Report to Congressional Requesters

United States General Accounting Office

GAO

April 2001 TENNESSEE VALLEY

AUTHORITY

Bond Ratings Based

on Ties to the Federal

Government and

Other Nonfinancial

Factors

GAO-01-540
Page 1 GAO-01-540 Tennessee Valley Authority

April 30, 2001

The Honorable Bob Smith

Chairman, Senate Committee on

 Environment and Public Works

United States Senate

The Honorable Mitch McConnell

United States Senate

This report responds to the remaining aspects of your request that we

review several issues pertaining to the Tennessee Valley Authority’s (TVA)

financial condition in light of the increasing competition in electricity

markets. On February 28, 2001, we issued a separate report on TVA’s

(1) progress in reducing debt and recovering the costs of deferred assets,

(2) financial condition compared to its likely competitors, and

(3) potential stranded costs.1

 As agreed with your offices, this report

provides perspective on several matters pertaining to TVA’s bond rating.

Specifically, you asked us to determine (1) whether TVA’s bonds are

explicitly or implicitly guaranteed by the federal government, including the

opinion of bond analysts regarding the effect of any such guarantee, and

(2) the impact of TVA’s bond rating on its annual interest expense.

The TVA Act states that the federal government does not guarantee TVA’s

bonds. In addition, TVA includes similar “no guarantee” language in its

Basic TVA Power Bond Resolution, Information Statement, and bond

offering circulars. However, because TVA is a wholly owned government

corporation, there is the perception in the investment community,

including two credit rating firms we contacted (Moody’s Investors Service

and Standard & Poor’s), that the federal government would support

principal and interest payments on TVA debt if TVA’s solvency were to be

seriously impaired. Because they believe that the federal government

would intercede to protect TVA’s solvency, the two credit rating firms we

contacted perceive that there is an implicit government guarantee of TVA

bonds.

 1

Tennessee Valley Authority: Debt Reduction Efforts and Potential Stranded Costs

(GAO-01-327, February 28, 2001).

United States General Accounting Office

Washington, DC 20548

Results in Brief
Page 2 GAO-01-540 Tennessee Valley Authority

According to bond analysts at the two credit rating firms, this perceived

implicit guarantee is one of the primary reasons that TVA’s bonds have

received the highest possible bond rating. One of the firms cited two

additional factors—TVA’s legislative protections from competition and its

strong operational performance—as part of the basis for assigning TVA’s

bonds their Aaa rating. Of the 119 electric utilities rated by one of the firms

as of October 2000, TVA was the only utility rated Aaa. The high bond

ratings result in lower interest expense for TVA, which in turn reduces its

fixed annual operating expense. According to our analysis, as a result of

its high bond ratings, the annual interest expense on TVA’s bonds

outstanding at September 30, 2000, would have been between $137 million

and $245 million higher (about 2 to 4 percent of fiscal year 2000 total

expenses) if TVA’s bond ratings were lower. Although high bond ratings

provide TVA with more financial flexibility to adjust its rates in a

competitive environment, our recently issued report indicates that

because of the magnitude of its debt, TVA continues to have higher fixed

financing costs and less financial flexibility than its likely competitors.

TVA’s Chief Financial Officer generally agreed with the report and

provided oral technical and clarifying comments, which we incorporated

as appropriate.

TVA is a multipurpose, independent, wholly owned federal corporation

established by the Tennessee Valley Authority Act of 1933 (TVA Act). The

TVA Act established TVA to improve the quality of life in the Tennessee

River Valley by improving navigation, promoting regional agricultural and

economic development, and controlling the floodwaters of the Tennessee

River. To those ends, TVA erected dams and hydroelectric power facilities

on the Tennessee River and its tributaries.

To meet the need for more electric power during World War II, TVA

expanded beyond hydropower, building coal-fired power plants. In the

1960s, TVA decided to add nuclear generating units to its power system.

Today, TVA operates one of the nation’s largest power systems, having

produced about 152 billion kilowatt-hours (kWh) of electricity in fiscal

year 2000. The system consists primarily of 113 hydroelectric units, 59

coal-fired units, and 5 operating nuclear units. TVA sells power in seven

states—Alabama, Georgia, Kentucky, Mississippi, North Carolina,

Tennessee, and Virginia.

TVA sells power at wholesale rates to 158 municipal and cooperative

utilities that, in turn, distribute the power on a retail basis to nearly

Background
Page 3 GAO-01-540 Tennessee Valley Authority

8 million people in an 80,000 square mile region. TVA also sells power to a

number of directly served large industrial customers and federal agencies.

In 1959, the Congress amended the TVA Act to authorize TVA to use debt

financing to pay for capital improvements for power programs. Under this

legislation, the Congress required that TVA’s power program be “selffinancing” through revenues from electricity sales. For capital needs in

excess of internally generated funds, TVA was authorized to borrow by

issuing bonds. TVA’s debt limit is set by the Congress and was initially

established at $750 million in 1959. Since then, TVA’s debt limit has been

increased four times by the Congress: to $1.75 billion in 1966, $5 billion in

1970, $15 billion in 1975, and $30 billion in 1979. As of September 30, 2000,

TVA’s outstanding debt was $26.0 billion.

TVA’s bonds are considered “government securities” for purposes of the

Securities and Exchange Act of 1934 and are exempt from registration

under the Securities Act of 1933. All of TVA’s bonds are publicly held, and

several are traded on the bond market of the New York Stock Exchange.

Since TVA’s first public issue in 1960,2

 Moody’s Investors Service and

Standard & Poor’s have assigned TVA’s bonds their highest credit

rating—Aaa/AAA.3

To determine whether TVA’s bonds are explicitly or implicitly guaranteed

by the federal government, we analyzed various documents, including

Section 15d of the TVA Act, as amended, the Basic TVA Power Bond

Resolution, TVA’s Information Statement,4

 and the language included in

TVA’s bond offering circulars. We also discussed this issue with bond

analysts at two credit rating firms (Moody’s Investors Service and

Standard & Poor’s) and TVA officials.

 2

During the period 1974–1988, TVA borrowed exclusively from the Federal Financing Bank

(FFB). The FFB debt was not rated. However, during this period, the outstanding public

debt from the 1960–1974 issues continued to be rated Aaa/AAA.

3

Aaa is the highest rating given to bonds by Moody’s; it corresponds to the AAA rating

issued by Standard & Poor’s.

4

The Information Statement is included with the bond-offering circular. It provides

information on the business, operations, and financial condition of TVA.

Objectives, Scope,

and Methodology
Page 4 GAO-01-540 Tennessee Valley Authority

To determine the opinion of bond analysts regarding the effect of an

implicit or explicit guarantee on TVA’s bonds, we interviewed officials at

two credit rating firms that rate TVA’s bonds to discuss their rating

methodology for TVA and other electric utilities’ bonds. In addition, we

reviewed recent reports issued by the credit rating agencies for any

language about an implicit federal guarantee of TVA’s debt. As agreed with

your offices, we did not attempt to determine what TVA’s bond rating

would be without its ties to the federal government as a wholly owned

government corporation.

To determine the impact of TVA’s bond rating on its annual interest

expense, we obtained information from TVA about its outstanding bonds

as of September 30, 2000. We then obtained comparable information on

the average bond ratings and bond yield rates applicable to public utilities

for the various bond rating categories. Using the average bond yield rates

for public utility debt in the various bond rating categories, we used two

approaches to estimate the amount of TVA’s annual interest expense if its

bonds outstanding at September 30, 2000, carried the lower ratings.

Additional information on our scope and methodology is contained in

appendix I.

We conducted our review from July 2000 through April 2001 in accordance

with generally accepted government auditing standards. We requested

written comments from TVA on a draft of this report. TVA’s Chief

Financial Officer provided us with oral comments, which we incorporated,

as appropriate.

The TVA Act states that the federal government does not guarantee the

principal of, or interest on, TVA’s bonds. However, the perception of the

bond analysts at the two credit rating firms we contacted is that since TVA

is a wholly owned government corporation, the federal government would

support debt service and would not allow a default to occur. Both of the

credit rating firms stated that this perception of an implicit federal

guarantee is one of the primary reasons that TVA’s bonds have received

the highest credit rating. One of the firms cited two other factors—TVA’s

legislative protections from competition and its strong operational

performance—as additional reasons for assigning TVA’s bonds its highest

rating.

The TVA Act specifically states that the federal government does not

guarantee TVA bonds. TVA includes similar “no federal guarantee”

The Federal

Government Does Not

Guarantee TVA’s

Bonds but Is

Perceived to

Implicitly Back Them
Page 5 GAO-01-540 Tennessee Valley Authority

language in its Basic TVA Power Bond Resolution, Information Statement,

and bond offering circulars. The relevant language is as follows:

• Section 15d of the TVA Act, as amended, 16 USC § 831n-4—“Bonds

issued by the Corporation [TVA] hereunder shall not be obligations of, nor

shall payment of the principal thereof or interest thereon be guaranteed

by, the United States.”

• Basic TVA Power Bond Resolution, Section 2.2 Authorization and

Issuance of Bonds—“They [the TVA bonds] shall be payable as to both

principal and interest solely from Net Power Proceeds and shall not be

obligations of or guaranteed by the United States of America.”

• Information Statement—“Evidences of Indebtedness are not obligations

of the United States of America, and the United States of America does not

guarantee the payment of the principal of or interest on any Evidences of

Indebtedness.”

• TVA bond offering circulars—“The interest and principal on the Bonds

are payable solely from Net Power Proceeds and are not obligations of, or

guaranteed by, the United States of America.”

Although TVA’s bonds expressly disclaim a federal guarantee, the two

bond rating firms we contacted perceive TVA’s bonds to be implicitly

backed by the federal government. This perception of an implied federal

guarantee is one of the primary reasons that TVA’s bonds have received

the highest credit rating. For example, Standard & Poor’s, in its January

2001 analysis of TVA’s global power bonds, stated that “the rating reflects

the US government’s implicit support of TVA and Standard & Poor’s view

that, without a binding legal obligation, the federal government will

support principal and interest payments on certain debt issued by entities

created by Congress.”

5

Further, in its June 2000 opinion update on TVA, Moody’s Investors

Service (Moody’s) reported that “the Aaa rating on Tennessee Valley

Authority (TVA) power bonds derives from its strong operational

performance and its status as a wholly owned corporate agency of the US

Government.” In addition, Moody’s reported that although the federal

government does not guarantee TVA’s bonds, the government would not

allow a default on TVA’s debt because of the impact it would have on the

cost of debt issued by government-sponsored enterprises, such as Fannie

 5

Tennessee Valley Authority $1B Global Power Bonds Rated ‘AAA,’ Standard & Poor’s

CreditWire, January 11, 2001.
Page 6 GAO-01-540 Tennessee Valley Authority

Mae and Freddie Mac.6, 7As in the case of TVA, the government does not

guarantee the debt of these enterprises. Also as with TVA, there is a

perception in the investment community that the federal government

would not allow these enterprises to default on their obligations.

In its January 2001 analysis of TVA’s global power bonds, Standard &

Poor’s acknowledged that its rating of these bonds did not reflect TVA’s

underlying business or financial condition and that the rating of these

bonds would have been lower without TVA’s ties to the federal

government. In addition, a Moody’s official stated that financial statistics

and ratios for other electric utilities are significantly stronger than those

for TVA in each rating category and that government ownership was a

fundamental underpinning of the Aaa rating it assigned to TVA’s debt.

Moody’s and Standard & Poor’s generally use a complex methodology

involving both quantitative and qualitative analyses when determining

ratings for electric utilities. For example, Moody’s examines the volatility

and reliability of cash flows, the contributions of the utility to the profits

of its corporate parent (if any), and how the utility is positioning itself to

operate in a competitive environment. Also included in Moody’s analysis is

the utility’s ability to balance business and financial risk with

performance. Similarly, Standard & Poor’s measures financial strength by

a utility’s ability to generate consistent cash flow to service its debt,

finance its operations, and fund its investments. In addition, Standard &

Poor’s analyzes business risk by examining the utility’s operating

characteristics such as regulatory environment, reliability, and

management.

In summarizing the results of the analyses, the bond analysts assign a

credit rating to the electric utility (issuer rating) representing their opinion

on the general creditworthiness of the utility. In addition, bond analysts

may also assign a rating to an individual debt issue (issue-specific rating)

representing their opinion on the general creditworthiness of the utility

with respect to the specific debt issue. Further, specific debt issues of the

issuer may be rated differently. Moody’s and Standard & Poor’s use their

same rating symbols to indicate credit quality of the issuer and the

investment quality of the debt issue. Both maintain similar rating

 6

Opinion Update: Tennessee Valley Authority, Moody’s Investors Service, June 22, 2000.

7

Government-sponsored enterprises are federally established, privately owned

corporations designed to increase the flow of credit to specific economic sectors.
Page 7 GAO-01-540 Tennessee Valley Authority

categories, using A, B, and C, with Aaa/AAA being the highest rating.

Triple, double, and single characters distinguish the gradations of

credit/investment quality.8

 For example, issuers rated Aaa/AAA indicate

exceptional financial security, Baa/BBB indicate adequate financial

security, and Ba/BB or below offer questionable to poor financial security.

Debt issues rated in the four highest categories, Aaa/AAA, Aa/AA, A, and

Baa/BBB, generally are recognized as investment-grade. Table 1 describes

the investment-grade rating categories used by Moody’s and Standard &

Poor’s. Debt rated Ba/BB or below generally is referred to as speculative

grade.

Table 1: Description of Investment-Grade Bond Rating Categories

Moody’s Investors Service/Standard & Poor’s Investment-Grade Rating Categories

Aaa/AAA Aa/AA A Baa/BBB

Highest rating

category—smallest

degree of investment

risk. Ability to pay

interest and principal

is extremely strong.

Together with the

highest rating, this

group composes the

high-grade bonds.

Long-term risk

appears somewhat

greater than in the

highest rated

securities. Ability to

pay interest and

principal is very

strong.

Upper-mediumgrade obligations—

elements may be

present that suggest

a susceptibility to

impairment

sometime in the

future. However,

ability to pay interest

and principal is still

strong.

Medium-grade

obligations—the

ability to pay interest

and principal

appears adequate

for the present but

certain protective

elements may be

lacking or may be

characteristically

unreliable over any

great length of time.

Source: Based on information from Moody’s Investors Service website, www.moodys.com, and

Standard & Poor’s 2000 Corporate Ratings Criteria.

In addition, Moody’s applies numerical modifiers, 1, 2, and 3, and Standard

& Poor’s uses “plus” and “minus” signs in each rating category from Aa/AA

through Caa/CCC in their corporate bond rating system. The modifier 1

and “plus” indicate that the issuer/obligation ranks in the higher end of a

rating category; 3 and “minus” indicates a ranking in the lower end.

According to a Moody’s official, the firm places less significance on

financial factors in analyzing TVA debt than in analyzing the debt of other

electric utilities.9

 Because of TVA’s ties to the federal government, Moody’s

 8

In their rating system, Moody’s uses lowercase “a” as its second and third character (e.g.,

Baa); Standard and Poor’s uses uppercase of the same character (e.g., BBB).

9

The previously mentioned January 2001 Standard & Poor’s analysis of TVA also deemphasized TVA’s underlying financial condition in determining its bond rating.
Page 8 GAO-01-540 Tennessee Valley Authority

considers other factors more important in its assessment of TVA.

Specifically, Moody’s looks at how TVA will react to its changing operating

environment and places “considerable value” on the legislative framework

in which TVA operates. For example, in its June 2000 analysis of TVA,

Moody’s reported that key provisions in the TVA Act and the Energy

Policy Act of 1992 (EPAct) provide credit protection for bondholders.

Under the TVA Act, TVA’s Board of Directors is required to set rates at

levels sufficient to generate revenues to cover operating and financing

costs. EPAct provides TVA with certain protections from competition.

Under EPAct, TVA is exempt from having to allow other utilities to use its

transmission lines to transmit power to customers within TVA’s service

territory. Further, the Moody’s official stated, as long as TVA is able to set

its own rates and to benefit from legislative and other competitive

advantages over other utilities, Moody’s will continue to assign TVA’s

bonds a Aaa rating.

As shown in figure 1, of the 119 electric utilities rated by Moody’s as of

October 2000, TVA was the only utility rated Aaa. The ratings of other

electric utilities range from a high of Aa1 to a low of Ba2, with an average

rating at A3. Figure 1 shows the number of utilities in each rating category

compared to TVA.
Page 9 GAO-01-540 Tennessee Valley Authority

Figure 1: TVA and Other U.S. Electric Utilities Rated by Moody’s by Rating Category

as of October 2000

Source: Based on information from Moody’s Electric Utilities Industry Outlook, October 2000.

As noted previously, the TVA Act authorizes TVA to issue and sell bonds to

assist in financing its power program. Investor-owned electric utilities also

use debt financing, but unlike TVA, they can and do issue common and

preferred stock to finance capital needs.10 Figure 2 shows the capital

structure of electric utilities by rating category. It also shows that, in

general, electric utilities that have obtained a greater portion of financing

through debt have lower credit ratings. However, even though the capital

structure of TVA consists entirely of debt, and, as illustrated in our

February 2001 report, it has higher fixed financing costs and less financial

flexibility than its likely competitors, TVA remains the only AAA-rated

electric utility in the United States.

 10TVA and other electric utilities can also finance capital improvements through cash

generated from operations.

Aa

A

Baa

Ba

0

10

20

30

40

50

60

70

TVA US Electric Utilities 

Number of utilities

Aaa
Page 10 GAO-01-540 Tennessee Valley Authority

Figure 2: Capital Structure of Electric Utility Companies Rated by Standard & Poor’s

by Rating Category

Source: GAO analysis based on data from Standard and Poor’s Corporate Ratings Criteria, 2000.

Data for electric utility companies is for the 12 months ended June 30, 1999.

As a result of TVA’s high bond ratings, the private lending market has

provided TVA with access to billions of dollars of financing at low interest

rates, an advantage that in turn results in lower interest expense than if its

rating had been lower.

To determine the impact of TVA’s bond rating on its interest expense, we

estimated what TVA’s annual interest expense on its bonds outstanding at

September 30, 2000, would have been if the debt had been given lower

investment-grade ratings. Using two different methodologies, we obtained

similar results. In the first methodology, we compared the coupon rate of

each of TVA’s bonds outstanding at September 30, 2000, to the average

bond yield rates applicable to public utility bonds with similar terms at the

time of issuance for each investment-grade rating category. For example,

TVA’s Aaa-rated 2000 Series E Power Bonds that were outstanding at

September 30, 2000, have a coupon rate of 7.75 percent. When these bonds

TVA’s High Bond

Ratings Result in

Lower Interest

Expense

0

10

20

30

40

50

60

70

80

90

100

AA A BBB BB

Rating Category

Percent

Preferred Stock

Common Stock

Debt
Page 11 GAO-01-540 Tennessee Valley Authority

were issued on February 16, 2000,11 the average bond yields for public

utility debt averaged 8.16 percent. In total, using the first methodology, we

found that the annual interest expense of TVA’s bonds outstanding at

September 30, 2000, would have been between $137 million and

$235 million (about 2 to 3 percent of fiscal year 2000 total expenses)

higher if the debt had been given lower investment-grade bond ratings.

In the second methodology, we categorized TVA’s bonds into long-term (at

least 20 years to maturity at time of issuance) and intermediate-term (less

than 20 years to maturity at time of issuance) debt issues. We then

identified the difference between TVA’s average coupon interest rates

grouped as long-term and intermediate-term on its bonds outstanding at

September 30, 2000, and the average bond yield rates grouped as long-term

and intermediate-term for public utilities for the various investment-grade

rating categories. Specifically, we compared the average coupon interest

rate on TVA’s long-term bonds to the 9-year (1992–2000) average bond

yield rates for long-term public utility bonds. Similarly, we compared the

average coupon interest rate on TVA’s intermediate-term bonds to the

5-year (1996–2000) average bond yield rates for intermediate-term public

utility bonds. The years used (maturities and time of issuance) for public

utility long-term and intermediate-term debt are, in general, comparable to

TVA’s bonds outstanding at September 30, 2000. For example, the average

coupon interest rate for TVA’s bonds outstanding at September 30, 2000,

with at least 20 years to maturity at time of issuance was 6.96 percent. In

comparison, the average bond yield rates for the period 1992–2000 for

public utility debt with at least 20 years to maturity averaged 7.82 percent.

Using this methodology, we estimated that the annual interest expense on

TVA’s bonds outstanding at September 30, 2000, would have been about

$141 million to $245 million (about 2 to 4 percent of fiscal year 2000 total

expenses) higher if its bonds had been rated lower.12

Table 2 shows the impact of lower bond ratings on annual interest

expense using both methodologies. It is important to note that our

analyses assumed that TVA’s coupon rates on its bonds corresponded to

 11February 16, 2000, is the bond offering circular date, which is the day the bonds were

priced. The issuance date is typically 3 to 5 business days after pricing.

12We also obtained and analyzed an analysis of the impact of TVA’s high bond rating on its

annual interest expense that was done by the Department of Energy’s Energy Information

Administration (EIA). The results of EIA’s analysis showed that TVA’s interest expense

would have been from $77 million to $248 million higher if its bonds were rated similarly to

other utilities.
Page 12 GAO-01-540 Tennessee Valley Authority

the bond yield rates of other lower-rated public utilities at the time TVA

issued its bonds. Assuming that were the case, we estimated that TVA’s

interest expense would have been higher by the amounts shown in table 2.

If TVA’s debt were no longer perceived to be implicitly guaranteed by the

federal government, the resulting impact on TVA’s interest expense would

relate to future bonds and refinancings rather than to its bonds

outstanding at September 30, 2000.

Table 2: Impact of Lower Bond Ratings on TVA’s Annual Interest Expense on TVA’s

Bonds Outstanding at September 30, 2000

(Dollars in millions)

Investment-grade Additional annual interest expense using

Rating category Methodology 1 Methodology 2

Aa/AA $137 $ 141

A $167 $ 174

Baa/BBB $235 $ 245

Source: GAO analysis based on TVA coupon interest rates and public utility bond yield data.

TVA’s high bond rating results in lower interest expense, enhancing TVA’s

competitive prospects by providing it with more financial flexibility to

respond to financial or competitive challenges.

While the criteria used to rate the bonds of TVA and other electric utilities

are the same, they are weighted differently and, as a result, the basis for

TVA’s bond rating is more nonfinancial in nature than that for other

electric utilities. According to bond analysts, TVA’s high bond rating is

largely based on the perception that its debt is federally backed because of

its ties to the federal government as a wholly owned government

corporation and its legislative protections from competition. If these

conditions were to change, TVA’s bond rating would likely be lowered,

which in turn would affect the cost of new debt. This would add to its

already high interest expense and corresponding financial challenges in a

competitive market.

TVA’s Chief Financial Officer generally agreed with the report and

provided oral technical and clarifying comments, which we incorporated

as appropriate.

Conclusion

Agency Comments

and Our Evaluation
Page 13 GAO-01-540 Tennessee Valley Authority

As agreed with your offices, unless you publicly announce its contents

earlier, we plan no further distribution of this report until 7 days from its

date. At that time, we will send copies of this report to appropriate House

and Senate Committees; interested Members of Congress; TVA’s Board of

Directors; The Honorable Spencer Abraham, Secretary of Energy; The

Honorable Mitchell E. Daniels, Jr., Director, Office of Management and

Budget; and other interested parties. The report will also be on GAO’s

home page at http://www.gao.gov. We will make copies available to others

upon request.

Please call me at (202) 512-9508 if you or your staffs have any questions.

Major contributors to this report are listed in appendix II.

Linda M. Calbom

Director

Financial Management and Assurance
Appendix I: Objectives, Scope, and

Methodology

Page 14 GAO-01-540 Tennessee Valley Authority

We were asked to answer specific questions regarding TVA’s financial

condition. This report addresses the questions pertaining to TVA’s bond

rating; specifically, (1) whether TVA’s bonds are explicitly or implicitly

guaranteed by the federal government, including the opinion of bond

analysts regarding the effect of any such guarantee, and (2) the impact of

TVA’s bond rating on its annual interest expense. As agreed with your

offices, we issued a separate report on February 28, 2001, on the three

other issues regarding TVA’s (1) debt and deferred assets, (2) financial

condition compared to its likely competitors, and (3) potential stranded

costs.

To determine whether TVA’s bonds are explicitly or implicitly guaranteed

by the federal government, we

• reviewed prior GAO products discussing TVA’s bonds;

• reviewed and analyzed the section of the TVA Act pertaining to TVA’s

bonds;

• reviewed and analyzed various TVA documents, including the Basic TVA

Power Bond Resolution, TVA’s Information Statement, and the language

included in TVA’s outstanding bond offerings at September 30, 2000;

• interviewed bond analysts at Moody’s and Standard & Poor’s; and

• interviewed TVA officials.

To determine the opinion of bond analysts regarding the effect of any such

guarantee, we

• interviewed officials at the credit rating firms that rate TVA’s bonds—

Moody’s and Standard & Poor’s; and

• reviewed and analyzed documents issued by Moody’s and Standard &

Poor’s on their methodology for rating TVA and other electric utilities.

To determine the impact of TVA’s bond rating on its annual interest

expense, we

• obtained information from TVA about its outstanding bonds at September

30, 2000;

• reconciled information from TVA about its outstanding bonds at

September 30, 2000, to its audited financial statements;

• reviewed information pertaining to TVA’s outstanding debt contained in its

annual reports;

Appendix I: Objectives, Scope, and

Methodology

Determining Whether

the Federal

Government

Guarantees TVA’s

Bonds

Determining the

Impact of TVA’s

Bond Rating on Its

Interest Expense
Appendix I: Objectives, Scope, and

Methodology

Page 15 GAO-01-540 Tennessee Valley Authority

• reviewed a report issued by the Department of Energy’s Energy

Information Administration which assessed the impact of TVA’s bond

rating on its interest expense;

• interviewed Moody’s regarding the availability of historical bond yield data

by rating category for electric utilities and public utilities;

• obtained Moody’s information on the average bond yields applicable to

public utilities in the various bond rating categories from Standard &

Poor’s DRI (long-term) and Moody’s Investors Service Credit Perspectives

(intermediate-term); and

• estimated the additional annual interest expense on TVA’s bonds

outstanding at September 30, 2000, using the average bond yield rates for

public utilities in various investment-grade rating categories.

Using Moody’s public utility long-term and intermediate-term

(unweighted) bond yield data in various investment-grade rating

categories, we applied two methods for estimating what the additional

annual interest expense on TVA’s bonds outstanding at September 30,

2000, would have been if TVA’s debt were rated lower. Our analysis

considered the characteristics of TVA’s bonds, such as date of issuance

and term; however, we did not assess the effect of call provisions.1

Under Methodology 1, we

• analyzed TVA’s annual interest expense on its bonds outstanding at

September 30, 2000, to determine, for each issuance outstanding, the (1)

coupon rate, (2) date of issuance, (3) term, and (4) maturity;

• identified the average bond yield rates applicable to public utility bonds

with similar terms at the time of issuance of each of TVA’s bonds

outstanding at September 30, 2000, in the Aa/AA, A, and Baa/BBB rating

categories;

• calculated the annual interest expense for each of TVA’s debt issues in the

various rating categories; and

• determined the estimated additional annual interest expense by taking the

difference between TVA’s annual interest expense and the interest

expense in the various rating categories.

 1

A call provision is a written agreement between an issuer and its bondholders that gives

the issuer the option of redeeming the bond at a specified price before the maturity date.
Appendix I: Objectives, Scope, and

Methodology

Page 16 GAO-01-540 Tennessee Valley Authority

Under Methodology 2, we

• categorized TVA’s bonds into long-term (at least 20 years to maturity at

time of issuance) and intermediate-term (less than 20 years to maturity at

time of issuance);

• calculated TVA’s (unweighted) average coupon interest rates for long-term

and intermediate-term debt by taking the average of the coupon rates

applicable for each category (long-term and intermediate-term) of TVA’s

bonds outstanding at September 30, 2000;

• calculated the annual interest expense for TVA’s long-term and

intermediate-term debt using the average coupon interest rates calculated

for each category;

• determined the (unweighted) average public utility bond yield rates for

calendar years 1992 to 2000 in each of the various rating categories for

long-term debt and 1996 to 2000 for intermediate-term debt, which, in

general, are comparable to the maturities and time of issuance of TVA’s

bonds outstanding at September 30, 2000;

• calculated the annual interest expense for TVA’s long-term and

intermediate-term debt using the average public utility bond yield rates

applicable to the various rating categories; and

• determined the estimated additional annual interest expense (long-term

and intermediate-term) by taking the difference between TVA’s annual

interest expense and the interest expense in the various rating categories.

We conducted our review from July 2000 through April 2001 in accordance

with generally accepted government auditing standards. We obtained our

information on public utility bond yield rates from authoritative sources

(e.g., Standard & Poor’s DRI, Moody’s Investors Service) that provide

and/or regularly use that data; however, we did not verify the accuracy of

the bond yield data they provided.

During the course of our work, we contacted the following organizations.

• Tennessee Valley Authority

• Department of Energy’s Energy Information Administration

Organizations

Contacted

Federal Agencies
Appendix I: Objectives, Scope, and

Methodology

Page 17 GAO-01-540 Tennessee Valley Authority

• Moody’s Investors Service, New York, New York

• Standard & Poor’s, New York, New York

• Standard & Poor’s DRI, Washington, D.C.

• Standard & Poor’s DRI, Lexington, Massachusetts

Bond Rating Firms

Others
Appendix II: GAO Contact and Staff

Acknowledgments

Page 18 GAO-01-540 Tennessee Valley Authority

Robert E. Martin, (202) 512-4063

In addition to the individual named above, Richard Cambosos,

Philip Farah, Jeff Jacobson, Joseph D. Kile, Mary B. Merrill,

Donald R. Neff, Patricia B. Petersen, and Maria Zacharias made key

contributions to this report.

Appendix II: GAO Contact and Staff

Acknowledgments

GAO Contact

Staff

Acknowledgments

(190008)
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