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Statement of Guy C. Lewis, Jr. President
National Rural Electric Cooperative Association,
Senate Committee on Banking, Housing and Urban Affairs
Mr. Chairman, and distingushed members of the Banking, Housing and Urban Affairs Committee..
My name is Guy C. Lewis, Jr. I am President of the National Rural Electric Cooperative Association, a voluntary national service organization, comprised of nearly 1,000 rural electric cooperatives which operate in 46 states and serve more than 25-million consumer members.
With your permission, Mr. Chairman, I will submit for the hearing record several documents which support and amplify the information contained in this statement, including policy resolutions approved by the NRECA membership at our 41st Annual Meeting earlier this year.
Let me begin, if I may, by assuring the members of this Committee that the NRECA -- and, I believe, the vast majority of the rural citizens served by our co-op members are in full accord with the fundamental objectives of S. 1679, and agree that top priority must be placed on seeking long term solutions to our nation's severe economic crisis.
Our consumer-members throughout rural America, many of whom are farmers, ranchers and small businessmen who must use credit to operate, have been especially hard hit by the high interest costs and economic instability of recent years. Rural people are aware of and a great many share your concern about the degree of influence which Federal activity in the credit markets has on the overall cost and availability of capital, and we applaud your efforts to gain a better understanding in this area.
At the same time, however, rural people are deeply concerned about the future of the REA financing program a program which has brought about substantial and well-documented social and economic improvements, benefiting not only rural areas, but the nation as a whole. In this light, then, we feel it is extremely important that the Committee have a full understanding of:
1. How the REA loan program evolved to its present state;
2. The extent to which Congress can -- and does exert direct control over the volume and focus of REA lending activities, and;
3. The unique and, we feel, mutually beneficial relationship which now exists among rural electric borrowers, REA, the Federal Financing Bank and the private credit marketplace.
Until 1973, REA lending relied on Treasury funds made available for this purpose, in amounts authorized each year by the Congress. These funds were treated in the Federal budget as expenditures rather than loans, with the principal and interest repayrnents from co-ops going to the U.S. Treasury as general revenues, with no offsetting budgetary credits allocated to the REA program.
To the extent that funds were available in a given year, qualifying borrowers were able to obtain 100% of their capital needs through REA, and except for some variance during the early years of the program, all loans were made at a two percent interest rate. As rural areas began to grow both in population and in their demand for electric energy, however, the gap between the amount of loan funds available and the needs of REA borrowers grew ever wider, resulting in a substantial backlog of loan applications.
In 1973, however, several major changes took place. The REA direct loan program was for all practical purposes terminated. In its stead, Congress created two new REA loan authorities: REA insured loans, designed to meet the capital needs of local rural electric distribution systems, and REA guaranteed loans, meant to make it possible for rural electrics to undertake major construction projects, most often in the generation and transmission areas.
To provide a new funding source for the REA insured loans, Congress in 1973 created a Rural Electric and Telephone Revolving Fund. Originally capitalized with the asset value of REA's outstanding loans, and a small amount of cash in unexpended loan funds, the revolving fund was designed to be largely self-replenishing through the inflow of principal and interest repayments on existing and new REA loans, and by "rolling over" existing notes through the sale of Certificates of Beneficial Ownership (CBOs) in them. Under existing law, these CBOs are sold to the Federal Financing Bank and carry an interest rate equal to the FFB's cost of money plus one-eighth of one percent.
According to the terms of the insured loan program, REA could make loans to qualified borrowers at either a five or two percent interest rate, depending on the individual applicant's consumer density and/or financial strength. Between 1973 and 1981, only a small percentage of these loans were made at the special two percent interest rate. Most were made at the standard five percent rate, and of these, the vast majority covered only 70% of the borrower's total need, thereby requiring the co-op to acquire 30% of its capital from non-REA sources at full market rates. With legislative changes made in 1981, there no longer are any situations in which the use of the two percent interest rate is mandatory, although the Administrator of REA retains the authority to make loans at rates between two and five percent in cases of extreme hardship.
The REA loan guarantee program was also created in 1973, with REA acting as a guarantor and the Federal Financing Bank serving as a conduit for funds acquired by the Treasury in the private capital marketplace. REA borrowers utilizing this program are nearly all power supply cooperatives engaged in the construction and operation of large generating and transmission facilities.
Loans made under the REA guarantee carry an interest rate fully equal to the FFB and Treasury's cost of acquiring these funds, with a one-eighth percent service fee added to cover administrative expenses. Through this fee, the federal government makes a "profit" of some $6-million per year through the placement and servicing of REA guaranteed loans. This income is shown in the budget as general, undesignated revenues to the Treasury.
It's important to note, I believe, that the administration of both programs by REA entails a very well established and effective procedure for evaluating and processing loan applications. For the information of the Committee, I have attached to my statement a review of the key steps in this process. Very briefly, REA puts each application through a rigorous review process which includes strict tests of both the technical and economic feasibility of the project. The efficacy of this aspect of the process is well demonstrated by the fact that in the history of the program there have been only two defaults on loans. Both occurred in the 1940's, and neither involved an operating electric cooperative. The total amount defaulted was $37,237, and there has never been a default of any kind on REA guaranteed loans.
When the RE Act amendments were enacted in 1973 as Public Law 93-32, the Congress clearly expressed its belief that the power it retained to establish annual loan levels for REA was an adequate mechanism for oversight of the rural electric program and that further controls through the inclusion of these transactions in the unified budget would be unnecessary and redundant. This is reflected in the RE Act itself, where in no fewer than six different places, Congress clearly states its intent that REA loan levels and advances be excluded from the annual Federal budget totals, and that these loans not be charged against any statutory or other limitations on the budget, federal expenditures or net lending by government.
With regard to the insured loan program, Congress sets annual "floor" and "ceiling" levels within which the REA must operate. These limitations are included in the Agriculture and Related Agencies Appropriations bill enacted for each fiscal year, and are based on information provided to the Congress from several key sources. One source is REA itself which, after consultation with the Office of Management and Budget and other agencies, recommends loan activity levels it deems to be appropriate. Another source is the rural electric borrowers themselves, speaking through their national association, NRECA. Specific recommendations are made based on the borrowers own projections of capital needs as determined through an annual loan fund survey. In addition, other interested parties can make their views known to Congress through the hearing process.
A similar procedure is in effect for the REA guaranteed loan program. Here again, Congress reviews the information it receives on projected capital need which it receives from REA, NRECA and other sources, and sets a floor and ceiling limitation on the year's loan guarantees.
An additional measure of control is available through a provision in the law which requires the REA Administrator to provide Congress with no less than 30 days advance notice of his intent to approve a loan guarantee application. The Administrator also is required to provide the Congress with information on the cumulative total of loans approved with each notification of an intended guarantee. In addition, REA must also publish notice in the Federal Register, 30 days in advance of any new guarantee loan commitment.
To change the accounting of Federal Financing Bank transactions without regard for the budget status of the agencies making use of FFB services would, we believe, be in direct conflict with existing provisions of law. This is particularly so in the case of the RE Act, which specifically exempts REA loan levels from the budget totals. We believe that the present budgetary treatment of the Bank's transactions with REA is fully consistent with the provisions of the RE Act, and provides Congress and the public with full and complete information on the nature and volume of these transactions.
In summary, we believe that Congress already has in place a very workable and effective mechanism to closely monitor and control the activity of the REA loan programs. The existing system allows the Congress to fully evaluate the need of the rural electric systems to raise new capital, and balance that need with the current capability of the federal government through REA -- to assist in acquiring it.
THE FEDERAL FINANCING BANK'S ROLE IN RURAL ELECTRIFICATION
Rural electric cooperatives, like every other type of utility, have a unique relationship with and responsibility to their consumers. As far as electric power is concerned, consumers have come to expect, and depend upon, the ability of utilities to meet all of their needs.
What this means, insofar as credit demand is concerned, is that unlike many other businesses, the utility industry's need for new capital entails very little discretion. Utilities build new facilities because they must build them to meet their consumers' needs. They must raise the capital needed to build these facilities one way or another when they need it, regardless of how good or bad the credit market may be at that particular time. For most electric utilities, the option of not building the facilities they need is one choice that is not available to them.
Such is the case with the rural electric cooperatives. We borrow for one reason and for one reason only to build the facilities needed to provide adequate and reliable service to our member-consumers. Cooperatives borrow from REA to maintain, expand and improve a service which the nation's rural areas cannot do without, and the rural electrics will have to continue to borrow one way or another to meet these needs in the future.
Because co-op borrowing is largely non-discretionary, reductions in the size and scope of the REA lending programs that might result from ceilings or other overall restrictions placed on FFB activities would have little impact on the actual credit demand of rural electric systems, and -- because the co-ops would by necessity go directly to the private credit marketplace for their needed capital -- would have no discernable impact on the overall credit marketplace.
They would, however, have a significant impact on the cost of that borrowing. Since co-ops are non-profit and all costs necessarily flow-through to the consumer-members, these increased costs would quickly show up in the electric rates rural consumers must pay rates which, it should be noted, already average approximately 12% higher than those charged to urban and suburban consumers served by other types of utilities.
In addition, the reliability and quality of utility service provided to rural consumers could be affected also. As non-profit cooperative entities, rural electrics are not at this time well known or understood by a large segment of the investment community. Even with the exemplary record of repayment we have established through the REA program, there's good reason to wonder how Wall Street might respond to a significant and abrupt increase in rural electric borrowings, even with the guarantee in place. Because of this, it's conceivable that some rural electrics would be unable to raise the capital they need at any price.
The FFB, in this sense, plays an extremely critical role, since it is both familiar to and understood by investors. This is in addition, of course, to the key role it always has played as a mechanism for coordinating and timing the capital demands of not only REA, but a variety of other programs involving guarantees or other types of federal participation.
SPECIFIC CONCERNS WITH REGARD TO S. 1679
This Congress and the present Administration have acknowledged the important role of electric energy and the financial plight of the investor owned utility industry by providing them with significant new subsidies through the granting of a broad range of new tax credits and advantages. We are sympathetic to these steps because we are fully aware of the difficulties these utilities have had in recent years in meeting their capital needs. At the same time, however, we are concerned that the legislation before this Committee would handicap the rural electric cooperatives in fulfilling their service obligations.
The following questions arise from language contained in S. 1679 in its present form: (1) We disagree with the proposed budgetary treatment of guaranteed loans as an outlay when, in fact, they also represent an significant asset to the government.
A more appropriate, and we believe, equitable approach to this issue would be the implementation of a so-called "capital budget" for our government. Under this system, which is used by most business enterprises and a majority of states, budgeting is done in two separate categories: a "current outlays" budget, representing day to day operating expenses, and a "capital budget," which accounts for long term investments and expenditures for land, capital equipment and other items of significant value and longevity. This budget also provides a means to recognize and account for the value of assets held, including, of course, that of long term notes receivable. NRECA has for many years supported the creation of a capital budget for the Federal government and continues to do so today.