Tennessee Valley Authority: Bond Ratings Based on Ties to the
Federal Government and Other Nonfinancial Factors (30-APR-01,
GAO-01-540).
While the criteria used to rate the bonds of the Tennessee Valley
Authority (TVA) and other electric utilities are the same, they
are weighted differently and, as a result, the basis for TVA's
bond rating is more nonfinancial in nature than that for other
electric utilities. According to bond analysts, TVA's high bond
rating is largely based on the perception that its debt is
federally backed because of its ties to the federal government as
a wholly owned government corporation and its legislative
protections from competition. If these conditions were to change,
TVA's bond rating would likely be lowered, which in turn would
affect the cost of new debt. This would add to its already high
interest expense and corresponding financial challenges in a
competitive market.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-01-540
ACCNO: A00927
TITLE: Tennessee Valley Authority: Bond Ratings Based on Ties to
the Federal Government and Other Nonfinancial Factors
DATE: 04/30/2001
SUBJECT: Bonds (legal)
Competition
Financial analysis
Electric utilities
Federal corporations
Interest rates
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GAO-01-540
Report to Congressional Requesters
United States General Accounting Office
GAO
April 2001 TENNESSEE VALLEY AUTHORITY
Bond Ratings Based on Ties to the Federal Government and Other Nonfinancial
Factors
GAO- 01- 540
Page 1 GAO- 01- 540 Tennessee Valley Authority
April 30, 2001 The Honorable Bob Smith Chairman, Senate Committee on
Environment and Public Works United States Senate
The Honorable Mitch McConnell United States Senate
This report responds to the remaining aspects of your request that we review
several issues pertaining to the Tennessee Valley Authority?s (TVA)
financial condition in light of the increasing competition in electricity
markets. On February 28, 2001, we issued a separate report on TVA?s (1)
progress in reducing debt and recovering the costs of deferred assets, (2)
financial condition compared to its likely competitors, and (3) potential
stranded costs. 1 As agreed with your offices, this report provides
perspective on several matters pertaining to TVA?s bond rating.
Specifically, you asked us to determine (1) whether TVA?s bonds are
explicitly or implicitly guaranteed by the federal government, including the
opinion of bond analysts regarding the effect of any such guarantee, and (2)
the impact of TVA?s bond rating on its annual interest expense.
The TVA Act states that the federal government does not guarantee TVA?s
bonds. In addition, TVA includes similar ?no guarantee? language in its
Basic TVA Power Bond Resolution, Information Statement, and bond offering
circulars. However, because TVA is a wholly owned government corporation,
there is the perception in the investment community, including two credit
rating firms we contacted (Moody?s Investors Service and Standard & Poor?s),
that the federal government would support principal and interest payments on
TVA debt if TVA?s solvency were to be seriously impaired. Because they
believe that the federal government would intercede to protect TVA?s
solvency, the two credit rating firms we contacted perceive that there is an
implicit government guarantee of TVA bonds.
1 Tennessee Valley Authority: Debt Reduction Efforts and Potential Stranded
Costs (GAO- 01- 327, February 28, 2001).
United States General Accounting Office Washington, DC 20548
Results in Brief
Page 2 GAO- 01- 540 Tennessee Valley Authority
According to bond analysts at the two credit rating firms, this perceived
implicit guarantee is one of the primary reasons that TVA?s bonds have
received the highest possible bond rating. One of the firms cited two
additional factors- TVA?s legislative protections from competition and its
strong operational performance- as part of the basis for assigning TVA?s
bonds their Aaa rating. Of the 119 electric utilities rated by one of the
firms as of October 2000, TVA was the only utility rated Aaa. The high bond
ratings result in lower interest expense for TVA, which in turn reduces its
fixed annual operating expense. According to our analysis, as a result of
its high bond ratings, the annual interest expense on TVA?s bonds
outstanding at September 30, 2000, would have been between $137 million and
$245 million higher (about 2 to 4 percent of fiscal year 2000 total
expenses) if TVA?s bond ratings were lower. Although high bond ratings
provide TVA with more financial flexibility to adjust its rates in a
competitive environment, our recently issued report indicates that because
of the magnitude of its debt, TVA continues to have higher fixed financing
costs and less financial flexibility than its likely competitors.
TVA?s Chief Financial Officer generally agreed with the report and provided
oral technical and clarifying comments, which we incorporated as
appropriate.
TVA is a multipurpose, independent, wholly owned federal corporation
established by the Tennessee Valley Authority Act of 1933 (TVA Act). The TVA
Act established TVA to improve the quality of life in the Tennessee River
Valley by improving navigation, promoting regional agricultural and economic
development, and controlling the floodwaters of the Tennessee River. To
those ends, TVA erected dams and hydroelectric power facilities on the
Tennessee River and its tributaries.
To meet the need for more electric power during World War II, TVA expanded
beyond hydropower, building coal- fired power plants. In the 1960s, TVA
decided to add nuclear generating units to its power system. Today, TVA
operates one of the nation?s largest power systems, having produced about
152 billion kilowatt- hours (kWh) of electricity in fiscal year 2000. The
system consists primarily of 113 hydroelectric units, 59 coal- fired units,
and 5 operating nuclear units. TVA sells power in seven states- Alabama,
Georgia, Kentucky, Mississippi, North Carolina, Tennessee, and Virginia.
TVA sells power at wholesale rates to 158 municipal and cooperative
utilities that, in turn, distribute the power on a retail basis to nearly
Background
Page 3 GAO- 01- 540 Tennessee Valley Authority
8 million people in an 80,000 square mile region. TVA also sells power to a
number of directly served large industrial customers and federal agencies.
In 1959, the Congress amended the TVA Act to authorize TVA to use debt
financing to pay for capital improvements for power programs. Under this
legislation, the Congress required that TVA?s power program be
?selffinancing?
through revenues from electricity sales. For capital needs in excess of
internally generated funds, TVA was authorized to borrow by issuing bonds.
TVA?s debt limit is set by the Congress and was initially established at
$750 million in 1959. Since then, TVA?s debt limit has been increased four
times by the Congress: to $1.75 billion in 1966, $5 billion in 1970, $15
billion in 1975, and $30 billion in 1979. As of September 30, 2000, TVA?s
outstanding debt was $26.0 billion.
TVA?s bonds are considered ?government securities? for purposes of the
Securities and Exchange Act of 1934 and are exempt from registration under
the Securities Act of 1933. All of TVA?s bonds are publicly held, and
several are traded on the bond market of the New York Stock Exchange. Since
TVA?s first public issue in 1960, 2 Moody?s Investors Service and Standard &
Poor?s have assigned TVA?s bonds their highest credit rating- Aaa/ AAA. 3
To determine whether TVA?s bonds are explicitly or implicitly guaranteed by
the federal government, we analyzed various documents, including Section 15d
of the TVA Act, as amended, the Basic TVA Power Bond Resolution, TVA?s
Information Statement, 4 and the language included in TVA?s bond offering
circulars. We also discussed this issue with bond analysts at two credit
rating firms (Moody?s Investors Service and Standard & Poor?s) and TVA
officials.
2 During the period 1974- 1988, TVA borrowed exclusively from the Federal
Financing Bank (FFB). The FFB debt was not rated. However, during this
period, the outstanding public debt from the 1960- 1974 issues continued to
be rated Aaa/ AAA.
3 Aaa is the highest rating given to bonds by Moody?s; it corresponds to the
AAA rating issued by Standard & Poor?s. 4 The Information Statement is
included with the bond- offering circular. It provides information on the
business, operations, and financial condition of TVA. Objectives, Scope,
and Methodology
Page 4 GAO- 01- 540 Tennessee Valley Authority
To determine the opinion of bond analysts regarding the effect of an
implicit or explicit guarantee on TVA?s bonds, we interviewed officials at
two credit rating firms that rate TVA?s bonds to discuss their rating
methodology for TVA and other electric utilities? bonds. In addition, we
reviewed recent reports issued by the credit rating agencies for any
language about an implicit federal guarantee of TVA?s debt. As agreed with
your offices, we did not attempt to determine what TVA?s bond rating would
be without its ties to the federal government as a wholly owned government
corporation.
To determine the impact of TVA?s bond rating on its annual interest expense,
we obtained information from TVA about its outstanding bonds as of September
30, 2000. We then obtained comparable information on the average bond
ratings and bond yield rates applicable to public utilities for the various
bond rating categories. Using the average bond yield rates for public
utility debt in the various bond rating categories, we used two approaches
to estimate the amount of TVA?s annual interest expense if its bonds
outstanding at September 30, 2000, carried the lower ratings. Additional
information on our scope and methodology is contained in appendix I.
We conducted our review from July 2000 through April 2001 in accordance with
generally accepted government auditing standards. We requested written
comments from TVA on a draft of this report. TVA?s Chief Financial Officer
provided us with oral comments, which we incorporated, as appropriate.
The TVA Act states that the federal government does not guarantee the
principal of, or interest on, TVA?s bonds. However, the perception of the
bond analysts at the two credit rating firms we contacted is that since TVA
is a wholly owned government corporation, the federal government would
support debt service and would not allow a default to occur. Both of the
credit rating firms stated that this perception of an implicit federal
guarantee is one of the primary reasons that TVA?s bonds have received the
highest credit rating. One of the firms cited two other factors- TVA?s
legislative protections from competition and its strong operational
performance- as additional reasons for assigning TVA?s bonds its highest
rating.
The TVA Act specifically states that the federal government does not
guarantee TVA bonds. TVA includes similar ?no federal guarantee? The Federal
Government Does Not Guarantee TVA?s Bonds but Is Perceived to Implicitly
Back Them
Page 5 GAO- 01- 540 Tennessee Valley Authority
language in its Basic TVA Power Bond Resolution, Information Statement, and
bond offering circulars. The relevant language is as follows:
Section 15d of the TVA Act, as amended, 16 USC sect. 831n- 4-? Bonds issued by
the Corporation [TVA] hereunder shall not be obligations of, nor shall
payment of the principal thereof or interest thereon be guaranteed by, the
United States.?
Basic TVA Power Bond Resolution, Section 2.2 Authorization and Issuance of
Bonds-? They [the TVA bonds] shall be payable as to both principal and
interest solely from Net Power Proceeds and shall not be obligations of or
guaranteed by the United States of America.?
Information Statement-? Evidences of Indebtedness are not obligations of
the United States of America, and the United States of America does not
guarantee the payment of the principal of or interest on any Evidences of
Indebtedness.?
TVA bond offering circulars-? The interest and principal on the Bonds are
payable solely from Net Power Proceeds and are not obligations of, or
guaranteed by, the United States of America.?
Although TVA?s bonds expressly disclaim a federal guarantee, the two bond
rating firms we contacted perceive TVA?s bonds to be implicitly backed by
the federal government. This perception of an implied federal guarantee is
one of the primary reasons that TVA?s bonds have received the highest credit
rating. For example, Standard & Poor?s, in its January 2001 analysis of
TVA?s global power bonds, stated that ?the rating reflects the US
government?s implicit support of TVA and Standard & Poor?s view that,
without a binding legal obligation, the federal government will support
principal and interest payments on certain debt issued by entities created
by Congress.? 5
Further, in its June 2000 opinion update on TVA, Moody?s Investors Service
(Moody?s) reported that ?the Aaa rating on Tennessee Valley Authority (TVA)
power bonds derives from its strong operational performance and its status
as a wholly owned corporate agency of the US Government.? In addition,
Moody?s reported that although the federal government does not guarantee
TVA?s bonds, the government would not allow a default on TVA?s debt because
of the impact it would have on the cost of debt issued by government-
sponsored enterprises, such as Fannie
5 Tennessee Valley Authority $1B Global Power Bonds Rated ?AAA, ? Standard &
Poor?s CreditWire, January 11, 2001.
Page 6 GAO- 01- 540 Tennessee Valley Authority
Mae and Freddie Mac. 6 , 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.
In summarizing the results of the analyses, the bond analysts assign a
credit rating to the electric utility (issuer rating) representing their
opinion on the general creditworthiness of the utility. In addition, bond
analysts may also assign a rating to an individual debt issue (issue-
specific rating) representing their opinion on the general creditworthiness
of the utility with respect to the specific debt issue. Further, specific
debt issues of the issuer may be rated differently. Moody?s and Standard &
Poor?s use their same rating symbols to indicate credit quality of the
issuer and the investment quality of the debt issue. Both maintain similar
rating
6 Opinion Update: Tennessee Valley Authority, Moody?s Investors Service,
June 22, 2000. 7 Government- sponsored enterprises are federally
established, privately owned corporations designed to increase the flow of
credit to specific economic sectors.
Page 7 GAO- 01- 540 Tennessee Valley Authority
categories, using A, B, and C, with Aaa/ AAA being the highest rating.
Triple, double, and single characters distinguish the gradations of credit/
investment quality. 8 For example, issuers rated Aaa/ AAA indicate
exceptional financial security, Baa/ BBB indicate adequate financial
security, and Ba/ BB or below offer questionable to poor financial security.
Debt issues rated in the four highest categories, Aaa/ AAA, Aa/ AA, A, and
Baa/ BBB, generally are recognized as investment- grade. Table 1 describes
the investment- grade rating categories used by Moody?s and Standard &
Poor?s. Debt rated Ba/ BB or below generally is referred to as speculative
grade.
Table 1: Description of Investment- Grade Bond Rating Categories Moody?s
Investors Service/ Standard & Poor?s Investment- Grade Rating Categories
Aaa/ AAA Aa/ AA A Baa/ BBB Highest rating category- smallest degree of
investment risk. Ability to pay interest and principal is extremely strong.
Together with the highest rating, this group composes the high- grade bonds.
Long- term risk appears somewhat greater than in the highest rated
securities. Ability to pay interest and principal is very strong.
Upper- mediumgrade obligations- elements may be present that suggest a
susceptibility to impairment sometime in the future. However, ability to pay
interest and principal is still strong.
Medium- grade obligations- the ability to pay interest and principal appears
adequate for the present but certain protective elements may be lacking or
may be characteristically unreliable over any great length of time.
Source: Based on information from Moody?s Investors Service website, www.
moodys. com, and
Standard & Poor?s 2000 Corporate Ratings Criteria.
In addition, Moody?s applies numerical modifiers, 1, 2, and 3, and Standard
& Poor?s uses ?plus? and ?minus? signs in each rating category from Aa/ AA
through Caa/ CCC in their corporate bond rating system. The modifier 1 and
?plus? indicate that the issuer/ obligation ranks in the higher end of a
rating category; 3 and ?minus? indicates a ranking in the lower end.
According to a Moody?s official, the firm places less significance on
financial factors in analyzing TVA debt than in analyzing the debt of other
electric utilities. 9 Because of TVA?s ties to the federal government,
Moody?s
8 In their rating system, Moody?s uses lowercase ?a? as its second and third
character (e. g., Baa); Standard and Poor?s uses uppercase of the same
character (e. g., BBB). 9 The previously mentioned January 2001 Standard &
Poor?s analysis of TVA also deemphasized TVA?s underlying financial
condition in determining its bond rating.
Page 8 GAO- 01- 540 Tennessee Valley Authority
considers other factors more important in its assessment of TVA.
Specifically, Moody?s looks at how TVA will react to its changing operating
environment and places ?considerable value? on the legislative framework in
which TVA operates. For example, in its June 2000 analysis of TVA, Moody?s
reported that key provisions in the TVA Act and the Energy Policy Act of
1992 (EPAct) provide credit protection for bondholders. Under the TVA Act,
TVA?s Board of Directors is required to set rates at levels sufficient to
generate revenues to cover operating and financing costs. EPAct provides TVA
with certain protections from competition. Under EPAct, TVA is exempt from
having to allow other utilities to use its transmission lines to transmit
power to customers within TVA?s service territory. Further, the Moody?s
official stated, as long as TVA is able to set its own rates and to benefit
from legislative and other competitive advantages over other utilities,
Moody?s will continue to assign TVA?s bonds a Aaa rating.
As shown in figure 1, of the 119 electric utilities rated by Moody?s as of
October 2000, TVA was the only utility rated Aaa. The ratings of other
electric utilities range from a high of Aa1 to a low of Ba2, with an average
rating at A3. Figure 1 shows the number of utilities in each rating category
compared to TVA.
Page 9 GAO- 01- 540 Tennessee Valley Authority
Figure 1: TVA and Other U. S. Electric Utilities Rated by Moody?s by Rating
Category as of October 2000
Source: Based on information from Moody?s Electric Utilities Industry
Outlook, October 2000.
As noted previously, the TVA Act authorizes TVA to issue and sell bonds to
assist in financing its power program. Investor- owned electric utilities
also use debt financing, but unlike TVA, they can and do issue common and
preferred stock to finance capital needs. 10 Figure 2 shows the capital
structure of electric utilities by rating category. It also shows that, in
general, electric utilities that have obtained a greater portion of
financing through debt have lower credit ratings. However, even though the
capital structure of TVA consists entirely of debt, and, as illustrated in
our February 2001 report, it has higher fixed financing costs and less
financial flexibility than its likely competitors, TVA remains the only AAA-
rated electric utility in the United States.
10 TVA and other electric utilities can also finance capital improvements
through cash generated from operations.
Aa A
Baa Ba
0 10
20 30
40 50
60 70
TVA US Electric Utilities Number of utilities
Aaa
Page 10 GAO- 01- 540 Tennessee Valley Authority
Figure 2: Capital Structure of Electric Utility Companies Rated by Standard
& Poor?s by Rating Category
Source: GAO analysis based on data from Standard and Poor?s Corporate
Ratings Criteria, 2000.
Data for electric utility companies is for the 12 months ended June 30,
1999.
As a result of TVA?s high bond ratings, the private lending market has
provided TVA with access to billions of dollars of financing at low interest
rates, an advantage that in turn results in lower interest expense than if
its rating had been lower.
To determine the impact of TVA?s bond rating on its interest expense, we
estimated what TVA?s annual interest expense on its bonds outstanding at
September 30, 2000, would have been if the debt had been given lower
investment- grade ratings. Using two different methodologies, we obtained
similar results. In the first methodology, we compared the coupon rate of
each of TVA?s bonds outstanding at September 30, 2000, to the average bond
yield rates applicable to public utility bonds with similar terms at the
time of issuance for each investment- grade rating category. For example,
TVA?s Aaa- rated 2000 Series E Power Bonds that were outstanding at
September 30, 2000, have a coupon rate of 7.75 percent. When these bonds
TVA?s High Bond
Ratings Result in Lower Interest Expense
0 10
20 30
40 50
60 70
80 90
100 AA A BBB BB Rating Category Percent
Preferred Stock Common Stock Debt
Page 11 GAO- 01- 540 Tennessee Valley Authority
were issued on February 16, 2000, 11 the average bond yields for public
utility debt averaged 8.16 percent. In total, using the first methodology,
we found that the annual interest expense of TVA?s bonds outstanding at
September 30, 2000, would have been between $137 million and $235 million
(about 2 to 3 percent of fiscal year 2000 total expenses) higher if the debt
had been given lower investment- grade bond ratings.
In the second methodology, we categorized TVA?s bonds into long- term (at
least 20 years to maturity at time of issuance) and intermediate- term (less
than 20 years to maturity at time of issuance) debt issues. We then
identified the difference between TVA?s average coupon interest rates
grouped as long- term and intermediate- term on its bonds outstanding at
September 30, 2000, and the average bond yield rates grouped as long- term
and intermediate- term for public utilities for the various investment-
grade rating categories. Specifically, we compared the average coupon
interest rate on TVA?s long- term bonds to the 9- year (1992- 2000) average
bond yield rates for long- term public utility bonds. Similarly, we compared
the average coupon interest rate on TVA?s intermediate- term bonds to the 5-
year (1996- 2000) average bond yield rates for intermediate- term public
utility bonds. The years used (maturities and time of issuance) for public
utility long- term and intermediate- term debt are, in general, comparable
to TVA?s bonds outstanding at September 30, 2000. For example, the average
coupon interest rate for TVA?s bonds outstanding at September 30, 2000, with
at least 20 years to maturity at time of issuance was 6.96 percent. In
comparison, the average bond yield rates for the period 1992- 2000 for
public utility debt with at least 20 years to maturity averaged 7.82
percent. Using this methodology, we estimated that the annual interest
expense on TVA?s bonds outstanding at September 30, 2000, would have been
about $141 million to $245 million (about 2 to 4 percent of fiscal year 2000
total expenses) higher if its bonds had been rated lower. 12
Table 2 shows the impact of lower bond ratings on annual interest expense
using both methodologies. It is important to note that our analyses assumed
that TVA?s coupon rates on its bonds corresponded to
11 February 16, 2000, is the bond offering circular date, which is the day
the bonds were priced. The issuance date is typically 3 to 5 business days
after pricing. 12 We also obtained and analyzed an analysis of the impact of
TVA?s high bond rating on its annual interest expense that was done by the
Department of Energy?s Energy Information Administration (EIA). The results
of EIA?s analysis showed that TVA?s interest expense would have been from
$77 million to $248 million higher if its bonds were rated similarly to
other utilities.
Page 12 GAO- 01- 540 Tennessee Valley Authority
the bond yield rates of other lower- rated public utilities at the time TVA
issued its bonds. Assuming that were the case, we estimated that TVA?s
interest expense would have been higher by the amounts shown in table 2. If
TVA?s debt were no longer perceived to be implicitly guaranteed by the
federal government, the resulting impact on TVA?s interest expense would
relate to future bonds and refinancings rather than to its bonds outstanding
at September 30, 2000.
Table 2: Impact of Lower Bond Ratings on TVA?s Annual Interest Expense on
TVA?s Bonds Outstanding at September 30, 2000
(Dollars in millions)
Additional annual interest expense using Investment- grade Rating category
Methodology 1 Methodology 2
Aa/ AA $137 $ 141 A $167 $ 174 Baa/ BBB $235 $ 245
Source: GAO analysis based on TVA coupon interest rates and public utility
bond yield data.
TVA?s high bond rating results in lower interest expense, enhancing TVA?s
competitive prospects by providing it with more financial flexibility to
respond to financial or competitive challenges.
While the criteria used to rate the bonds of TVA and other electric
utilities are the same, they are weighted differently and, as a result, the
basis for TVA?s bond rating is more nonfinancial in nature than that for
other electric utilities. According to bond analysts, TVA?s high bond rating
is largely based on the perception that its debt is federally backed because
of its ties to the federal government as a wholly owned government
corporation and its legislative protections from competition. If these
conditions were to change, TVA?s bond rating would likely be lowered, which
in turn would affect the cost of new debt. This would add to its already
high interest expense and corresponding financial challenges in a
competitive market.
TVA?s Chief Financial Officer generally agreed with the report and provided
oral technical and clarifying comments, which we incorporated as
appropriate. Conclusion
Agency Comments and Our Evaluation
Page 13 GAO- 01- 540 Tennessee Valley Authority
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 7 days from
its date. At that time, we will send copies of this report to appropriate
House and Senate Committees; interested Members of Congress; TVA?s Board of
Directors; The Honorable Spencer Abraham, Secretary of Energy; The Honorable
Mitchell E. Daniels, Jr., Director, Office of Management and Budget; and
other interested parties. The report will also be on GAO?s home page at
http:// www. gao. gov. We will make copies available to others upon request.
Please call me at (202) 512- 9508 if you or your staffs have any questions.
Major contributors to this report are listed in appendix II.
Linda M. Calbom Director Financial Management and Assurance
Appendix I: Objectives, Scope, and Methodology
Page 14 GAO- 01- 540 Tennessee Valley Authority
We were asked to answer specific questions regarding TVA?s financial
condition. This report addresses the questions pertaining to TVA?s bond
rating; specifically, (1) whether TVA?s bonds are explicitly or implicitly
guaranteed by the federal government, including the opinion of bond analysts
regarding the effect of any such guarantee, and (2) the impact of TVA?s bond
rating on its annual interest expense. As agreed with your offices, we
issued a separate report on February 28, 2001, on the three other issues
regarding TVA?s (1) debt and deferred assets, (2) financial condition
compared to its likely competitors, and (3) potential stranded costs.
To determine whether TVA?s bonds are explicitly or implicitly guaranteed by
the federal government, we
reviewed prior GAO products discussing TVA?s bonds;
reviewed and analyzed the section of the TVA Act pertaining to TVA?s
bonds;
reviewed and analyzed various TVA documents, including the Basic TVA Power
Bond Resolution, TVA?s Information Statement, and the language included in
TVA?s outstanding bond offerings at September 30, 2000;
interviewed bond analysts at Moody?s and Standard & Poor?s; and
interviewed TVA officials. To determine the opinion of bond analysts
regarding the effect of any such guarantee, we
interviewed officials at the credit rating firms that rate TVA?s bonds-
Moody?s and Standard & Poor?s; and
reviewed and analyzed documents issued by Moody?s and Standard & Poor?s on
their methodology for rating TVA and other electric utilities.
To determine the impact of TVA?s bond rating on its annual interest expense,
we
obtained information from TVA about its outstanding bonds at September 30,
2000;
reconciled information from TVA about its outstanding bonds at September
30, 2000, to its audited financial statements;
reviewed information pertaining to TVA?s outstanding debt contained in its
annual reports; Appendix I: Objectives, Scope, and
Methodology Determining Whether the Federal Government Guarantees TVA?s
Bonds
Determining the Impact of TVA?s Bond Rating on Its Interest Expense
Appendix I: Objectives, Scope, and Methodology
Page 15 GAO- 01- 540 Tennessee Valley Authority
reviewed a report issued by the Department of Energy?s Energy Information
Administration which assessed the impact of TVA?s bond rating on its
interest expense;
interviewed Moody?s regarding the availability of historical bond yield
data by rating category for electric utilities and public utilities;
obtained Moody?s information on the average bond yields applicable to
public utilities in the various bond rating categories from Standard &
Poor?s DRI (long- term) and Moody?s Investors Service Credit Perspectives
(intermediate- term); and
estimated the additional annual interest expense on TVA?s bonds
outstanding at September 30, 2000, using the average bond yield rates for
public utilities in various investment- grade rating categories.
Using Moody?s public utility long- term and intermediate- term (unweighted)
bond yield data in various investment- grade rating categories, we applied
two methods for estimating what the additional annual interest expense on
TVA?s bonds outstanding at September 30, 2000, would have been if TVA?s debt
were rated lower. Our analysis considered the characteristics of TVA?s
bonds, such as date of issuance and term; however, we did not assess the
effect of call provisions. 1
Under Methodology 1, we
analyzed TVA?s annual interest expense on its bonds outstanding at
September 30, 2000, to determine, for each issuance outstanding, the (1)
coupon rate, (2) date of issuance, (3) term, and (4) maturity;
identified the average bond yield rates applicable to public utility bonds
with similar terms at the time of issuance of each of TVA?s bonds
outstanding at September 30, 2000, in the Aa/ AA, A, and Baa/ BBB rating
categories;
calculated the annual interest expense for each of TVA?s debt issues in
the various rating categories; and
determined the estimated additional annual interest expense by taking the
difference between TVA?s annual interest expense and the interest expense in
the various rating categories.
1 A call provision is a written agreement between an issuer and its
bondholders that gives the issuer the option of redeeming the bond at a
specified price before the maturity date.
Appendix I: Objectives, Scope, and Methodology
Page 16 GAO- 01- 540 Tennessee Valley Authority
Under Methodology 2, we
categorized TVA?s bonds into long- term (at least 20 years to maturity at
time of issuance) and intermediate- term (less than 20 years to maturity at
time of issuance);
calculated TVA?s (unweighted) average coupon interest rates for long- term
and intermediate- term debt by taking the average of the coupon rates
applicable for each category (long- term and intermediate- term) of TVA?s
bonds outstanding at September 30, 2000;
calculated the annual interest expense for TVA?s long- term and
intermediate- term debt using the average coupon interest rates calculated
for each category;
determined the (unweighted) average public utility bond yield rates for
calendar years 1992 to 2000 in each of the various rating categories for
long- term debt and 1996 to 2000 for intermediate- term debt, which, in
general, are comparable to the maturities and time of issuance of TVA?s
bonds outstanding at September 30, 2000;
calculated the annual interest expense for TVA?s long- term and
intermediate- term debt using the average public utility bond yield rates
applicable to the various rating categories; and
determined the estimated additional annual interest expense (long- term
and intermediate- term) by taking the difference between TVA?s annual
interest expense and the interest expense in the various rating categories.
We conducted our review from July 2000 through April 2001 in accordance with
generally accepted government auditing standards. We obtained our
information on public utility bond yield rates from authoritative sources
(e. g., Standard & Poor?s DRI, Moody?s Investors Service) that provide and/
or regularly use that data; however, we did not verify the accuracy of the
bond yield data they provided.
During the course of our work, we contacted the following organizations.
Tennessee Valley Authority
Department of Energy?s Energy Information Administration Organizations
Contacted Federal Agencies
Appendix I: Objectives, Scope, and Methodology
Page 17 GAO- 01- 540 Tennessee Valley Authority
Moody?s Investors Service, New York, New York
Standard & Poor?s, New York, New York
Standard & Poor?s DRI, Washington, D. C.
Standard & Poor?s DRI, Lexington, Massachusetts Bond Rating Firms
Others
Appendix II: GAO Contact and Staff Acknowledgments
Page 18 GAO- 01- 540 Tennessee Valley Authority
Robert E. Martin, (202) 512- 4063 In addition to the individual named above,
Richard Cambosos, Philip Farah, Jeff Jacobson, Joseph D. Kile, Mary B.
Merrill, Donald R. Neff, Patricia B. Petersen, and Maria Zacharias made key
contributions to this report. Appendix II: GAO Contact and Staff
Acknowledgments GAO Contact Staff Acknowledgments
(190008)
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