Statement of

Wally Beyer, Administrator
United States Department of Agriculture
Rural Utilities Service

July 8, 1997

Senate Committee on Agriculture, Nutrition, and Forestry Senator
Richard G. Lugar, Chairman

The Rural Electric Loan Portfolio and Electricity Deregulation

Mr. Chairman and Members of the Committee, I am pleased to appear before you today to discuss the potential effects of electricity deregulation on the Rural Utilities Service (RUS) electric loan portfolio.

My testimony will provide a brief overview of the RUS electric loan program, how RUS is dealing with the continuing problems involving some past loans, how RUS is preparing for the future as we move into a new, deregulated, and more competitive environment, and how industry restructuring could affect RUS borrowers, loan security, and the continued availability of high quality, reliable, affordable electric service in rural America.

Rural America and The RUS Electric Loan Program

The rural electric program has been a continuing success for rural areas and the Nation. For over 60 years, this cost-effective public-private partnership has been the primary mechanism for supporting affordable electric service to areas that are the highest cost to serve. The program helps ensure high quality, reliable electric service at affordable rates to approximately 26 million rural Americans living on 80 percent of the Nation's land in areas that investor-owned and municipal utilities originally failed to serve. Today, providers of electric service to rural areas are still challenged by distance, low population densities, huge geographic diversity, and limited abilities to take advantage of economies of scale.

The electric loan program today has 850 active borrowers -- 795 distribution borrowers and 55 generation and transmission (G&T) system borrowers. The outstanding principal on RUS loans and guarantees exceeds $32 billion. In 1995, RUS borrowers accounted for $14.5 billion (7 percent) of the $208 billion in total retail electricity sales in this Nation.

The RUS financing program continues to be a critical part of the Federal commitment to rural infrastructure investment. It generates valuable leverage of approximately 3 private dollars of capital investment for every federal dollar of credit for rural electric systems. As can be seen in the table below, rural electric systems have been investing approximately $3 billion annually to maintain, improve, and replace aging electric utility plants in rural areas to accommodate new growth and to assure quality, reliable electric service.

Investment In Electric Plant

Years 1991 through 1996

(Dollars in Millions) Year Gross Additions to Plant Funds Advanced RUS Loans Funds Advanced FFB Loans Private & Internally Generated Funds 1995 $3,269 $809 $211 $2,249 1994 3,344 618 242 2,484 1993 2,883 388 169 2,276 1992 3,104 401 208 2,495 1991 2,833 592 98 2,241

RUS foresees a continuing need for this federal assistance that provides critical credit support for private investment dollars to finance investments to upgrade and replace aging rural electric infrastructure and to maintain and improve reliability and quality of service.

The electric loan program continues to be financially sound. Historically, defaults have been relatively small. Since the inception of the Rural Electrification Program in 1936, USDA has made more than $55.8 billion in loans and loan guarantees to finance rural electric system infrastructure. Until the mid-1980s, only two borrowers had ever defaulted and the amounts involved were very small-- $44,478.

However, today the program is faced with significant challenges associated with the high debt levels of a number of G&T borrowers related to investments in costly nuclear power plants and other facilities that were made 15 to 20 years ago --in the mid 1970s and early 1980s -- under economic conditions and a regulatory environment markedly different than today.

The oil embargo of the 1970s changed the electric utility industry. By limiting the burning of oil and natural gas for electric generation plants, the Powerplant and Industrial Fuels Use Act of 1978 encouraged investment in nuclear power plant. Many rural generation and transmission cooperatives, like the investor-owned utilities, invested in the building of nuclear generation projects. As we know now, many of these projects were based on what turned out to be inaccurate assumptions and projections about construction, safety, energy, and regulatory costs, energy demand, economic growth and interest rates.

Electric power consumption had been increasing at a rate of 7 percent annually by 1978 when the Fuel Use Act was passed. Conservative estimates projected increases from 5 percent to 6 percent per year in the coming decade. From 1978 to 1983, actual use of electricity increased by only 3 percent per year nationally. Some rural areas experienced negative growth. In 1981, Congress made some adjustments to the Fuel Use Act with amendments to the Omnibus Budget Reconciliation Act of 1981 with regard to conversion of existing generation plants to other forms of energy. In 1987, Congress repealed the baseload restrictions for new generation plants.

The inability of G&T cooperatives to deal in a timely fashion with changes in the economy made the above-mentioned problems worse. In almost all instances G&T borrowers were minority partners in the investment. While some changes have occurred, accumulated interest costs resulting from earlier, high-cost debt remain a problem.

During the late 1970s and 1980s, there was considerable financial fallout in the electric industry. Consumers and regulators suffered sticker shock as the costs of newly constructed facilities entered into rate base. Billions of dollars in utility industry investments were disallowed by regulatory decisions. Many utilities failed to earn their authorized rate of return. Investor-owned and public power systems began to restructure themselves financially, and renegotiated and wrote off debt in investments that proved uneconomic in hindsight. By the late 1980s, some measure of financial health was returning to the electric utility industry.

The ability of many RUS G&T borrowers to respond effectively to these economic stresses was limited as a result of restrictions on debt refinancing in the decade of the ‘80s. This significantly exacerbated their financial difficulties in some cases. In contrast to investor-owned and municipal utilities, which were able to refinance their debt and pass the benefits of lower interest rates along to their customers, under the terms of their loan agreements RUS G&T borrowers were paying interest rates in excess of then current Treasury rates.

In 1993, RUS estimated that the inability to restructure and refinance these high-interest rate loans was costing rural cooperatives and their customers more than $318 million per year. In response, Congress proposed legislative changes to the Rural Electrification Act to aid in loan repricing. RUS estimated that enactment of the proposed changes would save rural cooperatives and their customers more that $138 million per year. Changes in federal policy and refinancing of this high-cost debt would have enhanced loan security, while at the same time providing significant benefit to rural consumers. Senators Lugar and Domenici are to be complimented for their introduction and support for this legislation in the Senate. RUS worked with the Federal Financing Bank (FFB) to assist RUS G&T borrowers to refinance and reprice existing high-cost debt. The following table reflects that activity:

Refinancing Of RUS Electric Borrower Debt

(Dollars in Millions) Years Amount Refinanced/Repriced 1987-88 $2,582.2 1989-91 None 1992 602.6 1993 1,948.6 1994 2,906.3 1995 884.2 1996 475.0 1997 67.0 TOTAL $9,467.0

The April 1997 GAO Report The April 1997 GAO Report, "Rural Development: Financial Conditions of the Rural Utilities Service's Loan Portfolio" (GAO/RCED-97-82) confirms the positive overall performance of the program. GAO found that:

Most RUS electricity borrowers had favorable financial characteristics at the end of calendar year 1995.

Over 98 percent of electric borrowers had positive equity.

À"À 96 percent of electric borrowers posted a profit in 1995.

À"À The majority of electric borrowers had other favorable financial ratios. GAO also recognized that almost all of the $7.4 billion in RUS electricity loans to problem borrowers--those in default, bankruptcy, or likely to default in the future-- are traceable to a relatively small number of borrowers and arise out of loans made for nuclear generation plants in the 1970s and 1980s.

Even under the stresses that the industry has sustained, most borrowers have continued to meet their loan obligations while delivering service to their member owners and contributing to the economic infrastructure of their communities

GAO also found that the total costs for the electric loan program from 1992 through 1996 were $551.3 million, including $446.2 million in subsidy costs and $105.1 million in administrative costs based on credit reform methods of measuring program costs.

The April 1997 GAO report identified 12 G&T borrowers as being in bankruptcy, or financially stressed. Those 12 loans totaled approximately $8.65 billion at the time they were classified as troubled. Since that time, RUS has classified and additional three loans as financially stressed, raising the amount in this category to $9.37 billion. Currently, of these 15 problems loans: four have been fully resolved with solutions to exit the RUS program; two have had their debts restructured and remain in the program; four are currently operating under bankruptcy (with three of the four having court-approved reorganization plans confirmed); and five are engaged in active negotiations with RUS. To date, the Government has explicitly written off $1.75 billion of troubled debt, including accrued interest. RUS continues to work with the remaining five borrowers in search of solutions that will result in maximum recovery of outstanding debt to the government. Clearly the past history of power plant investment is not useful in projecting the future in a new deregulated, competitive, restructured, unbundled infrastructure.

Electric Industry Restructuring Today, the Nation's electric industry is changing dramatically and the pace of change is accelerating. Generation markets are moving from a monopoly-based to a competitive structure. Already, to a great extent, competition is a reality in the wholesale power market as a result of the Energy Policy Act of 1992. As of June 1997, at least 10 States are moving forward in implementing competition at the retail level and legislatures in other States are actively considering like proposals. There are five bills proposing comprehensive electric industry restructuring that have been introduced in the 105th Congress.

To help address the changing nature of the industry, the RUS is reforming itself. We have made the first reform of our mortgage and loan security documents in 25 years. We have instituted an automated loan processing system, a computerization of our loan and security document preparation that has reduced the processing time. We have streamlined our regulations and processes to maximize borrower flexibility. The new regulations and procedures enhance a borrower's ability to attract private financing while at the same time making internal changes to compete more effectively. New merger regulations encourage borrowers to take advantage of the economies of scale. The agency continues to review our programs and procedures to allow for a more efficient program that is customer friendly while protecting the taxpayer investment in a modern rural infrastructure.

As the debate on electric utility restructuring and deregulation develops, RUS believes there are two goals that should be part of the development of any restructuring of the marketplace: one, continuation of reliable, high quality electric service at a reasonable cost to rural consumers; and two, protecting the integrity of the government's loan portfolio.

To accomplish these goals, RUS believes that any restructuring of the electric utility industry should be guided by the principles of reliability, fairness and flexibility. The transition to a more competitive industry environment must maintain the reliability of the Nation's electric system. The electric infrastructure in rural America should not be put at risk by restructuring legislation. A more competitive electric sector with retail choice should be fair and equitable to all consumers, including rural citizens, to existing electric utilities, and to Federal taxpayers who support the RUS program. Finally, industry restructuring should be flexible and contain a thoughtful transition process that accommodates the diversity of the electric utility industry, State regulatory structures and policies, and a process of educating consumers about the changes.

The agency has been an active participant at the State and Federal level in electric utility industry restructuring issues. The agency has commented to the Federal Energy Regulatory Commission (FERC) on its proposed open access transmission rule (FERC Orders 888 and 888A) concerning potential effects on RUS borrowers, loan security, and rural consumers. The agency provided comments to FERC about our concerns about its proposed merger policy and our comments were specifically acknowledged by FERC in the publication of its final merger policy. In addition, RUS has intervened in several FERC proceedings involving current RUS borrowers to be sure that we preserve our right to comment as a party on any proposed action that could negatively affect loan security. We will continue to do so on a case-by-case basis, whenever we believe it is appropriate.

The agency is actively participating in the ongoing interagency discussions on industry restructuring under the aegis of the President's National Economic Council . The Administration is currently considering various policy options to address electric industry restructuring and customer choice.

CONCLUSIONS

The Rural Utilities Service has had the opportunity to be at the vortex of change in two of the Nation's most important industries -- electricity and telecommunications. Each of these industries generate revenue of approximately $200 billion a year and both are evolving from a regulated monopoly to a competitive environment. Each of these industries are critical to the growth and stability of rural America as we more forward into a global economy.

Rural America is challenged by distance, density and economies of scale. The facts focus the issue -- rural America, 80 percent of the land mass and 20 percent of the population. Serving rural America simply costs more per person than serving urban and suburban America and therefore, the market creates an access, quality and affordability disparity between rural and urban and suburban areas. For over 60 years, RUS and its predecessor the Rural Electrification Administration has been committed to the concept of universal service in support of quality, reliable, affordable electricity in rural America. We look forward to helping rural America make a successful transition into the 21st Century.

Thank you for the opportunity to present this testimony.