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 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 “self- financing” 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, Moody’s Investors Service and Standard & Poor’s have assigned TVA’s bonds their highest credit rating—Aaa/AAA. 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, 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. 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” 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 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 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.” 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 Mae and Freddie Mac.6, 7 As 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. Opinion Update: Tennessee Valley Authority, Moody’s Investors Service, June 22, 2000. Government-sponsored enterprises are federally established, privately owned corporations designed to increase the flow of credit to specific economic sectors. 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. 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.