United States General Accounting Office

GAO Report to the Committee on Agriculture,

Nutrition, and Forestry, U.S. Senate

January 1998 RURAL UTILITIES

SERVICE

Opportunities to

Operate Electricity and

Telecommunications

Loan Programs More

Effectively

GAO/RCED-98-42

GAO United States

General Accounting Office

Washington, D.C. 20548

Resources, Community, and

Economic Development Division

B-278588 

January 21, 1998

The Honorable Richard G. Lugar

Chairman

The Honorable Tom Harkin

Ranking Minority Member

Committee on Agriculture, Nutrition,

 and Forestry

United States Senate

The U.S. Department of Agriculture’s (USDA) Rural Utilities Service (RUS)

has used its loan programs to successfully finance the development of

electricity and telecommunications infrastructure in rural areas for many

years.1 RUS’ loans are intended to assist in the development of sparsely

populated rural areas. Recently, the agency wrote off more than

$1.7 billion on electricity loans held by a handful of borrowers that did not

repay them. More write-offs are anticipated. In April 1997, we reported on

the financial condition of RUS’ multibillion-dollar portfolio of electricity

and telecommunications loans.2

 In summary, that report showed that at

the end of fiscal year 1996, about $8 billion of the $37.5 billion in

outstanding principal on these loans was held by borrowers experiencing

financial problems. We also reported that at the end of calendar year 1995,

most electricity and telecommunications loan borrowers had favorable

financial characteristics.

In response to the information contained in our April 1997 report, you

requested that we conduct a follow-up study focusing on RUS’ program

operations. Specifically, you asked us to identify ways to (1) make the

electricity and telecommunications loan programs more effective and less

costly for the government and (2) decrease RUS’ vulnerability to loan

losses. You also requested that we compile loan information on

commercial lenders that have a significant level of lending for rural

electricity and telecommunications purposes.

Results in Brief This report identifies a number of options that the Congress could

consider to make the Rural Utilities Service’s electricity and

telecommunications loan programs more effective and less costly.

1

RUS operates the electricity and telecommunications loan programs formerly administered by

USDA’s Rural Electrification Administration. In this report, we refer to these loan programs as RUS’

programs.

2

Rural Development: Financial Condition of the Rural Utilities Service’s Loan Portfolio

(GAO/RCED-97-82, Apr. 11, 1997).

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Specifically, because the loan programs are intended to assist in the

development of the nation’s rural areas, targeting loans to borrowers that

provide services to areas with low populations could result in the more

effective use of the agency’s limited loan funds. Current lending practices

sometimes result in loans to borrowers serving areas that are heavily

populated. Additionally, targeting subsidized direct loans to borrowers

that need the agency’s assistance to fund their utility projects could result

in the more effective use of the loan funds and reduce the level of

subsidized loans and program costs. Currently, the agency sometimes

makes its subsidized direct loans to borrowers capable of using their own

resources or of obtaining loans from the private sector to fund their utility

projects. Finally, graduating the agency’s financially viable borrowers from

direct loans to commercial credit could also reduce program costs. Many

of the agency’s borrowers are potential candidates for credit from the

commercial sector.

Opportunities also exist to decrease the Rural Utilities Service’s

vulnerability to losses. Specifically, the agency’s vulnerability could be

lessened if loan and indebtedness limits were established. Some

borrowers have been able to obtain large-dollar loans and accumulate

large amounts of debt because such limits are generally lacking.

Additionally, the repayment guarantee that the agency places on loans

made by other lenders could be reduced so that lenders holding the

guaranteed loans bear some portion of the financial risk. Currently, the

agency guarantees the repayment of loans made by other lenders at

100 percent. However, because all guaranteed loans in recent years have

been made by the Treasury’s Federal Financing Bank, the risk to the

federal government as a whole would not be reduced if the Federal

Financing Bank continues to be the sole source of loan funds. Finally,

lending policies could be strengthened to ensure that loans are not made

to delinquent borrowers or to borrowers that have caused the Rural

Utilities Service to incur loan losses. Although the agency did not make or

guarantee loans to such borrowers during the period covered by our

review, there are no policies prohibiting additional loans to such

borrowers.

The Rural Utilities Service is not the only provider of credit to rural

utilities. Specifically, two commercial lenders are actively involved in

lending to rural electricity and telecommunications providers. These two

lenders had approximately $13.1 billion in outstanding principal on loans

for rural electricity and telecommunications purposes as of June 30,

1997—an amount equal to 36.4 percent of the outstanding principal on the

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Rural Utilities Service’s loans. The largest lender—the National Rural

Utilities Cooperative Finance Corporation and its affiliated lending

organizations—had about $8.9 billion in rural utility loans, and two

banking elements of the Farm Credit System had a total of $4.2 billion in

rural utility loans.

Background RUS, established by the Federal Crop Insurance Reform and Department of

Agriculture Reorganization Act of 1994 (P.L. 103-354, Oct. 13, 1994),

administers the electricity and telecommunications loan programs that

formerly were operated by the Rural Electrification Administration (REA).3

As part of a general program of unemployment relief, REA was first

established by executive order in 1935 to provide loan funds to support the

electrification of rural America. At that time, most utilities served

high-density areas and did not extend lines to farmers and other rural

residents. In 1936, REA was given the statutory authority to operate the

electricity loan program, and in 1939, REA became part of USDA. In 1949, REA

was authorized to lend funds for telephone services in rural areas.

In recent years, RUS has made or guaranteed an average of about

$1.4 billion per year in loans to help borrowers develop, upgrade, or

expand their electricity and telecommunications systems. As of June 30,

1997, the outstanding principal on RUS’ electricity and telecommunications

loans totaled about $36 billion. The Rural Electrification Act of 1936, as

amended (7 U.S.C. 901 et seq.), referred to as the RE Act, provides the

basic statutory authority for the electricity and telecommunications

programs.

Electricity Loans RUS makes electricity loans—both direct and guaranteed—primarily to

electric cooperatives.4

 It makes direct loans to construct and maintain the

distribution facilities that provide electricity to users. It also provides

guarantees on loans that are made by other lenders for financing the

construction, repair, and improvement of electricity generating and

transmission facilities. Nearly all borrowers with electricity loans are

nonprofit cooperatives.

3

RUS also operates USDA’s water and waste disposal loan program, which was not included in this

review.

4

Cooperatives are organizations owned by and operated for the benefit of those using their services.

Utility cooperatives are owned by the consumers, who elect boards of directors responsible for policy

and operations.

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RUS’ direct loans include both hardship rate loans and municipal rate loans.

Hardship rate loans are made to borrowers that meet the following

criteria: (1) Their customers have below-average per capita income or

below-average median household income for the state, and (2) they have a

relatively high cost for providing service, as indicated by a high average

revenue per kilowatt-hour sold. Hardship rate loans have a 5-percent

interest rate. Generally, municipal rate loans are made to qualified

borrowers that do not meet the criteria for hardship rate loans. Municipal

rate loans have an interest rate that is tied to an index of municipal bond

rates; the rate can change quarterly.

All electricity loans on which RUS has provided repayment guarantees in

recent years have been made by the Treasury’s Federal Financing Bank

(FFB). These loans have an interest rate equal to the Treasury’s cost of

money plus one-eighth of 1 percent. While RUS can also guarantee

electricity loans made by commercial lenders, it has not done so in recent

years because borrowers have applied for loans from the FFB, which has

lower interest rates than those available from commercial lenders.

Telecommunications Loans RUS makes telecommunications loans—both direct and

guaranteed—primarily to commercial telephone companies and

cooperatives to build and improve telephone and telecommunications

facilities and services. These loans are also made for advanced

telecommunications facilities and services, such as fiber-optic cabling,

digital-switching equipment, and educational television applications.

About 72 percent of the borrowers with telecommunications loans are

for-profit companies, while the others are mostly nonprofit cooperatives.

RUS’ direct loans are hardship rate loans and cost-of-money rate loans.

Hardship rate loans are made to borrowers that meet the following

criteria: (1) an average of four or fewer customers per mile of

telecommunications line in their current service areas, (2) income that is 1

to 3 times more than their interest expenses, and (3) an average of 17 or

fewer customers per mile in the area to be served by the project to be

funded with the loan. These loans have a 5-percent interest rate. Generally,

cost-of-money rate loans are made to borrowers that do not qualify for

hardship rate loans and that have an income of 1 to 5 times more than

their interest expenses; these loans have an interest rate that matches

USDA’s cost of money, which currently exceeds the rate for hardship rate

loans. RUS also administers the Rural Telephone Bank (RTB) loan program,

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B-278588 

in which direct loans are made concurrently with cost-of-money rate

loans.5 RTB loans have an interest rate that matches RTB’s cost of money.

RUS also provides guarantees on loans made to commercial telephone

companies and cooperatives. As with electricity loans, all guaranteed

telecommunications loans in recent years have been made by the FFB, at an

interest rate equal to the Treasury’s cost of money plus one-eighth of

1 percent. RUS guaranteed only FFB loans because borrowers applied for

FFB loans rather than for commercial lenders’ loans.

RUS’ Loan Obligations in

Recent Years

During fiscal year 1994 through the first three-quarters of fiscal year 1997,

RUS made or provided guarantees on 926 electricity and

telecommunications loans; these loans totaled about $4.9 billion. Table 1

shows the total number and amount of loans made in each program during

this period.

Table 1: Total Number and Amount of

Electricity and Telecommunications

Loans Made or Guaranteed by RUS, by

Loan Type, Fiscal Years 1994 Through

June 30, 1997

Dollars in millions

Program/Loan type Total number of loans

Total dollar amount of

loans

Electricity

Direct hardship rate 97 $341.6

Direct municipal rate 401 1,945.4

Subtotal, direct 498 $2,286.9a

Guaranteed 36 835.5

Total electricity 534b $3,122.4

Telecommunications

Direct hardship rate 49 255.4

Direct cost-of-money rate 157 730.9

Direct RTB 157 544.7

Subtotal, direct 363 $1,531.0

Guaranteed 29 257.5

Total telecommunications 392c $1,788.5

aFigures do not add to subtotal because of rounding.

bA total of 457 borrowers obtained these 534 electricity loans.

cA total of 190 borrowers obtained these 392 telecommunications loans. In this program,

borrowers frequently receive a combination of loan types—e.g., hardship rate and concurrent

cost-of-money rate and RTB loans.

Source: RUS’ reports.

5

RTB is a government-private corporation with federal agency status until it is privatized through the

retirement of the stock that the government owns. Privatization began in fiscal year 1996.

Page 5 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

Outstanding Principal

Owed on RUS’ Electricity

and Telecommunications

Loans

According to RUS’ reports, the outstanding principal owed on electricity

and telecommunications loans totaled about $36 billion as of June 30,

1997. Table 2 shows the amount owed in each program.

Table 2: Amount of Outstanding

Principal on Electricity and

Telecommunications Loans Made or

Guaranteed by RUS, as of June 30,

1997

Dollars in millions

Loan type Electricity loans

Telecommunications

loans

RUS’ direct loans $11,369.1 $3,385.4

RTB’s direct loans 0 1,428.7

Guaranteed FFB loans 12,989.5 333.4

Other guaranteed loans 649.9 1.8

Restructured loansa 5,838.9 0

Total $30,847.4 $5,149.3

aRestructured loans are loans for which the original loan agreements have been altered, including

revised repayment schedules and changes in interest rates. These loans include previously

issued (1) direct loans made by RUS, (2) guaranteed loans made by the FFB, (3) guaranteed

loans made by commercial lenders on which RUS agreed to be directly liable for repaying the

loans, and (4) loans that had been owed by borrowers now assumed by other utilities. The

amounts cover the principal and the capitalized interest owed on the loans. The loans in this

category are not included in the other direct and guaranteed loan categories.

Source: RUS’ reports.

Opportunities Exist to

Make the Loan

Programs More

Effective and Less

Costly

RUS’ electricity and telecommunications loans are intended to assist in the

development of the nation’s rural areas. Modifying certain aspects of the

electricity and telecommunications loan programs could aid in reaching

this goal while reducing the government’s cost. First, lending practices

could be modified to ensure that the loans benefit areas with low

populations, thereby more effectively using the agency’s limited loan

funds. Currently, borrowers serving areas that are heavily populated

sometimes receive loans. Second, RUS’ subsidized direct loans could be

focused on borrowers that are not capable of using their own resources or

of obtaining loans from the private sector to fund their utility projects.

Targeting subsidized direct loans to borrowers in need of federal

assistance could result in the more effective use of the loan funds.6

Currently, financially healthy borrowers sometimes receive these

subsidized loans. Finally, a graduation program could be instituted to

attempt to move RUS’ financially viable borrowers with direct loans to

commercial sources of credit. This action could allow the agency to

6

In addition, the cost to the government could be less if the targeted borrowers required a lower dollar

volume of subsidized loans than those currently receiving loans.

Page 6 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

reduce the interest and administrative-servicing expenses that it now

incurs.

Loans Are Sometimes

Made to Borrowers Serving

Large Customer

Populations

A fundamental concept of both the electricity and the telecommunications

loan programs is that funds are to be provided to borrowers for delivering

service to sparsely populated rural areas. RUS’ regulations require

borrowers in both programs to establish that they serve rural areas when

they apply for their first loan. Generally, for a new borrower, the

population threshold is less than 2,500 for the electricity program and no

more than 5,000 for the telecommunications program. However, in both

programs, subsequent loans for service can be made without the

borrower’s having to meet the initial test of serving a rural area. In

addition, as the RE Act allows, telecommunications loans can be made for

service to nonrural areas when that service is considered incidental to

providing service to a rural area.

We found that RUS sometimes makes loans to existing borrowers for

providing service to areas where the population exceeds original

thresholds for rural areas. For example, an electricity distribution

borrower that first received a loan in 1945 received another loan in 1996;

in the year prior to receiving this recent loan, the borrower had almost

140,000 customers. This borrower provided service to customers in five

counties; one county had about 55,800 residential customers, and another

had about 45,100 residential customers. None of these counties was

classified as completely rural by USDA’s Economic Research Service—all

contained an urban population that exceeded 2,500. Furthermore, two of

the counties were within a metropolitan area having a population of at

least 1 million. Likewise, a telecommunications borrower that first

received a loan in 1964 received another loan in 1996; this borrower had

about 49,600 residential customers and about 13,700 business subscribers

in the year prior to receiving the latest loan. This borrower provided

service to customers located in one county, which also was identified by

the Economic Research Service as being a county within a metropolitan

area having a population that was between 250,000 and 1 million people.

While we did not evaluate the population density of the areas served by all

of RUS’ electricity and telecommunications borrowers, we did examine

customer service statistics as an indicator of population density.7

 We

found that 71 electricity distribution borrowers that received loans during

7

We recognize that some borrowers may serve multiple rural areas, which could result in their having a

high number of customers.

Page 7 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

calendar years 1994 through June 30, 1997, had more than 25,000

customers; 20 of these borrowers had more than 50,000 customers. Nine of

the telecommunications borrowers had more than 25,000 customers; five

of these borrowers served a customer base of more than 50,000. (See table

3.)8

Table 3: Number of Electricity

Distribution and Telecommunications

Borrowers That Obtained Loans

During Calendar Years 1994 Through

June 30, 1997, by Range of Customers

Electricity program Telecommunications program

Range of

customers

Number of

borrowers

Percentage of

borrowers

Number of

borrowers

Percentage of

borrowers

More than

100,000 4 0.9 0 0.0

50,001-100,000 16 3.7 5 3.0

25,001-50,000 51 11.8 4 2.4

10,001-25,000 156 36.1 12 7.1

5,001-10,000 104 24.1 33 19.6

2,501-5,000 75 17.4 39 23.2

2,500 or fewer 26 6.0 75 44.6

Total 432 100.0 168 100.0a

Note: This table covers borrowers that obtained loans from RUS during calendar years 1994

through June 30, 1997, and for which RUS’ databases contained information for the year prior to

the one in which the loans were made.

aFigures do not add to total because of rounding.

Source: GAO’s analysis of RUS’ automated databases, which contain information submitted by

electricity distribution and telecommunications borrowers.

Loans With Subsidized

Interest Rates Are Made to

Financially Healthy

Borrowers

Unlike the requirements for some other USDA rural credit programs—such

as the water and waste disposal, farm, single-family housing, and

community facilities loan programs—the RE Act does not require

electricity and telecommunications loan applicants to demonstrate that

they cannot obtain credit from other lenders before applying for a RUS

loan. The act also does not preclude a financially healthy borrower from

receiving a RUS loan. As a result, RUS’ loans are sometimes made to

financially healthy borrowers that may not need federal assistance to fund

their utility projects.9

 In addition, some financially healthy borrowers

8

RUS’ automated files contained operational data supplied by 432 electricity distribution and 168

telecommunications borrowers that received loans during calendar years 1994 through June 30, 1997.

9

In this section of the report, we use various financial measures that provide a broad prospective of the

financial strength of RUS’ borrowers. A more complete analysis would be needed to assess each

individual borrower’s financial circumstances.

Page 8 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

obtain municipal rate loan funds at interest rates lower than the rate

available on hardship rate loans.

Loans Are Made to Financially

Healthy Borrowers That May

Not Need RUS’ Assistance

The RE Act does not address the effect of an applicant’s financial health

on the applicant’s eligibility to obtain loans in either program. For

telecommunications loans, however, the relationship between income and

interest expenses influences the type of loan that an applicant may qualify

to receive. The RE Act does state that a loan cannot be denied or reduced

on the basis of a borrower’s level of general funds. However, a provision in

7 U.S.C. 930—a congressional policy declaration on RUS’ loan programs

that is not part of the RE Act—states that the agency’s electricity and

telecommunications borrowers should be encouraged and assisted in

satisfying their credit needs either internally or through other credit

sources.

Many electricity borrowers that obtained loans during calendar years 1994

through June 30, 1997, had favorable financial characteristics.10

Specifically, almost 56 percent of the borrowers had equity—total assets

less total liabilities—of $10 million or more at the end of the year prior to

receiving the loans, and another 43 percent had equity of between

$1 million and $10 million. In addition, about 40 percent of the borrowers

made a profit (net income) of $1 million or more in the year prior to

receiving the loans, and another 55 percent made a profit of between

$100,000 and $1 million.11 (App. I provides detailed information on

electricity loans to borrowers by various incremental ranges of equity and

profit.)

The electricity borrowers also had generally favorable current,

debt-to-asset, and times-interest-earned ratios (TIER). The current ratio is a

measure showing the extent to which a borrower has sufficient current

assets to cover its current liabilities. About 41 percent of the borrowers

had a current ratio of 2 or more times, indicating that their level of current

assets was at least twice the level of their current liabilities. The

debt-to-asset ratio reflects a borrower’s debt as a percentage of its

assets—it shows the extent to which a borrower has sufficient assets to

cover all of its debt. Eighty-six percent of the borrowers had a generally

favorable debt-to-asset ratio of 70 percent or less, including 7 percent

10RUS’ automated files contained financial data supplied by 452 electricity borrowers—432 distribution

and 20 power supply borrowers—that received loans during calendar years 1994 through June 30,

1997.

11RUS refers to the profits made by electricity and telecommunications borrowers that are nonprofit

cooperatives as “net margins.”

Page 9 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

whose ratio was no more than 40 percent. The TIER shows the extent to

which a borrower can pay its annual interest expenses from its net

income. Sixty-two percent of the borrowers had a TIER of 2 or more times,

which reflects their having at least twice the level of net income as interest

expenses. (App. I also provides detailed information on electricity loans to

borrowers by various incremental ranges of these three ratios.)

The following are examples of electricity loans to borrowers that had high

levels of equity and/or profit. A distribution borrower that received a

$4.5 million loan in 1997 had equity of $48.7 million, or almost 11 times the

loan amount, at the end of 1996; this borrower also had $5.1 million in

profit in 1996. Another distribution borrower had over 3 times more profit

than the RUS loan amount. Specifically, this borrower received a $630,000

loan in 1994 and had a profit of $2.1 million in 1993; this borrower also had

$12.2 million in equity at the end of 1993. Likewise, a power supply

borrower that received a $5.3 million loan in 1995 had $9.1 million in profit

in 1994; this borrower had $226.4 million in equity at the end of 1994.

Many telecommunications borrowers that obtained loans during calendar

years 1994 through June 30, 1997, also had favorable financial

characteristics.12 Specifically, about 24 percent of the borrowers had

equity of $10 million or more at the end of the year prior to receiving the

loans, and another 65 percent had equity of between $1 million and

$10 million. In addition, about 29 percent of the borrowers made a profit of

$1 million or more in the year prior to receiving the loans, and another 61

percent made a profit of between $100,000 and $1 million. Furthermore,

about 80 percent of the borrowers had a current ratio of 2 or more times,

83 percent had a debt-to-asset ratio of 70 percent or less, and 87 percent

had a TIER of 2 or more times. (App. I provides detailed information on

telecommunications loans to borrowers by various incremental ranges of

equity and profit, as well as these three ratios.)

The following are examples of telecommunications loans to borrowers

that had high levels of equity and/or profit. A borrower that received a

$1.1 million loan in 1995 had equity of about $9.2 million, or more than 8

times the loan amount, at the end of 1994; this borrower also had $800,000

in profit in 1994. Another borrower that received a loan of $10.4 million in

1994 had $11.7 million in profit in 1993; this borrower also had

$82.9 million in equity at the end of 1993.

12RUS’ automated files contained financial data supplied by 168 telecommunications borrowers that

received loans during calendar years 1994 through June 30, 1997.

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RUS incurs a considerable expense in providing direct loans to financially

healthy borrowers. The principal cost is associated with the interest rate

subsidies—the interest costs associated with loans made at rates below

the rate at which RUS borrows from the Treasury.13 Specifically, RUS’

estimated total subsidy costs (not including its administrative costs) on

direct electricity and telecommunications loans made during fiscal years

1994 through 1996 totaled $227.5 million: $49.6 million on hardship rate

loans and $148.9 million on municipal rate loans in the electricity program

(many more municipal rate loans than hardship rate loans were made) and

$29 million on hardship rate loans in the telecommunications program. We

did not quantify the portion of this estimated cost that relates to interest

rate subsidies and the portion that relates to default costs, fees, and other

costs. However, hardship rate loans in both programs are made at interest

rates that are less than RUS’ cost of acquiring funds from the Treasury. The

interest rates on municipal rate loans are based on the rates in effect for

municipal obligations of similar maturities; the rates on these loans are

also less than RUS’ cost of borrowing. In addition, RUS has had few

repayment problems with its direct loans. Finally, RUS estimated the

subsidy costs on the cost-of-money rate loans made during this 3-year

period at a far lower amount—$0.1 million. These loans do not have an

interest rate subsidy because they are made at rates that match RUS’ cost of

borrowing.

Financially Healthy Borrowers

Obtain Municipal Rate Loans at

Interest Rates Lower Than the

Rate on Hardship Loans

Currently, some financially healthy borrowers are obtaining municipal rate

loan funds at interest rates that are less than the 5-percent rate available

on hardship loans. More specifically, after RUS approves a loan application,

a borrower obtains loan funds by taking advances (drawdowns) against

the loan. All advances on hardship rate loans bear interest at 5 percent.

However, each advance on municipal rate loans bears interest at a rate

based on an index of municipal bond rates, which can change each

calendar quarter. At the beginning of each quarter, RUS publishes a

schedule of the interest rates applicable to advances taken during the

quarter. A borrower may take up to eight separate advances of funds on an

approved municipal rate loan. For each advance, the borrower selects an

interest rate term, which is the period of time used to determine the

interest rate. The minimum interest rate term is 1 year, and the maximum

is the number of years corresponding to the final maturity date of the loan.

13The Federal Credit Reform Act of 1990, which was included as title 13B of the Omnibus Budget

Reconciliation Act of 1990 (P.L. 101-508, Nov. 5, 1990), changed the way post-fiscal year 1991 credit

programs are reported. Subsidy cost under credit reform includes net present value estimates of

(1) interest costs associated with loans made at rates below the rate at which RUS borrows from the

Treasury, (2) default costs, (3) fees, and (4) other costs and revenues.

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By selecting shorter interest rate terms, borrowers can obtain interest

rates on advances for municipal rate loans that are less than 5 percent. As

a result, a borrower with a municipal rate loan can borrow at a lower cost

than can a borrower with a hardship rate loan. Specifically, interest rates

of less than 5 percent were available on advances for municipal rate loans

in 14 of the 15 quarters between January 1, 1994, and September 30, 1997.

The lowest rate available in the 15th quarter was 5 percent. As table 4

shows, the interest rates in effect for July 1, 1997, through September 30,

1997, included a range of 3.875 percent for a 1-year interest rate term to

4.875 percent for a 9-year interest rate term.

Table 4: Range of Interest Rates on

Municipal Rate Loan Advances Taken

During July 1, 1997, Through

September 30, 1997

Range of interest rate terms Range of interest rates

1 year to 9 years 3.875 to 4.875 percent

10 and 11 years 5.0 percent

12 years or more 5.125 to 5.5 percent

Source: 62 Fed. Reg. 121 (June 24, 1997).

At the end of the interest rate term selected by the borrower for each

advance, the borrower has the option of repaying the remaining portion of

the advance or rolling it over for a new interest rate term. If the borrower

rolls over the remaining amount, depending on the interest rates in effect

at that time, the borrower may again obtain an interest rate of less than

5 percent by selecting another short term. However, the borrower runs the

risk that interest rates may have increased from the rate initially selected.

Many borrowers that took advances on municipal rate loans obtained

interest rates of less than 5 percent. Specifically, 115 borrowers took a

total of 210 advances with interest rates of less than 5 percent on

municipal rate loans approved during fiscal years 1994 through June 30,

1997. The total amount of these advances was $242 million. For example, a

borrower with about 29,500 customers had $25.1 million in equity at the

end of 1994. In February 1995, RUS approved a $24.7 million loan, and in

August 1995, the borrower took a $12.4 million advance. The borrower

selected a 5-year interest rate term and obtained a 4.625-percent interest

rate. Another borrower with about 15,400 customers had $19.6 million in

equity at the end of 1995. In April 1996, RUS approved an $11 million loan,

and in February 1997, the borrower took a $9.4 million advance. This

borrower selected a 1-year interest rate term and obtained a 3.875-percent

interest rate.

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A Graduation Program

Could Assist in Moving

Financially Healthy Direct

Loan Borrowers to

Commercial Credit

While RUS’ water and waste disposal loan program has graduation

requirements, the RE Act does not require RUS to attempt to move

financially healthy direct loan borrowers in the electricity and

telecommunications programs to commercial credit sources. RUS officials

told us that they have not instituted a graduation procedure because the

RE Act is silent on this issue. Because graduation is not an integral part of

RUS’ operation of these two programs, some borrowers may have direct

loans longer than needed and are therefore able to take advantage of the

favorable terms that exist with such loans. As a result, RUS continues to

incur interest and other administrative expenses in servicing the accounts

of its financially healthy borrowers.

Many electricity and telecommunications borrowers with outstanding

direct loans as of December 31, 1996, had favorable financial

characteristics indicating that they may be viable candidates for having the

commercial sector refinance their RUS debt.14 Specifically, about 39

percent of the borrowers had equity of $10 million or more at the end of

calendar year 1996, and another 57 percent had equity of between

$1 million and $10 million. In addition, 36 percent of the borrowers made a

profit of $1 million or more in 1996, and another 57 percent made a profit

of between $100,000 and $1 million.

For example, in the electricity program, one distribution borrower with

about $146,000 in outstanding direct loan debt had $27.6 million in equity

at the end of 1996 and had made $1.7 million in profit in 1996. This

borrower also had a current ratio of 2.3, debt-to-asset ratio of 7 percent,

and TIER of 534.6. (These three ratios were previously discussed for the

electricity borrowers that received loans during calendar years 1994

through June 30, 1997.) In the telecommunications program, a borrower

with about $1.8 million in outstanding direct loans had over $23.4 million

in equity, $4.2 million in profit, and a current ratio of 11.7, debt-to-asset

ratio of 11 percent, and TIER of 31.2.

Although RUS has no systematic graduation program, borrowers with

direct electricity loans may initiate graduation on their own. That is, the

RE Act allows a borrower to prepay its outstanding direct electricity loan

at a discount—the discounted prepayment amount is the present value of

a borrower’s outstanding debt. Therefore, borrowers can graduate by

seeking and obtaining other financing. The act also provides that a

borrower that prepays at a discount cannot obtain another direct loan

14RUS’ automated files contained financial data supplied by about 1,600 borrowers that had

outstanding direct loans as of December 31, 1996.

Page 13 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

from RUS for 10 years from the prepayment date. If eligible, however, such

borrowers could obtain a guaranteed loan.

RUS’ records show that during fiscal years 1994 through June 30, 1997, a

total of 107 borrowers prepaid their direct electricity loans at a discount.

Their total outstanding debt was more than $1.5 billion, the prepayment

amount was about $1.3 billion, and the discount was about $239 million.

Other USDA rural credit programs generally have graduation procedures.

For example, RUS’ regulations provide for periodic reviews of financial

information submitted by direct loan borrowers in its water and waste

disposal loan program to determine if the borrowers are likely graduation

candidates. When graduation appears possible, a borrower or RUS may

submit financial information to other lenders to see if they would

refinance the borrower’s outstanding direct loan.

Opportunities Exist to

Decrease RUS’

Vulnerability to Loan

Losses

From a financial standpoint, RUS has successfully operated the

telecommunications loan program, but the agency has had, and continues

to have, significant financial problems with the electricity loan program.

Modifying certain aspects of both loan programs could reduce the

agency’s vulnerability to losses on new loans. First, loan and indebtedness

limits could be imposed. Currently, the loan programs generally lack

limits, and, as a result, some borrowers have obtained large-dollar loans

and accumulated large levels of debt. Second, the repayment guarantee

that RUS places on loans made by other lenders could be reduced so that

the lenders participating in RUS’ programs would share in the risk of the

loans they make. Currently, RUS guarantees 100 percent of other lenders’

loans. However, because all guaranteed loans in recent years have been

made by the FFB, the risk to the federal government as a whole would not

be reduced if the FFB continues to be the sole source of loan funds. Finally,

policies could be strengthened to ensure that additional loans are not

made to borrowers that are delinquent or that have caused RUS prior

losses. While RUS did not make or guarantee loans to such borrowers

during the period covered by our review, there are no policies to prevent

loans to such borrowers from being made in the future.

Electricity Program

Continues to Be Vulnerable

to Loan Losses

During fiscal years 1994 through June 30, 1997, RUS wrote off the debt of

five electricity loan borrowers; these write-offs totaled more than $1.7

billion. In February 1994, RUS wrote off about $14 million of debt for a

distribution borrower. In addition, RUS wrote off debt for four power

Page 14 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

supply borrowers: about $52 million in August 1995, $982 million in

September 1996, $502 million in October 1996, and $165 million in

June 1997. The majority of these loan losses resulted from investments in

nuclear power plants that were either constructed at costs substantially

higher than initial projections or abandoned during the construction

phase. No borrowers’ telecommunications loans were written off during

this period.

Additionally, a small number of borrowers still in the electricity program

are experiencing serious financial difficulties. These difficulties expose

RUS to the risk of more write-offs in the future. As of June 30, 1997, RUS had

three borrowers that were delinquent (at least 30 days past due) on

scheduled loan payments totaling over $1.2 billion: A distribution

borrower was past due on payments of $8.5 million, and two power supply

borrowers were past due on payments of $55.2 million and about $1.2

billion, respectively. At the end of June 1997, RUS also had 10 other

borrowers—all power supply borrowers—that were experiencing financial

distress: They were in bankruptcy, were likely to default on repaying the

loans, or had formally requested debt relief. These borrowers owed a total

principal of about $7.7 billion on their RUS loans: Six owed between

$100 million and $500 million each, two owed between $500 million and

$1 billion each, and two owed more than $1 billion each. As we reported in

April 1997, these borrowers’ problems generally stem from their

investments in nuclear-generating plants that were completed late and

over budget or in coal-fired generating plants that were built to satisfy

anticipated industrial growth that did not occur. On the other hand, no

borrowers with outstanding RUS telecommunications loans were

delinquent or otherwise financially stressed.

Furthermore, our April 1997 report stated that RUS’ electricity loan

portfolio faces the possibility of additional financial stress because of

increasing competition among the providers of electricity.15 Competition

in the wholesale electricity market is increasing as a result of legislation

that was enacted in the early 1990s, such as the Energy Policy Act of 1992

(P.L. 102-486, Oct. 24, 1992). The act encouraged additional wholesale

suppliers to enter the electricity market and provided greater access to

other utilities’ transmission lines. Additionally, the industry in which RUS’

telecommunications loan borrowers operate is changing. In particular,

there have been rapid advances in technology and changes in the

legislative environment, such as the Telecommunications Act of 1996 (P.L.

15We also reported similar results in Federal Electricity Activities: The Federal Government’s Net Cost

and Potential for Future Losses (GAO/AIMD-97-110, Sept. 19, 1997).

Page 15 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

104-104, Feb. 8, 1996). These factors could work to either the betterment

or the detriment of the borrowers that have telecommunications loans.

Loan and Debt Limits

Could Reduce RUS’

Vulnerability to Losses

The RE Act does not limit the amount of an electricity or a

telecommunications loan that a borrower may receive or the amount of

outstanding indebtedness that a borrower may accumulate through

multiple loans. RUS’ vulnerability to losses on future loans in the operation

of these two credit programs could be reduced if limits were imposed.

RUS has set loan limits only for direct telecommunications loans.

Specifically, the maximum amount of a hardship rate telecommunications

loan to any one borrower is the lesser of (1) up to 10 percent of the annual

loan appropriation or (2) $7 million, an operational level set

administratively by the agency in fiscal year 1996. RUS set this maximum

amount in order to distribute its limited funds among the largest number

of qualified borrowers. Similarly, to ensure that its cost-of-money rate and

RTB loan funds are broadly dispersed, on September 5, 1997, RUS published

a change to its regulations, providing a limit of 10 percent of the annual

loan appropriation to any single borrower. This change became effective

on October 6, 1997.

RUS officials in both programs told us that they had not set limits for the

other loan types—all electricity loans and guaranteed telecommunications

loans—or limits on the amount of debt that a borrower can accumulate

because the RE Act does not require limits. Electricity program officials

added that they believe they need to be able to provide an applicant with

the level of funds needed to support the proposed project.

The general lack of loan limits has allowed RUS to make large-dollar loans

to some borrowers. Specifically, while most electricity loans approved

during fiscal years 1994 through June 30, 1997, were for less than

$10 million, a total of 77 loans, or about 14 percent of the loans, were for

$10 million or more. These 77 loans totaled about $1.6 billion, or 51.7

percent of the amount for all loans approved during the period. Similarly,

while most telecommunications loans were made for less than $10 million,

a total of 36 loans, or about 9.2 percent, were for $10 million or more.

These 36 loans totaled about $653 million, or 36.5 percent of the amount

for all loans approved during the period. (App. II provides detailed

information on loans to borrowers by loan size.)

Page 16 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

In addition to the general absence of limits on individual loans, borrowers

do not have any limits on the total amount of debt that they can

accumulate through multiple loans. As a result, some borrowers owe a

high dollar amount of outstanding principal. For example, 128 borrowers

with outstanding direct loans in the electricity program as of June 30, 1997,

each owed more than $20 million; one owed about $122 million. In the

telecommunications program, 38 borrowers with outstanding direct loans

each owed more than $20 million; one owed over $100 million.

Loan and debt limits exist in some, but not all, of USDA’s rural credit

programs. For example, USDA has loan and debt limits on its farm

ownership, operating, and emergency disaster loans and on its

single-family housing loans. Conversely, it has no limits on loans in other

programs, such as those made in the water and waste disposal loan

program.

A Lower Repayment

Guarantee Could Reduce

the Level of RUS’

Vulnerability to Losses

The RE Act allows RUS to guarantee repayment on electricity and

telecommunications loans made by the FFB or other lenders. The act also

requires that the guarantee be 100 percent. As of June 30, 1997, RUS had

about $19.8 billion in guaranteed loan debt on which it has full risk

exposure. Almost $14 billion of this amount was outstanding principal on

original loans with RUS guarantees, and about $5.8 billion was on

restructured loans. The lenders that made the loans—the FFB and a few

commercial lenders—have no risk exposure. Providing a guarantee of less

than 100 percent could reduce RUS’ vulnerability to losses from these two

credit programs. However, because all guaranteed loans in recent years

have been made by the FFB, the risk to the federal government as a whole

would not be reduced if the FFB continues to be the sole source of loan

funds.

According to FFB officials, providing a guarantee of less than 100 percent

could cause the FFB to stop making electricity and telecommunications

loans because it only participates in lending programs when there is full

security on its loans. Even if the guarantee remains unchanged, however, a

provision in the recently enacted Balanced Budget Act of 1997 (P.L.

105-33, Aug. 5, 1997) may affect the FFB’s willingness to continue making

loans to electricity and telecommunications borrowers. The act provides

that the surcharge on FFB loans, which is one-eighth of 1 percent over the

Treasury’s cost of borrowing, is to be deposited in the RUS account held by

the Treasury and used to finance the cost of these two loan programs. FFB

officials told us that this surcharge has generally offset its administrative

Page 17 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

cost of participating in RUS’ programs. The act also provides that the FFB

can require RUS to reimburse it for the administrative expenses incurred

that are attributable to the loans.

All loans that received RUS’ guarantees during fiscal years 1994 through

June 30, 1997, were made by the FFB. While the RE Act gives the borrower

the option of selecting the FFB or a commercial lender, RUS officials told us

that borrowers have selected the FFB because it offers lower interest rates.

According to FFB officials, some borrowers also turn to the FFB because the

large amount of money they need is probably more than commercial

lenders would provide. While this may be true, our analysis of guaranteed

loans made by the FFB and commercial lenders showed that some

commercial lenders provided large-dollar loans and that the FFB made a

number of small-dollar loans that could have been funded by commercial

lenders. For example, as of June 30, 1997, 10 power supply borrowers had

outstanding guaranteed loans from commercial lenders that had been

made before the start of fiscal year 1994—six of these had received loans

for more than $100 million each. In addition, even though the FFB is

thought of as a high-dollar lender, RUS’ records showed that 9 of the 36

electricity loans and 20 of the 29 telecommunications loans made by the

FFB during fiscal years 1994 through June 30, 1997, were for less than

$5 million.

USDA has less risk exposure when guaranteeing loans in other rural credit

programs, such as farm ownership and operations, single-family housing,

community facilities, business and industry, and water and waste disposal

loans. With each of these loan programs, the maximum allowable loan

guarantee is generally 90 percent. In some cases, such as RUS’ water and

waste disposal loans, the guarantees are usually at 80 percent.

Establishing Policies to

Preclude Loans to Certain

Risky Borrowers Would

Reduce Future Exposure

to Loss

A borrower that is delinquent on an electricity or a telecommunications

loan is not prohibited by the RE Act or by RUS’ regulations from obtaining

an additional loan. Likewise, a borrower that has caused RUS to incur loan

losses is not prohibited from obtaining another loan. Our review of RUS’

loan approval records showed that no delinquent borrower or one that

caused prior losses received loans during fiscal years 1994 through

June 30, 1997. While RUS did not make or guarantee loans to such

borrowers during this period, we believe that the agency’s ability to do so

is an area of concern that could, if loans were made, contribute to future

exposure to loss. Prohibiting loans to such risky borrowers is a way of

Page 18 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

ensuring that RUS does not add to its vulnerability in operating these two

credit programs.

RUS has had few delinquent borrowers and borrowers that have caused it

to incur losses in recent years. Specifically, as of June 30, 1997, three

electricity loan borrowers were delinquent; no telecommunications loan

borrowers were delinquent. Additionally, during fiscal years 1994 through

June 30, 1997, RUS wrote off the debt of five electricity loan borrowers,

which resulted in losses to RUS; no telecommunications borrowers had

loans written off.

RUS’ electricity and telecommunications loan officials told us that a

borrower has to be in good standing on its existing debts in order to obtain

a RUS loan. An official in the telecommunications program said that it

would be highly unlikely for an additional loan to be made to a borrower

that had caused a loss because RUS would have pursued foreclosure

proceedings against the borrower and would have required disposal of

assets as a part of the settlement that resulted in the loss. Nonetheless,

officials in both programs acknowledged that their regulations do not

prohibit loans to delinquent borrowers or to those that have caused prior

losses.

On September 26, 1997, RUS published a change to its electricity loan

regulations that, rather than denying loans to borrowers that have had

debts written off, provides guidance on what such borrowers need to

provide as a condition for obtaining another loan. RUS stated that in

considering a loan request from a borrower whose debt had been settled,

including debt written off, the borrower would be required to demonstrate

evidence of financial support for the amount of the requested loan. This

support could include increasing the level of the applicant’s equity or a

guarantee of debt repayment, either from the applicant’s members (in the

case of a power supply borrower) or from a third party.

Prior to the Federal Agriculture Improvement and Reform Act of 1996

(P.L. 104-127, Apr. 4, 1996), USDA provided some loans in another rural

credit program—farm loans—to delinquent borrowers and to those whose

prior performance resulted in losses for USDA. However, because of

concerns about the fiscal prudence of making loans to such borrowers,

coupled with the high level of delinquencies and losses that USDA had

experienced, the Congress enacted provisions in that act that generally

prohibit farm loans to such borrowers.

Page 19 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

Commercial Lending

for Rural Electricity

and

Telecommunications

Purposes

RUS is not the only provider of credit to rural utilities. Two commercial

lenders have a significant level of lending activity for rural electricity and

telecommunications purposes: (1) the National Rural Utilities Cooperative

Finance Corporation (CFC) and its various affiliated lending organizations

and (2) the Farm Credit System (FCS). These two commercial lenders had a

combined total of $13.1 billion in outstanding principal on loans for rural

electricity and telecommunications purposes as of June 30, 1997.

CFC provides electricity loans to its owners, such as distribution

cooperatives and power suppliers. CFC’s loans parallel RUS’ lending—that

is, loans are made for financing the construction, improvement, and repair

of electricity systems. Loans are also made for other purposes, such as

financing operations and business activities related to the borrowers’

electricity operations, including acquiring office buildings and equipment.

One of CFC’s affiliates—the Guaranty Funding Cooperative—made

electricity loans to CFC’s owners for refinancing their outstanding FFB debt.

Another affiliate—the Rural Telephone Finance Cooperative

(RTFC)—makes loans to rural telephone systems that are eligible to

participate in RUS’ telecommunications program. While RTFC finances some

infrastructure development, most of its financing is for activities that RUS

is not involved in, such as cellular telephone operations, or is involved in

to only a limited extent, such as the acquisition of local telephone

exchanges.

FCS lends primarily to agricultural producers and agricultural cooperatives.

However, two FCS banks—CoBank and the St. Paul (Minnesota) Bank for

Cooperatives—also make loans to rural utilities. CoBank is FCS’ national

bank for lending to rural utility systems and cooperatives. The St. Paul

Bank, although it also has a national charter, provides similar lending to

borrowers located primarily in four upper midwestern states (Michigan,

Minnesota, North Dakota, and Wisconsin). Both banks provide electricity

and telecommunications loans to RUS’ borrowers, rural utility systems that

are eligible to borrow from RUS, and the subsidiary organizations of these

borrowers or other eligible entities. As with CFC and RTFC, the loans from

these banks parallel RUS’ infrastructure lending and are also made for other

activities that RUS is not involved in or is involved in to only a limited

extent.

These lenders and their affiliated organizations had about $10.4 billion in

outstanding principal on electricity loans and about $2.8 billion in

outstanding principal on telecommunications loans as of June 30, 1997. As

Page 20 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

table 5 shows, CFC’s loans accounted for the greatest portion of this

amount.

Table 5: Amount of Outstanding

Principal on Electricity and

Telecommunications Loans Held by

Various Commercial Lenders, as of

June 30, 1997

Dollars in millions

Lender Electricity loans

Telecommunications

loans

CFCa $7,766.4 $0

RTFC 0 1,123.2

CoBank 2,144.5 1,292.9

St. Paul Bank 454.2 336.0

Total $10,365.1 $2,752.1

aIncludes loans made by CFC to distribution and power supply systems and loans made by

CFC’s Guaranty Funding Cooperative for refinancing FFB debt.

Source: Financial reports provided by each lender to GAO.

Additionally, the information provided to us by each of these lenders

shows that their electricity and telecommunications portfolios were

generally financially sound. For example, less than 1 percent of CFC’s $7.8

billion electricity loan portfolio was owed by delinquent borrowers.

Furthermore, since its inception in 1969 through the end of May 1997, CFC

wrote off a total of $28.4 million in electricity loans. According to CFC and

RTFC officials, no borrowers with RTFC telecommunications loans were

delinquent, and no such loans had been written off since RTFC’s inception

in 1987.

CoBank and the St. Paul Bank had similar experiences. Specifically, all

borrowers with electricity and telecommunications loans were current on

their loan repayment. In addition, according to their officials, CoBank has

not written off any electricity or telecommunications loans in recent years,

and the St. Paul Bank has never written off such a loan.

Conclusions and

Options for

Congressional

Consideration

RUS has had a long and successful role in contributing to the development

of the utility infrastructure in the nation’s rural areas. However, RUS is now

at a significant crossroads. The size of the population in the areas served

by many of RUS’ borrowers has changed over time, as have the financial

resources available to borrowers. Furthermore, spurred by recent

legislative and/or technological changes, increasing competition in the

electricity and telecommunications industries may have an impact on

many of the agency’s borrowers. We recognize that difficult decisions are

Page 21 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

necessary to improve the effectiveness and reduce the cost of these loan

programs as well as to decrease RUS’ vulnerability to losses in operating

the programs. It may be hard to accomplish all these objectives

simultaneously.

Recognizing that there would be trade-offs with any changes to RUS’

electricity and telecommunications loan programs, the Congress has a

number of options that it could consider in its deliberations on the future

of RUS’ programs, including the following:

• To ensure that RUS’ assistance is targeted to rural areas with sparse

populations, the Congress could apply a population threshold test to the

service areas of borrowers who apply for any RUS loan—not only for initial

loans but also for any subsequent loans.

• To target subsidized direct loans to borrowers in need of RUS’ assistance

and to control program costs, the Congress could make financial tests a

part of the eligibility criteria for the various types of direct loans in both

programs. Additionally, cost-of-money rate loans could be established in

the electricity program for borrowers that do not meet the financial tests

for municipal rate loans. Furthermore, the interest rates for municipal rate

loans and cost-of-money rate loans, if established in the electricity

program, could be set no lower than the rate on a hardship rate loan.

Finally, a test could be established to require a borrower to seek

commercial credit as a condition for RUS’ assistance.

• To assist in moving financially healthy borrowers with direct loans to the

commercial sector, the Congress could have RUS establish a graduation

program to require borrowers to attempt to have their outstanding direct

loans refinanced by commercial credit sources.

• To limit the level of the agency’s vulnerability to losses, the Congress

could set limits on the total amount of money that RUS provides or

guarantees on any one loan and on the total amount of outstanding debt

that any one borrower can accumulate through a combination of loans.

• To further control RUS’ vulnerability to losses on guaranteed loans, the

Congress could set the repayment provision at less than 100 percent.

• To ensure that RUS does not increase its vulnerability to losses by making

loans to certain risky borrowers, the Congress could provide guidance

specifying that a borrower is ineligible for a direct or a guaranteed loan if

the borrower is delinquent or if the borrower has caused RUS to incur a

prior loan loss.

Page 22 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

Agency Comments

and Our Evaluation

We provided a draft of this report to USDA for its review and comment. In

summary, USDA expressed concern over several of the options presented in

the report, particularly those involving targeting loans, graduating

borrowers, and limiting borrowers’ loan and debt levels. In regard to

targeting loans, USDA noted, among other things, that a borrower serving a

combination of rural and nonrural customers is probably financially

stronger than a borrower that does not serve a diverse customer base. We

agree. Our point, however, is that some borrowers serve large numbers of

customers, including some in nonrural areas, and that the Congress may

want to target loans to borrowers who serve rural areas more exclusively.

USDA’s discomfort over options involving graduating borrowers and

limiting borrowers’ loan and debt levels reflects, in part, concern over

possible detrimental impacts that these options may have on borrowers or

their service to rural areas. It is difficult to predict the extent to which

USDA’s concerns would be realized if these options were to be put into

effect. However, we believe that the possible impacts to service in rural

areas should be considered in developing specific implementation plans

for these or any other options that the Congress may choose to act upon.

Overall, USDA’s comments provide additional perspectives on issues

discussed in the report and highlight the difficulties that face policymakers

as they consider options for improving the effectiveness and efficiency

while reducing the cost to the government of RUS’ electricity and

telecommunications loan programs. A complete presentation of USDA’s

comments and our response is provided in appendix III.

We performed our review of the operations of RUS’ electricity and

telecommunications loan programs from May 1997 through

December 1997 in accordance with generally accepted government

auditing standards. Our scope and methodology are discussed in appendix

IV.

As agreed, unless you publicly announce its contents earlier, we plan no

further distribution of this report until 14 days from the date of this letter.

At that time, we will send copies of this report to the appropriate Senate

and House committees; interested Members of Congress; the Secretary of

Agriculture; the Administrator of RUS; the Director, Office of Management

and Budget; and other interested parties. We will also make copies

available to others upon request.

Page 23 GAO/RCED-98-42 Operation of RUS’ Loan Programs
B-278588 

Please call me at (202) 512-5138 if you or your staff have any questions.

Major contributors to this report are listed in appendix V.

Robert A. Robinson

Director, Food and

 Agriculture Issues

Page 24 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Page 25 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Contents

Letter 1

Appendix I 

Financial Information

on Borrowers That

Received Loans in

Recent Years

30

Appendix II 

Information on the

Value of Loans Made

in Recent Years

33

Appendix III 

Comments From the

U.S. Department of

Agriculture

34

Appendix IV 

Objectives, Scope,

and Methodology

45

Appendix V 

Major Contributors to

This Report

48

Tables Table 1: Total Number and Amount of Electricity and

Telecommunications Loans Made or Guaranteed by RUS, by Loan

Type, Fiscal Years 1994 Through June 30, 1997

5

Table 2: Amount of Outstanding Principal on Electricity and

Telecommunications Loans Made or Guaranteed by RUS, as of

June 30, 1997

6

Page 26 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Contents

Table 3: Number of Electricity Distribution and

Telecommunications Borrowers That Obtained Loans During

Calendar Years 1994 Through June 30, 1997, by Range of

Customers

8

Table 4: Range of Interest Rates on Municipal Rate Loan

Advances Taken During July 1, 1997, Through September 30, 1997

12

Table 5: Amount of Outstanding Principal on Electricity and

Telecommunications Loans Held by Various Commercial

Lenders, as of June 30, 1997

21

Table I.1: Number of Electricity and Telecommunications

Borrowers That Obtained Loans During Calendar Years 1994

Through June 30, 1997, by Range of Equity Prior to Receiving the

Loans

30

Table I.2: Number of Electricity and Telecommunications

Borrowers That Obtained Loans During Calendar Years 1994

Through June 30, 1997, by Range of Profit Prior to Receiving the

Loans

31

Table I.3: Number of Electricity and Telecommunications

Borrowers That Obtained Loans During Calendar Years 1994

Through June 30, 1997, by Range of Current Ratio Prior to

Receiving the Loans

31

Table I.4: Number of Electricity and Telecommunications

Borrowers That Obtained Loans During Calendar Years 1994

Through June 30, 1997, by Range of Debt-to-Asset Ratio Prior to

Receiving the Loans

32

Table I.5: Number of Electricity and Telecommunications

Borrowers That Obtained Loans During Calendar Years 1994

Through June 30, 1997, by Range of Times-Interest-Earned Ratio

Prior to Receiving the Loans

32

Table II.1: Number of Electricity and Telecommunications Loans

Approved, Fiscal Years 1994 Through June 30, 1997, by Range of

Loan Amounts

33

Page 27 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Contents

Abbreviations

CFC National Rural Utilities Cooperative Finance Corporation

FCS Farm Credit System

FFB Federal Financing Bank

GAO General Accounting Office

REA Rural Electrification Administration

RE Act Rural Electrification Act of 1936, as amended

RTB Rural Telephone Bank

RTFC Rural Telephone Finance Cooperative

RUS Rural Utilities Service

TIER times-interest-earned ratio

USDA U.S. Department of Agriculture

Page 28 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Page 29 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix I 

Financial Information on Borrowers That

Received Loans in Recent Years

This appendix contains information on the financial characteristics of

borrowers that obtained electricity and telecommunications loans during

calendar years 1994 through June 30, 1997.1

 Table I.1 shows that the

overwhelming majority of the borrowers had equity of $1 million or more

at the end of the year prior to receiving the loans. Table I.2 shows that

most of these borrowers made a profit of at least $100,000 in the year prior

to receiving the loans. Tables I.3, I.4, and I.5 show that the current ratios,

debt-to-asset ratios, and times-interest-earned ratios of the borrowers

were generally favorable prior to receiving the loans.

Table I.1: Number of Electricity and Telecommunications Borrowers That Obtained Loans During Calendar Years 1994

Through June 30, 1997, by Range of Equity Prior to Receiving the Loans

Range of equity

Type of borrower Less than $0

$0 to less than

$100,000

$100,000 to

less than $1

million

$1 million to

less than $10

million

$10 million to

less than $100

million

$100 million

or more

Electricity distribution

borrowers 1 1 2 194 229 5

Electricity power supply

borrowers 1 0 0 0 16 3

Telecommunications

borrowers 1 1 17 109 40 0

Total 3 2 19 303 285 8

Note: Equity, or net worth, is the difference between assets and liabilities and includes capital

stock and/or patronage capital, memberships, and capital credits.

Source: GAO’s analysis of RUS’ automated databases, which contain financial information

submitted by electricity and telecommunications borrowers.

1

This appendix covers borrowers that obtained loans from the Rural Utilities Service (RUS) during

calendar years 1994 through June 30, 1997, and for which RUS’ databases contained financial

information for the year prior to the one in which the loans were made.

Page 30 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix I 

Financial Information on Borrowers That

Received Loans in Recent Years

Table I.2: Number of Electricity and Telecommunications Borrowers That Obtained Loans During Calendar Years 1994

Through June 30, 1997, by Range of Profit Prior to Receiving the Loans

Range of profit

Type of borrower Less than $0

$0 to less than

$100,000

$100,000 to

less than $1

million

$1 million to

less than $10

million

$10 million to

less than $100

million

$100 million

or more

Electricity distribution

borrowers 12 13 246 158 3 0

Electricity power supply

borrowers 0 0 2 16 2 0

Telecommunications

borrowers 4 12 103 46 3 0

Total 16 25 351 220 8 0

Note: Profit, or net income, is the difference between revenues and expenses and includes

operating income plus or minus nonoperating income, capital credits, and fixed charges (e.g.,

interest on funded debt and other interest expenses). RUS refers to the profits made by electricity

and telecommunications loan borrowers that are nonprofit cooperatives as “net margins” and to

the losses as “deficits in net margins.”

Source: GAO’s analysis of RUS’ automated databases, which contain financial information

submitted by electricity and telecommunications borrowers.

Table I.3: Number of Electricity and

Telecommunications Borrowers That

Obtained Loans During Calendar Years

1994 Through June 30, 1997, by Range

of Current Ratio Prior to Receiving the

Loans

Range of current ratio

Type of borrower

Less than

one time

Up to

two times

Two to up to

five times

Five or more

times

Electricity

distribution

borrowers 73 188 145 26

Electricity power

supply borrowers 1 5 14 0

Telecommunications

borrowers 15 19 83 51

Total 89 212 242 77

Note: The current ratio is a measure showing the extent to which a borrower has sufficient current

assets to cover its current liabilities. It is computed by dividing a borrower’s current assets by

current liabilities.

Source: GAO’s analysis of RUS’ automated databases, which contain financial information

submitted by electricity and telecommunications borrowers.

Page 31 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix I 

Financial Information on Borrowers That

Received Loans in Recent Years

Table I.4: Number of Electricity and

Telecommunications Borrowers That

Obtained Loans During Calendar Years

1994 Through June 30, 1997, by Range

of Debt-to-Asset Ratio Prior to

Receiving the Loans

Range of debt-to-asset ratio

Type of borrower

100 percent

or more

71 to 99

percent

41 to 70

percent

40 percent

or less

Electricity

distribution

borrowers 1 45 353 33

Electricity power

supply borrowers 1 15 4 0

Telecommunications

borrowers 1 28 113 26

Total 3 88 470 59

Note: The debt-to-asset ratio shows the extent to which a borrower has sufficient assets to cover

all of its debt. It is computed by dividing a borrower’s total debt by total assets.

Source: GAO’s analysis of RUS’ automated databases, which contain financial information

submitted by electricity and telecommunications borrowers.

Table I.5: Number of Electricity and

Telecommunications Borrowers That

Obtained Loans During Calendar Years

1994 Through June 30, 1997, by Range

of Times-Interest-Earned Ratio Prior to

Receiving the Loans

Range of times-interest-earned ratio

Type of borrower

Less than

one time

Up to

two times

Two to up to

five times

Five times or

more

Electricity

distribution

borrowers 11 146 249 26

Electricity power

supply borrowers 0 17 1 2

Telecommunications

borrowers 4 18 95 51

Total 15 181 345 79

Note: The times-interest-earned ratio shows the extent to which a borrower can pay its annual

interest expenses from its net income. It is computed by dividing the sum of a borrower’s total net

income and interest on debt by interest on debt.

Source: GAO’s analysis of RUS’ automated databases, which contain financial information

submitted by electricity and telecommunications borrowers.

Page 32 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix II 

Information on the Value of Loans Made in

Recent Years

This appendix contains information on the dollar value of electricity and

telecommunications loans made to borrowers during fiscal years 1994

through June 30, 1997. Table II.1 shows that while most of the 926 loans

approved during this period were made for less than $10 million, 113 loans

were for $10 million or more.

Table II.1: Number of Electricity and Telecommunications Loans Approved, Fiscal Years 1994 Through June 30, 1997, by

Range of Loan Amounts

Range of loan amounts

Program and loan type

Less than $1

million

$1 million to

less than $5

million

$5 million to

less than $10

million

$10 million to

less than $20

million

$20 million to

less than $50

million

$50 million

or more

Electricity

Direct hardship rate 12 68 11 5 1 0

Direct municipal rate 43 232 76 42 8 0

Guaranteed 2 7 6 10 6 5

Total 57 307 93 57 15 5

Telecommunications

Direct hardship rate 3 18 27 1 0 0

Direct cost-of-money rate 26 82 28 18 3 0

Direct Rural Telephone Bank 39 79 30 8 1 0

Guaranteed 13 7 4 2 1 2

Total 81 186 89 29 5 2

Source: GAO’s analysis of RUS’ loan records.

Page 33 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

Note: GAO comments

supplementing those in the

report text appear at the

end of this appendix.

See comment 1.

See comment 2.

Page 34 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

See comment 3.

See comment 4.

See comment 5.

Page 35 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

See comment 6.

See comment 7.

See comment 8.

Page 36 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

See comment 9.

See comment 10.

See comment 11.

See comment 12.

See comment 13.

Page 37 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

See comment 14.

See comment 15.

Page 38 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

See comment 16.

See comment 17.

See comment 18.

Page 39 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

See comment 19.

Page 40 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

Page 41 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

The following are GAO’s comments on the U.S. Department of Agriculture’s

(USDA) letter dated December 18, 1997.

GAO Comments 1. The draft reviewed by USDA contained no GAO recommendations; rather,

as requested by the Senate Committee on Agriculture, Nutrition, and

Forestry, it presented several options for congressional consideration and

recognized that there would be tradeoffs for any option implemented.

2. Our report referenced the 7 U.S.C. 930 provision in a relatively narrowly

focused discussion of how an applicant’s financial health affects its

eligibility to obtain RUS’ loans. As a result, we had no reason to discuss the

other parts of the provision that dealt with broader policy statements on

the availability of RUS’ loan funds. We therefore continue to believe that we

cite the provision appropriately and that it indicates congressional intent

that borrowers in both programs should be encouraged and assisted to use

their own resources or seek credit through commercial sources to satisfy

their needs.

3. We believe that changes in the composition of a borrower’s service

territory should be considered in determining an applicant’s eligibility to

participate in RUS’ loan programs if the Congress is interested in targeting

loans primarily to rural areas. We agree with the benefits of diversity cited

by USDA—that a combination of rural and nonrural customers reduces risk

and contributes to financial health. Our point is that the Congress may

want to consider clarifying the level at which RUS’ loans are primarily

benefiting nonrural rather than rural customers.

4. We appreciate USDA’s concerns about the changing environment in

which RUS’ borrowers operate. We recognize in the report’s discussion on

the continuing vulnerability to loan losses that competition may affect

borrowers.

5. RUS uses net margins to refer to the bottom-line income of its

cooperative borrowers; we recognize RUS’ use of this term in footnote 11 in

the report. Rather than use this term, however, we use profits (net

income), which is more widely recognized. Profits, or net margins, and

losses, or deficits in net margins, are calculated in the same manner. That

is, operating revenue less operating expenses plus or minus nonoperating

income/expenses, other fixed charges (including interest expense), and

other income statement adjustments. We also recognize that a

Page 42 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

cooperative’s distribution of profits/margins to its members has the effect

of reducing the rates that the members pay.

6. Our intention in providing information on customer populations was to

show that some borrowers serve large populations—a fact that USDA

acknowledges in its response. While most RUS borrowers may be serving

sparsely populated areas, as USDA points out, our purpose was to report on

customer populations and identify instances in which borrowers appear to

be serving areas that are not sparsely populated. Regarding the example of

a telecommunications loan borrower, documentation in RUS’ files stated

that the loan was intended to benefit the borrower’s entire service

area—not just its rural customers.

7. Our draft report did not suggest that customer size be a criterion for

program eligibility. In fact, the report acknowledges that customer service

statistics are only an indicator of population density, which, in our view,

should be considered if the Congress wants to target program benefits to

rural areas.

8. The draft reviewed by USDA did not discuss the extent to which

borrowers invested their own funds or sought nonfederal financing.

Rather, it discussed the levels of equity, profit, and various ratios for

borrowers that obtained loans during calendar years 1994 through June 30,

1997.

9. The draft reviewed by the Department defines equity as total assets less

total liabilities—it did not state nor attempt to imply that equity is only

cash.

10. We recognize that there is some judgment involved in determining

benchmarks for financial ratios. This is why we presented data on the

number of RUS’ borrowers having debt-to-asset ratios of 70 percent or less

as well as those having debt-to-asset ratios of no more than 40 percent.

11. We agree. As the draft reviewed by USDA stated, the current ratio is a

measure that shows the extent to which a borrower has sufficient current

assets to cover its current liabilities. As such, it is one measure of the

financial health of borrowers.

12. The draft reviewed by USDA stated that the discounted prepayment

amount is the present value of a borrower’s outstanding debt.

Page 43 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix III 

Comments From the U.S. Department of

Agriculture

13. The borrower we use as an example in the report is one of many

borrowers that appear to be candidates for commercial lenders to

refinance their outstanding direct loans. As the report states, about 39

percent of RUS’ electricity and telecommunications borrowers had equity

of $10 million or more at the end of 1996. In addition, about 36 percent

made a profit of $1 million or more in 1996.

14. We appreciate USDA’s concerns about requiring borrowers to refinance

their direct loans with private sector financing during a time in which the

environment that the borrowers operate in is changing. However, the fact

is that some borrowers appear to have such highly favorable financial

characteristics that we believe a graduation program is a logical step in

terms of assisting them to move to private sector financing.

15. The draft reviewed by USDA recognized that the Telecommunications

Act of 1996 and the Energy Policy Act of 1992 could have either positive or

negative impacts on RUS’ borrowers and on the quality of the agency’s

portfolio. This issue is covered in the discussion on the continuing

vulnerability to loan losses.

16. We agree that the telecommunications loan program has been operated

very successfully. The draft reviewed by USDA stated that there were no

telecommunications loans written off during the period covered by our

review and that no telecommunications loans were delinquent as of

June 30, 1997. We have revised the report to reflect USDA’s comment

concerning the losses in the electricity loan program.

17. USDA states that it does not agree that loan limits will reduce RUS’

vulnerability to loan losses. We believe that limits would reduce the

agency’s vulnerability because individual borrowers would be restricted to

a maximum amount on any one loan and on the level of debt that they

could accumulate through multiple loans.

18. The extent to which these problems occur would, of course, depend on

how much of a limit was placed on loans and debt. These limits could be

established with the intent of balancing consideration for minimizing risk

as well as optimizing operational efficiency.

19. We do not agree with USDA that the September 1997 rule adequately

addresses our concerns. The rule allows borrowers whose accounts are

settled, including a write-off of debt, to obtain additional loans, rather than

prohibiting such borrowers from being eligible for loans.

Page 44 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix IV 

Objectives, Scope, and Methodology

In April 1997, we reported on the financial condition of RUS’

multibillion-dollar portfolio of electricity and telecommunications loans.

Subsequently, the Chairman and the Ranking Minority Member of the

Senate Committee on Agriculture, Nutrition, and Forestry requested that

we conduct a follow-up study focusing on RUS’ program operations,

specifically looking to identify ways to (1) make the electricity and

telecommunications loan programs more effective and less costly for the

government and (2) decrease RUS’ vulnerability to loan losses. They also

requested that we compile loan information on commercial lenders that

have a significant level of lending for rural electricity and

telecommunications purposes.

To compile information on loans and outstanding debt, we used RUS’

automated loan records and various loan reports. We did not adjust the

outstanding loan amounts to reflect the allowance for losses that RUS

includes in its financial statements or assess the adequacy of reserves on

the loans.

To address our first two objectives—ways to make the loan programs

more effective and less costly for the government and to decrease RUS’

vulnerability to loan losses—we interviewed officials at RUS’ headquarters,

including the Assistant Administrators and Deputy Assistant

Administrators for Electricity and Telecommunications. We reviewed in

detail the Rural Electrification Act of 1936, as amended, and its legislative

history; and RUS’ implementing regulations and other program operating

guidance. We conducted extensive analyses of information in RUS’ various

automated records. First, we identified borrowers from the automated

records that received loans in calendar years 1994 through June 30, 1997,

and then matched those borrowers with the agency’s databases containing

borrower-submitted operational and financial information for the year

prior to the one in which the loans were made. In addition, we categorized

the borrowers that received loans by various incremental ranges of loan

amounts. Second, we analyzed borrowers’ financial data at the end of 1996

to determine the financial characteristics of borrowers with outstanding

direct loans. Third, we analyzed information covering borrowers that

prepaid their direct electricity loans at a discount during fiscal years 1994

through June 30, 1997. We also interviewed RUS’ officials in Oklahoma and

Missouri, and an electricity borrower and a telecommunications borrower

in each of those two states.

The information on the subsidy costs of the programs for fiscal years 1994

through 1996 was obtained from USDA reports. The information on interest

Page 45 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix IV 

Objectives, Scope, and Methodology

rates that were available on municipal rate loan advances from January 1,

1994, through September 30, 1997, was obtained from RUS’ quarterly

publications in the Federal Register and/or from other RUS

announcements. We also extracted from RUS’ loan portfolio databases the

information on borrowers that obtained advances with interest rates of

less than 5 percent.

We interviewed Federal Financing Bank (FFB) officials to obtain

information on the bank’s participation in RUS’ loan programs. We

reviewed the FFB’s annual financial statements and independent auditor’s

reports for fiscal years 1994 through 1996. We also reviewed the provisions

in the Balanced Budget Act of 1997 that relate to the FFB’s participation in

RUS’ programs.

We obtained the information on problem borrowers, including borrowers

that caused losses, from interviews of RUS officials, including those in the

electricity program; testimony by RUS’ Administrator at a July 8, 1997,

hearing before the Senate Committee on Agriculture, Nutrition, and

Forestry; and the agency’s financial reports and automated records.

To address our third objective—information on commercial lenders that

have a significant level of lending for rural electricity and

telecommunications—we interviewed RUS’ loan program officials and FFB

officials. We also interviewed officials with each of the private lending

institutions that we identified—the National Rural Utilities Cooperative

Finance Corporation, Rural Telephone Finance Cooperative, CoBank, and

the St. Paul Bank for Cooperatives—and reviewed documents they

provided that describe their organizations and lending activities, and, as of

June 30, 1997, the extent of their outstanding loans and the quality of their

loan portfolios. We did not verify the accuracy of the loan information that

they provided to us, but we noted that it was consistent with data in their

1996 annual reports, which had been audited by independent auditors. We

also reviewed the reporting requirements of federal banking regulators to

determine if commercial banks report on their lending activities for rural

electricity and telecommunications purposes. However, the regulators do

not require banks to report such information.

Much of the financial data presented in this report were taken from RUS’

reports and automated records, which include data submitted by

borrowers. We did not verify the accuracy of the information contained in

the agency’s reports and automated records. We also did not verify the

accuracy of the submissions from the borrowers to RUS.

Page 46 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix IV 

Objectives, Scope, and Methodology

We conducted our review from May 1997 through December 1997 in

accordance with generally accepted government auditing standards. We

provided copies of a draft of this report to USDA for review and comment.

The Department’s comments and our response to them appear in appendix

III and are discussed in the body of the report. We also provided extracts

from our draft report to the Cooperative Finance Corporation and the

Rural Telephone Finance Cooperative, and to CoBank and the St. Paul

Bank, which covered their respective lending activity. We made technical

corrections to the report on the basis of their comments.

Page 47 GAO/RCED-98-42 Operation of RUS’ Loan Programs
Appendix V 

Major Contributors to This Report

Food and Agriculture

Issues—Kansas City

Field Office

Ronald E. Maxon, Jr., Assistant Director

Ruth Anne Decker

Jerry D. Hall

Larry D. Van Sickle

Food and Agriculture

Issues—Resources,

Community, and

Economic

Development

Division, Washington,

D.C.

Patrick J. Sweeney

Office of the General

Counsel, Washington,

D.C.

Oliver H. Easterwood

(150725) Page 48 GAO/RCED-98-42 Operation of RUS’ Loan Programs
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