United States General Accounting Office

GAO Testimony

Before the Subcommittee on Government

Management, Information and Technology

Committee on Government Reform and Oversight

House of Representatives

For Release on Delivery

Expected at

10 a.m.

Monday,

March 30, 1998

RURAL UTILITIES

SERVICE

Risk Assessment for the

Electric Loan Portfolio

Statement of Linda M. Calbom

Director, Resources, Community, and Economic

Development Accounting and Financial Management

Accounting and Information Management Division

GAO/T-AIMD-98-123

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to summarize the results of our work

analyzing the Rural Utilities Service’s (RUS) electric loan portfolio and the

potential for future losses to the federal government from these loans. My

testimony is based on our September 1997 report1

 on federal electricity

activities, which discusses these issues in depth. Although the RUS

portfolio contains electricity, telecommunications, and water and waste

disposal loans, you asked that our testimony focus on electricity loans

since they generally pose the greatest risk of loss to the federal

government, particularly given the onset of competition in the electricity

industry.

Deregulation of the electricity industry has led to wholesale competition,

which, combined with other factors, has caused wholesale electricity

prices to fall in many parts of the country. The increasingly competitive

wholesale market and the financial vulnerability of the RUS borrowers have

increased the risk of future losses the federal government faces. Thus, my

testimony today will focus on the RUS electric loan portfolio and will

discuss the findings from our September 1997 report concerning

• substantial write-offs of loans to rural electric cooperatives;

• likely additional losses to the federal government from loans to financially

stressed2

 borrowers; and

• the potential for future losses from viable loans that may become stressed

in the future due to high production costs and competitive or regulatory

pressures.

I would like to begin my testimony by providing a brief background on the

history and purpose of RUS. I will then discuss our risk assessment of the

electric loan portfolio. Our assessment was generally based on the

condition of the portfolio as of September 30, 1996; therefore, changes

may have occurred since the date of our review.

Background The U.S. Department of Agriculture (USDA) is the federal government’s

principal provider of loans used to assist the nation’s rural areas in

1

Federal Electricity Activities: The Federal Government’s Net Cost and Potential for Future Losses

(GAO/AIMD-97-110 and 110A, September 19, 1997).

2

Borrowers classified by RUS as financially stressed have defaulted on their loans, had their loans

restructured but are still experiencing financial difficulty, declared bankruptcy, or have formally

requested financial assistance from RUS.

Page 1 GAO/T-AIMD-98-123
developing their utility infrastructure. Through RUS, USDA finances the

construction, improvement, and repair of electrical, telecommunications,

and water and waste disposal systems. RUS provides credit assistance

through direct loans and through repayment guarantees on loans made by

other lenders. Established by the Federal Crop Insurance Reform and the

Department of Agriculture Reorganization Act of 1994, RUS administers the

electricity and telecommunications programs that were operated by the

former Rural Electrification Administration3

 and the water and waste

disposal programs that were operated by the former Rural Development

Administration. As of September 30, 1996, which was the most recent

information available to us at the time of our review, RUS’ entire portfolio

of loans—including direct and guaranteed electricity, telecommunications,

and water and waste disposal loans—totaled $42.5 billion.4

 Electricity

loans made up over $32 billion, or 75 percent of this total.

Most of the RUS electric loans and loan guarantees were made during the

late 1970s and early 1980s. For example, from fiscal years 1979 through

1983, RUS approved loans and loan guarantees of about $29 billion,

whereas during fiscal years 1992 through 1996, it approved a total of about

$4 billion in electric loans and loan guarantees. RUS electricity loans were

made primarily to rural electric cooperatives; more than 99 percent of the

borrowers with electricity loans are nonprofit cooperatives. These

cooperatives are either Generation and Transmission (G&T) cooperatives

or distribution cooperatives. A G&T cooperative is a nonprofit rural electric

system whose chief function is to produce and sell electric power on a

wholesale basis to its owners, who consist of distribution cooperatives

and other G&T cooperatives. A distribution cooperative sells the electricity

it buys from a G&T cooperative to its owners, the retail customers.

As of September 30, 1996, the bulk of the electric loan portfolio was made

up of loans to the G&Ts. The principal outstanding on these G&T loans was

approximately $22.5 billion, about 70 percent of the portfolio. Distribution

borrowers made up the remaining 30 percent of the electric portfolio. At

the time of our review, there were 55 G&T borrowers and 782 distribution

borrowers. Our review focused on the G&T loans since they make up the

majority, in terms of dollars, of the portfolio and generally pose the

greatest risk of loss to the federal government.

3

The Rural Electrification Act of 1936, as amended (7 U.S.C. 901 et seq.), provides the basic statutory

authority for the electricity and telecommunications programs, including the authority for loans to be

made by the Federal Financing Bank.

4

For a further discussion of the financial condition of the entire RUS portfolio, as of September 30,

1996, see our report Rural Development: Financial Condition of the Rural Utilities Service’s Loan

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

Page 2 GAO/T-AIMD-98-123
The federal government incurs financial losses when borrowers are unable

to repay the balances owed on their loans and the government does not

have sufficient legal recourse against the borrowers to recover the full

loan amounts. In all instances, G&T loans are collateralized; however, RUS

has never foreclosed on a loan. RUS generally has been unable to

successfully pursue foreclosure once the borrower files for bankruptcy

because the borrower’s assets are protected until the proceedings are

settled. In addition, in recent cases where debt was written off, the

government forgave the debt and therefore did not attempt to pursue

further collection.

Substantial Loan

Write-Offs Occurred

in Recent Years

Under Department of Justice (DOJ) authority, during fiscal year 1996 and

through July 31, 1997, RUS wrote off about $1.5 billion of loans to rural

electric cooperatives. The most significant write-offs relate to two G&T

loans. In fiscal year 1996, one G&T made a lump sum payment of

$237 million to RUS in exchange for RUS writing off and forgiving the

remaining $982 million of its RUS loan balance. The G&T’s financial

problems began with its involvement as a minority-share owner in a

nuclear project that experienced lengthy delays in construction as well as

severe cost escalation. When construction of the plant began in 1976, its

total cost was projected to be $430 million. However, according to the

Congressional Research Service, the actual cost at completion in 1987 was

$3.9 billion as measured in nominal terms (1987 dollars). These cost

increases are due in part to changes in Nuclear Regulatory Commission

health and safety regulations after the Three Mile Island accident. The

remaining portion is generally due to inflation over time and capitalization

of interest during the delays. The borrower defaulted in 1986, had its debt

restructured in 1993, and finally had its debt partially forgiven in

September 1996. This borrower is no longer in the RUS program.

In the early part of fiscal year 1997, another G&T borrower made a lump

sum payment of approximately $238.5 million in exchange for forgiveness

of its remaining $502 million loan balance. The G&T and its six distribution

cooperatives borrowed the $238.5 million from a private lender, the

National Rural Utilities Cooperative Finance Corporation. The G&T had

originally borrowed from RUS to build a two-unit coal-fired generating

plant and to finance a coal mine that would supply fuel for the generating

plant. The plant was built in anticipation of industrial development from

the emerging shale oil industry. However, the growth in demand did not

materialize, and there was no market for the power. Although the

borrower had its debt restructured in 1989, it still experienced financial

Page 3 GAO/T-AIMD-98-123
difficulties due to a depressed power market. RUS and DOJ decided that the

best way to resolve the matter was to accept a partial lump sum payment

on the debt rather than force the borrower into bankruptcy. The borrower

and its member distribution cooperatives are no longer in the RUS program.

Additional Losses

From Financially

Stressed G&T Loans

Are Probable in the

Short Term

It is probable that RUS will have additional loan write-offs and therefore

that the federal government will incur further losses in the short term from

loans to borrowers that have been identified as financially stressed by RUS

management. At the time of our review, RUS reports indicated that about

$10.5 billion of the $22.5 billion in G&T debt was owed by 13 financially

stressed G&T borrowers.5

 Of these, four borrowers with about $7 billion in

outstanding debt were in bankruptcy. The remaining nine borrowers had

investments in uneconomical generating plants and/or had formally

requested financial assistance in the form of debt forgiveness from RUS.

According to RUS officials, these plant investments became uneconomical

because of cost overruns, continuing changes in regulations, and soaring

interest rates. These investments resulted in high levels of debt and

debt-servicing requirements, making power produced from these plants

expensive. (See attachment I for a list and brief discussion of these

borrowers.)

Since cooperatives are nonprofit organizations, there is little or no profit

built into their rate structure, which helps keep electric rates as low as

possible. However, the lack of retained profit generally means the

cooperatives have little or no cash reserves to draw upon. Thus, when

cash flow is insufficient to service debt, cooperatives must raise electricity

rates and/or cut other costs enough to service debt obligations. If they are

unable to do so, they may default on their government loans.

This was the scenario for the previously discussed write-offs in fiscal year

1996 and through July 31, 1997. Additional write-offs are expected to

occur. For example, according to RUS officials, at the time of our review,

the agency was considering writing off as much as $3 billion of the total

$4.2 billion debt owed by Cajun Electric, a RUS borrower that has been in

bankruptcy since December 1994. Cajun Electric filed for bankruptcy

protection after the Louisiana Public Service Commission disapproved a

5

In our previous report, Rural Development: Financial Condition of the Rural Utilities Service’s Loan

Portfolio (GAO/RCED-97-82, April 11, 1997), we noted 12 G&T and distribution borrowers that were

delinquent or in financial distress. However, in this testimony, as in our September 1997 report, we

discuss 13 financially stressed G&T borrowers identified by RUS management. The primary difference

is that this testimony and our September 1997 report do not include one financially stressed

distribution borrower, but did include two borrowers that have officially requested financial

assistance.

Page 4 GAO/T-AIMD-98-123
requested rate increase and instead lowered rates to a level that reduced

the amount of revenues available to Cajun to make annual debt service

payments. Several factors contributed to Cajun’s heavy debt, including its

investment in a nuclear facility that experienced construction cost

overruns and its excess electricity generation capacity resulting from

overestimation of the demand for electricity in Louisiana during the 1980s.

Some Losses From

Loans Considered

Viable Are Probable in

the Future

In addition to the financially stressed loans, RUS had loans outstanding to

G&T borrowers that were considered viable by RUS but may become

stressed in the future due to high costs and competitive or regulatory

pressures. We believe it is probable that the federal government will

eventually incur losses on some of these G&T loans.

We believe the future viability of these G&T borrowers will be determined

based on their ability to be competitive in a deregulated market. In order

to assess the ability of RUS cooperatives to withstand competitive

pressures, we focused on production costs6

 for 33 of the 55 G&T borrowers

with loans outstanding of about $11.7 billion as of September 30, 1996. We

excluded 9 G&Ts that only transmit electricity and the 13 financially

stressed borrowers discussed above. Our analysis showed that for 27 of

the 33 G&T borrowers, production costs were higher in their respective

regional markets than investor-owned utilities, and that for 17 of the 33,

production costs were higher than publicly-owned generating utilities. The

relatively high average production costs indicate that the majority of G&Ts

may have difficulty competing in a deregulated market. RUS officials told

us that several borrowers have already asked RUS to renegotiate or write

off their debt because they do not expect to be competitive due to high

costs. RUS officials stated that they will not write off debt solely to make

borrowers more competitive.

As with the financially stressed borrowers, some of the G&T borrowers

considered viable by RUS at the time of our work had high debt costs

because of investments in uneconomical plants. In addition, according to

RUS officials, there are two unique factors that cause cost disparity

between the G&Ts and their competition. One factor is the sparser

customer density per mile for cooperatives and the corresponding high

cost of providing service to the rural areas. A second factor has been the

inability to refinance higher cost Federal Financing Bank (FFB) debt when

lower interest rates have prevailed. However, RUS officials said that recent

6

As a surrogate for production costs, w\ used average revenue per kilowatthour (kWh) for wholesale

sales (sales for resale), which is explained in detail in our September 1997 report.

Page 5 GAO/T-AIMD-98-123
legislative changes that enable cooperatives to refinance FFB debt with a

penalty may help align G&T interest rates with those of the investor-owned

utilities.

In the short term, G&Ts will likely be shielded from competition because of

the all-requirements wholesale power contracts between the G&T and their

member distribution cooperatives. With rare exceptions, these long-term

contracts obligate the distribution cooperatives to purchase all of their

respective power needs from the G&T. In fact, RUS requires the terms of the

contracts to be at least as long as the G&T loan repayment period.

However, wholesale power contracts have been challenged recently in the

courts by several distribution cooperatives because of the obligation to

purchase expensive G&T power. According to RUS officials, one bankrupt

G&T’s member cooperatives challenged their wholesale power contracts in

court in order to obtain less expensive power. RUS officials believe that the

long-term contracts will come under increased scrutiny and potential

renegotiation or court challenges as other sources of less expensive power

become available.

Wholesale rates under these contracts are set by a G&T’s board of directors

with approval from RUS. In states whose commissions regulate

cooperatives, the cooperatives must file requests with the commissions for

rate increases or decreases. Several of the currently bankrupt borrowers

were denied requests for rate increases from state commissions. However,

RUS officials indicated they do not expect G&Ts to pursue rate increases as

a means to recover their costs because of the recognition of declining

rates in a competitive environment. RUS officials also acknowledge that

borrowers with high costs are likely to request debt forgiveness as a

means to reduce costs in order to be competitive in the future.

As discussed above, denials of requested rate increases by state

commissions culminated in several G&Ts filing for bankruptcy. Eighteen of

the RUS G&T borrowers operate in states where regulatory commissions

must approve rate increases. These commissions may deny a request for a

rate increase if they believe such an increase will have a negative impact

on the region. According to RUS officials, some commissions have denied

rate increases to cover the costs of projects that the commissions had

previously approved for construction. Therefore, G&Ts with high costs may

be likely candidates to default on their RUS loans, even without direct

competitive pressures.

Page 6 GAO/T-AIMD-98-123
In summary, in the last several years, through July 1997, RUS has

experienced loan write-offs of $1.5 billion. Additional write-offs related to

the $10.5 billion in loans identified by RUS as financially stressed as of the

time of our review are likely in the near term. And finally, RUS has loans

outstanding to G&T borrowers that are currently considered viable by RUS

that may become stressed in the future due to high production costs and

competitive or regulatory pressures. We believe it is probable that the

federal government will incur losses eventually on some of these G&T

loans. The future viability of these G&T loans will be determined based in

part on the RUS cooperatives’ ability to be competitive in a deregulated

market.

Mr. Chairman, that concludes my statement. I would be happy to answer

any questions you or other Members of the Subcommittee may have.

Page 7 GAO/T-AIMD-98-123
Attachment I 

Information on the 13 Financially Stressed

G&T Borrowers as of September 30, 1996

The following is a list and brief discussion of each of the 13 financially

stressed G&T borrowers. This information is as of September 30, 1996;

therefore, changes may have occurred subsequent to our review.

Table I.1: RUS Financially Stressed

G&T Cooperatives, as of

September 30, 1996

Dollars in millions

Borrower Total debt outstanding

Borrower Aa,b $1,619.6

Borrower B 167.9

Borrower C 103.2

Borrower Db 562.3

Borrower Eb 183.3

Borrower Fa,b 1,101.2

Borrower Ga,b 4,154.8

Borrower Hb 313.4

Borrower Ib 354.8

Borrower J 1,070.7

Borrower K 445.1

Borrower L 351.7

Borrower Ma 92.8

Total debt $10,520.8

aCooperative in bankruptcy.

bState regulated cooperative.

Borrower A: Invested in construction of a nuclear plant that experienced

cost overruns and was never completed. The state commission denied rate

increases to cover the cost of the cooperative’s investment in the plant.

The borrower defaulted on its loan in 1984 and declared bankruptcy in

1985. The bankruptcy proceedings have been in court for 12 years and are

still not completely resolved.

Borrower B: Made an investment in a nuclear plant that proved to be

uneconomical. While this borrower does not appear to be currently

experiencing financial difficulties, RUS considers it financially stressed

because it has formally requested financial assistance due to impending

competitive pressures.

Borrower C: Made an investment in a nuclear plant that proved to be

uneconomical. While this borrower does not appear to be currently

experiencing financial difficulties, RUS considers it financially stressed

Page 8 GAO/T-AIMD-98-123
Attachment I 

Information on the 13 Financially Stressed

G&T Borrowers as of September 30, 1996

because it has formally requested financial assistance due to impending

competitive pressures.

Borrower D: Uses primarily coal-fired generation. The borrower overbuilt

due to anticipated growth in electricity demand that did not occur. During

construction of a new plant, economic conditions in the area changed and

demand for electricity dropped, which resulted in less revenue than

predicted from the plant. The cooperative was repeatedly denied rate

increases to cover the cost of its plants by the state commission.

Borrower E: Has a small percentage share in a nuclear plant that proved

to be uneconomical. The borrower has substantially higher electricity

rates than the investor-owned utilities in its region. The cooperative has

been denied rate increases to cover its losses by the state commission.

Although the borrower has had some of its debt refinanced, it is still

experiencing financial difficulties.

Borrower F: A G&T with primarily coal-fired generating plants that

overbuilt due to anticipated industrial growth related to two large

aluminum smelting companies. When aluminum prices dropped in the

early 1980s, the companies threatened to move their operations if the

cooperative did not lower electricity rates. The state commission denied

rate increases over the fear of losing these industries. RUS restructured the

borrower’s debt in 1987 and 1990. The cooperative filed for bankruptcy in

September 1996 because its other creditors were unwilling to negotiate.

Borrower G: Built a coal-fired plant and invested in a nuclear plant in the

mid-1970s that was completed late and experienced construction cost

overruns. Several factors contributed to the cooperative’s heavy debt,

including excess electricity generation construction resulting from

overestimation of the demand for electricity during the 1980s. The new

capacity was intended to serve a growth in demand that did not

materialize. The state commission disapproved a rate increase and instead

lowered rates to a level that precluded full debt service coverage. The

commission also refused to support a restructuring agreement that

included a significant RUS loan write-off.1

 The rate increase was requested

by the cooperative because of its high costs. The borrower filed for

bankruptcy in December 1994.

1

In states that regulate cooperatives, the state commissions must approve restructuring agreements

between the cooperatives and their creditors.

Page 9 GAO/T-AIMD-98-123
Attachment I 

Information on the 13 Financially Stressed

G&T Borrowers as of September 30, 1996

Borrower H: Invested in construction of a nuclear plant that proved to be

uneconomical. The project was completed 10 years late and over budget.

In addition, there was a dramatic drop in the demand for electricity in the

cooperative’s service area, and the state commission would not allow rate

increases to recover capital investment. The borrower had its debt

restructured in 1987; however, it is requesting additional financial

assistance due to anticipated competitive pressure. A final settlement

between RUS and the borrower was reached in June 1997. The borrower

was expected to receive a write-off of $165 million. The final payment and

related debt write-off were scheduled to occur December 30, 1997.

Borrower I: Invested in a clean-burning coal plant that experienced

severe cost overruns. The borrower has substantially higher electricity

rates than the investor-owned utilities in its region. The state commission

has denied the cooperative’s request for rate increases. The borrower had

some of its debt refinanced, but it is still experiencing financial difficulty.

Borrower J: Invested in a nuclear plant that proved to be uneconomical.

The plant was completed late, which resulted in cost overruns. As a result,

the cooperative’s wholesale power rates are very high. The borrower has

requested debt restructuring due to its high cost of production and

anticipated competitive pressure.

Borrower K: Invested in a nuclear plant that proved to be uneconomical.

The plant was completed late, which resulted in severe cost overruns. The

cooperative’s wholesale power rates are very high, which has resulted in

extreme unrest in the member distribution cooperatives. The borrower is

surrounded by investor-owned utilities with lower wholesale rates. In

addition, the borrower’s system is very difficult and expensive to maintain

and experiences frequent power outages. The borrower has requested

financial assistance because of anticipated competitive pressure.

Borrower L: Invested in a nuclear plant that proved to be uneconomical.

The plant was completed late, which resulted in severe cost overruns. The

cooperative has only five member distribution cooperatives, which makes

it difficult to cover its high production costs. This borrower chose not to

declare bankruptcy and is seeking financial assistance. This borrower has

refinanced its debt to lower its interest rate, but is still experiencing

financial difficulty and has requested additional financial assistance.

Borrower M: Invested in a nuclear plant that proved to be uneconomical.

In addition, the cooperative had a stagnant customer base in the 1980s. RUS

Page 10 GAO/T-AIMD-98-123
Attachment I 

Information on the 13 Financially Stressed

G&T Borrowers as of September 30, 1996

tried to negotiate a restructuring agreement, but the state commission

denied two separate plans. In April 1996, the borrower filed for

bankruptcy.

(913823) Page 11 GAO/T-AIMD-98-123
Ordering Information

The first copy of each GAO report and testimony is free.

Additional copies are $2 each. Orders should be sent to the

following address, accompanied by a check or money order

made out to the Superintendent of Documents, when

necessary. VISA and MasterCard credit cards are accepted, also.

Orders for 100 or more copies to be mailed to a single address

are discounted 25 percent.

Orders by mail:

U.S. General Accounting Office

P.O. Box 37050

Washington, DC 20013

or visit:

Room 1100

700 4th St. NW (corner of 4th and G Sts. NW)

U.S. General Accounting Office

Washington, DC

Orders may also be placed by calling (202) 512-6000 

or by using fax number (202) 512-6061, or TDD (202) 512-2537.

Each day, GAO issues a list of newly available reports and

testimony. To receive facsimile copies of the daily list or any

list from the past 30 days, please call (202) 512-6000 using a

touchtone phone. A recorded menu will provide information on

how to obtain these lists.

For information on how to access GAO reports on the INTERNET,

send an e-mail message with "info" in the body to:

info@www.gao.gov

or visit GAO’s World Wide Web Home Page at:

http://www.gao.gov

PRINTED ON RECYCLED PAPER
United States

General Accounting Office

Washington, D.C. 20548-0001

Official Business

Penalty for Private Use $300

Address Correction Requested

Bulk Rate

Postage & Fees Paid

GAO

Permit No. G100