Financial Management: Impact of RUS' Electricity Loan Restructurings
(Letter Report, 09/29/2000, GAO/AIMD-00-288).

Pursuant to a congressional request, GAO reviewed the Rural Utilities
Service's (RUS) electricity loan restructurings, focusing on: (1) RUS'
policies and procedures for restructuring financially troubled
generation and transmission (G&T) loans and whether these are being
consistently followed; (2) whether RUS properly carried out loan
restructurings in accordance with criteria defined in the Federal Credit
Reform Act of 1990 and Office of Management and Budget (OMB) guidance;
(3) how much it cost the federal government to restructure RUS debt
since enactment of its debt settlement authority; and (4) whether the
costs of restructuring loans are accurately reported.

GAO noted that: (1) while RUS generally followed its policies and
procedures for restructuring loans of two financially troubled
borrowers, GAO found one instance where RUS' policies were not fully
utilized and other instances where procedures could be improved; (2)
RUS' procedures lack detailed written criteria for determining when a
borrower should be added or removed from RUS' list of financially
troubled borrowers; (3) RUS maintains this list to assist in minimizing
the federal government's risk of loss by identifying those borrowers
that require additional monitoring of their ability to repay the loans;
(4) RUS properly carried out its loan restructurings under its debt
settlement authority in accordance with the Federal Credit Reform Act of
1990 and OMB guidance; (5) under Credit Reform, loan restructurings are
classified as either "workouts" or "modifications" and require
significantly different accounting and budgetary treatment to accurately
measure and report the costs associated with restructured loans; (6) OMB
concluded that the costs of workouts are considered to be part of the
costs of defaults and are not treated as modifications; (7) in this
case, RUS restructured the loans of two financially troubled borrowers
under its debt settlement authority to maximize its recovery in the face
of imminent default; (8) RUS did not have to obtain new budget authority
to cover the cost of the restructurings; (9) RUS' restructuring of the
borrowers' loans resulted in new borrowing agreements that included
significant concessions and forgiveness of interest; (10) these two
borrowers had outstanding RUS debt of $331 million and $406 million,
respectively, after their debt was restructured; (11) RUS estimated that
it could lose approximately $185 million on loans restructured for the
first borrower and between $110 and $120 million for the second
borrower; (12) the Rural Development Service (RD) did not include in the
fiscal year 1999 financial reports the estimated loss of $185 million it
anticipates will occur as a result of restructuring loans for one
borrower, and included only $30 million of the estimated $110 to $120
million anticipated loss on the restructured loan for the other
borrower; (13) also, RD did not record in its accounting records a $7.2
million forgiveness of interest due to the agency as a result of
restructuring one of the borrower's loans; and (14) these errors
occurred because the accounting department lacked documented procedures
to ensure that debt forgiveness and losses resulting from restructuring
loans were properly reported in the financial statements.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-00-288
     TITLE:  Financial Management: Impact of RUS' Electricity Loan
	     Restructurings
      DATE:  09/29/2000
   SUBJECT:  Electric utilities
	     Loan repayments
	     Accounting procedures
	     Losses
	     Federal agency accounting systems
	     Internal controls
	     Debt collection
	     Cost analysis
	     Loan defaults
	     Direct loans

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GAO/AIMD-00-288

A Report to Congressional Requesters

September 2000 FINANCIAL MANAGEMENT

Impact of RUS' Electricity Loan Restructurings

GAO/ AIMD- 00- 288

Accounting and Information Management Division

Lett er

B- 286021 September 29, 2000 The Honorable John R. Kasich Chairman Committee
on the Budget House of Representatives

The Honorable Stephen Horn Chairman, Subcommittee on Government Management,
Information and Technology Committee on Government Reform House of
Representatives

This report responds to your request, as expressed in your letters of
October 15, 1999, and March 23, 2000, to review the Rural Utilities
Service's (RUS) policies, procedures, and assumptions used when
restructuring loans of financially troubled borrowers to mitigate future
loan losses. Increased competition in the electricity industry has increased
the risk of the federal government incurring future losses on loans to
generation and transmission (G& T) cooperatives. This risk is directly
related to the G& Ts' ability to set their rates in a competitive and/ or
regulated market at a level sufficient to recover all their costs. In fiscal
year 1999, under its debt settlement authority, RUS restructured the loans
of two financially troubled G& T borrowers which totaled $737 million after
the restructuring. In the event that G& Ts are unable to establish a
competitive position within the

electricity industry, it is probable that in the future, RUS will have to
use its debt settlement authority to restructure additional G& T borrowers'
loans that represent $19 billion of the $28 billion electric loan portfolio
as of September 30, 1999. Based on agreement with your staff, we reported to
you separately in a February 10, 2000, letter 1 on RUS' loan origination

policies and procedures for making new G& T loans. In that letter, we
recommended that the Secretary of Agriculture direct the Acting
Administrator of RUS to develop and document written procedures to ensure
consistent implementation of its G& T loan origination policies. In this
report, we have focused on RUS' restructurings of loans made to two
financially troubled G& T borrowers prior to implementation of the Federal 1
Rural Utilities Service: Loan Origination Policies and Procedures for
Generation and Transmission Loans (GAO/ AIMD- 00- 89R, February 10, 2000).

Credit Reform Act of 1990. Specifically, you asked us to determine (1) RUS'
policies and procedures for restructuring financially troubled G& T loans
and whether these are being consistently followed, (2) whether RUS properly
carried out loan restructurings in accordance with criteria defined in the
Federal Credit Reform Act of 1990 and Office of Management and Budget (OMB)
guidance, (3) how much it cost the federal government to restructure RUS'
debt since enactment of its debt settlement authority, and (4) whether the
costs of restructured loans are accurately reported.

Results in Brief While RUS generally followed its policies and procedures
for restructuring loans of two financially troubled borrowers, we found one
instance where RUS' policies were not fully utilized and other instances
where procedures could be improved. For example, RUS' policies provide that
a borrower may be required to obtain credit support from its member
distribution

cooperatives, such as obtaining a co- signature when restructuring the G& T
loans. RUS exercised this option for only one of the two financially
troubled borrowers, and in that case, only a portion of the restructured
note was guaranteed by the G& T's member distribution cooperatives. A co-
signature allows RUS to seek payment from the member distribution
cooperatives if the G& T defaults on its restructured loans, which could
help mitigate future loan losses to the government by better securing the
restructured loans. In addition, RUS' procedures lack detailed written
criteria for determining when a borrower should be added or removed from
RUS' list of financially troubled borrowers. RUS maintains this list to
assist in minimizing the federal government's risk of loss by identifying
those

borrowers that require additional monitoring of their ability to repay the
loans. Lack of detailed written criteria increases the potential for not
properly identifying those loans that require increased monitoring and for
inconsistent determinations as to when to add or remove a borrower from the
list.

RUS properly carried out its loan restructurings under its debt settlement
authority in accordance with the Federal Credit Reform Act of 1990 and OMB
guidance. 2 Under Credit Reform, loan restructurings are classified as
either “workouts” or “modifications” and, depending
on the classification, require significantly different accounting and/ or
budgetary treatment to accurately measure and report the costs associated
with restructured

2 OMB Circulars A- 11 and A- 34 include guidance for implementing credit
reform and provide the criteria used to identify workouts versus
modifications.

loans. Among other differences, modifications require new budget authority
while workouts do not. OMB concluded, and we agree, that the costs of
workouts are considered to be part of the costs of defaults and are not
treated as modifications. In this case, RUS restructured the loans of two
financially troubled borrowers under its debt settlement authority to
maximize its recovery in the face of imminent default. Thus, any changes in

the original terms of the loan or guarantee as a result of restructuring
should be classified as a workout rather than a modification. Therefore, RUS
did not have to obtain new budget authority to cover the cost of the
restructurings.

RUS' restructuring of the borrowers' loans resulted in new borrowing
agreements that included significant concessions, such as noninterest
bearing notes, notes that included payments based on contingencies such as
the sale of assets, and forgiveness of interest. These two borrowers had

outstanding RUS debt of $331 million and $406 million, respectively, after
their debt was restructured. RUS estimated that it could lose approximately
$185 million on loans restructured for the first borrower and between $110
and $120 million on loans restructured for the second borrower, on a net
present- value basis. These estimates may change based on several events
that could occur in the future. For example, according to RUS and an
independent consultant, the exact cost of restructuring one borrower's debt
may vary from current estimates because the debt restructuring agreement
contains contingencies, such as the borrower

paying the principal outstanding based on net proceeds from asset sales,
which may result in RUS receiving more or less from the borrower than
current estimates.

As part of the debt restructuring agreements, RUS entered into transactions
with the borrowers and a third- party creditor that resulted in RUS
acquiring the borrowers' non- RUS guaranteed debt, totaling about $12.3
million. According to RUS officials, the acquisition of the borrowers' debt
held by a third party and not guaranteed by RUS was in RUS' best interest.
RUS reached this conclusion because, among other things, it allows RUS to
make all the creditor decisions in the final development of the restructured
agreement, improves RUS' security interest in the

restructured loans, and increases RUS' flexibility to make decisions
concerning the sale or other marketing of the borrowers' nuclear assets.

Rural Development (RD) 3 did not include in its fiscal year 1999 financial
reports the estimated loss of $185 million RUS anticipates will occur as a
result of restructuring loans for one borrower, and included only $30
million of RUS' estimated $110 to $120 million anticipated loss on the
restructured loan for the other borrower. Also, RD did not record in its
accounting records a $7.2 million forgiveness of interest due to the agency
as a result of restructuring one of the borrower's loans. These errors
occurred because RD lacked documented procedures to ensure that debt

forgiveness, as well as estimated losses resulting from restructuring loans,
were properly reported in the financial statements.

The overall outcome of RUS' restructuring activities will not be known for
some time and will be significantly affected by the unfolding of events
surrounding the current move towards competitive electricity markets. It is
uncertain how these events will affect the remainder of RUS' $19 billion G&
T electric loan portfolio; however, it is likely that additional
restructurings and losses will occur. To the extent that additional
restructurings occur, it is essential that RUS fully utilize all measures

available to minimize the risk of loss from these problem loans and ensure
that losses that do occur are properly recorded and reported to Congress and
other decisionmakers. We are making several recommendations to address these
accounting and reporting deficiencies.

RUS and RD generally agreed with the thrust of our recommendations directed
toward improving the accuracy of estimated future loan losses and the
procedures to be employed when loans are restructured. However, RUS
disagreed with our position that it had not fully used the member guarantee
option when it restructured certain G& T loans and did not agree that such
guarantees were mandatory. Our point is that if RUS decides to obtain member
guarantees as part of a restructuring agreement, the guarantees should cover
all loans and remain in effect until all loans are repaid in order to
optimally protect the government's interest. With regard to our

conclusion on RD's inaccurate reporting of costs associated with
restructured loans, RD disagrees with our assessment because the allowance
for loan loss is an accounting estimate and RD believes that the issue is
one of “timely” reporting rather than accurate reporting. While
we agree that estimates can never be totally “accurate,” in this
case, even though the loss estimates had been determined at the time of the
3 RUS is a component of RD's mission area. RD provides accounting services
to RUS for its electric, telecommunications, and water and environmental
loan programs.

restructuring, they were not fully reflected in RD's fiscal year 1999
financial statements, which were issued 9 months after the last
restructuring. Background RUS, an entity within the Department of
Agriculture (USDA), provides

direct loans or loan guarantees primarily to rural electric cooperatives
that market power on a wholesale and retail basis. Most RUS borrowers are
either G& Ts or distribution cooperatives. A G& T cooperative is a nonprofit
rural electric system whose chief function is to sell electric power on a
wholesale basis to its owners- 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.

In the 1970s and 1980s, RUS provided financing for several G& Ts that had
invested in the construction of large nuclear and coal- fired generating
power plants. Several of these plants were completed late and over budget.

In addition, an expected increase in demand for electric power did not
materialize, and as a result, several of these G& Ts became financially
troubled and could not meet their debt- servicing requirements. In turn, the
federal government incurred several billion dollars in loan losses. For
example, from fiscal year 1992 through July 1999, RUS wrote off $1. 8
billion of debt related to financially troubled G& Ts and is in the process
of writing off an additional $3 billion of the $4.1 billion in loans owed by
a borrower as directed by the bankruptcy courts. We reported 4 that it is
probable that the federal government will continue to incur losses from loan
write- offs

related to RUS borrowers that were bankrupt or financially troubled. In
addition, we reported that it is also probable that future losses will arise
from other RUS borrowers with high production costs and the inability to
raise rates because of regulatory and/ or market pressures.

4 Rural Utilities Service: Status of Electric Loan Portfolio (GAO/ AIMD- 99-
264R, August 17, 1999).

Under Public Law 104- 127, the Secretary of Agriculture has the authority to
compromise, adjust, reduce, or charge off debts or claims arising from loans
made or guaranteed, such as those obtained by G& Ts, under the Rural
Electrification Act of 1936 (RE Act). 5 The Secretary of Agriculture has
delegated this authority to the Administrator of RUS, with respect to loans
made or guaranteed by RUS. 6 The Federal Credit Reform Act of 1990 governs
how RUS should budget for

loans and loan guarantees made under the RE Act. The act requires that the
budget reflect a more accurate measurement of the government's subsidy costs
7 for federal direct loans and loan guarantees, which permits better cost
comparisons both among credit programs and between credit and noncredit
programs. In addition, accounting standards for credit programs were
developed to ensure that financial reporting for credit program activities
generally mirror the requirements of the Federal Credit Reform Act of 1990.
The requirements for budgeting and accounting for the costs of debt
restructurings are drawn from the Federal Credit Reform Act, OMB

guidance, and RUS' authority to make loans and loan guarantee commitments
and its debt settlement authority. The costs of the workouts/ restructuring
of debt in imminent or actual default are not considered modifications, but
are considered to be part of the cost of default for which the agency has
permanent, indefinite budget authority.

Scope and We selected for review all troubled debt restructured by RUS under
its Methodology

authority granted in Public Law 104- 127 dated April 4, 1996. Two debt
restructuring agreements had been completed by the agency under this
authority as of May 1999. In addition to these two restructurings, another
borrower had requested that RUS settle its debt in the form of debt

5 According to 7 CFR 1717, a claim is defined as any claim of the government
arising from loans made or guaranteed under the RE Act, as amended, to a
rural electric borrower. Debt is defined as, but not limited to, outstanding
principal, accrued interest, penalties, and the government's costs of debt
collection arising from loans made or guaranteed under the RE Act.

6 Prior to April 4, 1996, the Department of Justice had to approve all
write- offs that were part of any agreement RUS reached with a G& T to
restructure its debt. 7 The credit subsidy cost is the government's
estimated net cost, in present value terms, of direct or guaranteed loans
over the entire period the loans are outstanding. The data used for these
budgetary estimates are generally reestimated after the fiscal year- end to
reflect

any changes in actual loan performance since the budget was prepared.

forgiveness. However, restructuring of the borrower's loans did not
materialize because RUS negotiated a deal that resulted in the borrower
merging with another RUS borrower considered financially viable. As part of
this deal, the financially viable borrower assumed the debt of the
financially troubled borrower. To determine RUS' policies and procedures for
restructuring financially troubled G& T loans, we reviewed RUS' policies
outlined in regulation 7 CFR 1717.1200, Settlement of Debt and RUS'
operating procedures documented in Staff Instruction 1717Y- 1, Processing
Requests for Settlement of Debt Owed by Electric Borrowers. In addition, we
interviewed RUS officials to obtain background information regarding the
enactment of RUS' authority. To determine if RUS consistently followed its
policies and procedures

when restructuring the loans of two financially troubled borrowers, we
reviewed RUS' administrative documents supporting the debt restructuring
agreements and compared those documents to RUS' policies and

procedures. We also reviewed both financially troubled borrowers'
applications to RUS requesting settlement of debt to determine whether the
documents included with each borrower's application supported its statement
that it was unable or would be unable to meet its financial obligations in
the short term. We interviewed RUS officials regarding the status of RUS'
list of financially troubled G& T borrowers and the criteria it uses to add
and remove borrowers from the list. In addition, we

interviewed officials at the National Rural Utilities Cooperative Finance
Corporation (CFC) to identify policies and procedures it uses when
restructuring financially troubled borrowers' debt. We did not verify the
accuracy of the underlying data RUS used to assess the borrowers' need for
debt settlement, nor did we reperform any of RUS' procedures to approve the
borrowers' application for debt settlement.

To determine whether RUS properly carried out loan restructurings in
accordance with criteria defined in the Federal Credit Reform Act of 1990
and OMB guidance, we interviewed RUS' Office of General Counsel staff and
OMB officials. In addition, we reviewed the Federal Credit Reform Act of
1990, as amended by the Balanced Budget Act of 1997, RUS' authority under
the RE Act and its debt settlement authority, and our Office of

General Counsel analyzed how troubled debt restructurings should be budgeted
and accounted for based on the requirements of those laws.

To determine how much it cost the federal government to restructure RUS'
debt since enactment of its debt settlement authority, we analyzed debt
restructuring agreements and supporting documentation, independent
consultants' reports, agency and borrower financial reports, and held
discussions with agency program, accounting, and budget officials. We did
not determine the administrative costs, such as salaries, associated with
the debt restructurings because that information was not tracked by the
agency and could not be readily determined. To determine whether the costs
of restructured loans have been accurately reported, we reviewed agency
audited financial statements and supporting records. We compared cost data
included in the debt restructuring

agreements to the agency's financial statements and supporting records. We
interviewed agency accounting staff to determine policies and procedures
used to estimate losses on outstanding loan balances. In addition, we
interviewed budget staff to determine how loan losses are

reported in the budget. Because RUS is a component of USDA's Rural
Development mission area, RUS' financial data are included in Rural
Development's consolidated financial statements. We conducted our review
from September 1999 through July 2000 in accordance with generally accepted
government auditing standards. We requested comments on a draft of this
report from the Administrator of the

Rural Utilities Service or his designee. The Administrator provided us with
written comments, which are discussed in the “Agency Comments and Our
Evaluation” section and reprinted in appendix II.

Policies and RUS' policies for the settlement of debt and claims owed by
rural electric

Procedures for Loan borrowers are documented in 7 CFR 1717. 1200, Settlement
of Debt. This

regulation implements RUS' statutory authority to settle borrowers' debts
Restructurings Were

and claims arising from loans made or guaranteed to rural electric Not Fully
Utilized and borrowers under the Rural Electrification Act of 1936. 8 RUS'
internal Staff Could Be Improved

Instruction 1717Y- 1, Processing Requests for Settlement of Debt Owed by
Electric Borrowers, documents the procedures for processing borrowers'
requests for settlement of debt owed to RUS. Key policies and procedures are
discussed in more detail in appendix I. 8 The Rural Electrification Act of
1936, as amended (7 U. S. C. sect. 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.

While RUS generally followed its policies and procedures for restructuring
loans of two financially troubled borrowers, we found one instance where
RUS' policies were not fully utilized and other instances where procedures
could be improved. For example, RUS' policies provide that a borrower may be
required to obtain credit support from its member distribution

cooperatives, such as obtaining a co- signature when restructuring the G&
Ts' loans. RUS exercised this option for only one of the two financially
troubled borrowers, and in that case, only a portion of the restructured
note was guaranteed by the G& T's member distribution cooperatives. A

co- signature allows RUS to seek payment from the member distribution
cooperatives if the G& T defaults on its restructured loans. Requiring a co-
signature could help mitigate future loan losses to the government by better
securing the restructured loans. In addition, RUS' procedures lack detailed
written criteria for determining when a borrower should be added or removed
from RUS' list of financially troubled borrowers. Federal internal control
standards require that (1) internal control procedures be clearly
documented, (2) the documentation be readily available for examination, and
(3) the documentation appear in management directives,

administrative policies, or operating manuals. 9 RUS maintains the list to
assist in minimizing the federal government's risk of loss by identifying
those borrowers that require additional monitoring of their ability to repay
the loans. Lack of detailed written criteria increases the potential for not
properly identifying those loans that require increased monitoring and for
inconsistent determinations as to when to add or remove a borrower from the
list.

In the first two restructurings completed under its debt settlement
authority, which we will refer to as borrower A and borrower B, RUS only
obtained a member guarantee for borrower B, and in that case, only a portion
of the restructured note was guaranteed by that G& T's members. For this
borrower, RUS made three restructured notes totaling $331 million. Of the
$331 million, RUS required the borrower's members to

guarantee approximately 3 percent (about $10.2 million). In addition, RUS
has agreed to reduce the guarantee by 7 cents for each dollar of original
principal paid on the first two notes and eliminate the member guarantee
after the notes are paid. RUS stated that the level of guarantee obtained

9 Standards for Internal Control in the Federal Government (GAO/ AIMD- 00-
21.3.1, November 1999). These standards provide an overall framework for
establishing and maintaining internal control and for identifying and
addressing major performance and management challenges and areas at greatest
risk of fraud, waste, abuse, and mismanagement.

was based on the value of the members' equity. However, we believe that this
does not maximize the government's security in the restructured loans
because the level of guarantee is reduced as the first two loans are repaid
and then eliminated for the life of the third loan. Had RUS structured the
guarantee to include the third loan until it was paid in full, it would have
maximized its recovery chances. That is, the guarantee would have remained
in effect for the third loan which has significant risk because

payment of this note is contingent on net proceeds from asset sales and
other recovery mechanisms. RUS' debt settlement policies outlined in 7 CFR
1717.1200 include various factors to consider when restructuring a

borrower's loan, including obtaining member guarantees to secure loans. This
practice of requiring member guarantees is used by CFC, a private, not- for-
profit cooperative association whose principal purpose is to provide its
members with a source of financing to supplement the loan programs of RUS.
CFC officials stated that when it restructures troubled debt of G& T
borrowers, its policy is to obtain guarantees from the borrower's member
systems. Utilizing member guarantees, to the greatest extent possible, when
restructuring loan agreements could help reduce the government's risk of
future losses even if the amount guaranteed is not a

substantial part of the loan. In addition, RUS' procedures lack detailed
criteria used to determine when a borrower should be added or removed from
RUS' list of financially troubled borrowers. For example, RUS' procedures
require that any borrower assigned to RUS' Financial Services Staff- who
monitor financially troubled borrowers- will automatically be designated as
financially troubled. No other criteria is documented as to when to add a
borrower to the list. Also, RUS' procedures require that a borrower be

removed from the list when its financial troubles have been successfully
mitigated. However, there is no explanation provided to define
“successfully mitigated.” RUS' broad criteria documented in its
procedures does not reflect the detailed definitions used by RUS and
communicated to us during this and a previous assignment. In September 1997,
we reported 10 RUS management's definition of a financially troubled
borrower. According to RUS, borrowers considered financially troubled have
either defaulted on their loans, had their loans restructured but are still
experiencing financial 10 Federal Electricity Activities: The Federal
Government's Net Cost and Potential for Future Losses (GAO/ AIMD- 97- 110
and 110A, September 19, 1997). This report discusses the federal
government's net costs and exposure to future financial losses to support
electricity- related activities, including RUS.

difficulty, declared bankruptcy, or have formally requested financial
assistance from RUS. During this assignment, in an interview with a senior
RUS official, we were told that borrowers are removed from the list of
financially troubled borrowers when RUS is no longer actively negotiating
with that borrower regarding its outstanding debt. Although RUS staff are

aware of the various criteria used, not documenting this criteria increases
the potential for not properly identifying those loans that require
increased monitoring. Other improvements we believe RUS could make to its

procedures for reporting the cost of restructuring G& T debt are discussed
later in this report. RUS Properly Carried

RUS properly carried out its loan restructurings under its debt settlement
Out Loan authority in accordance with the Federal Credit Reform Act of 1990
and OMB guidance. Under Credit Reform, loan restructurings are classified as
Restructurings

either “workouts” or “modifications” and depending
on the classification, require significantly different accounting and/ or
budgetary treatment in order to accurately measure the costs associated with
restructured loans.

As mentioned earlier, RUS restructured loans totaling about $737 million for
the two financially troubled G& T borrowers under its debt settlement
authority. Both debt restructuring agreements were completed during fiscal
year 1999. RUS restructured these loans to provide the borrowers more
favorable payment terms and to improve the borrowers' competitive

position and ability to repay their loans. New borrowing agreements were
made as part of both debt restructurings, which included significant
concessions such as issuing noninterest bearing notes and allowing the
borrowers to make payments based on contingencies, including net proceeds
from asset sales.

The accounting and/ or budgetary treatment for a workout significantly
differs from the treatment of a modification. A workout does not require an
agency to obtain budget authority in the current year to cover the full cost
of the loan or guarantee over its remaining life. The cost of the revision
under a workout (e. g., a change in cash receipts and/ or any defaults that
may occur in the future) is recognized in the budget over the remaining life
of the restructured loan or guarantee in the year( s) the change in the cost
occurs. However, for a modification, Credit Reform requires an agency to

obtain budget authority in the current year to cover the full cost of the
modified loan (referred to as subsidy) over its remaining life. Also, the
full cost of the modified loan or guarantee must be reflected in the
agency's current year financial statements and budget. While agencies are
required to annually reestimate the subsidy cost, Congress provided
permanent,

indefinite authority to cover the difference between the reestimated cost
and prior estimate. Therefore, improper classification of restructured loans
could result in RUS and Congress not having accurate budgetary and financial
statement data to help make informed decisions about future funding needs
for the electric loan program.

RUS classified the loans it restructured under its debt settlement authority
as workouts and not modifications in accordance with the Federal Credit
Reform Act and OMB guidance. When the government takes an action that
differs from the actions assumed in the original estimates and changes the

estimated cost of an outstanding loan or guarantee from the current estimate
of cash flows, such as eliminating any fees associated with the program, the
action must be classified as a loan modification, which requires new budget
authority. On the other hand, if the action is allowed by an existing
statute, under the original terms of the loan or guarantee, or was included
in the original estimate of the subsidy cost, such as a

restructuring as a result of imminent or actual default, then the revision
to the loan or guarantee should be classified as a workout, although the
estimated cost of the loan or guarantee may be altered. Therefore, OMB
concluded, and we agree, that the costs of workouts are considered to be
part of the costs of default and are not treated as modifications. Here, RUS
restructured the loans of two financially troubled borrowers under its debt
settlement authority to maximize its recovery in the face of imminent
default. Thus, any changes in the original terms of the loan or guarantee

should result in classifying the restructuring as a workout rather than a
modification. As a result, RUS did not have to obtain new budget authority
to cover the cost of the restructurings.

The Federal The federal government has incurred costs related to
restructuring loans Government Has

for the two financially troubled borrowers. These two borrowers had
outstanding RUS debt totaling about $737 million after their debt was
Incurred Costs on restructured. RUS stated that it could lose approximately
$185 million on Restructured Loans loans restructured for borrower B and
between $110 and $120 million on loans restructured for borrower A. These
estimates may change based on several events that could occur in the future.
For example, according to

RUS and an independent consultant, the exact cost of restructuring borrower
B's debt may vary from current estimates because the debt restructuring
agreement contains contingencies, such as the borrower

paying the principal outstanding based on net proceeds from asset sales,
which may result in RUS receiving more or less from the borrower than
current estimates. RUS restructured the borrowers' loans to provide more

favorable payment terms to improve the borrowers' competitive position and
ability to repay the loans. RUS officials reported that they negotiated the
best deals possible for the federal government taking into consideration,
among other things, the probability that the borrowers

would file for bankruptcy, which according to RUS, would leave minimal or
possibly no funds available for RUS to collect on the troubled debt.

As part of the debt restructuring agreements, RUS entered into transactions
with the borrowers and a third- party creditor that resulted in RUS
acquiring the borrowers' non- RUS guaranteed debt. According to RUS

officials, the acquisition of the borrowers' debt held by a third party and
not guaranteed by RUS was in RUS' best interest. RUS reached this conclusion
because, among other things, acquiring the borrowers' debt allowed RUS to
make all the creditor decisions in the final development of the restructured
agreement, improves RUS' security interest in the restructured loans, and
increases RUS' flexibility to make decisions concerning the sale or other

marketing of the borrowers' nuclear assets. Also, the third party agreed
that RUS could acquire the borrower's debt at a significant discount. RUS'
acquisition of the borrowers' non- RUS guaranteed debt to maximize its

recovery of the restructured loans in the face of imminent default is
allowed under RUS' broad authority to settle debt related to loans and loan
guarantees under the RE Act. Thus, RUS' acquisitions of the non- RUS
guaranteed debt are not considered new loans under Credit Reform and,
therefore, do not require the agency to obtain budget authority to cover the
cost of the new loans.

RUS' restructuring of the borrowers' loans resulted in new borrower
agreements that included significant concessions like noninterest bearing
notes, notes that included payments based on contingencies such as the sale
of assets, and forgiveness of interest. Both borrowers had significant
investments in nuclear power facilities, which, according to RUS officials,
had questionable market value under a forced liquidation proceeding such as
bankruptcy. From a negotiating standpoint, RUS officials stated that they
needed to balance RUS' objective of minimizing the federal government's
losses against the likely outcome of forced collection of assets at current
market prices in the event of bankruptcy. RUS officials also estimated that
the government's recovery would most likely have been minimal or possibly
zero under a forced collection scenario. The following

is a brief discussion of the agreements between RUS and the two borrowers
whose loans were restructured under RUS' debt settlement authority.

RUS' Agreement With On May 28, 1998, borrower A submitted an application to
the RUS Borrower A

Administrator requesting debt settlement under RUS' debt settlement
authority. The borrower's financial difficulties stemmed from high
production costs of its nuclear generating asset as well as state
initiatives establishing retail competition. Prior to submitting its
application,

borrower A pursued opportunities to reduce administrative overhead, improve
efficiency and effectiveness, and expand its markets and revenues. However,
according to RUS, these actions could not alleviate borrower A's

financial difficulties. In 1997, RUS undertook a review of borrower A's
member systems operations to identify inefficiencies and opportunities for
cost savings. RUS reported that while savings could be realized if the
member systems changed their operating practices, such as updating their
meter reading systems and combining customer service groups, these savings,
if realized, would have little effect on the overall competitiveness of
members' retail rates. On March 29, 1999, RUS and borrower A entered into a
debt restructuring agreement to address the borrower's financial stress.
This restructuring agreement included the borrower's RUS- guaranteed Federal
Financing

Bank (FFB) 11 debt, but not the borrower's direct loans held by RUS at that
time. Prior to the restructuring, borrower A's FFB debt totaled about $416
million. After the restructuring, borrower A's new note totaled $406
million. According to RUS, the $10 million difference in principal resulted
from RUS reducing the amount due by the borrower's payments received during
the restructuring process. The new note, with an interest rate of 7. 18
percent, replaces old notes with interest rates ranging from

5.18 percent to 10.3 percent. Also included in the $406 million note is a
$95 million balloon payment due at maturity on January 1, 2008. However, RUS
recognizes that the borrower should have several options for payment of the
$95 million, including a reamortization of the amount due. In addition,
terms of the $406 million note and borrowing agreement include

forgiveness of interest, calculated on a quarterly basis, if all members of
the borrower's system agreed to the terms of the debt settlement that are
applicable to them, such as paying revised wholesale rates. The amount of
interest forgiveness is prorated when there is less than 100 percent
participation.

11 The Federal Financing Bank is a government corporation under the U. S.
Treasury created by Congress to centralize and reduce the cost of federal
and federally assisted borrowing from the public.

In addition, RUS and borrower A entered into another loan agreement that
resulted in RUS paying $1.07 million to CFC to satisfy debt that borrower A
had with CFC, but was not guaranteed by RUS. RUS acquired borrower A's $3
million net outstanding debt with CFC at a substantial discount by agreeing
to offset the $1. 07 million from amounts CFC owed RUS under a separate debt
settlement arrangement. RUS' Agreement With

On March 2, 1999, borrower B submitted an application to the RUS Borrower B

Administrator requesting debt settlement under RUS' debt settlement
authority. The borrower's financial difficulties stemmed from high
production costs of its nuclear generating asset and significant rate
disparity between the borrower's wholesale power costs and those of its

competition. Prior to submitting its application, borrower B undertook
efforts to address its financial stress. These initial efforts, among
others, included cost- cutting measures, renegotiation of its power supply
contracts with another utility, refinancing of RUS- guaranteed debt, and
sale of its

transmission facilities to another RUS borrower. However, these efforts did
not resolve borrower B's financial stress.

On May 6, 1999, RUS and borrower B entered into a debt restructuring
agreement to address the borrower's financial stress, with an effective date
of April 30, 1999. Prior to the restructured agreement, borrower B's debt

held by RUS totaled about $310 million. After the restructuring, borrower
B's debt totaled about $331 million. The increase in principal amount held
by RUS after the restructuring is a result of RUS acquiring borrower B's
other debt that was held by a third party and not guaranteed by RUS. The
$331 million consists of three new notes that all mature on December 31,
2008. Two notes are interest- bearing, with an interest rate of 5.23
percent. The remaining note is noninterest bearing. However, the exact
amount of recovery cannot be assured since payments are not fixed, but are
based on

the amount of available cash for debt service and the net proceeds from the
sale of borrower B's nuclear and other assets. As a result, forgiveness of
principal may occur if the net proceeds are insufficient to pay off the
notes.

As part of the debt restructuring agreement, RUS acquired borrower B's loans
with CFC. RUS negotiated with CFC to acquire the $31 million of CFC loans at
a significant discount for $9.3 million. To carry out the acquisition, RUS,
CFC, and borrower B entered into a formal purchase agreement

where the borrower was directed to skip a payment to FFB and use the funds
to make a $9.3 million payment to CFC on behalf of RUS. RUS made payment to
FFB for the missed scheduled payment and in turn,

incorporated the acquired debt in borrower B's newly restructured notes
resulting from the debt settlement agreement. Borrower B no longer has any
debt service obligations to CFC.

Rural Development Did RD did not include the estimated loss of $185 million
RUS anticipates will Not Accurately Report occur as a result of
restructuring loans for borrower B in the agency's fiscal

year 1999 financial reports. In addition, only $30 million of RUS' estimated
RUS' Costs for

$110 million to $120 million anticipated loss on the restructured loan for
Restructuring G& T

borrower A was included in RD's fiscal year 1999 financial reports. Also,
Debt

RD did not record in its accounting records a $7. 2 million forgiveness of
interest due to the agency as a result of restructuring borrower A's loans.
These errors occurred because RD lacks documented procedures to ensure that
debt forgiveness, as well as estimated losses resulting from restructuring
loans, is properly recorded in the financial reports. Until this situation
is corrected, Congress and other decisionmakers cannot rely on

the reported costs of RUS' electric loan program included in RD's annual
consolidated financial statement reports.

Lack of Documented RD did not properly report estimated future loan losses
for the restructured

Policies and loans. Reporting errors occurred for the restructured loans
because RUS' procedures for processing borrower's requests for settlement of
debt owed

Procedures Has Led to to RUS do not include accounting staff
responsibilities during the loan Improper Reporting of

restructuring process to ensure proper reporting of the cost of Estimated
Losses for restructuring the debt as well as amounts due after the
restructuring. Also, RD lacks documented procedures to ensure that losses
estimated to occur

RUS' Electric Loan as a result of restructuring loans are properly
calculated and net loan

Portfolio balances are reported in accordance with Statement of Federal
Financial Accounting Standards (SFFAS) No. 2, Accounting for Direct Loans
and Loan Guarantees. 12 For example, when recording borrower B's
restructured loans, no loss was included in the agency's estimated future
loan losses calculation for electric loans, even though RUS stated that it
anticipated recovery of less than half of the loans on a net present value

basis. For borrower A, RD significantly understated RUS' estimated loss.
Specifically, in its financial reports, RD reported that a $30 million 12
SFFAS No. 2, which generally mirrors the Federal Credit Reform Act of 1990,
requires that all direct loans obligated and loan guarantees committed after
September 30, 1991, be accounted for on a present value basis.

estimated loan loss would occur on the restructured loan. However, this
information is inconsistent with one of RUS' program documents which states
that “the debt settlement negotiated would result in a write- off of
between $110 and $120 million with respect to outstanding RUS- guaranteed
FFB debt in the principal amount of $416.1 million.” Also, RD did not
document whether it considered applicable accounting requirements outlined
in SFFAS No. 2 when it calculated estimated loan losses for the electric
loan portfolio. 13 SFFAS No. 2 provides guidance for

reporting estimated future loan losses on direct loans and loan guarantees.
One of the key factors used to estimate future loan losses is default costs.
The default cost of direct loans results from any anticipated deviation,
other than prepayments, by the borrowers from the payments schedule in

the loan contracts. The deviations include delinquencies and omissions in
interest and principal payments. In estimating default costs, SFFAS No. 2,
par. 34, recommends that the following risk factors be considered: (1) loan
performance experience; (2) current and forecasted international, national,

or regional economic conditions that may effect the performance of the
loans; (3) financial and other relevant characteristics of borrowers; (4)
the value of collateral to loan balance; (5) changes in recoverable value;
and (6) newly developed events that would affect the loan's performance. In
addition, SFFAS No. 2, par. 35, requires that if individual accounts with
significant amounts carry a high weight in risk exposure, an analysis of the

individual accounts is warranted in making a default cost estimate for that
category. During our review of RD's fiscal year 1999 calculation of
estimated future loan losses for the electric loan portfolio, we noted that
RD does not maintain supporting documentation that addresses the risk
factors used to estimate the default costs. Unless RD develops policies and
procedures to

estimate future loan losses in accordance with SFFAS No. 2 and establishes
accounting staff responsibilities during the loan restructuring process,
there is no assurance that the accounting information related to the
electric loan program provides an accurate basis for Congress and other
decisionmakers to evaluate credit program performance.

13 RUS' credit program receivable data are reported in RD's financial
reports. As of September 30, 1999, RD reported $23. 1 billion in pre- 1992
electric loans or about 82 percent of the total $28.1 billion gross electric
loans receivable. RD elected to report its pre- 1992 electric loans on a net
present value basis. SFFAS No. 2 permits, but does not require, restatement
of pre- 1992 direct loans and loan guarantees on a present value basis.

Other Loan For borrower A's restructured loans, RD did not record in its
accounting Restructuring Costs records a $7.2 million forgiveness of
interest to the borrower. As part of the debt settlement agreement, RUS
provided the borrower debt forgiveness Were Not Reported

on accrued interest owed. However, this information was not reported in the
agency's financial reports. During interviews with RD officials regarding
the borrower's debt settlement agreement, we noted that the officials were
unaware of all the facts surrounding the borrower's debt settlement
agreement and did not have copies of applicable loan file documents
maintained by the program office, which outline the terms of the borrower's
debt settlement agreement. After further discussions with RD staff, the
Deputy Chief Financial Officer agreed that a write- off for the

debt forgiveness should have been recorded at the time of the restructuring
and the records would be adjusted to reflect the debt forgiveness. Without
accurately reporting debt forgiveness associated with the loan
restructuring, Congress and other decisionmakers do not have valid cost data
to make informed decisions about the electric loan program.

Conclusions RUS has exercised its broad authority in restructuring the loans
of two G& T borrowers, including acquisition of third- party non- RUS
guaranteed

debt, and providing significant concessions to the borrowers, such as
noninterest bearing notes, contingent payments, and forgiveness of interest.
RUS officials stated that their main objective is to minimize the

federal government's losses and that the restructurings were necessary to
carry out this objective. Yet, RUS did not obtain member guarantees on the
bulk of the restructured loans and does not have adequate procedures for
updating its list of financially troubled borrowers that need special
monitoring- two important factors in minimizing potential losses.

Thus far, these restructurings have resulted in estimated losses of $295
million to $305 million, 14 of which only $30 million was reported in RD's
financial statements. The overall outcome of RUS' restructuring activities
will not be known for some time, and will be significantly affected by the
unfolding of events surrounding the current move towards 14 The range of
anticipated losses is calculated by combining the dollar amounts of losses
for both borrowers. The $295 million is calculated by adding borrower A's
anticipated minimal

loss of $110 million to borrower B's anticipated loss of $185 million. The
$305 million amount is calculated by adding borrower A's maximum anticipated
loss of $120 million to borrower B's anticipated loss of $185 million.

competitive electricity markets. It is uncertain how these events will
affect the remainder of RUS' $19 billion G& T electric loan portfolio;
however, it is likely that additional restructurings and losses will occur.
To the extent that

additional restructurings occur, it is essential that RUS fully utilize all
measures available to minimize the risk of loss from these problem loans and
ensure that losses that do occur are properly recorded and reported to
Congress and other decisionmakers.

Recommendations To better secure the restructured loans and to improve RUS'
process to restructure and report financially troubled borrower's loans, we
recommend that the Secretary of Agriculture direct the Administrator of the
Rural Utilities Service and in some instances, the Under Secretary of Rural
Development to take the following actions:

Utilize member guarantees to the greatest extent possible by ensuring that
such guarantees obtained remain in effect until all restructured loans are
paid in full. Broaden procedures in its Staff Instruction document, 1717Y-
1,

Processing Requests for Settlement of Debt Owed By Electric Borrowers to
include the program staff's coordination with accounting staff to provide
all

relevant information regarding the terms of the borrowers' restructured
loans and procedures that identify the criteria RUS uses to determine when a
borrower should be added or removed from the list of financially troubled
borrowers. Develop and document written procedures to estimate future loan
losses for its credit program receivables in accordance with Statement of
Federal Financial Accounting Standards No. 2, Accounting for Direct

Loans and Loan Guarantees. Adjust accounting reports to properly disclose
the full costs associated

with the restructured loans. Agency Comments and

We provided RUS and Rural Development with a draft of this report for Our
Evaluation

review and comment. In summary, RUS and RD officials generally agreed with
our recommendations to broaden RUS' procedures regarding the coordination of
program and accounting staff responsibilities, develop and document written
procedures to estimate future loan losses for its credit program receivables
in accordance with federal accounting standards, and

adjust its financial reports to reflect the costs associated with the
restructured loans. RUS also plans to review the criteria used to determine
when to add or remove a borrower from the list of financially troubled
borrowers. However, RUS and RD officials disagreed with our conclusions
regarding RUS' use of member guarantees when restructuring loans of
financially troubled borrowers and its inaccurate reporting of costs
associated with the restructured loans.

Specifically, RUS stated that our finding regarding its utilization of
member guarantees implies that RUS' efforts were somehow deficient because
it did not obtain more guarantees. Further, RUS stated that our conclusion
suggests that we disagree with its policy on member guarantees, and that our
report “misreads” the requirements of RUS' regulations regarding
debt compromise. Our report does not state that RUS should require member

guarantees as a condition of debt settlement nor does it imply that RUS
should have used the member guarantee option in the case of borrower A.
However, our report does state that when RUS exercises its option to require
its borrowers to obtain member guarantees, it should utilize these
guarantees to the greatest extent possible by structuring the guarantee to
include all of the borrower's restructured loans until the last loan is paid
in full. This was not the scenario in the case of borrower B. Also, contrary
to RUS' statement, we take no issue with RUS' debt settlement policy, which

states that the Administrator of RUS will “consider requiring the
borrower to obtain credit support from its member systemsï¿½.” Our
discussion of member guarantees in this report is not a suggestion that RUS
consider changing its policy, but rather to more fully utilize it to help
maximize the

federal government's recovery on troubled loans. With regard to our
conclusion on RD's inaccurate reporting of costs associated with
restructured loans, RD disagrees with our assessment because the allowance
for loan loss is an accounting estimate and RD believes that the issue is
one of “timely” reporting rather than accurate reporting. While
we agree that estimates can never be totally “accurate,” in this
case the estimates were significantly understated. As noted by RUS, the
restructurings were completed in March and May 1999 and the estimated losses
were determined at that time. Yet, because of a lack of communication
between the program staff and accounting staff, these loss estimates were
not reported in RD's fiscal year 1999 financial statements,

which were issued in February 2000. Additionally, for borrower B, RD
included an estimated loss of $200 million in its fiscal year 1998 financial
reports. However, accounting staff failed to include any loss estimate for
borrower B in the fiscal year 1999 financial reports, even though the

borrower's financial condition continued to deteriorate and the borrower had
requested financial assistance from RUS. Thus, the financial statements were
inaccurate and misleading in that they did not reflect all known information
about loss estimates. A complete presentation of RUS'

comments and our responses is provided in appendix II. As we arranged with
your office, unless you publicly announce its contents earlier, we plan no
further distributions of this report until 30 days from the date of this
letter. At that time, we will send copies of this report to the Honorable
John M. Spratt, Jr., and the Honorable Jim Turner, the Ranking Minority
Members of your Committee and Subcommittee; the Honorable Daniel Glickman,
the Secretary of Agriculture; the Honorable Christopher A. McLean,
Administrator of the Rural Utilities Service; the Honorable Jacob J. Lew,
the Director of the Office of Management and Budget; and other interested
parties. We will make copies available to others upon request.

If you have any questions regarding this report, please contact me at (202)
512- 9508 or McCoy Williams, Assistant Director, at (202) 512- 6906. Key
contributors to this assignment are listed in appendix III.

Linda M. Calbom Director, Resources, Community,

and Economic Development, Accounting and Financial Management Issues

Appendi xes Key Policies and Procedures Used to Settle

Appendi x I

Debt Owed by Electric Borrowers RUS' policies for the settlement of debt and
claims owed by rural electric borrowers are documented in 7 CFR 1717. 1200,
Settlement of Debt. This regulation implements RUS' statutory authority to
settle borrowers' debts and claims arising from loans made or guaranteed to
rural electric borrowers under the Rural Electrification Act of 1936. This
regulation outlines (1) the criteria and factors RUS must use to determine
the need for debt settlement, (2) conditions RUS may place on the settlement
agreement, (3) debt settlement measures RUS considers when restructuring
loans, and (4) consideration of loan requests after debt

settlement. The regulation also describes the type of information the
borrower must submit to RUS to support the borrower's statement that it is
unable or will be unable to meet its financial obligations in the short
term.

For example, the borrower must provide an analysis of the causes resulting
in the borrower's inability to meet its financial obligations. The borrower
must also provide a thorough review of opportunities available or
potentially available to reduce overhead and other costs and improve the
efficiency and effectiveness of its operations.

RUS' internal Staff Instruction 1717Y- 1, Processing Requests for Settlement
of Debt Owed by Electric Borrowers, documents the procedures for processing
borrowers' requests for settlement of debt owed to RUS. These operating
procedures include the responsibilities of RUS staff assigned to a troubled
borrower and their coordination with other offices during the restructuring
process. For example, the RUS staff assigned to a troubled borrower must
work with various RUS offices within the electric program as well as RUS'
Office of General Counsel on issues affecting the borrower's financial
condition. RUS' procedures also identify internal documents that staff must
prepare, which address the borrower's financial stress and justification for
the debt restructure. Two primary documents that staff must prepare as part
of the restructuring process include an

administrative action document and a recommendation and report document. The
administrative action document outlines those measures approved by the
Administrator to address the borrower's financial stress. A recommendation
and report outlines internal and external factors leading to the borrower's
stress; the process used to analyze the borrower's stress; steps taken by
RUS, the borrower, and the borrower's member systems to mitigate the
borrower's stress; and recommended action to be taken by RUS regarding debt
settlement. In addition, the procedures provide that

RUS monitor and maintain a list of financially troubled borrowers. RUS' key
policies documented in 7 CFR 1717.1200 to settle debt and claims owed by
rural electric borrowers are listed below.

Criteria and Factors The Administrator will not settle any debt or claim
unless RUS has

Used to Determine the determined that (1) the borrower is unable to meet its
financial obligations

under its loan agreement or (2) the borrower will not be able to meet its
Need for Debt obligations within 24 months following the month the borrower
submits its

Settlement application for debt settlement to RUS, and in either case,
default is likely to continue indefinitely. The determination of a
borrower's ability to meet

its financial obligations will be based on analyses and RUS' documentation
of the borrower's historical, current, and projected costs, revenues, cash
flows, assets, opportunities to reduce costs and/ or increase revenues, and
other factors that may be relevant to the request. In addition, RUS may
require that an independent consultant analyze the efficiency and
effectiveness of the borrower's organization and operations and those of the
borrower's member systems. Also, RUS may require the borrower to employ a
temporary or permanent manager during the time the debt

settlement is being considered, and possibly for some time after the debt
settlement or on a permanent basis, to manage the borrower's operations and
ensure that all actions are taken to avoid or minimize the need for debt
settlement.

Conditions RUS During the restructuring process, the Administrator may place
conditions

Considers When on the borrower as part of the debt settlement agreement and/
or consider other factors when restructuring a borrower's loans. During the

Restructuring Loans restructuring process, the Administrator will not grant
relief on debt owed to the federal government unless similar relief, on a
pro rata basis, is granted with respect to other secured

obligations of the borrower, or the other secured creditors provide other
benefits or value to the debt restructuring; consider requesting that the
borrower or independent consultant solicit competitive bids for the assets
of the borrower;

consider the value of the borrower's assets, including wholesale power
contracts 1 between the G& T and its member systems; consider rates charged
for electric service by the borrower and its member systems;

consider whether a settlement is favorable to the federal government in
comparison to recovery by enforced collection procedures; 1 Wholesale power
contracts are long- term contracts that obligate the distribution
cooperatives to purchase all of their respective power needs from the G& T.

require the borrower to provide satisfactory evidence that it has obtained
all approvals required by regulatory bodies that are needed to implement
rates or other provisions of the settlement; require the borrower and its
member systems to implement changes in structure, management, operations,
and performance deemed

necessary; consider requiring the borrower to convey some or all of its
assets to the

federal government; consider requiring the borrower to obtain credit support
from its

member systems, as well as action plans by the members to change their
operations, management, and organizational structure to reduce operating
costs, improve efficiency, and/ or expand markets and revenues; require the
borrower to warrant and agree that no bonuses or similar

extraordinary compensation has been or will be provided, for reasons related
to the settlement of debt, to any officer or employee of the borrower or to
other persons or entities identified by RUS; and

require borrower management to certify that all information provided to the
federal government in connection with the debt settlement, is true, correct,
and complete in all material respects.

Debt Settlement If the Administrator determines that debt settlement is
appropriate, the Measures

debt settlement measures considered with respect to direct or guaranteed
loans include, but are not limited to, reamortization of debt; extension of
debt maturity; 2 reduction of interest rate charged to the borrower; 3
forgiveness of interest accrued, penalties, and costs incurred by the

government to collect the debt; and forgiveness of loan principal with
concurrence from the Under Secretary for Rural Development. Also, for loans
guaranteed under section 306 of the RE Act made by the Federal Financing
Bank (FFB) or other third parties, the Administrator may restructure the
borrower's obligations by (1) acquiring and restructuring

the guaranteed loan, (2) restructuring the loan guarantee obligation, (3)
restructuring the borrower's reimbursement obligations, or (4) such

2 Extension of maturity shall not extend more than 10 years beyond the
latest maturity date prior to settlement. 3 The interest rate on any portion
of the restructured debt shall not be reduced to less than 5 percent, unless
the Administrator determines that reducing the rate below 5 percent would
maximize debt recovery by the federal government.

means as the Administrator deems appropriate, subject to such consents and
approvals, if any, that may be required by the third party lender.
Consideration of Loan

In considering any future loan requests from a borrower whose debt has
Requests After Debt

been settled in whole or part, it will be presumed that the Administrator
will require that the borrower provide credit support that is acceptable to
Settlement

the Administrator for the full amount of the loan request. Types of credit
support may include, but are not limited to, equity infusions and guarantees
of debt repayment, either from the applicant's members or from a third
party.

Appendi x II

Comments From the Rural Utilities Service Note: GAO comments supplementing
those in the report text appear at the end of this appendix. See comment 1.
See comment 3. See comment 2.

See comment 3. See comment 3. See comment 4. See comment 3. See comment 5.

See comment 6. See comment 7.

See comment 3. See comment 3.

See comment 3.

See comment 8. See comment 9.

See comment 10.

The following are GAO's comments on the Rural Utilities Service's (RUS)
letter dated September 14, 2000. GAO Comments 1. We have modified our report
to distinguish between Rural Development (RD) and RUS when discussing the
errors and

weaknesses found in the reporting and accounting procedures for the
restructured loans. However, as we have stated in our report, RUS is a
component of RD's mission area and RUS' financial data are included in RD's
consolidated financial statements.

2. The sentence being referred to is simply a statement of our findings and
reads as follows: “While RUS generally followed its policies and
procedures for restructuring loans of two financially troubled borrowers, we
found one instance where RUS' policies were not fully utilized and other
instances where procedures could be improved.”

3. Discussed in the “Agency Comments and Our Evaluation” section
in the letter report. 4. Regarding member guarantees as credit support, the
only aspect we

discuss in our report relates to the structuring of the guarantee to include
the third loan. 5. Our report does not contain comments or recommendations
regarding

member guarantees for borrower A. 6. For borrower B, the amount of the
initial guarantee represents about

$10.2 million, which is 3 percent of the $331 million total restructured
amount. Under the negotiated agreement, the guarantee only applies to the
first two loans and not the third loan. Had RUS structured the

guarantee to include the third loan until it was paid in full, it would have
maximized its recovery chances. That is, the guarantee would have remained
in effect for the third loan which has significant risk because payment of
this note is contingent on net proceeds from asset sales and other recovery
mechanisms.

7. We agree with RUS' comment that in situations where RUS and CFC both
remain creditors for a borrower whose debt is restructured, CFC has not
attempted to obtain nor been given member guarantees on its restructured
debt. However, we disagree with RUS' comment that the cases where CFC has
obtained member guarantees from financially

troubled borrowers differ from the two loan restructurings discussed in this
report. In our meeting with CFC officials, they stated that in cases where
CFC has bought out RUS' interest and is the sole lender as a result of a
troubled debt restructuring, it obtains member guarantees from the
borrower's member distribution systems. In addition, CFC officials provided
examples of three financially troubled borrowers, where CFC bought out RUS'
interest, became the sole lender of those loans, and in all cases obtained
guarantees. 8. Our report does not provide a recommendation that RUS prepare
and

complete checklists when determining whether a borrower is financially
troubled.

9. RUS' procedures state that a roster of financially troubled borrowers be
maintained. Also, it was beyond the scope of our review to make an
assessment of the completeness of RUS' list of financially troubled

borrowers. 10. GAO has provided guidance and consultation to the working
group, but is not involved in developing USDA policies and procedures.

Appendi x II I Staff Acknowledgments Tom Armstrong, Art Brouk, Carla Lewis,
Edda Emmanuelli- Perez, and Maria Zacharias made key contributions to this
report.

(913870) Lett er

GAO United States General Accounting Office

Page 1 GAO/ AIMD- 00- 288 RUS' Loan Restructurings

Contents Letter 3 Appendixes Appendix I: Key Policies and Procedures Used to
Settle Debt

Owed by Electric Borrowers 24 Appendix II: Comments From the Rural Utilities
Service 28 Appendix III: Staff Acknowledgments 36

Abbreviations

CFC National Rural Utilities Cooperative Finance Corporation FFB Federal
Financing Bank G& T generation and transmission OMB Office of Management and
Budget RD Rural Development RE Act Rural Electrification Act of 1936 RUS
Rural Utilities Service SFFAS Statement of Federal Financial Accounting
Standards USDA Department of Agriculture

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Accounting Office

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Appendix I

Appendix I Key Policies and Procedures Used to Settle Debt Owed by Electric
Borrowers

Page 25 GAO/ AIMD- 00- 288 RUS' Loan Restructurings

Appendix I Key Policies and Procedures Used to Settle Debt Owed by Electric
Borrowers

Page 26 GAO/ AIMD- 00- 288 RUS' Loan Restructurings

Appendix I Key Policies and Procedures Used to Settle Debt Owed by Electric
Borrowers

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Appendix II

Appendix II Comments From the Rural Utilities Service

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Appendix II Comments From the Rural Utilities Service

Page 30 GAO/ AIMD- 00- 288 RUS' Loan Restructurings

Appendix II Comments From the Rural Utilities Service

Page 31 GAO/ AIMD- 00- 288 RUS' Loan Restructurings

Appendix II Comments From the Rural Utilities Service

Page 32 GAO/ AIMD- 00- 288 RUS' Loan Restructurings

Appendix II Comments From the Rural Utilities Service

Page 33 GAO/ AIMD- 00- 288 RUS' Loan Restructurings

Appendix II Comments From the Rural Utilities Service

Page 34 GAO/ AIMD- 00- 288 RUS' Loan Restructurings

Appendix II Comments From the Rural Utilities Service

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Appendix III

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