Rural Utilities Service: Risk Assessment for the Electric Loan Portfolio
(Testimony, 03/30/98, GAO/T-AIMD-98-123).

Pursuant to a congressional request, GAO discussed the Rural Utilities
Service's (RUS) electric loan portfolio and the potential for future
losses to the federal government from these loans, focusing on: (1)
substantial write-offs of loans to rural electric cooperatives; (2)
likely additional losses to the federal government from loans to
financially stressed borrowers; and (3) the potential for future losses
from viable loans that may become stressed in the future due to high
production costs and competitive or regulatory pressures.

GAO noted that: (1) under Department of Justice authority, during fiscal
year (FY) 1996 and through July 31, 1997, RUS wrote off about $1.5
billion of loans to rural electric cooperatives; (2) the most
significant write-offs relate to two generation and transmission (G&T)
loans; (3) it is probable that RUS will have additional loan write-offs
and therefore that the federal government will incur losses in the short
term from loans to borrowers that have been identified as financially
stressed by RUS management; (4) at the time of GAO's review, RUS reports
indicated that about $10.5 billion of the $22.5 billion in G&T debt was
owed by 13 financially stressed G&T borrowers; (5) in addition to the
financially stressed loans, RUS had loans outstanding to G&T borrowers
that were considered viable by RUS but may become stressed in the future
due to high costs and competitive or regulatory pressures; (6) GAO
believes it is probable that the federal government will eventually
incur losses on some of these G&T loans; (7) GAO also believes the
future viability of these G&T borrowers will be determined based on
their ability to be competitive in a deregulated market; (8) relatively
high average production costs indicate that the majority of G&Ts may
have difficulty competing in a deregulated market; (9) as with the
financially stressed borrowers, some of the G&T borrowers considered
viable by RUS at the time of GAO's work had high debt costs because of
investments in uneconomical plants; (10) in the short term, G&Ts will
likely be shielded from competition because of the all-requirements
wholesale power contracts between the G&T and their member distribution
cooperatives; (11) wholesale rates under these contracts are set by a
G&T's board of directors with approval from RUS; (12) in states whose
commissions regulate cooperatives, the cooperative must file a request
with the commission for a rate increase or decrease; (13) these
commissions may deny a request for a rate increase if they believe such
an increase will have a negative impact on the region; (14) denials of
requested rate increases by state commissions culminated in several G&Ts
filing bankruptcy; (15) according to RUS officials, some commissions
have denied a rate increase to cover the cost of projects that the
commission had previously approved for construction; and (16) therefore,
G&Ts with high costs may be likely candidates to default on their RUS
loans, even without direct competitive pressures.

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

 REPORTNUM:  T-AIMD-98-123
     TITLE:  Rural Utilities Service: Risk Assessment for the Electric 
             Loan Portfolio
      DATE:  03/30/98
   SUBJECT:  Losses
             Electric utilities
             Rural economic development
             Financial management
             Electric power transmission
             Bankruptcy
             Government guaranteed loans
             Utility rates
             Electric power generation
             Delinquent loans

             
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Cover
================================================================ COVER


Before the Subcommittee on Government
Management, Information and Technology
Committee on Government Reform and Oversight
House of Representatives

For Release on Delivery
Expected at
10 a.m.
Monday,
March 30, 1998

RURAL UTILITIES SERVICE - RISK
ASSESSMENT FOR THE
ELECTRIC LOAN PORTFOLIO

Statement of Linda M.  Calbom
Director, Resources, Community, and Economic Development Accounting
and Financial Management
Accounting and Information Management Division

GAO/T-AIMD-98-123

GAO/AIMD-98-123T


(913823)


Abbreviations
=============================================================== ABBREV

  DOJ -
  FFB -
  G&T -
  RDA -
  REA -
  RUS -
  USDA -

============================================================ Chapter 0

Mr.  Chairman and Members of the Subcommittee: 

I am pleased to be here today to summarize the results of our work
analyzing the Rural Utilities Service's (RUS) electric loan portfolio
and the potential for future losses to the federal government from
these loans.  My testimony is based on our September 1997 report\1 on
federal electricity activities, which discusses these issues in
depth.  Although the RUS portfolio contains electricity,
telecommunications, and water and waste disposal loans, you asked
that our testimony focus on electricity loans since they generally
pose the greatest risk of loss to the federal government,
particularly given the onset of competition in the electricity
industry. 

Deregulation of the electricity industry has led to wholesale
competition, which, combined with other factors, has caused wholesale
electricity prices to fall in many parts of the country.  The
increasingly competitive wholesale market and the financial
vulnerability of the RUS borrowers have increased the risk of future
losses the federal government faces.  Thus, my testimony today will
focus on the RUS electric loan portfolio and will discuss the
findings from our September 1997 report concerning

  -- substantial write-offs of loans to rural electric cooperatives;

  -- likely additional losses to the federal government from loans to
     financially stressed\2

borrowers; and

  -- the potential for future losses from viable loans that may
     become stressed in the future due to high production costs and
     competitive or regulatory pressures. 

I would like to begin my testimony by providing a brief background on
the history and purpose of RUS.  I will then discuss our risk
assessment of the electric loan portfolio.  Our assessment was
generally based on the condition of the portfolio as of September 30,
1996; therefore, changes may have occurred since the date of our
review. 


--------------------
\1 Federal Electricity Activities:  The Federal Government's Net Cost
and Potential for Future Losses (GAO/AIMD-97-110 and 110A, September
19, 1997). 

\2 Borrowers classified by RUS as financially stressed have defaulted
on their loans, had their loans restructured but are still
experiencing financial difficulty, declared bankruptcy, or have
formally requested financial assistance from RUS. 


   BACKGROUND
---------------------------------------------------------- Chapter 0:1

The U.S.  Department of Agriculture (USDA) is the federal
government's principal provider of loans used to assist the nation's
rural areas in developing their utility infrastructure.  Through RUS,
USDA finances the construction, improvement, and repair of
electrical, telecommunications, and water and waste disposal systems. 
RUS provides credit assistance through direct loans and through
repayment guarantees on loans made by other lenders.  Established by
the Federal Crop Insurance Reform and the Department of Agriculture
Reorganization Act of 1994, RUS administers the electricity and
telecommunications programs that were operated by the former Rural
Electrification Administration\3 and the water and waste disposal
programs that were operated by the former Rural Development
Administration.  As of September 30, 1996, which was the most recent
information available to us at the time of our review, RUS' entire
portfolio of loans--including direct and guaranteed electricity,
telecommunications, and water and waste disposal loans--totaled $42.5
billion.\4 Electricity loans made up over $32 billion, or 75 percent
of this total. 

Most of the RUS electric loans and loan guarantees were made during
the late 1970s and early 1980s.  For example, from fiscal years 1979
through 1983, RUS approved loans and loan guarantees of about $29
billion, whereas during fiscal years 1992 through 1996, it approved a
total of about $4 billion in electric loans and loan guarantees.  RUS
electricity loans were made primarily to rural electric cooperatives;
more than 99 percent of the borrowers with electricity loans are
nonprofit cooperatives.  These cooperatives are either Generation and
Transmission (G&T) cooperatives or distribution cooperatives.  A G&T
cooperative is a nonprofit rural electric system whose chief function
is to produce and sell electric power on a wholesale basis to its
owners, who consist of 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. 

As of September 30, 1996, the bulk of the electric loan portfolio was
made up of loans to the G&Ts.  The principal outstanding on these G&T
loans was approximately $22.5 billion, about 70 percent of the
portfolio.  Distribution borrowers made up the remaining 30 percent
of the electric portfolio.  At the time of our review, there were 55
G&T borrowers and 782 distribution borrowers.  Our review focused on
the G&T loans since they make up the majority, in terms of dollars,
of the portfolio and generally pose the greatest risk of loss to the
federal government. 

The federal government incurs financial losses when borrowers are
unable to repay the balances owed on their loans and the government
does not have sufficient legal recourse against the borrowers to
recover the full loan amounts.  In all instances, G&T loans are
collateralized; however, RUS has never foreclosed on a loan.  RUS
generally has been unable to successfully pursue foreclosure once the
borrower files for bankruptcy because the borrower's assets are
protected until the proceedings are settled.  In addition, in recent
cases where debt was written off, the government forgave the debt and
therefore did not attempt to pursue further collection. 


--------------------
\3 The Rural Electrification Act of 1936, as amended (7 U.S.C.  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. 

\4 For a further discussion of the financial condition of the entire
RUS portfolio, as of September 30, 1996, see our report Rural
Development:  Financial Condition of the Rural Utilities Service's
Loan Portfolio (GAO/RCED-97-82, April 11, 1997). 


   SUBSTANTIAL LOAN WRITE-OFFS
   OCCURRED IN RECENT YEARS
---------------------------------------------------------- Chapter 0:2

Under Department of Justice (DOJ) authority, during fiscal year 1996
and through July 31, 1997, RUS wrote off about $1.5 billion of loans
to rural electric cooperatives.  The most significant write-offs
relate to two G&T loans.  In fiscal year 1996, one G&T made a lump
sum payment of $237 million to RUS in exchange for RUS writing off
and forgiving the remaining $982 million of its RUS loan balance. 
The G&T's financial problems began with its involvement as a
minority-share owner in a nuclear project that experienced lengthy
delays in construction as well as severe cost escalation.  When
construction of the plant began in 1976, its total cost was projected
to be $430 million.  However, according to the Congressional Research
Service, the actual cost at completion in 1987 was $3.9 billion as
measured in nominal terms (1987 dollars).  These cost increases are
due in part to changes in Nuclear Regulatory Commission health and
safety regulations after the Three Mile Island accident.  The
remaining portion is generally due to inflation over time and
capitalization of interest during the delays.  The borrower defaulted
in 1986, had its debt restructured in 1993, and finally had its debt
partially forgiven in September 1996.  This borrower is no longer in
the RUS program. 

In the early part of fiscal year 1997, another G&T borrower made a
lump sum payment of approximately $238.5 million in exchange for
forgiveness of its remaining $502 million loan balance.  The G&T and
its six distribution cooperatives borrowed the $238.5 million from a
private lender, the National Rural Utilities Cooperative Finance
Corporation.  The G&T had originally borrowed from RUS to build a
two-unit coal-fired generating plant and to finance a coal mine that
would supply fuel for the generating plant.  The plant was built in
anticipation of industrial development from the emerging shale oil
industry.  However, the growth in demand did not materialize, and
there was no market for the power.  Although the borrower had its
debt restructured in 1989, it still experienced financial
difficulties due to a depressed power market.  RUS and DOJ decided
that the best way to resolve the matter was to accept a partial lump
sum payment on the debt rather than force the borrower into
bankruptcy.  The borrower and its member distribution cooperatives
are no longer in the RUS program. 


   ADDITIONAL LOSSES FROM
   FINANCIALLY STRESSED G&T LOANS
   ARE PROBABLE IN THE SHORT TERM
---------------------------------------------------------- Chapter 0:3

It is probable that RUS will have additional loan write-offs and
therefore that the federal government will incur further losses in
the short term from loans to borrowers that have been identified as
financially stressed by RUS management.  At the time of our review,
RUS reports indicated that about $10.5 billion of the $22.5 billion
in G&T debt was owed by 13 financially stressed G&T borrowers.\5 Of
these, four borrowers with about $7 billion in outstanding debt were
in bankruptcy.  The remaining nine borrowers had investments in
uneconomical generating plants and/or had formally requested
financial assistance in the form of debt forgiveness from RUS. 
According to RUS officials, these plant investments became
uneconomical because of cost overruns, continuing changes in
regulations, and soaring interest rates.  These investments resulted
in high levels of debt and debt-servicing requirements, making power
produced from these plants expensive.  (See attachment I for a list
and brief discussion of these borrowers.)

Since cooperatives are nonprofit organizations, there is little or no
profit built into their rate structure, which helps keep electric
rates as low as possible.  However, the lack of retained profit
generally means the cooperatives have little or no cash reserves to
draw upon.  Thus, when cash flow is insufficient to service debt,
cooperatives must raise electricity rates and/or cut other costs
enough to service debt obligations.  If they are unable to do so,
they may default on their government loans. 

This was the scenario for the previously discussed write-offs in
fiscal year 1996 and through July 31, 1997.  Additional write-offs
are expected to occur.  For example, according to RUS officials, at
the time of our review, the agency was considering writing off as
much as $3 billion of the total $4.2 billion debt owed by Cajun
Electric, a RUS borrower that has been in bankruptcy since December
1994.  Cajun Electric filed for bankruptcy protection after the
Louisiana Public Service Commission disapproved a requested rate
increase and instead lowered rates to a level that reduced the amount
of revenues available to Cajun to make annual debt service payments. 
Several factors contributed to Cajun's heavy debt, including its
investment in a nuclear facility that experienced construction cost
overruns and its excess electricity generation capacity resulting
from overestimation of the demand for electricity in Louisiana during
the 1980s. 


--------------------
\5 In our previous report, Rural Development:  Financial Condition of
the Rural Utilities Service's Loan Portfolio (GAO/RCED-97-82, April
11, 1997), we noted 12 G&T and distribution borrowers that were
delinquent or in financial distress.  However, in this testimony, as
in our September 1997 report, we discuss 13 financially stressed G&T
borrowers identified by RUS management.  The primary difference is
that this testimony and our September 1997 report do not include one
financially stressed distribution borrower, but did include two
borrowers that have officially requested financial assistance. 


   SOME LOSSES FROM LOANS
   CONSIDERED VIABLE ARE PROBABLE
   IN THE FUTURE
---------------------------------------------------------- Chapter 0:4

In addition to the financially stressed loans, RUS had loans
outstanding to G&T borrowers that were considered viable by RUS but
may become stressed in the future due to high costs and competitive
or regulatory pressures.  We believe it is probable that the federal
government will eventually incur losses on some of these G&T loans. 

We believe the future viability of these G&T borrowers will be
determined based on their ability to be competitive in a deregulated
market.  In order to assess the ability of RUS cooperatives to
withstand competitive pressures, we focused on production costs\6 for
33 of the 55 G&T borrowers with loans outstanding of about $11.7
billion as of September 30, 1996.  We excluded 9 G&Ts that only
transmit electricity and the 13 financially stressed borrowers
discussed above.  Our analysis showed that for 27 of the 33 G&T
borrowers, production costs were higher in their respective regional
markets than investor-owned utilities, and that for 17 of the 33,
production costs were higher than publicly-owned generating
utilities.  The relatively high average production costs indicate
that the majority of G&Ts may have difficulty competing in a
deregulated market.  RUS officials told us that several borrowers
have already asked RUS to renegotiate or write off their debt because
they do not expect to be competitive due to high costs.  RUS
officials stated that they will not write off debt solely to make
borrowers more competitive. 

As with the financially stressed borrowers, some of the G&T borrowers
considered viable by RUS at the time of our work had high debt costs
because of investments in uneconomical plants.  In addition,
according to RUS officials, there are two unique factors that cause
cost disparity between the G&Ts and their competition.  One factor is
the sparser customer density per mile for cooperatives and the
corresponding high cost of providing service to the rural areas.  A
second factor has been the inability to refinance higher cost Federal
Financing Bank (FFB) debt when lower interest rates have prevailed. 
However, RUS officials said that recent legislative changes that
enable cooperatives to refinance FFB debt with a penalty may help
align G&T interest rates with those of the investor-owned utilities. 

In the short term, G&Ts will likely be shielded from competition
because of the all-requirements wholesale power contracts between the
G&T and their member distribution cooperatives.  With rare
exceptions, these long-term contracts obligate the distribution
cooperatives to purchase all of their respective power needs from the
G&T.  In fact, RUS requires the terms of the contracts to be at least
as long as the G&T loan repayment period.  However, wholesale power
contracts have been challenged recently in the courts by several
distribution cooperatives because of the obligation to purchase
expensive G&T power.  According to RUS officials, one bankrupt G&T's
member cooperatives challenged their wholesale power contracts in
court in order to obtain less expensive power.  RUS officials believe
that the long-term contracts will come under increased scrutiny and
potential renegotiation or court challenges as other sources of less
expensive power become available. 

Wholesale rates under these contracts are set by a G&T's board of
directors with approval from RUS.  In states whose commissions
regulate cooperatives, the cooperatives must file requests with the
commissions for rate increases or decreases.  Several of the
currently bankrupt borrowers were denied requests for rate increases
from state commissions.  However, RUS officials indicated they do not
expect G&Ts to pursue rate increases as a means to recover their
costs because of the recognition of declining rates in a competitive
environment.  RUS officials also acknowledge that borrowers with high
costs are likely to request debt forgiveness as a means to reduce
costs in order to be competitive in the future. 

As discussed above, denials of requested rate increases by state
commissions culminated in several G&Ts filing for bankruptcy. 
Eighteen of the RUS G&T borrowers operate in states where regulatory
commissions must approve rate increases.  These commissions may deny
a request for a rate increase if they believe such an increase will
have a negative impact on the region.  According to RUS officials,
some commissions have denied rate increases to cover the costs of
projects that the commissions had previously approved for
construction.  Therefore, G&Ts with high costs may be likely
candidates to default on their RUS loans, even without direct
competitive pressures. 

In summary, in the last several years, through July 1997, RUS has
experienced loan write-offs of $1.5 billion.  Additional write-offs
related to the $10.5 billion in loans identified by RUS as
financially stressed as of the time of our review are likely in the
near term.  And finally, RUS has loans outstanding to G&T borrowers
that are currently considered viable by RUS that may become stressed
in the future due to high production costs and competitive or
regulatory pressures.  We believe it is probable that the federal
government will incur losses eventually on some of these G&T loans. 
The future viability of these G&T loans will be determined based in
part on the RUS cooperatives' ability to be competitive in a
deregulated market. 


--------------------
\6 As a surrogate for production costs, w\ used average revenue per
kilowatthour (kWh) for wholesale sales (sales for resale), which is
explained in detail in our September 1997 report. 


-------------------------------------------------------- Chapter 0:4.1

Mr.  Chairman, that concludes my statement.  I would be happy to
answer any questions you or other Members of the Subcommittee may
have. 


INFORMATION ON THE 13 FINANCIALLY
STRESSED G&T BORROWERS AS OF
SEPTEMBER 30, 1996
=========================================================== Appendix I

The following is a list and brief discussion of each of the 13
financially stressed G&T borrowers.  This information is as of
September 30, 1996; therefore, changes may have occurred subsequent
to our review. 



                               Table I.1
                
                      RUS Financially Stressed G&T
                 Cooperatives, as of September 30, 1996

                         (Dollars in millions)

Borrower                                        Total debt outstanding
----------------------------------------  ----------------------------
Borrower A\a,b                                                $1,619.6
Borrower B                                                       167.9
Borrower C                                                       103.2
Borrower D\b                                                     562.3
Borrower E\b                                                     183.3
Borrower F\a,b                                                 1,101.2
Borrower G\a,b                                                 4,154.8
Borrower H\b                                                     313.4
Borrower I\b                                                     354.8
Borrower J                                                     1,070.7
Borrower K                                                       445.1
Borrower L                                                       351.7
Borrower M\a                                                      92.8
======================================================================
Total debt                                                   $10,520.8
----------------------------------------------------------------------
\a Cooperative in bankruptcy. 

\b State regulated cooperative. 

Borrower A:  Invested in construction of a nuclear plant that
experienced cost overruns and was never completed.  The state
commission denied rate increases to cover the cost of the
cooperative's investment in the plant.  The borrower defaulted on its
loan in 1984 and declared bankruptcy in 1985.  The bankruptcy
proceedings have been in court for 12 years and are still not
completely resolved. 

Borrower B:  Made an investment in a nuclear plant that proved to be
uneconomical.  While this borrower does not appear to be currently
experiencing financial difficulties, RUS considers it financially
stressed because it has formally requested financial assistance due
to impending competitive pressures. 

Borrower C:  Made an investment in a nuclear plant that proved to be
uneconomical.  While this borrower does not appear to be currently
experiencing financial difficulties, RUS considers it financially
stressed because it has formally requested financial assistance due
to impending competitive pressures. 

Borrower D:  Uses primarily coal-fired generation.  The borrower
overbuilt due to anticipated growth in electricity demand that did
not occur.  During construction of a new plant, economic conditions
in the area changed and demand for electricity dropped, which
resulted in less revenue than predicted from the plant.  The
cooperative was repeatedly denied rate increases to cover the cost of
its plants by the state commission. 

Borrower E:  Has a small percentage share in a nuclear plant that
proved to be uneconomical.  The borrower has substantially higher
electricity rates than the investor-owned utilities in its region. 
The cooperative has been denied rate increases to cover its losses by
the state commission.  Although the borrower has had some of its debt
refinanced, it is still experiencing financial difficulties. 

Borrower F:  A G&T with primarily coal-fired generating plants that
overbuilt due to anticipated industrial growth related to two large
aluminum smelting companies.  When aluminum prices dropped in the
early 1980s, the companies threatened to move their operations if the
cooperative did not lower electricity rates.  The state commission
denied rate increases over the fear of losing these industries.  RUS
restructured the borrower's debt in 1987 and 1990.  The cooperative
filed for bankruptcy in September 1996 because its other creditors
were unwilling to negotiate. 

Borrower G:  Built a coal-fired plant and invested in a nuclear plant
in the mid-1970s that was completed late and experienced construction
cost overruns.  Several factors contributed to the cooperative's
heavy debt, including excess electricity generation construction
resulting from overestimation of the demand for electricity during
the 1980s.  The new capacity was intended to serve a growth in demand
that did not materialize.  The state commission disapproved a rate
increase and instead lowered rates to a level that precluded full
debt service coverage.  The commission also refused to support a
restructuring agreement that included a significant RUS loan
write-off.\1 The rate increase was requested by the cooperative
because of its high costs.  The borrower filed for bankruptcy in
December 1994. 

Borrower H:  Invested in construction of a nuclear plant that proved
to be uneconomical.  The project was completed 10 years late and over
budget.  In addition, there was a dramatic drop in the demand for
electricity in the cooperative's service area, and the state
commission would not allow rate increases to recover capital
investment.  The borrower had its debt restructured in 1987; however,
it is requesting additional financial assistance due to anticipated
competitive pressure.  A final settlement between RUS and the
borrower was reached in June 1997.  The borrower was expected to
receive a write-off of $165 million.  The final payment and related
debt write-off were scheduled to occur December 30, 1997. 

Borrower I:  Invested in a clean-burning coal plant that experienced
severe cost overruns.  The borrower has substantially higher
electricity rates than the investor-owned utilities in its region. 
The state commission has denied the cooperative's request for rate
increases.  The borrower had some of its debt refinanced, but it is
still experiencing financial difficulty. 

Borrower J:  Invested in a nuclear plant that proved to be
uneconomical.  The plant was completed late, which resulted in cost
overruns.  As a result, the cooperative's wholesale power rates are
very high.  The borrower has requested debt restructuring due to its
high cost of production and anticipated competitive pressure. 

Borrower K:  Invested in a nuclear plant that proved to be
uneconomical.  The plant was completed late, which resulted in severe
cost overruns.  The cooperative's wholesale power rates are very
high, which has resulted in extreme unrest in the member distribution
cooperatives.  The borrower is surrounded by investor-owned utilities
with lower wholesale rates.  In addition, the borrower's system is
very difficult and expensive to maintain and experiences frequent
power outages.  The borrower has requested financial assistance
because of anticipated competitive pressure. 

Borrower L:  Invested in a nuclear plant that proved to be
uneconomical.  The plant was completed late, which resulted in severe
cost overruns.  The cooperative has only five member distribution
cooperatives, which makes it difficult to cover its high production
costs.  This borrower chose not to declare bankruptcy and is seeking
financial assistance.  This borrower has refinanced its debt to lower
its interest rate, but is still experiencing financial difficulty and
has requested additional financial assistance. 

Borrower M:  Invested in a nuclear plant that proved to be
uneconomical.  In addition, the cooperative had a stagnant customer
base in the 1980s.  RUS tried to negotiate a restructuring agreement,
but the state commission denied two separate plans.  In April 1996,
the borrower filed for bankruptcy. 

--------------------
\1 In states that regulate cooperatives, the state commissions must
approve restructuring agreements between the cooperatives and their
creditors. 


*** End of document. ***