

STRANDED COSTS AND REGULATORY ASSETS RECOVERY

The Texas electric restructuring law provides us an opportunity to recover
our "regulatory assets" and "stranded costs." "Stranded costs" include the
positive excess of the regulatory net book value of generation assets over the
market value of the generation assets. The Texas electric restructuring law
allows alternative methods of third party valuation of the market value of
generation assets, including outright sale, full and partial stock valuation and
asset exchanges. Reliant Energy agreed in the business separation plan approved
by the Texas Utility Commission that the market value of Texas Genco's
generating assets would be determined using the partial stock valuation method.
Accordingly, on January 6, 2003, CenterPoint Energy distributed to its
shareholders approximately 19% of the outstanding common stock of Texas Genco.
As the surviving regulated utility following the Restructuring, we will be
allowed to recover these stranded costs in 2004 following the determination by
the Texas Utility Commission of the amount of such costs. The market prices of
the publicly traded common stock will be used to determine the market value of
Texas Genco. For more information regarding the market value determination,
please read " -- Final True-Up -- Stranded Cost Component" below.

The Texas electric restructuring law also provides specific regulatory
remedies to reduce or mitigate a utility's stranded cost exposure. For example,
during a base rate freeze period from 1999 through 2001, earnings above the
utility's authorized rate of return formula were required to be applied in a
manner to accelerate depreciation of generation-related plant assets for
regulatory purposes if the utility was expected to have stranded costs. In
addition, depreciation expense for transmission and distribution related assets
could be redirected to generation assets for regulatory purposes during that
period if the utility was expected to have stranded costs. Reliant Energy
undertook both of these remedies provided in the Texas electric restructuring
law.

Under the Texas electric restructuring law, "regulatory assets" consist of
the Texas jurisdictional amount reported by an electric utility as regulatory
assets and liabilities (offset and adjusted by specified amounts) in its audited
financial statements for 1998. The Texas electric restructuring law permits
utilities to recover regulatory assets through non-bypassable transition charges
on retail electric customers' bills, to the extent that such assets and costs
are established in regulatory proceedings as discussed below. CenterPoint Energy
recovered a portion of its regulatory assets in 2001 through the issuance of
transition bonds.

The Texas electric restructuring law also permits us to issue
securitization bonds for the recovery of generation-related regulatory assets
and stranded costs. Please read " -- Securitization Financing" below for a more
complete discussion of the issuance of securitization bonds. Any stranded costs
not recovered through the sale of securitization bonds may be recovered through
a separate non-bypassable transition charge to transmission and distribution
customers.

Mitigation. In October 2001, the Texas Utility Commission ruled that
Reliant Energy had overmitigated its stranded costs by redirecting transmission
and distribution depreciation and by accelerating depreciation of generation
assets as provided under its transition plan and the Texas electric
restructuring law. In December 2001, Reliant Energy recorded a regulatory
liability of $1.1 billion to reflect the prospective refund of accelerated
depreciation, removed its previously recorded embedded regulatory asset of $841
million that had resulted from redirected depreciation and recorded a regulatory
asset of $2.0 billion based upon then current projections of the market value of
Reliant Energy's Texas generation assets to be recovered by the 2004 true-up
proceeding described below. These regulatory assets and liabilities are recorded
in our

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Consolidated Balance Sheets. Reliant Energy began refunding the excess
mitigation credits in January 2002, and we will continue to do so over a
seven-year period. If events occur that make the recovery of all or a portion of
the regulatory assets no longer probable, we will write off the corresponding
balance of these assets as a charge against earnings. CenterPoint Energy
appealed the Texas Utility Commission's true-up rule on the basis that there are
no negative stranded costs, that CenterPoint Energy should be allowed to collect
interest on stranded costs, and that the premium on the partial stock valuation
applies to only the equity of Texas Genco, not equity plus debt. The Texas court
of appeals issued a decision on February 6, 2003, upholding the rule in part and
reversing in part. The court ruled that there are no negative stranded costs and
that the premium on the partial stock valuation applies only to equity. The
court upheld the Texas Utility Commission's rule that interest on stranded costs
begins upon the date of the final true-up order. On February 21, 2003,
CenterPoint Energy filed a motion for rehearing on the issue that interest on
amounts determined in the true-up proceeding should accrue from an earlier date.
We have not accrued interest in our consolidated financial statements, but
estimate that interest could be material. If the court of appeals denies
CenterPoint Energy's motion, then CenterPoint Energy will have 45 days to appeal
to the Texas Supreme Court. CenterPoint Energy has not decided what action, if
any, it will take if the motion for rehearing is denied.

Final True-Up. Beginning in January 2004, the Texas Utility Commission
will conduct true-up proceedings for each investor-owned utility. The purpose of
the true-up proceeding is to quantify and reconcile the amount of stranded
costs, the difference in the price of power obtained through capacity auctions
conducted by Texas Genco and the power costs used in the Excess Cost Over Market
(ECOM) model, any fuel costs over- or under-recovery, the "price to beat"
clawback and other regulatory assets associated with the generating assets that
were not previously securitized as described below under "-- Securitization
Financing." The true-up proceeding will result in either additional charges
being assessed on, or credits being issued to, retail electric customers taking
delivery from us.

Stranded Cost Component. The regulatory net book value of generating
assets will be compared to the market value of those assets using the partial
stock valuation method. The resulting difference, if positive, represents
stranded costs that will be recovered through a transition charge, which is a
non-bypassable charge assessed to customers taking delivery service from us.
Stranded costs may be securitized. Please read "Securitization Financing" below
for a more complete discussion of the securitization.

The publicly traded common stock of Texas Genco will be used to determine
the market value of the generating assets of Texas Genco pursuant to the partial
stock valuation method for determining stranded costs. The market value will be
equal to the average daily closing price on The New York Stock Exchange for
publicly held shares of Texas Genco common stock for the 30 consecutive trading
days chosen by the Texas Utility Commission out of the last 120 trading days
immediately preceding the true-up filing, plus a control premium, up to a
maximum of 10%, to the extent included in the valuation determination made by
the Texas Utility Commission. The regulatory net book value of generating plant
assets is the balance as of December 31, 2001 plus certain costs incurred for
reductions in emissions of oxides of nitrogen (NOx) and any above-market
purchased power contracts.

ECOM True-Up Component. The Texas Utility Commission used a computer model
or projection, called an ECOM model, to estimate stranded costs related to
generation plant assets. Accordingly, the Texas Utility Commission estimated the
market power prices that would be received in the generation capacity auctions
mandated by the Texas electric restructuring law during the period from January
1, 2002 through December 31, 2003. Any difference between the actual market
power prices received in those auctions and the Texas Utility Commission's
earlier estimates of those market prices will be a component of the 2004 true-up
proceeding.

Fuel Over/Under Recovery Component. We filed a joint application along
with Texas Genco to reconcile fuel revenues and expenses with the Texas Utility
Commission on July 1, 2002. This final fuel reconciliation filing covers
reconcilable fuel revenue, fuel expense and interest of approximately $8.5
billion incurred from August 1, 1997 through January 30, 2002. Also included in
this amount is an under-recovery of $94 million, which was the balance at July
31, 1997 as approved in our last fuel reconciliation. On January 28,

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2003, a settlement agreement was reached under which it was agreed that certain
items totaling $24 million were written off during the fourth quarter of 2002
and items totaling $203 million will be carried forward for resolution by the
Texas Utility Commission in late 2003 or early 2004.

"Price to Beat" Clawback Component. In connection with the implementation
of the Texas electric restructuring law, the Texas Utility Commission has set a
"price to beat" that retail electric providers affiliated or formerly affiliated
with a former integrated utility must charge residential and small commercial
customers within their affiliated electric utility's service area. The true-up
provides for a clawback of "price to beat" in excess of the market price of
electricity if 40% of the "price to beat" load is not served by a non-affiliated
retail electric provider by January 1, 2004. Pursuant to the Texas electric
restructuring law and the master separation agreement between Reliant Energy and
Reliant Resources, Reliant Resources is obligated to pay us for the clawback
component of the true-up. The clawback may not exceed $150 times the number of
customers served by the affiliated retail electric provider in the transmission
and distribution utility's service territory, less the number of customers
served by the affiliated retail electric provider outside the transmission and
distribution utility's service territory, on January 1, 2004. We expect the
clawback, if any, will reduce any stranded cost recovery to which we are
entitled or, if no stranded costs are recoverable, will be refunded to retail
electric customers.

Securitization Financing. The Texas electric restructuring law provides
for the use of special purpose entities to issue securitization bonds for the
economic value of generation-related regulatory assets and stranded costs. These
securitization bonds will be amortized over a period not to exceed 15 years
through non-bypassable transition charges to customers taking delivery service
from us. Any stranded costs not recovered through the securitization bonds will
be recovered through a non-bypassable competition transition charge assessed to
customers taking delivery service from us.

In October 2001, one of our subsidiaries issued $749 million of transition
bonds to securitize generation-related regulatory assets. These transition bonds
have a final maturity date of September 15, 2015 and are non-recourse to us
other than to the special purpose issuer. Payments on the transition bonds are
made out of funds from non-bypassable transition charges assessed to customers
taking delivery service from us.

We expect that we will seek to securitize the true-up balance upon
completion of the 2004 true-up proceeding. The securitization bonds may have a
maximum maturity of 15 years. Payments on these securitization bonds would also
be made out of funds from non-bypassable transition charges assessed to
customers taking delivery service from us.

CUSTOMERS

Our customers consist of municipalities, electric cooperatives, other
distribution companies and approximately 31 retail electric providers in our
certificated service area. Each retail electric provider is licensed by the
Texas Utility Commission and must meet creditworthiness criteria established by
the Texas Utility Commission. Two of these retail electric providers are
subsidiaries of Reliant Resources. Our receivables balance from retail electric
providers on December 31, 2002, was $85 million. Approximately 72% of this
amount was owed by subsidiaries of Reliant Resources. Sales to Reliant Resources
represented approximately 83% of our transmission and distribution revenues
since deregulation began in 2002. We provide services under tariffs approved by
the Texas Utility Commission. We do not have long-term contracts with any of our
customers. We operate on a continuous billing cycle, with meter readings being
conducted and invoices being distributed to retail electric providers each
business day.

CREDIT STANDARDS FOR RETAIL ELECTRIC PROVIDERS

The Texas Utility Commission has set forth minimum creditworthiness
criteria that all retail electric providers serving retail electric customers
must meet. The retail electric provider must satisfy one of the following
criteria:

- a long-term, unsecured credit rating of not less than "BBB-" and "Baa3"
(or the equivalent) from Standard & Poor's Rating Services (S&P) and
Moody's Investors Services, Inc. (Moody's), respec-

8

tively, or provide a guarantee, surety bond or letter of credit from an
affiliate or another company that meets the requisite ratings;

- assets in excess of liabilities of $50 million, as reflected on its most
recent quarterly and annual independently audited financial statements;
or

- unused cash resources commensurate with the level of business it has been
certified by the Texas Utility Commission to conduct. The level of unused
cash resources must be $100,000 for the retail electric provider to
conduct business of up to $250,000 in total monthly billings (excluding
transition charges described above under "-- Stranded Costs and
Regulatory Assets Recovery -- Securitization Financing") by transmission
and distribution utilities and an additional $10,000 of unused cash
resources for every $25,000 of incremental business above the $250,000
level.

Additional creditworthiness standards are required of the retail electric
providers with regard to the billing and collection of the transition charges
described above under "-- Stranded Costs and Regulatory Assets
Recovery -- Securitization Financing."

REMEDIES UPON DEFAULT BY RETAIL ELECTRIC PROVIDER

If a retail electric provider defaults on its payments to us or on its
obligation to maintain the required security described above under "-- Credit
Standards for Retail Electric Providers," we may, pursuant to the tariff
relating to our services approved by the Texas Utility Commission:

- apply to delinquent balances the retail electric provider's cash deposit,
if any, and any accrued interest, or seek recourse against any letter of
credit or surety bond for the amount of delinquent charges due to us,
including any penalties or interest;

- avail ourselves of any legal remedies that may be appropriate to recover
unpaid amounts and associated penalties or interest;

- implement other mutually suitable and agreeable arrangements with the
retail electric provider, as long as such arrangements are available to
all retail electric providers on a nondiscriminatory basis;

- notify the Texas Utility Commission that the retail electric provider is
in default and request suspension or revocation of the retail electric
provider's certification; and

- require the retail electric provider to do one of the following:

(1) transfer the billing and collection responsibility for all charges
to the provider of last resort. Amounts collected by the provider of last
resort are applied first to amounts due to us, including any late fees and
penalties, and the remaining amount is released to the retail electric
provider;

(2) immediately arrange for all future remittances from the retail
electric provider's customers to be paid into a lockbox controlled by us.
Amounts collected in the lockbox are applied first to amounts due to us,
including any late fees and penalties, and the remaining amount is released
to the retail electric provider. The retail electric provider bears all the
costs of the lockbox mechanism; or

(3) immediately arrange for the retail electric provider's customers
to be served by another qualified retail electric provider or the provider
of last resort.

The defaulting retail electric provider must choose which of these three
options it will implement, but if it fails to implement immediately one of these
three options, we will immediately implement the first option.

Additional remedies are available to us upon a retail electric provider's
default in the remittance to us, as the servicer, of billed transition charges
described above under "-- Stranded Costs and Regulatory Assets
Recovery -- Securitization Financing."

COMPETITION

There are no other transmission and distribution utilities in our service
area. In order for another provider of transmission and distribution services to
provide such services in our territory, it would be required to obtain

9

a certificate of convenience and necessity in proceedings before the Texas
Utility Commission and, depending on the location of the facilities, may also be
required to obtain franchises from one or more municipalities. We know of no
other party intending to enter this business in our service area at this time.

REGULATION

We are subject to regulation by various federal, state and local
governmental agencies, including the regulations described below. We are not a
"public utility" under the Federal Power Act and therefore are not generally
regulated by the Federal Energy Regulatory Commission, except in limited
circumstances.

PUBLIC UTILITY HOLDING COMPANY ACT OF 1935

As a subsidiary of a registered public utility holding company, we are
subject to a comprehensive regulatory scheme imposed by the SEC in order to
protect customers, investors and the public interest. Although the SEC does not
regulate rates and charges under the 1935 Act, it does regulate the structure,
financing, lines of business and internal transactions of public utility holding
companies and their system companies. In order to obtain financing, acquire
additional public utility assets or stock, or engage in other significant
transactions, we are generally required to obtain approval from the SEC under
the 1935 Act.

Prior to the Restructuring, CenterPoint Energy and Reliant Energy obtained
an order from the SEC that authorized the Restructuring transactions, including
the Distribution, and granted CenterPoint Energy certain authority with respect
to system financing, dividends and other matters. The financing authority
granted by that order will expire on June 30, 2003, and CenterPoint Energy must
obtain a further order from the SEC under the 1935 Act, related, among other
things to the financing activities of CenterPoint Energy and its subsidiaries,
including us, subsequent to June 30, 2003.

In a July 2002 order, the SEC limited the aggregate amount of our external
borrowings to $3.55 billion. Our ability to pay dividends is restricted by the
SEC's requirement that common equity as a percentage of total capitalization
must be at least 30% after the payment of any dividend. In addition, the order
restricts our ability to pay dividends out of capital accounts to the extent
current or retained earnings are insufficient for those dividends. Under these
restrictions, we are permitted to pay dividends in excess of our current or
retained earnings in an amount up to $200 million.

In 2002 CERC obtained authority from each state in which such authority was
required to restructure CERC in a manner that would allow CenterPoint Energy to
claim an exemption from registration under the 1935 Act. CenterPoint Energy has
concluded that restructuring CERC would not be beneficial and has elected to
remain a registered holding company under the 1935 Act.

THE TEXAS ELECTRIC RESTRUCTURING LAW

In June 1999, the Texas legislature adopted the Texas electric
restructuring law, which substantially amended the regulatory structure
governing electric utilities in Texas in order to allow and encourage retail
competition. Retail pilot projects allowing competition for up to 5% of each
utility's load in all customer classes began in August 2001, and retail electric
competition for all other customers began in January 2002.

We conduct our operations pursuant to a certificate of convenience and
necessity issued by the Texas Utility Commission that covers our present service
area and facilities. In addition, we hold non-exclusive franchises from the
incorporated municipalities in our service territory. These franchises give us
the right to operate our transmission and distribution system within the streets
and public ways of these municipalities for the purpose of delivering electric
service to the municipality, its residents and businesses. None of these
franchises expires before 2007.

Historically, Reliant Energy paid the incorporated municipalities in its
service territory a franchise fee based on a formula that was usually a
percentage of gross receipts received from electricity sales for consumption
within each municipality. We have become responsible for Reliant Energy's
obligations under these franchise arrangements although the method for
calculating such fees was changed by the Texas electric restructuring law
effective January 1, 2002. We expect the franchise fees payable by us to remain
consistent with the historical fees paid by Reliant Energy.

10

For additional information regarding the Texas electric restructuring law,
retail competition in Texas and its application to our operations and structure,
please read "Our Business -- The Texas Electric Restructuring Law" above.

STATE AND LOCAL REGULATION

All retail electric providers in our service area pay the same rates and
other charges for transmission and distribution services.

Our distribution rates charged to retail electric providers are generally
based on amounts of energy delivered. Our transmission rates charged to other
distribution companies are based on amounts of energy transmitted under "postage
stamp" rates that do not vary with the distance the energy is being transmitted.
All distribution companies in ERCOT pay us the same rates and other charges for
transmission services. Our current transmission and distribution rates have been
in effect since January 1, 2002, when electric competition began. This regulated
delivery charge includes the transmission and distribution rate (which includes
costs for nuclear decommissioning and municipal franchise fees), a system
benefit fund fee imposed by the Texas electric restructuring law, a transition
charge associated with securitization of regulatory assets and an excess
mitigation credit imposed by the Texas Utility Commission.

ENVIRONMENTAL MATTERS

We are subject to numerous federal, state and local requirements relating
to the protection of the environment and the safety and health of personnel and
the public. These requirements relate to a broad range of our activities,
including: the discharge of pollutants into air, water, and soil; the proper
handling of solid, hazardous, and toxic materials; and waste, noise, and safety
and health standards applicable to the workplace.

If we do not comply with environmental requirements that apply to our
operations, regulatory agencies could seek to impose on us civil, administrative
and/or criminal liabilities as well as seek to curtail our operations. Under
some statutes, private parties could also seek to impose upon us civil fines or
liabilities for property damage, personal injury and possibly other costs.

Under the federal Comprehensive Environmental Response, Compensation and
Liability Act of 1980, or CERCLA, owners and operators of facilities from which
there has been a release or threatened release of hazardous substances, together
with those who have transported or arranged for the disposal of those
substances, are liable for:

- the costs of responding to that release or threatened release; and

- the restoration of natural resources damaged by any such release.

We are not aware of any liabilities under CERCLA that would have a material
adverse effect on us, our financial position, results of operations or cash
flows.

EMPLOYEES

As of December 31, 2002, we had approximately 3,286 full-time employees,
including approximately 1,549 employees covered by collective bargaining
agreements, which will expire in May 2003.

11

RISK FACTORS

RISK FACTORS ASSOCIATED WITH FINANCIAL CONDITION AND OTHER RISKS

IF WE ARE UNABLE TO ARRANGE FUTURE FINANCINGS ON ACCEPTABLE TERMS, OUR ABILITY
TO FUND FUTURE CAPITAL EXPENDITURES AND REFINANCE EXISTING INDEBTEDNESS COULD
BE LIMITED.

As a result of events occurring in 2001 and 2002, including the September
11, 2001 terrorist attacks, the bankruptcy of Enron Corp., the downgrading of
our credit ratings and the credit ratings of several energy companies, the
general downturn in the utility industry and the unusual volatility in the U.S.
financial markets, the availability and cost of capital for our business have
been adversely affected. If we are unable to obtain external financing to meet
our future capital requirements on terms that are acceptable to us, our
financial condition and future results of operations could be materially
adversely affected. As of December 31, 2002, we had $3.7 billion of outstanding
indebtedness, including a $1.3 billion collateralized term loan that will expire
in 2005. In addition, the capital constraints currently impacting our business
may require our future indebtedness to include terms that are more restrictive
or burdensome than those of our current indebtedness. These terms may negatively
impact our ability to operate our business. The success of our future financing
efforts may depend, at least in part, on:

- general economic and capital market conditions;

- credit availability from financial institutions and other lenders;

- investor confidence in us and the market in which we operate;

- maintenance of acceptable credit ratings by us and by CenterPoint Energy;

- market expectations regarding our future earnings and probable cash
flows;

- market perceptions of our ability to access capital markets on reasonable
terms;

- our exposure to Reliant Resources as our customer and in connection with
its indemnification obligations arising in connection with its separation
from CenterPoint Energy;

- provisions of relevant tax and securities laws; and

- our ability to obtain approval of specific financing transactions under
the 1935 Act.

As of December 31, 2002, we had $1.8 billion of general mortgage bonds
outstanding. We may issue additional general mortgage bonds on the basis of
retired bonds, 70% of property additions or cash deposited with the trustee.
Although approximately $900 million of additional general mortgage bonds could
be issued on the basis of property additions as of December 31, 2002, we have
agreed contractually to limit incremental secured debt to $300 million. In
addition, we are contractually prohibited, subject to certain exceptions, from
issuing additional first mortgage bonds.

Our current credit ratings are discussed in "Management's Narrative
Analysis of Results of Operations -- Liquidity -- Impact on Liquidity of a
Downgrade in Credit Ratings" in Item 7 of this report. We cannot assure you that
these credit ratings will remain in effect for any given period of time or that
one or more of these ratings will not be lowered or withdrawn entirely by a
rating agency. We note that these credit ratings are not recommendations to buy,
sell or hold our securities. Each rating should be evaluated independently of
any other rating. Any future reduction or withdrawal of one or more of our
credit ratings could have a material adverse impact on our ability to access
capital on acceptable terms.

THE FINANCIAL CONDITION AND LIQUIDITY OF OUR PARENT COMPANY COULD AFFECT OUR
ACCESS TO CAPITAL, OUR CREDIT STANDING AND OUR FINANCIAL CONDITION.

Our ratings and credit may be impacted by CenterPoint Energy's credit
standing. CenterPoint Energy and its subsidiaries other than us have
approximately $1.0 billion of debt that must be refinanced in 2003. We cannot
assure you that CenterPoint Energy and its other subsidiaries will be able to
pay or refinance these

12

amounts. If CenterPoint Energy were to experience a deterioration in its credit
standing or liquidity difficulties, our access to credit and our ratings could
be adversely affected and the repayment of $815 million demand notes receivable
from CenterPoint Energy could be adversely affected.

WE ARE A WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY. CENTERPOINT ENERGY CAN
EXERCISE SUBSTANTIAL CONTROL OVER OUR DIVIDEND POLICY AND BUSINESS AND
OPERATIONS AND COULD DO SO IN A MANNER THAT IS ADVERSE TO OUR INTERESTS.

We are managed by officers and employees of CenterPoint Energy. Our
management will make determinations with respect to the following:

- our payment of dividends;

- decisions on our financings and our capital raising activities;

- mergers or other business combinations; and

- our acquisition or disposition of assets.

There are no contractual restrictions on our ability to pay dividends to
CenterPoint Energy. Our management could decide to increase our dividends to
CenterPoint Energy to support its cash needs. This could adversely affect our
liquidity. Under the 1935 Act, our ability to pay dividends is restricted by the
SEC's requirement that common equity as a percentage of total capitalization
must be at least 30% after the payment of any dividend. In addition, the order
restricts our ability to pay dividends out of capital accounts to the extent
current or retained earnings are insufficient for those dividends. Under these
restrictions, we are permitted to pay dividends in excess of the respective
current or retained earnings in an amount up to $200 million.

AN INCREASE IN SHORT-TERM INTEREST RATES COULD ADVERSELY AFFECT OUR CASH FLOWS.

As of December 31, 2002, we had $1.3 billion of outstanding floating-rate
debt. Because of capital constraints impacting our business at the time this
floating-rate debt was entered into, the interest rates are substantially above
our historical borrowing rates. In addition, any floating-rate debt issued by us
in the future could be at interest rates substantially above our historical
borrowing rates. While we may seek to use interest rate swaps in order to hedge
portions of our floating-rate debt, we may not be successful in obtaining hedges
on acceptable terms. Any increase in short-term interest rates would result in
higher interest costs and could adversely affect our results of operations,
financial condition and cash flows.

OUR REVENUES AND RESULTS OF OPERATIONS ARE SUBJECT TO RISKS THAT ARE BEYOND
OUR CONTROL, INCLUDING BUT NOT LIMITED TO FUTURE TERRORIST ATTACKS OR RELATED
ACTS OF WAR.

The cost of repairing damage to our facilities due to storms, natural
disasters, wars, terrorist acts and other catastrophic events, in excess of
reserves established for such repairs, may adversely impact our results of
operations, financial condition and cash flows. The occurrence or risk of
occurrence of future terrorist activity may impact our results of operations,
financial condition and cash flows in unpredictable ways. These actions could
also result in adverse changes in the insurance markets and disruptions of power
and fuel markets. In addition, our transmission and distribution facilities
could be directly or indirectly harmed by future terrorist activity. The
occurrence or risk of occurrence of future terrorist attacks or related acts of
war could also adversely affect the United States economy. A lower level of
economic activity could result in a decline in energy consumption, which could
adversely affect our revenues and margins and limit our future growth prospects.
Also, these risks could cause instability in the financial markets and adversely
affect our ability to access capital.

13

WE COULD INCUR LIABILITIES ASSOCIATED WITH BUSINESS AND ASSETS WE HAVE
TRANSFERRED TO OTHERS.

Under some circumstances, we could incur liabilities associated with assets
and businesses we no longer own. These assets and businesses include:

- those transferred to Reliant Resources or its subsidiaries in connection
with the organization and capitalization of Reliant Resources prior to
its initial public offering in 2001;

- those transferred to Texas Genco in connection with its organization and
capitalization; and

- those transferred to CenterPoint Energy in connection with the
Restructuring.

In connection with the organization and capitalization of Reliant
Resources, Reliant Resources and its subsidiaries assumed liabilities associated
with various assets and businesses Reliant Energy transferred to them. Reliant
Resources also agreed to indemnify, and cause the applicable transferee
subsidiaries to indemnify, CenterPoint Energy and its subsidiaries, including
us, with respect to liabilities associated with the transferred assets and
businesses. The indemnity provisions were intended to place sole financial
responsibility on Reliant Resources and its subsidiaries for all liabilities
associated with the current and historical businesses and operations of Reliant
Resources, regardless of the time those liabilities arose. If Reliant Resources
is unable to satisfy a liability that has been so assumed in circumstances in
which Reliant Energy has not been released from the liability in connection with
the transfer, we, as successor to Reliant Energy, could be responsible for
satisfying the liability.

Reliant Resources has reported that it is facing large maturities of its
debt over the next year. If Reliant Resources is unable to meet its obligations,
it would need to consider, among various options, restructuring under the
bankruptcy laws, in which event Reliant Resources might not honor its
indemnification obligations and claims by Reliant Resources' creditors might be
made against us as its former owner.

As described in Note 10(b) to our consolidated financial statements,
Reliant Energy and Reliant Resources are named as defendants in a number of
lawsuits arising out of power sales in California and other West Coast markets
and financial reporting matters. Although these matters relate to the business
and operations of Reliant Resources, claims against Reliant Energy have been
made on grounds that include the effect of Reliant Resources' financial results
on Reliant Energy's historical financial statements and liability of Reliant
Energy as a controlling shareholder of Reliant Resources. As Reliant Energy's
successor, we could incur liability if claims in one or more of these lawsuits
were successfully asserted against us and indemnification from Reliant Resources
were determined to be unavailable or if Reliant Resources were unable to satisfy
indemnification obligations owed to us with respect to those claims.

In connection with the organization and capitalization of Texas Genco,
Texas Genco and its subsidiaries assumed liabilities associated with the
electric generation assets Reliant Energy transferred to it. Texas Genco also
agreed to indemnify, and cause the applicable transferee subsidiaries to
indemnify, CenterPoint Energy and its subsidiaries, including us, with respect
to liabilities associated with the transferred assets and businesses. In many
cases the liabilities assumed were held by us and we were not released by third
parties from these liabilities. The indemnity provisions were intended to place
sole financial responsibility on Texas Genco and its subsidiaries for all
liabilities associated with the current and historical businesses and operations
of Texas Genco, regardless of the time those liabilities arose. If Texas Genco
were unable to satisfy a liability that had been so assumed or indemnified
against, and provided Reliant Energy had not been released from the liability in
connection with the transfer, we could be responsible for satisfying the
liability.

OUR HISTORICAL FINANCIAL RESULTS AS THE UNINCORPORATED ELECTRIC TRANSMISSION
AND DISTRIBUTION DIVISION OF RELIANT ENERGY ARE NOT REPRESENTATIVE OF OUR
EXPECTED FUTURE RESULTS AS CENTERPOINT HOUSTON.

We have limited experience operating as a transmission and distribution
utility in a deregulated electricity market in which we are subject to rate
regulation, Although our transmission and distribution business had a
significant operating history at the time of the Restructuring of Reliant
Energy, this business was operated until January 1, 2002 as part of a vertically
integrated utility company. Out historical costs and expenses reflect charges
from Reliant Energy for centralized corporate services and infrastructure costs.
These

14

allocations have been determined based on what we and Reliant Energy considered
to be reasonable reflections of the utilization of services provided to us or
for the benefits received by us. We may experience significant changes in our
cost structure, funding and operations as a result of the restructuring of
Reliant Energy, including increased costs associated with reduced economies of
scale. In addition, since January 1, 2002, we have transmitted and distributed
electricity at rates regulated by the Texas Utility Commission. Therefore, the
historical financial information presented in or incorporated by reference into
this report prior to January 1, 2002 is not indicative of our future performance
and does not reflect what our results of operations, financial position, and
cash flows would have been had we operated as a separate stand-alone, rate-
regulated transmission and distribution utility in a deregulated market during
the periods presented.

IF CENTERPOINT ENERGY IS UNABLE TO OBTAIN AN EXTENSION OF ITS FINANCING ORDER
UNDER THE 1935 ACT, WE WILL NOT BE ABLE TO ENGAGE IN FINANCING TRANSACTIONS
AFTER JUNE 30, 2003.

In connection with CenterPoint Energy's registration as a public utility
holding company under the 1935 Act, the SEC issued a financing order which
authorizes us to enter into a wide range of financing transactions. This
financing order expires on June 30, 2003. If CenterPoint Energy is unable to
obtain an extension of the financing order, we would generally be unable to
engage in any financing transactions, including the refinancing of existing
obligations after June 30, 2003.

RISK FACTORS ASSOCIATED WITH OUR BUSINESS

WE MAY NOT BE SUCCESSFUL IN RECOVERING THE FULL VALUE OF OUR STRANDED COSTS
AND REGULATORY ASSETS RELATED TO GENERATION.

We are entitled to recover our stranded costs (the excess of regulatory net
book value of generation assets, as defined by the Texas electric restructuring
law, over the market value of those assets) and our regulatory assets related to
generation. We expect to make a filing in January 2004 in a true-up proceeding
provided for by the Texas electric restructuring law. The purpose of this
proceeding will be to quantify and reconcile:

- the amount of stranded costs;

- differences in the prices achieved in the auctions of Texas Genco's
generation capacity mandated by the Texas electric restructuring law and
Texas Utility Commission estimates (ECOM true-up);

- fuel over- or under-recovery;

- the "price to beat" clawback; and

- other regulatory assets associated with CenterPoint Energy's former
generation business that were not previously recovered through the
issuance of securitization bonds by a subsidiary.

We will be required to establish and support the amounts of these costs in
order to recover them. We expect these costs to be substantial. We cannot assure
you that we will be able to successfully establish and support our estimates of
the amount of these costs. For more information about the true-up proceeding,
please read "-- Electric Transmission and Distribution -- Stranded Costs and
Regulatory Assets Recovery" above and Note 4 to our consolidated financial
statements.

In addition, our $1.3 billion collateralized term loan matures on November
11, 2005 and is expected to be repaid or refinanced with the proceeds from the
recovery of these costs. To the extent we have not received the proceeds by
November 11, 2005, our ability to repay or refinance our $1.3 billion term loan
will be adversely affected.

OUR RECEIVABLES ARE CONCENTRATED IN A SMALL NUMBER OF RETAIL ELECTRIC
PROVIDERS.

Our receivables from the distribution of electricity are collected from
retail electric providers that supply the electricity we distribute to their
customers. Currently, we do business with approximately 31 retail electric
providers. Adverse economic conditions, structural problems in the new ERCOT
market or financial

15

difficulties of one or more retail electric providers could impair the ability
of these retail providers to pay for our services or could cause them to delay
such payments. We depend on these retail electric providers to remit payments
timely to us. Any delay or default in payment could adversely affect our cash
flows, financial condition and results of operations. Our receivables balance
from retail electric providers at December 31, 2002 was $85 million.
Approximately 72% of our receivables from retail electric providers at December
31, 2002, was owed by subsidiaries of Reliant Resources. Our financial condition
may be adversely affected if Reliant Resources is unable to meet its obligations
to us.

Reliant Resources, through its subsidiaries, is our largest customer.
Pursuant to the Texas electric restructuring law, Reliant Resources may be
obligated to make a large "price to beat" clawback payment to us in 2004. We
expect the clawback, if any, to be applied against any stranded cost recovery to
which we are entitled or, if no stranded costs are recoverable, to be refunded
to retail electric providers. Also, as discussed in "Risk Factors Associated
with Financial Condition and Other Risks -- We could incur liabilities
associated with business and assets we have transferred to others," Reliant
Resources is obligated to indemnify us for other potential liabilities. Reliant
Resources has reported that it is facing large maturities of its debt over the
next year and thus its ability to satisfy its obligations to us cannot be
assured.

RATE REGULATION OF OUR BUSINESS MAY DELAY OR DENY OUR FULL RECOVERY OF OUR
COSTS.

Our rates are regulated by certain municipalities and the Texas Utility
Commission based on an analysis of our invested capital and expenses incurred in
a test year. Thus, the rates we are allowed to charge may not match our expenses
at any given time. While rate regulation in Texas is premised on providing a
reasonable opportunity to recover reasonable and necessary operating expenses
and to earn a reasonable return on invested capital, there can be no assurance
that the Texas Utility Commission will judge all of our costs to be reasonable
or necessary or that the regulatory process in which rates are determined will
always result in rates that will produce full recovery of our costs.

WE ARE OPERATING IN A RELATIVELY NEW MARKET ENVIRONMENT IN WHICH WE AND OTHERS
HAVE LITTLE OPERATING EXPERIENCE.

The competitive electric market in Texas became fully operational in
January 2002. Neither we nor any of the Texas Utility Commission, ERCOT or other
market participants has any significant operating history under the market
framework created by the Texas electric restructuring law. Some operational
difficulties were encountered in the pilot program conducted in 2001 and
continue to be experienced now. These difficulties include delays in the
switching of some customers from one retail electric provider to another. These
difficulties create uncertainty as to the amount of transmission and
distribution charges owed by each retail electric provider, which may cause
payment of those amounts to be delayed. While to date these difficulties have
not been material, these operating difficulties could become material or
structural changes adopted to address these difficulties could materially
adversely affect our results of operations, financial condition and cash flows.

DISRUPTIONS AT POWER GENERATION FACILITIES OWNED BY THIRD PARTIES COULD
INTERRUPT OUR SALES OF TRANSMISSION AND DISTRIBUTION SERVICES.

We depend on power generation facilities owned by third parties to provide
retail electric providers with electric power which we transmit and distribute
to their customers. We do not own or operate any power generation facilities. If
power generation is disrupted or if power generation capacity is inadequate, our
services may be interrupted, and our results of operations, financial condition
and cash flows may be adversely affected.

OUR REVENUES AND RESULTS OF OPERATIONS ARE SEASONAL.

A portion of our revenues is derived from rates that we collect from each
retail electric provider based on the amount of electricity we distribute on
behalf of each retail electric provider. Thus, our revenues and results of
operations are subject to seasonality, weather conditions and other changes in
electricity usage, with revenues being higher during the warmer months.

16

WE DO NOT MAINTAIN INSURANCE COVERAGE ON OUR TRANSMISSION AND DISTRIBUTION
SYSTEM.

In common with other companies in our line of business that serve coastal
regions, we do not have insurance covering our transmission and distribution
system because we believe it to be cost prohibitive. If we were to sustain any
loss of or damage to our transmission and distribution properties, we would be
entitled to seek to recover such loss or damage through a change in our
regulated rates, although there is no assurance that we would ultimately obtain
any such rate recovery or that any such rate recovery would be timely granted.
Therefore, we cannot assure you that we will be able to restore any loss of or
damage to any of our transmission and distribution properties without negative
impact on our results of operations, financial condition and cash flows.

TECHNOLOGICAL CHANGE MAY MAKE ALTERNATIVE ENERGY SOURCES MORE ATTRACTIVE AND
MAY ADVERSELY AFFECT OUR REVENUES AND RESULTS OF OPERATIONS.

The continuous process of technological development may result in the
introduction to retail customers of economically attractive alternatives to
purchasing electricity through our distribution facilities. Manufacturers of
self-generation facilities continue to develop smaller-scale,
more-fuel-efficient generating units that can be cost-effective options for some
retail customers with smaller electric energy requirements. Any reduction in the
amount of electric energy we distribute as a result of these technologies may
have an adverse impact on our results of operations, financial condition and
cash flows in the future.

ITEM 2. PROPERTIES

CHARACTER OF OWNERSHIP

All of our properties are located in the State of Texas. Our transmission
system carries electricity from power plants to substations and from one
substation to another. These substations serve to connect power plants, the high
voltage transmission lines and the lower voltage distribution lines. Unlike the
transmission system, which carries high voltage electricity over long distances,
distribution lines carry lower voltage power from the substation to the retail
electric customers. The distribution system consists primarily of distribution
lines, transformers, secondary distribution lines and service wires. Most of our
transmission and distribution lines have been constructed over lands of others
pursuant to easements or along public highways and streets as permitted by law.

All of our real and tangible properties, subject to certain exclusions, are
currently subject to:

- the lien of a Mortgage and Deed of Trust (Mortgage) dated November 1,
1944, as supplemented, between our predecessor in interest, Houston
Lighting & Power Company, and JPMorgan Chase Bank (successor to South
Texas Commercial National Bank of Houston), as trustee; and

- the lien of a General Mortgage (General Mortgage) dated October 10, 2002,
as supplemented, between JPMorgan Chase Bank, as trustee, and us, which
is junior to the lien of the Mortgage.

We have issued approximately $1.2 billion aggregate principal amount of
first mortgage bonds under the Mortgage, including approximately $547 million to
secure certain medium-term notes and pollution control bonds for which
CenterPoint Energy is obligated. Additionally, under the General Mortgage, we
have issued approximately $527 million aggregate principal amount of general
mortgage bonds to secure certain additional pollution control bonds for which
CenterPoint Energy is obligated and approximately $1.3 billion aggregate
principal amount of general mortgage bonds to secure our borrowings under a
collateralized term loan due in 2005. For more information on the Mortgage and
the General Mortgage, please read "Management's Narrative Analysis of the
Results of Operations -- Liquidity -- Long-Term Debt" in Item 7 of this report.

Electric Lines -- Overhead. As of December 31, 2002, we owned 26,346 pole
miles of overhead distribution lines and 3,599 circuit miles of overhead
transmission lines, including 444 circuit miles operated at 69,000 volts, 2,078
circuit miles operated at 138,000 volts and 1,077 circuit miles operated at
345,000 volts.

17

Electric Lines -- Underground. As of December 31, 2002, we owned 13,364
circuit miles of underground distribution lines and 16.6 circuit miles of
underground transmission lines, including 4.5 circuit miles operated at 69,000
volts and 12.1 circuit miles operated at 138,000 volts.

Substations. As of December 31, 2002, we owned 224 major substation sites
having total installed rated transformer capacity of 44,163 megavolt amperes.

Service Centers. We operate 20 regional service centers located on a total
of 405 acres of land. These service centers consist of office buildings,
warehouses and repair facilities that are used in the business of transmitting
and distributing electricity.

Franchises. We have franchise contracts with 89 of the 90 cities in our
service area. The remaining city has enacted an ordinance that governs the
placement of utility facilities in its streets. These franchises and this
ordinance give us the right to construct, operate and maintain our electrical
transmission and distribution systems within city streets, alleys and
rights-of-ways in exchange for payment of a fee.

Fiber Optic System. We own a fiber optic system to provide communications
among our service center facilities and office operations. We own approximately
284 miles of single-mode fiber in Harris, Fort Bend and Galveston counties
located in Texas. This fiber is buried in transmission line rights-of-way or
strung on overhead electrical distribution or transmission facilities.

ITEM 3. LEGAL PROCEEDINGS

For a brief description of certain legal and regulatory proceedings
affecting us, see Note 10(b) to our consolidated financial statements, which
note is incorporated herein by reference.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The information called for by Item 4 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly-Owned
Subsidiaries).

PART II

ITEM 5. MARKET FOR COMMON STOCK AND RELATED SECURITY HOLDER MATTERS

All of our 1,000 outstanding common shares are held by Utility Holding,
LLC, a wholly owned subsidiary of CenterPoint Energy, Inc.

Our ability to pay dividends is restricted by the SEC's requirement that
common equity as a percentage of total capitalization must be at least 30% after
the payment of any dividend. In addition, the order restricts our ability to pay
dividends out of capital accounts to the extent current or retained earnings are
insufficient for those dividends. Under these restrictions, we are permitted to
pay dividends in excess of the respective current or retained earnings in an
amount up to $200 million.

ITEM 6. SELECTED FINANCIAL DATA

The information called for by Item 6 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly-Owned
Subsidiaries).

ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF RESULTS OF OPERATIONS

The following narrative analysis should be read in combination with our
consolidated financial statements and notes contained in Item 8 of this report.

Effective August 31, 2002, Reliant Energy, Incorporated (Reliant Energy)
consummated a restructuring transaction (the Restructuring) in which it, among
other things, (1) conveyed its Texas electric generation assets to Texas Genco
Holdings, Inc. (Texas Genco), (2) became an indirect, wholly owned subsidiary of
a new utility holding company, CenterPoint Energy, Inc. (CenterPoint Energy),
(3) was converted into a Texas
18

limited liability company named CenterPoint Energy Houston Electric, LLC
(CenterPoint Houston or the Company), and (4) distributed the capital stock of
its operating subsidiaries to CenterPoint Energy. As part of the Restructuring,
each share of Reliant Energy common stock was converted into one share of
CenterPoint Energy common stock. Pursuant to the provisions of certain of its
existing debt agreements applicable when the properties or assets of Reliant
Energy were transferred to another entity substantially as an entirety,
CenterPoint Energy assumed certain debt and other obligations of Reliant Energy,
and Reliant Energy was released as the primary obligor on such debt. Immediately
subsequent to the Restructuring, we had outstanding (a) $614.7 million of first
mortgage bonds issued directly to third parties, (b) $546.5 million of first
mortgage bonds that collateralized medium-term notes and pollution control bonds
of CenterPoint Energy (such amounts are not reflected in our consolidated
financial statements because of the contingent nature of the obligations), (c)
$300 million of notes issued by a subsidiary, (d) $735.8 million of transition
bonds issued by a subsidiary, and (e) a $1.6 billion note issued to CenterPoint
Energy. In addition, we had a $400 million credit facility. At December 31, 2002
we had $3.7 billion in outstanding indebtedness and had issued $1.1 billion of
first mortgage bonds and second mortgage bonds as collateral for long-term debt
of CenterPoint Energy.

We operate Reliant Energy's former electric transmission and distribution
business, which continues to be subject to cost-of-service rate regulation and
is responsible for the delivery of electricity sold to retail customers by
retail electric providers in the 5,000 square mile service area of Houston,
Texas and surrounding metropolitan areas as well as the transmission of bulk
power into and out of the Houston area.

Contemporaneous with the Restructuring, CenterPoint Energy registered and
became subject, with its subsidiaries, to regulation as a registered holding
company system under the Public Utility Holding Company Act of 1935 (1935 Act).
The 1935 Act directs the Securities and Exchange Commission (SEC) to regulate,
among other things, transactions among affiliates, sales or acquisitions of
assets, issuances of securities, distributions and permitted lines of business.

CONSOLIDATED RESULTS OF OPERATIONS

The consolidated financial statements present the former subsidiaries of
Reliant Energy that were distributed to CenterPoint Energy in the Restructuring
as discontinued operations, in accordance with Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" (SFAS No. 144). Accordingly, our consolidated financial statements
reflect these operations as discontinued operations for each of the three years
in the period ended December 31, 2002. Additionally, the conveyance of Reliant
Energy's electric generation assets to Texas Genco has been reflected as
discontinued operations in accordance with SFAS No. 144 for each of the three
years in the period ended December 31, 2002.

The following discussion of consolidated results of operations is based on
earnings from continuing operations before interest expense, distribution on
trust preferred securities, income taxes and extraordinary items (EBIT). EBIT,
as defined, is shown because it is a financial measure used by CenterPoint
Energy to evaluate our performance and we believe it is a measure of financial
performance that may be used as a means to analyze and compare companies on the
basis of operating performance. We expect that some analysts and investors will
want to review EBIT when evaluating our company. EBIT is not defined under
accounting principles generally accepted in the United States of America (GAAP),
should not be considered in isolation or as a substitute for a measure of
performance prepared in accordance with GAAP and is not indicative of operating
income from operations as determined under GAAP. Additionally, our computation
of EBIT may not be comparable to other similarly titled measures computed by
other companies, because all companies do not calculate it in the same fashion.
We consider operating income to be a comparable measure under GAAP. We believe
the difference between operating income and EBIT is not material. We have
provided a reconciliation of consolidated operating income to EBIT and EBIT to
net income in the table below.

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The following table sets forth selected financial and operating data for
the years ended December 31, 2000, 2001 and 2002, followed by a discussion of
significant variances in period-to-period results:

2002 Compared to 2001. Prior to January 1, 2002, CenterPoint Energy's
electric operations reflected the regulated electric utility business, including
generation, transmission and distribution, and retail electric sales. As of
January 1, 2002, with the opening of the Texas market to full retail electric
competition, generation and retail sales are no longer subject to cost of
service regulation. Retail electric sales involve the sale of electricity and
related services to end users of electricity and were included as part of the
bundled regulated service prior to 2002. This business is now conducted by
Reliant Resources. The previously regulated generation operations in Texas are
now a part of Texas Genco. We report results from two sources:

- the regulated electric transmission and distribution operations; and

- the generation-related stranded costs recoverable by us as a regulated
utility.

As a result of the implementation of deregulation, we recover the cost of
our service through an energy delivery charge, and not as a component of the
prior bundled rate, which included energy and delivery charges. The design of
the new energy delivery rate differs from the prior bundled rate. The
winter/summer rate differential for residential customers has been eliminated
and the energy component of the rate structure for commercial and industrial
customers has been removed, which will tend to lessen some of the pronounced
seasonal variation of revenues which has been experienced in prior periods.

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Although our former retail sales business is no longer conducted by us,
retail customers remained regulated customers of Reliant Energy through the date
of their first meter reading in 2002. Operations during this transition period
are reflected in our business. Operations during this transition period also
included power purchased from Texas Genco of approximately $48 million.

We reported EBIT of $1.1 billion in 2002, consisting of EBIT of $421
million for the regulated electric transmission and distribution business,
including retail sales during the transition period as discussed above, and
non-cash EBIT of $697 million of Excess Costs Over Market (ECOM) regulatory
assets associated with costs recorded pursuant to the Texas electric
restructuring law as explained below. Operating revenues were $1.5 billion,
excluding ECOM, and purchased power costs were $66 million in 2002. The
purchased power costs relate to operation of the regulated utility during the
transition period discussed above.

Under the Texas electric restructuring law, each power generator that is
unbundled from an integrated electric utility in Texas has an obligation to
conduct state mandated capacity auctions of 15% of its capacity. In addition,
under a master separation agreement between CenterPoint Energy and Reliant
Resources, Texas Genco is contractually obligated to auction all capacity in
excess of the state mandated capacity auctions. The auctions conducted
periodically between September 2001 and January 2003 were consummated at prices
below those used in the ECOM model by the Public Utility Commission of Texas
(Texas Utility Commission). Under the Texas electric restructuring law, we, as a
regulated utility, may recover in a regulatory proceeding scheduled for 2004 any
difference between market prices received through the state mandated auctions
and the Texas Utility Commission's earlier estimates of those market prices.
This difference, recorded as a regulatory asset, produced $697 million of EBIT
in 2002.

Our throughput declined 2% during 2002 as compared to 2001. The decrease
was primarily due to reduced energy delivery in the industrial sector resulting
from self-generation by several major customers, partially offset by increased
residential usage primarily due to non-weather related factors. Additionally,
despite a slowing economy, total metered customers continued to grow at an
approximate annual growth rate of 2% during 2002.

Operation and maintenance expenses decreased by $75 million in 2002,
compared to 2001. The decrease was primarily due to:

- a $77 million decrease in factoring expense as a result of the
termination of an agreement under which we sold our customer accounts
receivable;

- a $10 million decrease in transmission cost of service; and

- a $16 million decrease in transmission line losses in 2002 as this is now
a cost of retail electric providers.

These decreases were partially offset by a $25 million increase in benefits
expense, including severance costs of $11 million in connection with a reduction
in work force in 2002.

In June 1998, the Texas Utility Commission issued an order approving a
transition to competition plan (Transition Plan) filed by Reliant Energy in
December 1997. In order to reduce Reliant Energy's exposure to potential
stranded costs related to generation assets, the Transition Plan permitted the
redirection of depreciation expense to generation assets that we otherwise would
apply to transmission, distribution and general plant assets. In addition, the
Transition Plan provided that all earnings above a stated overall annual rate of
return on invested capital be used to recover our investment in generation
assets. Reliant Energy implemented the Transition Plan effective January 1,
1998. For further discussion of the Transition Plan, please read Note 4(a) to
our consolidated financial statements.

Depreciation and amortization decreased $28 million in 2002 compared to
2001. The decrease was primarily due to a decrease in amortization of the book
impairment regulatory asset ($281 million) recorded in June 1999, which was
fully amortized in December 2001, offset by depreciation expense recorded in
2002 as a result of the discontinuance of redirection of depreciation expense
related to electric transmission and distribution assets ($217 million) and
increased amortization related to transition property associated with the

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transition bonds issued in November 2001 ($35 million). For further discussion
related to the impairment recorded in June 1999, please read Note 4(a) to our
consolidated financial statements.

Taxes other than income taxes decreased $75 million compared to 2001. The
decrease was primarily due to lower gross receipts taxes ($64 million), which
became the responsibility of the retail electric providers upon deregulation,
and lower franchise taxes ($27 million) partially offset by increased property
taxes ($10 million).

Other income, net decreased $23 million in 2002 compared to 2001. The
decrease was primarily due to a $37 million decrease in interest income from
under-recovery of fuel in 2002 compared to 2001, partially offset by a $19
million increase in interest income from affiliated parties.

Our effective tax rates for 2002 and 2001 were 34.3% and 33.8%,
respectively.

See Note 2 to our consolidated financial statements for a discussion of
discontinued operations and Note 6 for a discussion of the extraordinary item.

2001 Compared to 2000. Our EBIT for 2001 decreased $48 million compared to
2000. The decrease was primarily due to milder weather, decreased customer
demand, increased contract services and benefit expenses and a charge recorded
in the fourth quarter of 2001 resulting from the early termination of an
accounts receivable factoring agreement. The decrease was also due to the
implementation of the pilot program for Texas deregulation in August 2001,
reduced rates for certain governmental agencies and increased administrative
expenses related to the separation of our regulated and unregulated businesses.
These decreases were partially offset by decreased amortization expense and
customer growth.

Operating revenues decreased $61 million in 2001 primarily due to decreased
customer demand as a result of the effect of milder weather compared to 2000 and
decreased customer usage on a weather normalized basis.

Operation and maintenance expenses increased $64 million in 2001 compared
to 2000 primarily due to the following items:

- a $27 million increase in benefits expense primarily driven by medical
and pension costs;

- an $11 million increase in administrative expenses related to the
separation of our regulated and unregulated businesses;

- a $20 million charge recorded in the fourth quarter of 2001 resulting
from the early termination of an accounts receivable factoring agreement;
and

- a $7 million increase due to an overall increase in bad debt expense.

Depreciation and amortization expense decreased $57 million primarily due
to a decrease in amortization of the book impairment regulatory asset recorded
in June 1999 and decreased amortization expense due to regulatory assets related
to cancelled projects being fully amortized in June 2000, partially offset by
accelerated amortization of certain regulatory assets related to energy
conservation management as required by the Texas Utility Commission.

Other income, net increased $24 million in 2001 compared to 2000. The
increase was primarily due to an increase in interest income from under-recovery
of fuel in 2001 compared to 2000.

Our effective tax rates for 2001 and 2000 were 33.8% and 32.2%,
respectively.

CERTAIN FACTORS AFFECTING FUTURE EARNINGS

Our past earnings are not necessarily indicative of our future earnings and
results of operations. The magnitude of our future earnings and results of our
operations will depend on numerous factors including:

- state and federal legislative and regulatory actions or developments,
including deregulation, re-regulation and restructuring of the electric
utility industry, constraints placed on our activities or

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business by the 1935 Act, changes in or application of laws or
regulations applicable to other aspects of our business and actions with
respect to:

- approval of stranded costs;

- allowed rates of return;

- rate structures;

- recovery of investments; and

- operation and construction of facilities;

- non-payment for our services due to financial distress of our customers,
including our largest customer, Reliant Resources;

- the successful and timely completion of our capital projects;

- industrial, commercial and residential growth in our service territory
and changes in market demand and demographic patterns;

- changes in business strategy or development plans;

- changes in interest rates or rates of inflation;

- unanticipated changes in operating expenses and capital expenditures;

- weather variations and other natural phenomena, which can affect the
demand for power over our transmission and distribution system;

- commercial bank and financial market conditions, our access to capital,
the cost of such capital, receipt of certain approvals under the 1935
Act, and the results of our financing and refinancing efforts, including
availability of funds in the debt capital markets for transmission and
distribution companies;

- actions by rating agencies;

- legal and administrative proceedings and settlements;

- changes in tax laws;

- inability of various counterparties to meet their obligations with
respect to our financial instruments;

- any lack of effectiveness of our disclosure controls and procedures;

- changes in technology;

- significant changes in our relationship with our employees, including the
availability of qualified personnel and the potential adverse effects if
labor disputes or grievances were to occur;

- significant changes in critical accounting policies;

- acts of terrorism or war, including any direct or indirect effect on our
business resulting from terrorist attacks such as occurred on September
11, 2001 or any similar incidents or responses to those incidents;

- the availability and price of insurance;

- the outcome of the pending securities lawsuits against Reliant Energy and
Reliant Resources;

- the outcome of the Securities and Exchange Commission investigation
relating to the treatment in our consolidated financial statements of
certain activities of Reliant Resources;

- the ability of Reliant Resources to satisfy its indemnity obligations to
us;

- the reliability of the systems, procedures and other infrastructure
necessary to operate the retail electric business in our service
territory, including the systems owned and operated by the ERCOT ISO;

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- political, legal, regulatory and economic conditions and developments in
the United States; and

- other factors discussed in Item 1 of this report under "Risk Factors."

LIQUIDITY

Long-Term Debt. The following table shows future maturity dates of
long-term debt issued by us to third parties and affiliates and expected future
maturity dates of transition bonds issued by our subsidiary CenterPoint Energy
Transition Bond Company, LLC, as of December 31, 2002. Amounts are expressed in
thousands.

Third-party debt of $1.3 billion maturing in 2005 is senior and secured by
our general mortgage bonds. First mortgage bonds in an aggregate principal
amount of $615 million have been issued directly to third parties. The affiliate
debt is senior and unsecured.

As of October 10, 2002, we increased the size of our credit facility to
$850 million in connection with the amendment and extension of our bank facility
and CenterPoint Energy's bank facility. Proceeds from the loan were used to (1)
repay maturing loans under a $400 million credit facility and (2) repay $450
million of the notes payable to CenterPoint Energy. The $850 million facility
was secured by $850 million aggregate principal amount of our general mortgage
bonds issued under our General Mortgage Indenture dated as of October 10, 2002.
The lien of the general mortgage indenture is junior to that of our Mortgage and
Deed of Trust dated as of November 1, 1944. The $850 million of general mortgage
bonds was released by the banks upon the November 2002 repayment and termination
of the facility using proceeds from our $1.3 billion collateralized term loan as
discussed below.

On November 12, 2002, we entered into a $1.3 billion collateralized term
loan maturing November 2005. The interest rate on the loan is the London
inter-bank offered rate (LIBOR) plus 9.75%, subject to a minimum rate of 12.75%.
The loan is secured by our general mortgage bonds. Proceeds from the loan were
used to (1) repay our $850 million term loan as discussed above, (2) repay $100
million of intercompany notes maturing in 2028, (3) repay $300 million of debt
that matured on November 15, 2002 and (4) pay

24

transaction costs. The loan agreement contains various business and financial
covenants including a covenant restricting our debt, excluding transition bonds,
as a percent of its total capitalization to 68%. The loan agreement also limits
incremental secured debt that may be issued by us to $300 million. At December
31, 2002 we were in compliance with this covenant.

We have outstanding approximately $1.1 billion aggregate principal amount
of affiliate notes which represent borrowings from our parent.

On February 28, 2003, CenterPoint Energy amended its existing $3.85 billion
bank facility. The amendment provides that proceeds from capital stock or
indebtedness issued or incurred by us must be applied (subject to a $200 million
basket for CERC and its subsidiaries and another $250 million basket for
borrowings by us and CenterPoint Energy's other subsidiaries and other limited
exceptions) to repay bank loans and reduce the bank facility. Cash proceeds from
issuances of indebtedness to refinance indebtedness existing on October 10, 2002
are not subject to this limitation.

We have issued approximately $1.2 billion aggregate principal amount of
first mortgage bonds and approximately $1.8 billion aggregate principal amount
of general mortgage bonds, of which approximately $1.1 billion combined
aggregate principal amount of first mortgage bonds and general mortgage bonds
collateralizes debt of CenterPoint Energy.

The following table shows the future maturity dates of the $1.1 billion of
first mortgage bonds and general mortgage bonds that we have issued as
collateral for $150 million of CenterPoint Energy's medium term notes and $924
million of pollution control bonds for which CenterPoint Energy is obligated.
These bonds are not reflected in our consolidated financial statements because
of the contingent nature of the obligations. Amounts are expressed in thousands.

The aggregate amount of additional general mortgage bonds and first
mortgage bonds that could be issued is approximately $900 million based on
estimates of the value of property encumbered by the General Mortgage, the cost
of such property and the 70% bonding ratio contained in the General Mortgage. As
of December 31, 2002, the outstanding principal amount of first mortgage bonds
and general mortgage bonds aggregated approximately $3.0 billion. The agreement
relating to the $1.3 billion collateralized term loan debt maturing in 2005
limits incremental secured debt to $300 million of general mortgage bonds.

Our subsidiary, CenterPoint Energy Transition Bond Company, LLC, has $736
million aggregate principal amount of outstanding transition bonds that were
issued in 2001 in accordance with the Texas electric restructuring law. Classes
of the transition bonds have final maturity dates of September 15, 2007,
September 15, 2009, September 15, 2011 and September 15, 2015 and bear interest
at rates of 3.84%, 4.76%, 5.16% and 5.63%, respectively. The transition bonds
are secured by "transition property," as defined in the Texas electric
restructuring law, which includes the irrevocable right to recover, through
non-bypassable

25

transition charges payable by retail electric customers, qualified costs
provided in the Texas electric restructuring law. The transition bonds are
reported as our long-term debt, although the holders of the transition bonds
have no recourse to any of our assets or revenues, and our creditors have no
recourse to any assets or revenues (including, without limitation, the
transition charges) of the transition bond company. We have no payment
obligations with respect to the transition bonds except to remit collections of
transition charges as set forth in a servicing agreement between us and the
transition bond company and in an intercreditor agreement among us, our indirect
transition bond subsidiary and other parties.

Bank Facilities. As of December 31, 2002, we had no bank facilities
available to meet our short-term liquidity needs.

In February 2003, we obtained a $75 million revolving credit facility that
terminates on April 30, 2003. A condition precedent to utilizing the facility is
that security in the form of general mortgage bonds must be delivered to the
lender. Rates for borrowings under this facility, including the facility fee,
will be LIBOR plus 250 basis points.

Money Pool. We participate in a "money pool" through which we and certain
of our affiliates can borrow or invest on a short-term basis. Funding needs are
aggregated and external borrowing or investing is based on the net cash
position. The money pool's net funding requirements are generally met by
borrowings of CenterPoint Energy. The terms of the money pool are in accordance
with requirements applicable to registered public utility holding companies
under the 1935 Act. At December 31, 2002, we had borrowings of $48 million from
the money pool. The money pool may not provide sufficient funds to meet our cash
needs.

Temporary Investments. On December 31, 2002, we had approximately $44
million of investments in a money market fund.

Capital Requirements. We anticipate capital expenditures of up to $1.5
billion in the years 2003 through 2007. We anticipate capital expenditures to be
approximately $258 million and $300 million in 2003 and 2004, respectively.

Contractual Obligations. Excluding long-term debt discussed above, our
contractual obligations to make future payments consist of operating leases of
$5 million each in the years 2003 through 2005 and $6 million each in the years
2006 and 2007. For a discussion of operating leases, please read Note 10(a) to
our consolidated financial statements.

Refunds to Our Customers. An order issued by the Texas Utility Commission
on October 3, 2001 established the transmission and distribution rates that
became effective in January 2002. The Texas Utility Commission determined that
we had overmitigated our stranded costs by redirecting transmission and
distribution depreciation and by accelerating depreciation of generation assets
(an amount equal to earnings above a stated overall rate of return on rate base
that was used to recover our investment in generation assets) as provided under
the 1998 transition plan and the Texas electric restructuring law. In this final
order, we are required to reverse the amount of redirected depreciation and
accelerated depreciation taken for regulatory purposes as allowed under the
transition plan and the Texas electric restructuring law. Per the October 3,
2001 order, we recorded a regulatory liability to reflect the prospective refund
of the accelerated depreciation. We began refunding excess mitigation credits
with the January 2002 unbundled bills, to be refunded over a seven-year period.
The annual refund of excess earnings is approximately $237 million. Under the
Texas electric restructuring law, a final settlement of these stranded costs
will occur in 2004.

Cash Requirements in 2003. Our liquidity and capital requirements are
affected primarily by our results of operations, capital expenditures, debt
service requirements, and working capital needs. Our principal cash requirements
during 2003 include the following:

- approximately $258 million of capital expenditures;

- an estimated $237 million which we are obligated to return to customers
as a result of the Texas Utility Commission's finding of over-mitigation
of stranded costs; and

- $167 million of maturing long-term debt to affiliate.

26

We expect to fund cash requirements with cash from operations, liquidations
of short-term investments, short-term borrowings and proceeds from debt
offerings. We believe that our current liquidity, along with anticipated cash
flows from operations and proceeds from possible debt issuances will be
sufficient to meet our cash needs. However, disruptions in our ability to access
the capital markets on a timely basis could adversely affect our liquidity.
Limits on our ability to issue secured debt, as described in this report, may
adversely affect our ability to issue debt securities. In addition, the cost of
our recent secured debt issuances has been very high. A similar cost with regard
to additional issuances could significantly impact our debt service. Please read
"Risk Factors -- Risk Factors Associated with Financial Condition and Other
Risks -- If we are unable to arrange future financings on acceptable terms, our
ability to fund future capital expenditures and refinance existing indebtedness
could be limited" in Item 1 of this report.

Prior to the Restructuring, Reliant Energy obtained an order from the SEC
that granted us certain authority with respect to financing, dividends and other
matters. The financing authority granted by that order will expire on June 30,
2003, and CenterPoint Energy must obtain a further order from the SEC under the
1935 Act in order for it and its subsidiaries, including us, to engage in
financing activities subsequent to that date.

The amount of any debt issuance, whether registered or unregistered, or whether
debt is secured or unsecured, is expected to be affected by the market's
perception of our creditworthiness, market conditions and factors affecting our
industry. Proceeds from the issuance of debt are expected to be used to
refinance maturing debt, to finance capital expenditures and to permit the
payment of dividends.

Principal Factors Affecting Cash Requirements in 2004 and 2005. We expect
to issue securitization bonds in 2004 or 2005 to monetize and recover the
balance of stranded costs relating to previously owned electric generation
assets and other qualified costs as determined in the 2004 true-up proceeding.
The issuance will be done pursuant to a financing order to be issued by the
Texas Utility Commission. As with the debt of our existing transition bond
company, payments on these new securitization bonds would also be made out of
funds from non-bypassable charges assessed to retail electric customers required
to take delivery service from us. The holders of the securitization bonds would
not have recourse to any of our assets or revenues, and our creditors would not
have recourse to any assets or revenues of the entity issuing the securitization
bonds. All or a portion of the proceeds from the issuance of securitization
bonds remaining after repayment of our $1.3 billion collateralized term loan are
expected to be utilized to retire affiliate debt and pay a dividend to our
parent.

Impact on Liquidity of a Downgrade in Credit Ratings. As of March 4, 2003,
Moody's Investors Service, Inc. (Moody's), Standard & Poor's Ratings Services, a
division of The McGraw Hill Companies (S&P) and Fitch, Inc. (Fitch) had assigned
the following credit ratings to our senior secured debt:

- ---------------

(1) A "stable" outlook from Moody's indicates that Moody's does not expect to
put the rating on review for an upgrade or downgrade within 18 months from
when the outlook was assigned or last affirmed.

(2) A "stable" outlook from S&P indicates that the rating is not likely to
change over the intermediate to longer term.

(3) A "negative" outlook from Fitch encompasses a one- to two-year horizon as to
the likely rating direction.

We cannot assure you that these ratings will remain in effect for any given
period of time or that one or more of these ratings will not be lowered or
withdrawn entirely by a rating agency. We note that these credit ratings are not
recommendations to buy, sell or hold our securities and may be revised or
withdrawn at any time by the rating agency. Each rating should be evaluated
independently of any other rating. Any future reduction or withdrawal of one or
more of our credit ratings could have a material adverse impact on our

27

ability to obtain short- and long-term financing, the cost of such financings
and the execution of our commercial strategies. A decline in credit ratings
would also increase the interest rate on long-term debt to be issued in the
capital markets and would negatively impact our ability to complete capital
market transactions.

Our $75 million bank facility executed in February 2003 contains a
"material adverse change" clause that could impact our ability to make new
borrowings under the facility. The "material adverse change" clause relates to
an event, development or circumstance that has had or would reasonably expected
to have a material adverse affect on our business, financial condition or
operations, the legality, validity or enforceability of the loan documents, or
the perfection or priority of the lien of the general mortgage.

Cross Defaults. The terms of our debt instruments generally provide that a
default on obligations by CenterPoint Energy does not cause a default under our
debt instruments. A payment default by us exceeding $50 million will cause a
default under our $1.3 billion loan maturing in 2005. Acceleration of the
maturity of CenterPoint Energy's $150 million of collateralized medium-term
notes due in April 2003 would force us to redeem our related $150 million of
first mortgage bonds.

Other Factors that Could Affect Cash Requirements. In addition to the
above factors, our liquidity and capital resources could be affected by:

- various regulatory actions; and

- the ability of Reliant Resources and its subsidiaries to satisfy their
obligations to us as a principal customer and in respect of its indemnity
obligation to us.

Capitalization. Factors affecting our capitalization include:

- covenants in our borrowing agreements; and

- limitations imposed on us because our parent company is a registered
public utility holding company.

In connection with our parent company's registration as a public utility
holding company under the 1935 Act, the SEC has limited the aggregate amount of
our external borrowings to $3.55 billion. Our ability to pay dividends is
restricted by the SEC's requirement that common equity as a percentage of total
capitalization must be at least 30% after the payment of any dividend. In
addition, the order restricts our ability to pay dividends out of capital
accounts to the extent current or retained earnings are insufficient for those
dividends. Under these restrictions, we are permitted to pay dividends in excess
of the respective current or retained earnings in an amount up to $200 million.

Relationship to CenterPoint Energy. We are a wholly owned subsidiary of
CenterPoint Energy. As a result of this relationship, the financial condition
and liquidity of our parent company could affect our access to capital, our
credit standing and our financial condition.

Asset Sales. Factors affecting our ability to sell assets (including
assets of our subsidiaries) or to satisfy our cash requirements include the
following:

- the 1935 Act may require us to obtain prior approval of certain assets
sales; and

- obligations under existing credit facilities to use certain cash received
from asset sales and securities offerings to pay down debt.

Pension Plan. As discussed in Note 8(a) to the consolidated financial
statements, we participate in CenterPoint Energy's qualified non-contributory
pension plan covering substantially all employees. Pension expense for 2003 is
estimated to be $26 million based on an expected return on plan assets of 9.0%
and a discount rate of 6.75% as of December 31, 2002. Pension expense for the
year ended December 31, 2002 was $7 million. Future changes in plan asset
returns, assumed discount rates and various other factors related to the pension
will impact our future pension expense and liabilities. We cannot predict with
certainty what these factors will be in the future.

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CRITICAL ACCOUNTING POLICIES

A critical accounting policy is one that is both important to the
presentation of our financial condition and results of operations and requires
management to make difficult, subjective or complex accounting estimates. An
accounting estimate is an approximation made by management of a financial
statement element, item or account in the financial statements. Accounting
estimates in our historical consolidated financial statements measure the
effects of past business transactions or events, or the present status of an
asset or liability. The accounting estimates described below require us to make
assumptions about matters that are highly uncertain at the time the estimate is
made. Additionally, different estimates that we could have used or changes in an
accounting estimate that are reasonably likely to occur could have a material
impact on the presentation of our financial condition or results of operations.
The circumstances that make these judgments difficult, subjective and/or complex
have to do with the need to make estimates about the effect of matters that are
inherently uncertain. Estimates and assumptions about future events and their
effects cannot be predicted with certainty. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances, the results of which form the basis for making
judgments. These estimates may change as new events occur, as more experience is
acquired, as additional information is obtained and as our operating environment
changes. We believe the following accounting policies involve the application of
critical accounting estimates.

ACCOUNTING FOR RATE REGULATION

SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation"
(SFAS No. 71), provides that rate-regulated entities account for and report
assets and liabilities consistent with the recovery of those incurred costs in
rates if the rates established are designed to recover the costs of providing
the regulated service and if the competitive environment makes it probable that
such rates can be charged and collected. We apply SFAS No. 71, which results in
our accounting for the regulatory effects of recovery of "stranded costs" and
other "regulatory assets" resulting from the unbundling of the transmission and
distribution business from our electric generation operations in our
consolidated financial statements. Certain expenses and revenues subject to
utility regulation or rate determination normally reflected in income are
deferred on the balance sheet and are recognized in income as the related
amounts are included in service rates and recovered from or refunded to
customers. Regulatory assets reflected in our Consolidated Balance Sheets
aggregated $3.2 billion and $4.0 billion as of December 31, 2001 and 2002,
respectively. Significant accounting estimates embedded within the application
of SFAS No. 71 relate to $2.0 billion of recoverable electric generation plant
mitigation assets (stranded costs) and $697 million of ECOM true-up. The
stranded costs are comprised of $1.0 billion of previously recorded accelerated
depreciation and $841 million of previously redirected depreciation. These
stranded costs are recoverable under the provisions of the Texas electric
restructuring law. The ultimate amount of stranded cost recovery is subject to a
final determination, which will occur in 2004 and is contingent upon the market
value of Texas Genco. Any significant changes in our accounting estimate of
stranded costs as a result of current market conditions or changes in the
regulatory recovery mechanism currently in place could result in a material
write-down of all or a portion of these regulatory assets. Regulatory assets
related to ECOM true-up represent the regulatory assets associated with costs
incurred as a result of mandated capacity auctions conducted beginning in 2002
by Texas Genco being consummated at market-based prices that have been
substantially below the estimate of those prices made by the Texas Utility
Commission in the spring of 2001. Any significant changes in our estimate of our
regulatory asset associated with ECOM true-up could have a significant effect on
our financial condition and results of operations. Additionally, any significant
changes in our estimated stranded costs or ECOM true-up recovery could
significantly affect our liquidity subsequent to the final true-up proceedings
conducted by the Texas Utility Commission which are expected to conclude in late
2004.

IMPAIRMENT OF LONG-LIVED ASSETS

Long-lived assets recorded in our Consolidated Balance Sheets primarily
consist of property, plant and equipment (PP&E). Net PP&E comprises $3.8 billion
or 42% of our total assets as of December 31, 2002. We make judgments and
estimates in conjunction with the carrying value of these assets, including
amounts to be capitalized, depreciation and amortization methods and useful
lives. We evaluate our PP&E for impairment

29

whenever indicators of impairment exist. During 2002, no such indicators of
impairment existed. Accounting standards require that if the sum of the
undiscounted expected future cash flows from a company's asset is less than the
carrying value of the asset, an asset impairment must be recognized in the
financial statements. The amount of impairment recognized is calculated by
subtracting the fair value of the asset from the carrying value of the asset.

UNBILLED REVENUES

Revenues related to the sale and/or delivery of electricity are generally
recorded when electricity is delivered to customers. However, the determination
of deliveries to individual customers is based on the reading of their meters,
which is performed on a systematic basis throughout the month. At the end of
each month, amounts of electricity delivered to customers since the date of the
last meter reading are estimated and the corresponding unbilled revenue is
estimated. Unbilled electric delivery revenue is estimated each month based on
daily supply volumes, applicable rates and analyses reflecting significant
historical trends and experience. Accrued unbilled revenues recorded in the
Consolidated Balance Sheets as of December 31, 2001 and 2002 were $33 million
and $70 million, respectively.

NEW ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, "Accounting for Asset Retirement Obligations" (SFAS No. 143). SFAS No.
143 requires the fair value of an asset retirement obligation to be recognized
as a liability is incurred and capitalized as part of the cost of the related
tangible long-lived assets. Over time, the liability is accreted to its present
value each period, and the capitalized cost is depreciated over the useful life
of the related asset. Retirement obligations associated with long-lived assets
included within the scope of SFAS No. 143 are those for which a legal obligation
exists under enacted laws, statutes and written or oral contracts, including
obligations arising under the doctrine of promissory estoppel. SFAS No. 143 is
effective for fiscal years beginning after June 15, 2002, with earlier
application encouraged. SFAS No. 143 requires entities to record a cumulative
effect of change in accounting principle in the income statement in the period
of adoption. We adopted SFAS No. 143 on January 1, 2003. We have not identified
any asset retirement obligations in connection with the adoption of SFAS No.
143.

We have previously recognized removal costs as a component of depreciation
expense in accordance with regulatory treatment. As of December 31, 2002, these
previously recognized removal costs of $240 million do not represent SFAS No.
143 asset retirement obligations, but rather embedded regulatory liabilities.

In August 2001, the FASB issued SFAS No. 144. SFAS No. 144 provides new
guidance on the recognition of impairment losses on long-lived assets to be held
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. SFAS No. 144 supercedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and Accounting Principles Board Opinion No. 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," while retaining many of the requirements of these two
statements. Under SFAS No. 144, assets held for sale that are a component of an
entity will be included in discontinued operations if the operations and cash
flows will be or have been eliminated from the ongoing operations of the entity
and the entity will not have any significant continuing involvement in the
operations prospectively. SFAS No. 144 was effective for fiscal years beginning
after December 15, 2001, with early adoption encouraged. SFAS No. 144 did not
materially change the methods we use to measure impairment losses on long-lived
assets, but may result in more future dispositions being reported as
discontinued operations than would previously have been permitted. We adopted
SFAS No. 144 on January 1, 2002.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (SFAS No. 145). SFAS No. 145 eliminates the current requirement
that gains and losses on debt extinguishment must be classified as extraordinary
items in the income statement. Instead, such gains and losses will be classified
as extraordinary items only if they are deemed to be unusual and infrequent.
SFAS No. 145 also requires that capital leases that are modified so that the
resulting lease agreement is classified as an operating lease be accounted for
as a
30

sale-leaseback transaction. The changes related to debt extinguishment are
effective for fiscal years beginning after May 15, 2002, and the changes related
to lease accounting are effective for transactions occurring after May 15, 2002.
We have applied this guidance prospectively as it relates to lease accounting
and will apply the accounting provisions to debt extinguishments to 2003. The
requirements of SFAS No. 145 were not applicable to the extraordinary item
related to the loss on early extinguishment of debt recorded in 2002. Upon
adoption of SFAS No. 145, any gain or loss on extinguishment of debt that was
classified as an extraordinary item in prior periods will be reclassified.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies Emerging Issues Task Force (EITF) No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" (EITF No. 94-3). The
principal difference between SFAS No. 146 and EITF No. 94-3 relates to the
requirements for recognition of a liability for costs associated with an exit or
disposal activity. SFAS No. 146 requires that a liability be recognized for a
cost associated with an exit or disposal activity when it is incurred. A
liability is incurred when a transaction or event occurs that leaves an entity
little or no discretion to avoid the future transfer or use of assets to settle
the liability. Under EITF No. 94-3, a liability for an exit cost was recognized
at the date of an entity's commitment to an exit plan. In addition, SFAS No. 146
also requires that a liability for a cost associated with an exit or disposal
activity be recognized at its fair value when it is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002 with early application encouraged. We will apply the provisions of SFAS No.
146 to all exit or disposal activities initiated after December 31, 2002.

In November 2002, the FASB issued FASB Interpretation No. (FIN) 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of a
guarantee. In addition, FIN 45 requires disclosures about the guarantees that an
entity has issued. The provision for initial recognition and measurement of the
liability will be applied on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions of FIN 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of FIN 45 is not expected to materially affect
our consolidated financial statements. We have adopted the additional disclosure
provisions of FIN 45 in our consolidated financial statements as of December 31,
2002.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have long-term debt, which subjects us to the risk of loss associated
with movements in market interest rates.

At December 31, 2001 and 2002, we had outstanding fixed-rate debt
aggregating $3.7 billion and $2.4 billion in principal amount and having a fair
value of $3.6 billion and $2.5 billion, respectively. This fixed-rate debt does
not expose us to the risk of loss in earnings due to changes in market interest
rates. However, the fair value of this debt would increase by approximately $89
million if interest rates were to decline by 10% from their levels at December
31, 2002. In general, such an increase in fair value would impact earnings and
cash flows only if we were to reacquire all or a portion of this debt in the
open market prior to its maturity.

Our floating-rate obligations aggregated $164 million and $1.3 billion at
December 31, 2001 and 2002, respectively. These floating-rate obligations expose
us to the risk of increased interest expense in the event of increases in
short-term interest rates. If the floating interest rates were to increase by
10% from December 31, 2002 rates, our combined interest expense would increase
by a total of $1.4 million each month in which such increase continued. For more
information regarding our floating rate obligations, please read Note 6 to our
consolidated financial statements.

31

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA OF THE COMPANY

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

STATEMENTS OF CONSOLIDATED INCOME

See Notes to the Company's Consolidated Financial Statements
32

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME

See Notes to the Company's Consolidated Financial Statements
33

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

CONSOLIDATED BALANCE SHEETS

See Notes to the Company's Consolidated Financial Statements
34

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

STATEMENTS OF CONSOLIDATED CASH FLOWS

See Notes to the Company's Consolidated Financial Statements
35

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

STATEMENTS OF CONSOLIDATED STOCKHOLDER'S AND MEMBER'S EQUITY

See Notes to the Company's Consolidated Financial Statements
36

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) BACKGROUND AND BASIS OF PRESENTATION

ORGANIZATIONAL STRUCTURE AND RESTRUCTURING

CenterPoint Energy Houston Electric, LLC (CenterPoint Houston or the
Company) is a regulated utility engaged in the transmission and distribution of
electric energy in a 5,000 square mile area located along the Texas Gulf Coast,
including the City of Houston. CenterPoint Houston is an indirect wholly owned
subsidiary of CenterPoint Energy, Inc. (CenterPoint Energy), a new public
utility holding company.

The Company's business includes:

- Distribution. The Company's electric distribution business distributes
electricity for retail electric providers in its certificated service
area by carrying power from the substation to the retail electric
customer.

- Transmission. The Company's transmission business transports electricity
from power plants to substations and from one substation to another in
locations in the control area managed by the Electric Reliability Council
of Texas, Inc. (ERCOT).

The Company's business also includes the stranded costs and regulatory
asset recovery associated with the Company's historical generating operations.
The Company operates its business as a single segment. In addition to the
electric transmission and distribution business, the consolidated financial
statements include the operations of one financing subsidiary.

The Company's business does not include:

- the generation or sale of electricity;

- the procurement, supply or delivery of fuel for the generation of
electricity; or

- the marketing to or billing of retail electric customers.

Effective August 31, 2002, Reliant Energy, Incorporated (Reliant Energy)
consummated a restructuring transaction (Restructuring) in which it, among other
things, (1) conveyed its Texas electric generation assets to Texas Genco
Holdings, Inc. (Texas Genco), (2) became an indirect, wholly owned subsidiary of
a new utility holding company, CenterPoint Energy, (3) was converted into a
Texas limited liability company named CenterPoint Energy Houston Electric, LLC
and (4) distributed the capital stock of its operating subsidiaries, including
Texas Genco, to CenterPoint Energy. As part of the Restructuring, each share of
Reliant Energy common stock was converted into one share of CenterPoint Energy
common stock. The Company's operating subsidiaries which were distributed in
connection with the Restructuring and presented as discontinued operations
included $2.1 billion of indebtedness. An additional $1.9 billion of
indebtedness was assumed by CenterPoint Energy at the time of the Restructuring,
consisting of $1.6 billion of debt and $0.3 billion of trust preferred
securities that were reflected in continuing operations in the Company's
Consolidated Balance Sheet as of December 31, 2001. Additionally, at
Restructuring the Company issued a $1.6 billion note payable to CenterPoint
Energy. CenterPoint Energy assumed a $2.5 billion Senior A Credit Agreement,
dated as of July 13, 2001 among Houston Industries FinanceCo LP (a subsidiary of
Reliant Energy), Reliant Energy and the lender parties thereto, and a $1.8
billion Senior B Credit Agreement, dated as of July 13, 2001 among Houston
Industries FinanceCo LP, Reliant Energy and the lender parties thereto.

In a July 2002 order, the SEC limited the aggregate amount of our external
borrowings to $3.55 billion. Our ability to pay dividends is restricted by the
SEC's requirement that common equity as a percentage of total capitalization
must be at least 30% after the payment of any dividend. In addition, the order
restricts our ability to pay dividends out of capital accounts to the extent
current or retained earnings are insufficient for

37

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

those dividends. Under these restrictions, we are permitted to pay dividends in
excess of our current or retained earnings in an amount up to $200 million.

(2) DISCONTINUED OPERATIONS

The consolidated financial statements have been prepared to reflect the
effect of the Restructuring as described above as it relates to the Company, and
have been prepared based upon Reliant Energy's historical consolidated financial
statements.

The consolidated financial statements present operations of Reliant Energy
that were distributed to CenterPoint Energy in the Restructuring as discontinued
operations, in accordance with Statement of Financial Accounting Standards
(SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
(SFAS No. 144). Included in discontinued operations of CenterPoint Energy
Houston are the Wholesale Energy, European Energy, Retail Energy, Natural Gas
Distribution, Pipelines and Gathering and Electric Generation business segments.
Accordingly, the consolidated financial statements of CenterPoint Houston
reflect these operations as discontinued operations for each of the two years in
the period ended December 31, 2001 and for the eight months ended August 31,
2002.

Total revenues included in discontinued operations were $26.2 billion,
$38.8 billion and $29.8 billion in 2000, 2001 and 2002, respectively. Income
from discontinued operations for each of the two years in the period ended
December 31, 2001 is reported net of income tax expense of $120 million and $297
million 2000 and 2001, respectively. Income from discontinued operations for the
eight months ended August 31, 2002 is reported net of income tax expense of $254
million. Total revenues included in discontinued operations have been presented
prior to adoption of Emerging Issues Task Force (EITF) Issue No. 02-3,
"Recognition and Reporting Gains and Losses on Energy Trading Contracts under
Issues No. 98-10 and 00-17."

Summarized balance sheet information related to discontinued operations is
as follows as of December 31, 2001:

38

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) RECLASSIFICATIONS AND USE OF ESTIMATES

In addition to the items discussed in Note 2, some amounts from the
previous years have been reclassified to conform to the 2002 presentation of
financial statements. These reclassifications do not affect net income.

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

(b) PRINCIPLES OF CONSOLIDATION

The accounts of the Company and its wholly owned subsidiary are included in
the Company's consolidated financial statements. All significant intercompany
transactions and balances are eliminated in consolidation.

(c) REVENUES

The Company records revenue for electricity under the accrual method and
these revenues are generally recognized upon delivery. However, the
determination of the deliveries to individual customers is based on the reading
of their meters which is performed on a systematic basis throughout the month.
As a result of the implementation of the Texas Electric Choice Plan (Texas
electric restructuring law), the Company's regulated transmission and
distribution business recovers the cost of its service through an energy
delivery charge, and not as a component of the prior bundled rate, which
included energy and delivery charges. The design of the new energy delivery rate
differs from the prior bundled rate. The winter/summer rate differential for
residential customers has been eliminated and the energy component of the rate
structure has been removed, which will tend to lessen some of the pronounced
seasonal variation in revenues which has been experienced in prior periods. At
the end of each month, amounts of electricity delivered to customers since the
date of the last meter reading are estimated and the corresponding unbilled
revenue is estimated.

39

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(d) LONG-LIVED ASSETS AND INTANGIBLES

The Company records property, plant and equipment at historical cost. The
Company expenses all repair and maintenance costs as incurred. The cost of
utility plant and equipment retirements is charged to accumulated depreciation.
Property, plant and equipment includes the following:

The Company periodically evaluates long-lived assets, including property,
plant and equipment and specifically identifiable intangibles, when events or
changes in circumstances indicate that the carrying value of these assets may
not be recoverable. The determination of whether an impairment has occurred is
based on an estimate of undiscounted cash flows attributable to the assets, as
compared to the carrying value of the assets. To date, no impairment has been
indicated. The Company adopted the provisions of Statement of Financial
Accounting Standards (SFAS) No. 142 "Goodwill and Other Intangible Assets" (SFAS
No. 142) on January 1, 2002. The Company had specific intangibles related to
land rights at December 31, 2001 and 2002 of $38 million (net of $8 million
accumulated amortization) and $40 million (net of $8 million accumulated
amortization), respectively. The Company amortizes these acquired intangibles on
a straight-line basis over the lesser of their contractual or estimated useful
lives that range between 50 and 75 years.

(e) REGULATORY ASSETS AND LIABILITIES

The Company applies the accounting policies established in SFAS No. 71,
"Accounting for the Effects of Certain Types of Regulation" (SFAS No. 71).

The following is a list of regulatory assets/liabilities reflected on the
Company's Consolidated Balance Sheets as of December 31, 2001 and 2002:

40

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

If events were to occur that would make the recovery of these assets and
liabilities no longer probable, the Company would be required to write off or
write down these regulatory assets and liabilities. In addition, the Company
would be required to determine any impairment of the carrying costs of plant and
inventory assets.

Through December 31, 2001, the Public Utility Commission of Texas (Texas
Utility Commission) provided for the recovery of most of the Company's fuel and
purchased power costs from customers through a fixed fuel factor included in
electric rates. Included in the above table in recoverable electric generation-
related regulatory assets, net are $126 million and $66 million of regulatory
assets related to the recovery of fuel costs as of December 31, 2001 and 2002,
respectively. For additional information regarding our fuel filings, see Note
4(c).

In 2001, the Company monetized $738 million of regulatory assets in a
securitization financing authorized by the Texas Utility Commission pursuant to
the Texas electric restructuring law. The securitized regulatory assets are
being amortized ratably as transition charges are collected over the life of the
outstanding transition bonds. For additional information regarding the
securitization financing, see Note 6.

(f) DEPRECIATION AND AMORTIZATION EXPENSE

Depreciation is computed using the straight-line method based on economic
lives or a regulatory mandated method. Other amortization expense includes
amortization of regulatory assets and other intangibles. See Notes 3(d) and 3(e)
for additional discussion of these items.

The following table presents depreciation and amortization expense for
2000, 2001 and 2002.

(g) ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION

Allowance for funds used during construction (AFUDC) represents the
approximate net composite interest cost of borrowed funds and a reasonable
return on the equity funds used for construction. Although AFUDC increases both
utility plant and earnings, it is realized in cash through depreciation
provisions included in rates. AFUDC is capitalized as a component of projects
under construction and will be amortized over the assets' estimated useful
lives. During 2000, 2001 and 2002, the Company capitalized AFUDC related to debt
of $4.0 million, $4.6 million and $3.7 million, respectively.

(h) INCOME TAXES

The Company is included in the consolidated income tax returns of
CenterPoint Energy. The Company calculates its income tax provision on a
separate return basis under a tax sharing agreement with CenterPoint Energy. The
Company uses the liability method of accounting for deferred income taxes and
measures deferred income taxes for all significant income tax temporary
differences. Investment tax credits were deferred and are being amortized over
the estimated lives of the related property. Current federal and certain state
income taxes are payable to or receivable from CenterPoint Energy. For
additional information regarding income taxes, see Note 9.

41

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(i) ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

Accounts and notes receivable, net, are net of an allowance for doubtful
accounts of $13 million and $5 million at December 31, 2001 and 2002,
respectively. The provisions for doubtful accounts in the Company's Statements
of Consolidated Income for 2000, 2001 and 2002 were $5 million, $13 million and
$10 million, respectively.

(j) INVENTORY

Inventory consists principally of materials and supplies and is valued at
average cost.

(k) STATEMENTS OF CONSOLIDATED CASH FLOWS

For purposes of reporting cash flows, the Company considers cash
equivalents to be short-term, highly liquid investments with maturities of three
months or less from the date of purchase. In connection with the issuance of
transition bonds in October 2001, the Company was required to establish
restricted cash accounts to collateralize the bonds that were issued in this
financing transaction. These restricted cash accounts are classified as
long-term as they are not available for withdrawal until the maturity of the
bonds. Cash and cash equivalents does not include restricted cash. For
additional information regarding the securitization financing, see Note 4(a).

(l) CHANGES IN ACCOUNTING PRINCIPLES AND NEW ACCOUNTING PRONOUNCEMENTS

See Note 3(d) for a discussion of the Company's adoption of SFAS No. 142 on
January 1, 2002.

In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, "Accounting for Asset Retirement Obligations" (SFAS No. 143). SFAS No.
143 requires the fair value of an asset retirement obligation to be recognized
in the period in which it is incurred and capitalized as part of the cost of the
related tangible long-lived asset. Over time, the liability is accreted to its
present value each period, and the capitalized cost is depreciated over the
useful life of the related asset. Retirement obligations associated with
long-lived assets included within the scope of SFAS No. 143 are those for which
a legal obligation exists under enacted laws, statutes and written or oral
contracts, including obligations arising under the doctrine of promissory
estoppel. SFAS No. 143 is effective for fiscal years beginning after June 15,
2002, with earlier application encouraged.

As of January 1, 2003, the Company has not identified any asset retirement
obligations; however, the Company has previously recognized removal costs as a
component of depreciation expense in accordance with regulatory treatment. As of
December 31, 2002, these previously recognized removal costs of $240 million do
not represent SFAS No. 143 asset retirement obligations, but rather imbedded
regulatory liabilities.

In August 2001, the FASB issued SFAS No. 144. SFAS No. 144 provides new
guidance on the recognition of impairment losses on long-lived assets to be held
and used or to be disposed of and also broadens the definition of what
constitutes a discontinued operation and how the results of a discontinued
operation are to be measured and presented. SFAS No. 144 supercedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and Accounting Principles Board Opinion No. 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," while retaining many of the requirements of these two
statements. Under SFAS No. 144, assets held for sale that are a component of an
entity will be included in discontinued operations if the operations and cash
flows will be or have been eliminated from the ongoing operations of the entity
and the entity will not have any significant continuing involvement in the
operations prospectively. SFAS No. 144 did not materially change the methods
used by the Company to measure impairment losses on long-lived assets, but may
result in more
42

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

future dispositions being reported as discontinued operations than would
previously have been permitted. The Company adopted SFAS No. 144 on January 1,
2002.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections" (SFAS No. 145). SFAS No. 145 eliminates the current requirement
that gains and losses on debt extinguishment must be classified as extraordinary
items in the income statement. Instead, such gains and losses will be classified
as extraordinary items only if they are deemed to be unusual and infrequent.
SFAS No. 145 also requires that capital leases that are modified so that the
resulting lease agreement is classified as an operating lease be accounted for
as a sale-leaseback transaction. The changes related to debt extinguishment are
effective for fiscal years beginning after May 15, 2002, and the changes related
to lease accounting are effective for transactions occurring after May 15, 2002.
The Company has applied this guidance prospectively as it relates to lease
accounting and will apply the accounting provisions to debt extinguishment in
2003. Upon adoption of SFAS No. 145, any gain or loss on extinguishment of debt
that was classified as an extraordinary item in prior periods presented that
does not meet the criteria in APB Opinion No. 30 for classification as an
extraordinary item shall be reclassified.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" (SFAS No. 146). SFAS No. 146
nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)" (EITF No. 94-3). The principal difference
between SFAS No. 146 and EITF No. 94-3 relates to the requirements for
recognition of a liability for costs associated with an exit or disposal
activity. SFAS No. 146 requires that a liability be recognized for a cost
associated with an exit or disposal activity when it is incurred. A liability is
incurred when a transaction or event occurs that leaves an entity little or no
discretion to avoid the future transfer or use of assets to settle the
liability. Under EITF No. 94-3, a liability for an exit cost was recognized at
the date of an entity's commitment to an exit plan. In addition, SFAS No. 146
also requires that a liability for a cost associated with an exit or disposal
activity be recognized at its fair value when it is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002 with early application encouraged. The Company will apply the provisions of
SFAS No. 146 to all exit or disposal activities initiated after December 31,
2002.

In November 2002, the FASB issued FASB Interpretation No. (FIN) 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that a
liability be recorded in the guarantor's balance sheet upon issuance of certain
guarantees. In addition, FIN 45 requires disclosures about the guarantees that
an entity has issued. The provision for initial recognition and measurement of
the liability will be applied on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure provisions of FIN 45 are
effective for financial statements of interim or annual periods ending after
December 15, 2002. The adoption of FIN 45 is not expected to materially affect
the Company's consolidated financial statements. The Company has adopted the
additional disclosure provisions of FIN 45 in its consolidated financial
statements as of December 31, 2002.

(4) REGULATORY MATTERS

(a) TEXAS ELECTRIC RESTRUCTURING LAW AND DISCONTINUANCE OF SFAS NO. 71 FOR
ELECTRIC GENERATION OPERATIONS

In June 1999, the Texas legislature adopted the Texas electric
restructuring law, which substantially amended the regulatory structure
governing electric utilities in Texas in order to allow retail electric
competition. Retail pilot projects allowing competition for up to 5% of each
utility's load in all customer classes began in the third quarter of 2001, and
retail electric competition for all other customers began in January 2002. In
preparation for competition, CenterPoint Energy made significant changes in the
electric
43

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

utility operations it conducts through the Company. In addition, the Texas
Utility Commission issued a number of new rules and determinations in
implementing the Texas electric restructuring law.

The Texas electric restructuring law defined the process for competition
and created a transition period during which most utility rates were frozen at
rates not in excess of their then-current levels. The Texas electric
restructuring law provided for utilities to recover their generation related
stranded costs and regulatory assets (as defined in the Texas electric
restructuring law).

Unbundling. As of January 1, 2002, electric utilities in Texas such as the
Company unbundled their businesses in order to separate power generation,
transmission and distribution, and retail activities into different units.
Pursuant to the Texas electric restructuring law, CenterPoint Energy submitted a
plan in January 2000 that was later amended and updated to accomplish the
required separation (the business separation plan). The Company continues to be
subject to cost-of-service rate regulation and is responsible for the
transmission and distribution of electricity to retail customers. The Company
transferred its Texas generation facilities that were formerly part of Reliant
Energy HL&P (Texas generation business) to Texas Genco in connection with the
Restructuring.

Transmission and Distribution Rates. All retail electric providers in the
Company's service area pay the same rates and other charges for transmission and
distribution services.

The Company's distribution rates charged to retail electric providers are
generally based on amounts of energy delivered. The Company's transmission rates
charged to other distribution companies are based on amounts of energy
transmitted under "postage stamp" rates that do not vary with the distance the
energy is being transmitted. All distribution companies in ERCOT pay the Company
the same rates and other charges for transmission services. The transmission and
distribution rates for the Company have been in effect since January 1, 2002,
when electric competition began. This regulated delivery charge includes the
transmission and distribution rate (which includes costs for nuclear
decommissioning and municipal franchise fees), a system benefit fund fee imposed
by the Texas electric restructuring law, a transition charge associated with
securitization of regulatory assets and an excess mitigation credit imposed by
the Texas Utility Commission.

Stranded Costs. The Company will be entitled to recover its stranded costs
(the excess of net regulatory book value of historical generation assets (as
defined by the Texas electric restructuring law) over the market value of those
assets) and its regulatory assets related to generation. The Texas electric
restructuring law prescribes specific methods for determining the amount of
stranded costs and the details for their recovery. During the transition period
to deregulation (the Transition Period), which included 1998 and the first six
months of 1999, and extending through the base rate freeze period from July 1999
through 2001, the Texas electric restructuring law provided that earnings above
a stated overall annual rate of return on invested capital be used to recover
CenterPoint Energy's investment in generation assets (Accelerated Depreciation).
In addition, during the Transition Period, the redirection of depreciation
expense to generation assets that the Company would otherwise apply to
transmission, distribution and general plant assets was permitted for regulatory
purposes (Redirected Depreciation). Please read the discussion of the accounting
treatment for depreciation for financial reporting purposes below under
"-- Accounting." The Company cannot predict the amount, if any, of these costs
that may not be recovered.

In accordance with the Texas electric restructuring law, beginning on
January 1, 2002, and ending December 31, 2003, any difference between market
power prices received in Texas Genco's generation capacity auctions mandated by
the Texas electric restructuring law and the Texas Utility Commission's earlier
estimates of those prices will be included in the 2004 stranded cost true-up
proceeding, as further discussed below. This component of the true-up is
intended to ensure that neither the customers nor CenterPoint Energy is
disadvantaged economically as a result of the two-year transition period by
providing this pricing structure.

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CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On October 24, 2001, CenterPoint Energy Transition Bond Company, LLC (Bond
Company), a Delaware limited liability company and wholly owned subsidiary of
the Company, issued $749 million aggregate principal amount of its Series 2001-1
Transition Bonds (Transition Bonds) pursuant to a financing order of the Texas
Utility Commission. Classes of the bonds have final maturity dates of September
15, 2007, September 15, 2009, September 15, 2011 and September 15, 2015, and
bear interest at rates of 3.84%, 4.76%, 5.16% and 5.63%, respectively. Scheduled
payments on the bonds are from 2002 through 2013. Net proceeds to the Bond
Company from the issuance were $738 million. The Bond Company paid the Company
$738 million for the transition property. Proceeds were used for general
corporate purposes, including the repayment of indebtedness.

The Transition Bonds are secured primarily by the "transition property,"
which includes the irrevocable right to recover, through non-bypassable
transition charges payable by certain retail electric customers, the qualified
costs of the Company authorized by the financing order. The holders of the Bond
Company's bonds have no recourse to any assets or revenues of the Company, and
the creditors of the Company have no recourse to any assets or revenues
(including, without limitation, the transition charges) of the Bond Company. The
Company has no payment obligations with respect to the Transition Bonds except
to remit collections of transition charges as set forth in a servicing agreement
between the Company and the Bond Company and in an intercreditor agreement among
the Company, the Bond Company and other parties.

The non-bypassable transition charges are required by the financing order
to be trued-up annually, effective November 1, for the term of the transition
charge. The Company filed an annual true-up with the Texas Utility Commission on
August 2, 2002 for transition charges that became effective November 1, 2002.

Costs associated with nuclear decommissioning will continue to be subject
to cost-of-service rate regulation and are included in a charge to transmission
and distribution customers. For further discussion of the effect of the business
separation plan on funding of the nuclear decommissioning trust fund, see Note
4(b).

True-Up Proceeding. The Texas electric restructuring law and current Texas
Utility Commission implementation guidance provide for a true-up proceeding to
be initiated in or after January 2004. The purpose of the true-up proceeding is
to quantify and reconcile the amount of stranded costs, the capacity auction
true-up, unreconciled fuel costs (see Note 3(e)), and other regulatory assets
associated with the Company's former electric generating operations that were
not previously securitized through the Transition Bonds. The 2004 true-up
proceeding will result in either additional charges being assessed on or credits
being issued to certain retail electric customers. CenterPoint Energy appealed
the Texas Utility Commission's true-up rule on the basis that there are no
negative stranded costs, that CenterPoint Energy should be allowed to collect
interest on stranded costs, and that the premium on the partial stock valuation
applies to only the equity of Texas Genco, not equity plus debt. The Texas court
of appeals issued a decision on February 6, 2003 upholding the rule in part and
reversing in part. The court ruled that there are no negative stranded costs and
that the premium on the partial stock valuation applies only to equity. The
court upheld the Texas Utility Commission's rule that interest on stranded costs
begins upon the date of the final true-up order. On February 21, 2003,
CenterPoint Energy filed a motion for rehearing on the issue that interest on
amounts determined in the true-up proceeding should accrue from an earlier date.
CenterPoint Energy has not accrued interest in its consolidated financial
statements, but estimates that interest could be material. If the court of
appeals denies CenterPoint Energy's motion, then CenterPoint Energy will have 45
days to appeal to the Texas Supreme Court. CenterPoint Energy has not decided
what action, if any, it will take if the motion for rehearing is denied.

Accounting. Historically, CenterPoint Energy has applied the accounting
policies established in SFAS No. 71. Effective June 30, 1999, CenterPoint Energy
applied SFAS No. 101 to Texas Genco.

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CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In 1999, CenterPoint Energy evaluated the effects that the Texas electric
restructuring law would have on the recovery of its generation related
regulatory assets and liabilities. CenterPoint Energy determined that a pre-tax
accounting loss of $282 million existed because it believes only the economic
value of its generation related regulatory assets (as defined by the Texas
electric restructuring law) will be recoverable. Therefore, the Company recorded
a $183 million after-tax extraordinary loss in the fourth quarter of 1999.
Pursuant to EITF Issue No. 97-4 "Deregulation of the Pricing of
Electricity -- Issues Related to the Application of FASB Statements No. 71 and
No. 101" (EITF No. 97-4), the remaining recoverable regulatory assets are now
associated with the Company. For details regarding the Company's regulatory
assets, see Note 3(e).

At June 30, 1999, CenterPoint Energy performed an impairment test of its
previously regulated electric generation assets pursuant to SFAS No. 121 on a
plant specific basis. Under SFAS No. 121, an asset is considered impaired, and
should be written down to fair value, if the future undiscounted net cash flows
expected to be generated by the use of the asset are insufficient to recover the
carrying amount of the asset. For assets that are impaired pursuant to SFAS No.
121, CenterPoint Energy determined the fair value for each generating plant by
estimating the net present value of future cash flows over the estimated life of
each plant. CenterPoint Energy determined that $797 million of electric
generation assets was impaired in 1999. The Texas electric restructuring law
provides for recovery of this impairment through regulated cash flows during the
transition period and through charges to transmission and distribution
customers. As such, a regulatory asset for an amount equal to Texas Genco's
impairment loss and was included on the Company's Consolidated Balance Sheets as
a regulatory asset. The Company recorded amortization expense related to the
recoverable impaired plant costs and other assets created from discontinuing
SFAS No. 71 of $221 million during the six months ended December 31, 1999, $329
million in 2000 and $247 million in 2001.

The impairment analysis requires estimates of possible future market
prices, load growth, competition and many other factors over the lives of the
plants. The resulting impairment loss is highly dependent on these underlying
assumptions. In addition, after January 10, 2004, the Company must finalize and
reconcile stranded costs (as defined by the Texas electric restructuring law) in
a filing with the Texas Utility Commission. Any positive difference between the
regulatory net book value and the fair market value of the generation assets (as
defined by the Texas electric restructuring law) will be collected through
future charges. Any overmitigation of stranded costs may be refunded by a
reduction in future charges. This final reconciliation allows alternative
methods of third party valuation of the fair market value of these assets,
including outright sale, stock valuations and asset exchanges.

In order to reduce potential exposure to stranded costs related to
generation assets, the Company recognized Redirected Depreciation of $195
million and $99 million 1998 and for the six months ended June 30, 1999,
respectively, for regulatory and financial reporting purposes. This redirection
was in accordance with the Company's Transition Plan. Subsequent to June 30,
1999, Redirected Depreciation expense could no longer be recorded by CenterPoint
Energy's electric generation business for financial reporting purposes as these
operations are no longer accounted for under SFAS No. 71. During the six months
ended December 31, 1999 and during 2000 and 2001, $99 million, $218 million and
$230 million in depreciation expense, respectively, was redirected from
transmission and distribution for regulatory and financial reporting purposes
and was established as an embedded regulatory asset included in transmission and
distribution related plant and equipment balances. As of December 31, 2001, the
cumulative amount of Redirected Depreciation for regulatory purposes was $841
million, prior to the effects of the October 3, 2001 order discussed below.

Additionally, as allowed by the Texas Utility Commission, in an effort to
further reduce potential exposure to stranded costs related to generation
assets, the Company recorded Accelerated Depreciation of $194 million and $104
million in 1998 and for the six months ended June 30, 1999, respectively, for
regulatory and financial reporting purposes. Accelerated Depreciation expense
was recorded in accordance with the Company's Transition Plan during this
period. Subsequent to June 30, 1999, Accelerated Depreciation

46

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

expense could no longer be recorded by CenterPoint Energy's electric generation
business for financial reporting purposes, as these operations are no longer
accounted for under SFAS No. 71. During the six months ended December 31, 1999
and during 2000 and 2001, $179 million, $385 million and $264 million,
respectively, of Accelerated Depreciation was recorded for regulatory reporting
purposes, reducing the regulatory book value of the Company's stranded costs
recovery.

The Texas Utility Commission issued a final order on October 3, 2001
(October 3, 2001 Order) that established the transmission and distribution
utility rates that became effective in January 2002. In this Order, the Texas
Utility Commission found that the Company had overmitigated its stranded costs
by redirecting transmission and distribution depreciation and by accelerating
depreciation of generation assets as provided under the Transition Plan and
Texas electric restructuring law. As a result of the October 3, 2001 Order, the
Company was required to reverse the $841 million embedded regulatory asset
related to Redirected Depreciation, thereby reducing the net book value of
transmission and distribution assets. The Company was required to record a
regulatory liability of $1.1 billion related to Accelerated Depreciation. The
October 3, 2001 Order requires this amount to be refunded through excess
mitigation credits to certain retail electric customers during a seven-year
period which began in January 2002.

As of December 31, 2002, in contemplation of the 2004 true-up proceeding,
the Company has recorded a regulatory asset of $2.0 billion representing the
estimated future recovery of previously incurred stranded costs, which includes
$1.1 billion of previously recorded Accelerated Depreciation plus Redirected
Depreciation, both reversed in 2001. Offsetting this regulatory asset is a $969
million regulatory liability to refund the excess mitigation to ratepayers. This
estimated recovery is based upon current projections of the market value of
CenterPoint Energy's Texas generation assets to be covered by the 2004 true-up
proceeding calculations. The regulatory liability reflects a current refund
obligation arising from prior mitigation of stranded costs deemed excessive by
the Texas Utility Commission. The Company began refunding excess mitigation
credits with January 2002 bills. These credits are to be refunded over a
seven-year period. Because accounting principles generally accepted in the
United States of America require the Company to estimate fair market values in
advance of the final reconciliation, the financial impacts of the Texas electric
restructuring law with respect to the final determination of stranded costs in
the 2004 true-up proceeding are subject to material changes. Factors affecting
such changes may include estimation risk, uncertainty of future energy and
commodity prices and the economic lives of the plants. If events were to occur
that made the recovery of some of the remaining generation related regulatory
assets no longer probable, the Company would write off the unrecoverable balance
of such assets as a charge against earnings.

(b) AGREEMENTS RELATED TO TEXAS GENERATING ASSETS

Texas Genco is the beneficiary of the decommissioning trust that has been
established to provide funding for decontamination and decommissioning of the
South Texas Project in which Texas Genco owns a 30.8% interest. The Company
collects through rates or other authorized charges to its electric utility
customers amounts designated for funding the decommissioning trust, and pays the
amounts to Texas Genco. Texas Genco in turn deposits these amounts into the
decommissioning trust. Upon decommissioning of the facility, in the event funds
from the trust are inadequate, the Company or its successor will be required to
collect through rates or other authorized charges to customers as contemplated
by the Texas Utilities Code all additional amounts required to fund Texas
Genco's obligations relating to the decommissioning of the facility. Following
the completion of the decommissioning, if surplus funds remain in the
decommissioning trust, the excess will be refunded to the ratepayers of the
Company or its successor.

47

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(c) CENTERPOINT HOUSTON REGULATORY FILINGS

Texas Genco and the Company filed their joint application to reconcile fuel
revenues and expenses with the Texas Utility Commission on July 1, 2002. This
final fuel reconciliation filing covers reconcilable fuel revenue, fuel expense
and interest of approximately $8.5 billion incurred from August 1, 1997 through
January 30, 2002. Also included in this amount is an under-recovery of $94
million, which was the balance at July 31, 1997 as approved in the Company's
last fuel reconciliation. On January 28, 2003, a settlement agreement was
reached under which it was agreed that certain items totaling $24 million were
written off during the fourth quarter of 2002 and items totaling $203 million
will be carried forward for resolution by the Texas Utility Commission in late
2003 or early 2004.

(5) RELATED PARTY TRANSACTIONS

From time to time, the Company has advanced money to, or borrowed money
from, CenterPoint Energy or its subsidiaries. As of December 31, 2001, the
Company had net accounts payable of $40 million included in accounts
payable-affiliated companies. As of December 31, 2002, the Company had net
short-term borrowings of $226 million included in notes payable-affiliated
companies. As of December 31, 2002, the Company had net accounts payable of $44
million included in accounts payable-affiliated companies. As of December 31,
2002, the Company had net short-term notes payables of $48 million and $167
million current portion of long-term note payable to affiliate included in notes
payable-affiliated companies. As of December 31, 2001, the Company had net
long-term borrowings, included in notes payable-affiliated companies, totaling
$11 million. As of December 31, 2002, the Company had a $815 million long-term
note receivable from affiliate, as further discussed below, and a $1.1 billion
long-term note payable to affiliate as further discussed in Note 5. Net interest
expense on these borrowings was $27 million, $30 million and $72 million in
2000, 2001 and 2002, respectively.

Prior to August 31, 2002, the Company had $737 million invested in a money
fund through which the Company and certain of its affiliates could borrow and/or
invest on a short-term basis. At the time of the Restructuring, the Company
converted a money fund investment into a $750 million note receivable from
CenterPoint Energy payable on demand and bearing interest at the prime rate,
leaving $13 million borrowed from the money fund. Since August 31, 2002, the
Company has been a participant in the CenterPoint Energy money pool. The $750
million note receivable is included in long-term notes receivable from affiliate
in the Consolidated Balance Sheets because the Company does not plan to demand
repayment of the note within the next twelve months.

In 2002, revenues derived from energy delivery charges provided by the
Company to a subsidiary of Reliant Resources, Inc. (Reliant Resources), a former
affiliate, totaled $273 million.

Although the former retail sales business is no longer conducted by the
Company, retail customers remained regulated customers of the Company through
the date of their first meter reading in January 2002. During this transition
period, the Company purchased $48 million of power from Texas Genco.

In 2000 and 2001, a subsidiary of Reliant Resources, a former affiliate,
provided certain support services to the Company totaling $22 million and $53
million, respectively.

CenterPoint Energy provides some corporate services to the Company. The
costs of services have been directly charged to the Company using methods that
management believes are reasonable. These methods include negotiated usage
rates, dedicated asset assignment, and proportionate corporate formulas based on
assets, operating expenses and employees. These charges are not necessarily
indicative of what would have been incurred had the Company not been an
affiliate. Amounts charged to the Company for these services were $116 million
for 2002 and are included primarily in operation and maintenance expenses.

48

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(6) LONG-TERM DEBT AND SHORT-TERM BORROWINGS

- ---------------

(1) Includes amounts due within one year of the date noted.

(2) These series of debt are secured by the Company's first mortgage bonds.

(3) The December 31, 2001 debt balances have been reclassified to give effect to
the Restructuring, which occurred on August 31, 2002.

(4) LIBOR has a minimum rate of 3%. This collateralized term loan is secured by
the Company's general mortgage bonds.

(5) The Series 2001-1 Transition Bonds were issued by one of the Company's
subsidiaries, and are non-recourse to the Company. For further discussion of
the securitization financing, see Note 4(a).

(6) Of the total $1.1 billion notes payable to affiliate at December 31, 2002,
$547 million has the same principal amounts and interest rates as the
medium-term notes and pollution control bonds of CenterPoint Energy that are
secured by first mortgage bonds of CenterPoint Houston.

During 2002, the Company recorded a $16 million after-tax extraordinary
item related to a loss on the early extinguishment of debt related to the
Company's $850 million term loan and the repurchase of $175 million of the
Company's pollution control bonds.

Assumption and Release of Certain Debt

In connection with the Restructuring, Reliant Energy transferred assets and
subsidiaries to CenterPoint Energy or its subsidiaries and became a subsidiary
of CenterPoint Energy. As part of the Restructuring, each share of Reliant
Energy common stock was converted into one share of CenterPoint Energy common
stock. The Company's operating subsidiaries which were distributed in connection
with the Restructuring and

49

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

presented as discontinued operations included $2.1 billion of indebtedness. An
additional $1.9 billion of indebtedness was assumed by CenterPoint Energy at the
time of the Restructuring, consisting of $1.6 billion of debt and $0.3 billion
of trust preferred securities that were reflected in continuing operations in
the Company's Consolidated Balance Sheet as of December 31, 2001. Additionally,
at Restructuring the Company issued a $1.6 billion note payable to CenterPoint
Energy. CenterPoint Energy also assumed a $2.5 billion Senior A Credit
Agreement, dated as of July 13, 2001 among Houston Industries FinanceCo LP (a
subsidiary of Reliant Energy), Reliant Energy and the lender parties thereto,
and a $1.8 billion Senior B Credit Agreement, dated as of July 13, 2001 among
Houston Industries FinanceCo LP, Reliant Energy and the lender parties thereto.

Bank Loans

As of December 31, 2002, the Company had no bank loans or revolving credit
facilities. At December 31, 2002, the Company had short-term loans from
affiliates of $48 million. The weighted average interest rate on the Company's
short-term borrowings at December 31, 2001 and 2002 was 3.36% and 6.2%,
respectively. At December 31, 2001, the Company had a $400 million credit
facility, which was replaced on October 10, 2002 by an $850 million secured
credit facility which was subsequently repaid on November 12, 2002 as discussed
below.

In February 2003, the Company obtained a $75 million revolving credit
facility that terminates on April 30, 2003. A condition precedent to utilizing
the facility is that security in the form of general mortgage bonds must be
delivered to the lender. Rates for borrowings under this facility, including the
facility fee, will be LIBOR plus 250 basis points.

Money Pool Borrowings

On December 31, 2002, the Company had borrowed $48 million from its
affiliates. The Company participates in a "money pool" through which it can
borrow or invest on a short-term basis. Funding needs are aggregated and
external borrowing or investing is based on the net cash position. The money
pool's net funding requirements are generally met with short-term borrowings of
CenterPoint Energy. The terms of the money pool are in accordance with
requirements applicable to registered public utility holding companies under the
1935 Act.

50

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Long-term Debt

The following table shows future maturity dates of long-term debt issued by
CenterPoint Houston and expected future maturity dates of the Transition Bonds
issued by the Bond Company as of December 31, 2002. Amounts are expressed in
thousands.

First mortgage bonds in an aggregate principal amount of $615 million have
been issued directly to third parties. External debt of $1.3 billion maturing in
2005 is senior and secured by general mortgage bonds. The affiliate debt is
senior and unsecured.

As of October 10, 2002, CenterPoint Houston increased the size of its
credit facility to $850 million in connection with the amendment and extension
of its bank facility and the bank facilities of its parent. Proceeds from the
loan were used to (1) repay maturing loans under a $400 million credit facility
and (2) repay $450 million of the note payable to CenterPoint Energy. The $850
million facility was secured by $850 million aggregate principal amount of
CenterPoint Houston's general mortgage bonds issued under CenterPoint Houston's
General Mortgage dated as of October 10, 2002. The lien of the General Mortgage
is junior to that of CenterPoint Houston's Mortgage and Deed of Trust dated as
of November 1, 1944. The $850 million of general mortgage bonds was released by
the banks upon the November 2002 repayment and termination of the facility using
proceeds from CenterPoint Houston's $1.3 billion collateralized term loan as
discussed below.

On November 12, 2002, CenterPoint Houston entered into a $1.3 billion
collateralized term loan maturing November 2005. The interest rate on the loan
is the London inter-bank offered rate (LIBOR) plus 9.75%, subject to a minimum
rate of 12.75%. The loan is secured by CenterPoint Houston's general mortgage
bonds. Proceeds from the loan were used to (1) repay CenterPoint Houston's $850
million term loan as

51

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

discussed above, (2) repay $100 million of intercompany notes maturing in 2028,
(3) repay $300 million of debt that matured on November 15, 2002 and (4) pay
transaction costs. The loan agreement contains various business and financial
covenants including a covenant restricting CenterPoint Houston's debt, excluding
transition bonds, as a percent of its total capitalization to 68%. The loan
agreement also limits incremental secured debt that may be issued by CenterPoint
Houston to $300 million.

Other than the affiliate notes due 2028, the amounts, maturities and
interest rates of the intercompany debt payable to CenterPoint Energy of $547
million effectively match the amounts, maturities and interest rates of
medium-term notes and certain pollution control bond obligations of CenterPoint
Energy that are secured by the Company's first mortgage bonds in the same
amounts in the table below.

The following table shows the maturity dates of the $1.1 billion of first
mortgage bonds and general mortgage bonds that the Company has issued as
collateral for long-term debt of CenterPoint Energy. These bonds are not
reflected on the financial statements of CenterPoint Houston because of the
contingent nature of the obligations. Amounts are expressed in thousands.

The aggregate amount of additional general mortgage bonds and first
mortgage bonds that could be issued is approximately $900 million based on
estimates of the value of property encumbered by the general mortgage, the cost
of such property and the 70% bonding ratio contained in the general mortgage.
The issuance of additional first mortgage and general mortgage bonds is
currently contractually limited to an additional $300 million in general
mortgage bonds. As of December 31, 2002, outstanding first mortgage bonds and
general mortgage bonds aggregated approximately $3.0 billion.

The Bond Company has $736 million aggregate principal amount of outstanding
Transition Bonds. Classes of the Transition Bonds have final maturity dates of
September 15, 2007, September 15, 2009, September 15, 2011 and September 15,
2015 and bear interest at rates of 3.84%, 4.76%, 5.16% and 5.63%, respectively.
The Transition Bonds are secured by "transition property," as defined in the
Texas electric restructuring law, which includes the irrevocable right to
recover, through non-bypassable transition charges payable by retail electric
customers, qualified costs provided in the Texas electric restructuring law and
a tariff issued by the Texas Utility Commission. The Transition Bonds are
reported as CenterPoint Houston's long-term debt, although the holders of the
Transition Bonds have no recourse to any of CenterPoint Houston's assets or
revenues, and CenterPoint Houston's creditors have no recourse to any assets or
revenues (including, without limitation, the transition charges) of the Bond
Company. CenterPoint Houston has no payment obligations with respect to the
Transition Bonds except to remit collections of transition charges as set forth
in

52

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

a servicing agreement between CenterPoint Houston and the Bond Company and in an
intercreditor agreement among CenterPoint Houston, our indirect transition bond
subsidiary and other parties.

Liens. The Company's assets are subject to liens securing approximately
$1.2 billion of first mortgage bonds. Sinking or improvement fund and
replacement fund requirements on the first mortgage bonds may be satisfied by
certification of property additions. Sinking fund and replacement fund
requirements for 2000, 2001 and 2002 have been satisfied by certification of
property additions. The replacement fund requirement to be satisfied in 2003 is
approximately $347 million, and the sinking fund requirement to be satisfied in
2003 is approximately $15 million. The Company expects to meet these 2003
obligations by certification of property additions. The Company's assets are
subject to liens securing approximately $1.8 billion of general mortgage bonds,
which are junior to the liens of the first mortgage bonds.

(7) TRUST PREFERRED SECURITIES

As part of the Restructuring on August 31, 2002, CenterPoint Energy assumed
the junior subordinated debt obligations related to trust preferred securities
from the Company. For additional information on the Restructuring, see Note 1.

(8) EMPLOYEE BENEFIT PLANS

(a) PENSION PLANS

Substantially all of the Company's employees participate in CenterPoint
Energy's qualified non-contributory pension plan. Under the cash balance
formula, participants accumulate a retirement benefit based upon 4% of eligible
earnings and accrued interest. Prior to 1999, the pension plan accrued benefits
based on years of service, final average pay and covered compensation. As a
result, certain employees participating in the plan as of December 31, 1998 are
eligible to receive the greater of the accrued benefit calculated under the
prior plan through 2008 or the cash balance formula.

CenterPoint Energy's funding policy is to review amounts annually in
accordance with applicable regulations in order to achieve adequate funding of
projected benefit obligations. Pension expense is allocated to the Company based
on covered employees. This calculation is intended to allocate pension costs in
the same manner as a separate employer plan. Assets of the plan are not
segregated or restricted by CenterPoint Energy's participating subsidiaries.
Pension benefit was $10 million and $6 million for the years ended December 31,
2000 and 2001, respectively. The Company recognized pension expense of $7
million for the year ended December 31, 2002.

In addition to the Plan, the Company participates in CenterPoint Energy's
non-qualified pension plan, which allows participants to retain the benefits to
which they would have been entitled under the qualified pension plan except for
federally mandated limits on these benefits or on the level of salary on which
these benefits may be calculated. The expense associated with the non-qualified
pension plan was $3 million in 2000 and less than $1 million in 2001 and 2002.

As of December 31, 2001, CenterPoint Energy allocated $83 million of
pension assets, $7 million of non-qualified pension liabilities and $2 million
of minimum pension liabilities to the Company. As of December 31, 2002,
CenterPoint Energy has not allocated such pension assets or liabilities to the
Company. This change in method of allocation had no impact on pension expense
recorded for the year ended December 31, 2002.

53

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(b) SAVINGS PLAN

The Company participates in CenterPoint Energy's qualified savings plan,
which includes a cash or deferred arrangement under Section 401(k) of the
Internal Revenue Code of 1986, as amended. Under the plan, participating
employees may contribute a portion of their compensation, on a pre-tax or
after-tax basis, generally up to a maximum of 16% of compensation. The Company
matches 75% of the first 6% of each employee's compensation contributed. The
Company may contribute an additional discretionary match of up to 50% of the
first 6% of each employee's compensation contributed. These matching
contributions are fully vested at all times. A substantial portion of the
matching contribution is initially invested in CenterPoint Energy common stock.
CenterPoint Energy allocates to the Company the savings plan benefit expense
related to the Company's employees.

Savings plan benefit expense was $14 million, $10 million and $14 million
for the years ended December 31, 2000, 2001 and 2002, respectively.

(c) POSTRETIREMENT BENEFITS

The Company's employees participate in CenterPoint Energy's plans which
provide certain healthcare and life insurance benefits for retired employees on
a contributory and non-contributory basis. Employees become eligible for these
benefits if they have met certain age and service requirements at retirement, as
defined in the plans. Under plan amendments effective in early 1999, health care
benefits for future retirees were changed to limit employer contributions for
medical coverage. Such benefit costs are accrued over the active service period
of employees.

The Company is required to fund a portion of its obligations in accordance
with rate orders. All other obligations are funded on a pay-as-you-go basis.

The net postretirement benefit cost includes the following components:

54

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Following are the Company's reconciliations of beginning and ending
balances of its postretirement benefit plans benefit obligation, plan assets and
funded status for 2001 and 2002.

For the year ended December 31, 2001, the assumed health care cost trend
rates were 7.5% for participants under age 65 and 8.5% for participants age 65
and over. For the year ended December 31, 2002, the assumed health cost trend
rate was increased to 12% for all participants. The health care cost trend rates
decline by .75% annually to 5.5% by 2011.

If the health care cost trend rate assumptions were increased by 1%, the
accumulated postretirement benefit obligation as of December 31, 2002 would
increase by approximately 4.4%. The annual effect of the 1% increase on the
total of the service and interest costs would be an increase of approximately
3.7%. If the health care cost trend rate assumptions were decreased by 1%, the
accumulated postretirement benefit obligation as of December 31, 2002 would
decrease by approximately 4.4%. The annual effect of the 1% decrease on the
total of the service and interest costs would be a decrease of 3.7%.

55

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The Company's postretirement obligation is presented as a liability in the
Consolidated Balance Sheet under the caption Benefit Obligations.

(d) POSTEMPLOYMENT BENEFITS

The Company provides postemployment benefits through CenterPoint Energy's
plans for former or inactive employees, their beneficiaries and covered
dependents, after employment but before retirement (primarily health care and
life insurance benefits for participants in the long-term disability plan).
Postemployment benefits costs were $3 million and $6 million for the years ended
December 31, 2001 and 2002, respectively. The Company recognized postemployment
benefit income of $1 million for the year ended December 31, 2000.

(e) OTHER NON-QUALIFIED PLANS

The Company participates in CenterPoint Energy's deferred compensation
plans which permit eligible participants to elect each year to defer a
percentage of that year's salary and up to 100% of that year's annual bonus. In
general, employees who attain the age of 60 during employment and participate in
CenterPoint Energy's deferred compensation plans may elect to have their
deferred compensation amounts repaid in (a) fifteen equal annual installments
commencing at the later of age 65 or termination of employment or (b) a lump-sum
distribution following termination of employment. Interest generally accrues on
deferrals at a rate equal to the average Moody's Long-Term Corporate Bond Index
plus 2%, determined annually until termination when the rate is fixed at the
rate in effect for the plan year immediately prior to that in which a
participant attains age 65. The Company recorded interest expense related to its
deferred compensation obligation of $3 million, $2 million and $2 million for
the years ended December 31, 2000, 2001 and 2002, respectively. The discounted
deferred compensation obligation recorded by the Company was $41 million and $19
million as of December 31, 2001 and 2002, respectively.

(f) OTHER EMPLOYEE MATTERS

As of December 31, 2002, the Company employed approximately 3,286 people.
Of these employees, approximately 47% are covered by collective bargaining
agreements which will expire in May 2003.

(9) INCOME TAXES

The Company's current and deferred components of income tax expense are as
follows:

56

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A reconciliation of the federal statutory income tax rate to the effective
income tax rate is as follows:

Following are the Company's tax effects of temporary differences between
the carrying amounts of assets and liabilities in the financial statements and
their respective tax bases:

The Company is included in the consolidated income tax returns of
CenterPoint Energy. CenterPoint Energy's consolidated federal income tax returns
have been audited and settled through the 1996 tax year. The 1997, 1998 and 1999
consolidated federal income tax returns are currently under audit. No audit
adjustments that would impact the Company have been proposed for the current
audit cycle.

57

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(10) COMMITMENTS AND CONTINGENCIES

(a) LEASE COMMITMENTS

The following table sets forth information concerning the Company's
obligations under non-cancelable long-term operating leases at December 31,
2002, which primarily consist of rental agreements for building space, data
processing equipment and vehicles, including major work equipment (in millions).

2003........................................................ $ 5
2004........................................................ 5
2005........................................................ 5
2006........................................................ 6
2007........................................................ 6
---
Total $27
===

Total lease expense for all operating leases was $3 million during 2000 and
$5 million during 2001 and 2002, respectively.

(b) LEGAL MATTERS

The Company's predecessor, Reliant Energy, and certain of its former
subsidiaries are named as defendants in several lawsuits described below. Under
a master separation agreement between Reliant Energy and Reliant Resources,
CenterPoint Energy and its subsidiaries, including the Company, are entitled to
be indemnified by Reliant Resources for any losses arising out of the lawsuits
described under "California Class Actions and Attorney General Cases,"
"Long-Term Contract Class Action," "Washington and Oregon Class Actions,"
"Bustamante Price Reporting Class Action" and "Trading and Marketing
Activities," including attorneys' fees and other costs. Pursuant to the
indemnification obligation, Reliant Resources is defending CenterPoint Energy
and its subsidiaries, including the Company, to the extent named in these
lawsuits. The ultimate outcome of these matters cannot be predicted at this
time.

California Class Actions and Attorney General Cases. Reliant Energy,
Reliant Resources, Reliant Energy Services, Inc. (Reliant Energy Services),
Reliant Energy Power Generation, Inc. (REPG) and several other subsidiaries of
Reliant Resources, as well as two former officers and one present officer of
some of these companies, have been named as defendants in class action lawsuits
and other lawsuits filed against a number of companies that own generation
plants in California and other sellers of electricity in California markets.
While the plaintiffs allege various violations by the defendants of antitrust
laws and state laws against unfair and unlawful business practices, each of the
lawsuits is grounded on the central allegation that the defendants conspired to
drive up the wholesale price of electricity. In addition to injunctive relief,
the plaintiffs in these lawsuits seek treble the amount of damages alleged,
restitution of alleged overpayments, disgorgement of alleged unlawful profits
for sales of electricity, costs of suit and attorneys' fees. All of these suits
originally were filed in state courts in San Diego, San Francisco and Los
Angeles Counties. The suits in San Diego and Los Angeles Counties were
consolidated and removed to the federal district court in San Diego, but on
December 13, 2002, that court remanded the suits to the state courts. Prior to
the remand, Reliant Energy was voluntarily dismissed from two of the suits.
Several parties, including the Reliant defendants, have appealed the judge's
remand decision. The United States court of appeals has entered a briefing
schedule that could result in oral arguments by summer of 2003. Proceedings
before the state court are expected to resume during the first quarter of 2003.

In March and April 2002, the California Attorney General filed three
complaints, two in state court in San Francisco and one in the federal district
court in San Francisco, against Reliant Energy, Reliant

58

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Resources, Reliant Energy Services and other subsidiaries of Reliant Resources
alleging, among other matters, violations by the defendants of state laws
against unfair and unlawful business practices arising out of transactions in
the markets for ancillary services run by the California independent systems
operator, charging unjust and unreasonable prices for electricity, in violation
of antitrust laws in connection with the acquisition in 1998 of electric
generating facilities located in California. The complaints variously seek
restitution and disgorgement of alleged unlawful profits for sales of
electricity, civil penalties and fines, injunctive relief against unfair
competition, and undefined equitable relief. Reliant Resources has removed the
two state court cases to the federal district court in San Francisco where all
three cases are now pending.

Following the filing of the Attorney General cases, seven additional class
action cases were filed in state courts in Northern California. Each of these
purports to represent the same class of California ratepayers, assert the same
claims as asserted in the other California class action cases, and in some
instances repeat as well the allegations in the Attorney General cases. All of
these cases have been removed to federal district court in San Diego. Reliant
Resources has not filed an answer in any of these cases. The plaintiffs have
agreed to a stipulated order that would require the filing of a consolidated
complaint by early March 2003 and the filing of the defendants' initial response
to the complaint within 60 days after the consolidated complaint is filed. In
all of these cases before the federal and state courts in California, the
Reliant defendants have filed or intend to file motions to dismiss on grounds
that the claims are barred by federal preemption and the filed rate doctrine.

Long-Term Contract Class Action. In October 2002, a class action was filed
in state court in Los Angeles against Reliant Energy and several subsidiaries of
Reliant Resources. The complaint in this case repeats the allegations asserted
in the California class actions as well as the Attorney General cases and also
alleges misconduct related to long-term contracts purportedly entered into by
the California Department of Water Resources. None of the Reliant entities,
however, has a long-term contract with the Department of Water Resources. This
case has been removed to federal district court in San Diego.

Washington and Oregon Class Actions. In December 2002, a lawsuit was filed
in Circuit Court of the State of Oregon for the County of Multnomah on behalf of
a class of all Oregon purchasers of electricity and natural gas. Reliant Energy,
Reliant Resources and several Reliant Resources subsidiaries are named as
defendants, along with many other electricity generators and marketers. Like the
other lawsuits filed in California, the plaintiffs claim the defendants
manipulated wholesale power prices in violation of state and federal law. The
plaintiffs seek injunctive relief and payment of damages based on alleged
overcharges for electricity. Also in December 2002, a nearly identical lawsuit
on behalf of consumers in the State of Washington was filed in federal district
court in Seattle. Reliant Resources has removed the Oregon suit to federal
district court in Portland. It is anticipated that before answering the
lawsuits, the defendants will file motions to dismiss on the grounds that the
claims are barred by federal preemption and by the filed rate doctrine.

Bustamante Price Reporting Class Action. In November 2002, California
Lieutenant Governor Cruz Bustamante filed a lawsuit in state court in Los
Angeles on behalf of a class of purchasers of gas and power alleging violations
of state antitrust laws and state laws against unfair and unlawful business
practices based on an alleged conspiracy to report and publish false and
fraudulent natural gas prices with an intent to affect the market prices of
natural gas and electricity in California. Reliant Energy, Reliant Resources and
several Reliant Resources subsidiaries are named as defendants, along with other
market participants and publishers of some of the price indices. The complaint
seeks injunctive relief, compensatory and punitive damages, restitution of
alleged overpayment, disgorgement of all profits and funds acquired by the
alleged unlawful conduct, costs of suit and attorneys' fees. The parties have
stipulated to a schedule that would require the defendants to respond to the
complaint by March 31, 2003. The Reliant defendants intend to deny both their
alleged violation of any laws and their alleged participation in any conspiracy.

59

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Trading and Marketing Activities. Reliant Energy has been named as a party
in several lawsuits and regulatory proceedings relating to the trading and
marketing activities of its former subsidiary, Reliant Resources.

In June 2002, the SEC advised Reliant Resources and Reliant Energy that it
had issued a formal order in connection with its investigation of Reliant
Resources' financial reporting, internal controls and related matters. The
Company understands that the investigation is focused on Reliant Resources'
same-day commodity trading transactions involving purchases and sales with the
same counterparty for the same volume at substantially the same price and
certain structured transactions. These matters were previously the subject of an
informal inquiry by the SEC. Reliant Resources and CenterPoint Energy are
cooperating with the SEC staff.

In connection with the Texas Utility Commission's industry-wide
investigation into potential manipulation of the ERCOT market on and after July
31, 2001, Reliant Energy and Reliant Resources have provided information to the
Texas Utility Commission concerning their scheduling and trading activities.

Fifteen class action lawsuits filed in May, June and July 2002 on behalf of
purchasers of securities of Reliant Resources and/or Reliant Energy have been
consolidated in federal district court in Houston. Reliant Resources and certain
of its executive officers are named as defendants. Reliant Energy is also named
as a defendant in seven of the lawsuits. Two of the lawsuits also name as
defendants the underwriters of the May 2001 initial public offering of
approximately 20% of the common stock of Reliant Resources (Reliant Resources
Offering). One lawsuit names Reliant Resources' and Reliant Energy's independent
auditors as a defendant. The consolidated amended complaint seeks monetary
relief purportedly on behalf of three classes: (1) purchasers of Reliant Energy
common stock from February 3, 2000 to May 13, 2002; (2) purchasers of Reliant
Resources common stock on the open market from May 1, 2001 to May 13, 2002; and
(3) purchasers of Reliant Resources common stock in the Reliant Resources
Offering or purchasers of shares that are traceable to the Reliant Resources
Offering. The plaintiffs allege, among other things, that the defendants
misrepresented their revenues and trading volumes by engaging in round-trip
trades and improperly accounted for certain structured transactions as cash-flow
hedges, which resulted in earnings from these transactions being accounted for
as future earnings rather than being accounted for as earnings in fiscal year
2001.

In February 2003, a lawsuit was filed by three individuals in federal
district court in Chicago against CenterPoint Energy and certain former and
current officers of Reliant Resources for alleged violations of federal
securities laws. The plaintiffs in this lawsuit allege that the defendants
violated federal securities laws by issuing false and misleading statements to
the public, and that the defendants made false and misleading statements as part
of an alleged scheme to inflate artificially trading volumes and revenues. In
addition, the plaintiffs assert claims of fraudulent and negligent
misrepresentation and violations of Illinois consumer law. The defendants expect
to file a motion to transfer this lawsuit to the federal district court in
Houston and to consolidate this lawsuit with the consolidated lawsuits described
above.

The Company believes that none of these lawsuits has merit because, among
other reasons, the alleged misstatements and omissions were not material and did
not result in any damages to any of the plaintiffs.

In May 2002, three class action lawsuits were filed in federal district
court in Houston on behalf of participants in various employee benefits plans
sponsored by Reliant Energy. Reliant Energy and its directors are named as
defendants in all of the lawsuits. Two of the lawsuits have been dismissed
without prejudice. The remaining lawsuit alleges that the defendants breached
their fiduciary duties to various employee benefits plans, directly or
indirectly sponsored by Reliant Energy, in violation of the Employee Retirement
Income Security Act. The plaintiffs allege that the defendants permitted the
plans to purchase or hold securities issued by Reliant Energy when it was
imprudent to do so, including after the prices for such securities became
artificially inflated because of alleged securities fraud engaged in by the
defendants. The complaints seek

60

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

monetary damages for losses suffered by a putative class of plan participants
whose accounts held Reliant Energy or Reliant Resources securities, as well as
equitable relief in the form of restitution.

In October 2002, a derivative action was filed in the federal district
court in Houston, against the directors and officers of CenterPoint Energy. The
complaint sets forth claims for breach of fiduciary duty, waste of corporate
assets, abuse of control and gross mismanagement. Specifically, the shareholder
plaintiff alleges that the defendants caused CenterPoint Energy to overstate its
revenues through so-called "round trip" transactions. The plaintiff also alleges
breach of fiduciary duty in connection with the spin-off and the Reliant
Resources Offering. The complaint seeks monetary damages on behalf of
CenterPoint Energy as well as equitable relief in the form of a constructive
trust on the compensation paid to the defendants. The defendants have filed a
motion to dismiss this case on the ground that the plaintiff did not make an
adequate demand on CenterPoint Energy before filing suit.

A Special Litigation Committee appointed by CenterPoint Energy's Board of
Directors is investigating similar allegations made in a June 28, 2002 demand
letter sent on behalf of a CenterPoint Energy shareholder. The letter states
that the shareholder and other shareholders are considering filing a derivative
suit on behalf of CenterPoint Energy and demands that CenterPoint Energy take
several actions in response to alleged round-trip trades occurring in 1999,
2000, and 2001. The Special Litigation Committee is reviewing the demands made
by the shareholder to determine if these proposed actions are in the best
interests of CenterPoint Energy.

Reliant Energy Municipal Franchise Fee Lawsuits. In February 1996, the
cities of Wharton, Galveston and Pasadena filed suit, for themselves and a
proposed class of all similarly situated cities in Reliant Energy's electric
service area, against Reliant Energy and Houston Industries Finance, Inc.
(formerly a wholly owned subsidiary of Reliant Energy) alleging underpayment of
municipal franchise fees. The plaintiffs claim that they are entitled to 4% of
all receipts of any kind for business conducted within these cities over the
previous four decades. A jury trial of the original claimant cities (but not the
class of cities) in the 269th Judicial District Court for Harris County, Texas,
ended in April 2000 (the Three Cities case). Although the jury found for Reliant
Energy on many issues, it found in favor of the original claimant cities on
three issues, and assessed a total of $4 million in actual and $30 million in
punitive damages. However, the jury also found in favor of Reliant Energy on the
affirmative defense of laches, a defense similar to a statute of limitations
defense, due to the original claimant cities having unreasonably delayed
bringing their claims during the 43 years since the alleged wrongs began. The
trial court in the Three Cities case granted most of Reliant Energy's motions to
disregard the jury's findings. The trial court's rulings reduced the judgment to
$1.7 million, including interest, plus an award of $13.7 million in legal fees.
In addition, the trial court granted Reliant Energy's motion to decertify the
class. Following this ruling, 45 cities filed individual suits against Reliant
Energy in the District Court of Harris County.

On February 27, 2003, the state court of appeals in Houston rendered an
opinion reversing the judgment against CenterPoint Energy and rendering judgment
that the Three Cities take nothing by their claims. The court of appeals found
that the jury's finding of laches barred all of the Three Cities' claims and
that the Three Cities were not entitled to recovery of any attorneys' fees. The
judgment of the court of appeals is subject to motions for rehearing and an
appeal to the Texas Supreme Court.

The extent to which issues in the Three Cities case may affect the claims
of the other cities served by Reliant Energy cannot be assessed until judgments
are final and no longer subject to appeal. However, the court of appeals' ruling
appears to be consistent with Texas Supreme Court opinions. The Company
estimates the range of possible outcomes for recovery by the plaintiffs in the
Three Cities case to be between $0 and $18 million inclusive of interest and
attorneys' fees.

61

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Other Matters

The Company is involved in other legal, environmental, tax and regulatory
proceedings before various courts, regulatory commissions and governmental
agencies regarding matters arising in the ordinary course of business. Some of
these proceedings involve substantial amounts. The Company's management
regularly analyzes current information and, as necessary, provides accruals for
probable liabilities on the eventual disposition of these matters. The Company's
management believes that the disposition of these matters will not have a
material adverse effect on the Company's financial condition, results of
operations or cash flows.

(11) ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair values of cash and cash equivalents and short-term borrowings are
estimated to be equivalent to carrying amounts and have been excluded from the
table below.

(12) UNAUDITED QUARTERLY INFORMATION

Summarized quarterly financial data is as follows:

62

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

63

INDEPENDENT AUDITORS' REPORT

To the Member of CenterPoint Energy Houston Electric, LLC and subsidiaries:

We have audited the accompanying consolidated balance sheets of CenterPoint
Energy Houston Electric, LLC (formerly Reliant Energy, Incorporated) and its
subsidiaries (CenterPoint Houston) as of December 31, 2001 and 2002, and the
related statements of consolidated income, consolidated comprehensive income,
consolidated stockholder's and member's equity and consolidated cash flows for
each of the three years in the period ended December 31, 2002. Our audits also
included CenterPoint Houston's financial statement schedule listed in Item
15(a)(2). These financial statements and the financial statement schedule are
the responsibility of CenterPoint Houston's management. Our responsibility is to
express an opinion on these financial statements and the financial statement
schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of CenterPoint Houston at December
31, 2001 and 2002, and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, such financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.

As discussed in Note 2 to the consolidated financial statements,
CenterPoint Houston distributed its ownership interest in subsidiaries on August
31, 2002. The results of operations of these subsidiaries for periods prior to
the distribution are included in discontinued operations in the accompanying
consolidated financial statements.

DELOITTE & TOUCHE LLP

Houston, Texas
February 28, 2003

64

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

The information called for by Item 10 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly Owned
Subsidiaries).

ITEM 11. EXECUTIVE COMPENSATION

The information called for by Item 11 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly Owned
Subsidiaries).

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED SECURITY HOLDER MATTERS

The information called for by Item 12 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly Owned
Subsidiaries).

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information called for by Item 13 is omitted pursuant to Instruction
I(2) to Form 10-K (Omission of Information by Certain Wholly Owned
Subsidiaries).

PART IV

ITEM 14. CONTROLS AND PROCEDURES

Within the 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. Based
on that evaluation, the Chief Executive Officer and the Chief Financial Officer
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information relating to us (including our consolidated
subsidiaries) required to be included in our periodic SEC filings. Subsequent to
the date of their evaluation, there were no significant changes in our internal
controls or in other factors that could significantly affect the internal
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)(1) Financial Statements

Statements of Consolidated Income for the Three Years Ended
December 31, 2002......................................... 32
Statements of Consolidated Comprehensive Income for the
Three Years Ended December 31, 2002....................... 33
Consolidated Balance Sheets at December 31, 2001 and 2002... 34
Statements of Consolidated Cash Flows for the Three Years
Ended December 31, 2002................................... 35
Statements of Consolidated Stockholder's and Member's Equity
for the Three Years Ended December 31, 2002............... 36
Notes to Consolidated Financial Statements.................. 37
Independent Auditors' Report................................ 64

65

(a)(2) Financial Statement Schedules for the Three Years Ended December 31,
2002

Schedule II -- Reserves..................................... 67

The following schedules are omitted because of the absence of the
conditions under which they are required or because the required information is
included in the financial statements:

I, III, IV and V.

(a)(3) Exhibits

See Index of Exhibits on page 71.

(b) Reports on Form 8-K

On October 11, 2002, we filed a Current Report on Form 8-K dated
October 11, 2002, to announce that CenterPoint Energy, Inc., our parent
company, had negotiated new, one-year credit facilities totaling $4.7
billion to replace similar facilities that expired on October 10, 2002.

On November 8, 2002, we filed a Current Report on Form 8-K dated
November 8, 2002, to announce that CenterPoint Energy, Inc., had negotiated
a new $1.31 billion senior secured credit facility at CenterPoint Energy
Houston Electric, LLC.

66

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC AND SUBSIDIARIES
(AN INDIRECT WHOLLY OWNED SUBSIDIARY OF CENTERPOINT ENERGY, INC.)

SCHEDULE II -- RESERVES
FOR THE THREE YEARS ENDED DECEMBER 31, 2002

- ---------------

(1) Deductions from reserves represent losses or expenses for which the
respective reserves were created. In the case of the uncollectible accounts
reserve, such deductions are net of recoveries of amounts previously written
off.

67

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Houston, the State of Texas, on the 11th day of March, 2003.

CENTERPOINT ENERGY HOUSTON ELECTRIC,
LLC
(Registrant)

By: /s/ DAVID M. MCCLANAHAN
------------------------------------
David M. McClanahan
Chairman

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 11, 2003.

68

CERTIFICATIONS

I, David M. McClanahan, certify that:

1. I have reviewed this annual report on Form 10-K of CenterPoint Energy
Houston Electric, LLC;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.

Date: March 11, 2003

By /s/ DAVID M. MCCLANAHAN
-----------------------------------
David M. McClanahan
Chairman and Principal Executive
Officer

69

CERTIFICATIONS

I, Gary L. Whitlock, certify that:

1. I have reviewed this annual report on Form 10-K of CenterPoint Energy
Houston Electric, LLC;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;

b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.

Date: March 11, 2003

By /s/ GARY L. WHITLOCK
-----------------------------------
Gary L. Whitlock
Executive Vice President and Chief
Financial Officer

70

CENTERPOINT ENERGY HOUSTON ELECTRIC, LLC

EXHIBITS TO THE ANNUAL REPORT ON FORM 10-K
FOR FISCAL YEAR ENDED DECEMBER 31, 2002

INDEX OF EXHIBITS

Exhibits not incorporated by reference to a prior filing are designated by
a cross (+); all exhibits not so designated are incorporated herein by reference
to a prior filing as indicated.