One of the dumbest rules suggested by the FCC for the new $16.4 billion RDOF grants is that an ISP must provide a letter of credit (LOC) to guarantee that the ISP will be able to meet their obligation to provide the matching funds for the RDOF grants. The FCC had a number of grant winners years ago in the stimulus broadband grant program that never found financing, and the FCC is clearly trying to avoid a repeat of that situation. A coalition of major industry associations wrote a recent letter to the FCC asking them to remove the LOC requirement – this includes, NTCA, INCOMPAS, USTelecom, NRECA, WTA, and WISPA.
There may be no better example of how out of touch Washington DC is with the real world because whoever at the FCC came up with that requirement has no idea what a letter of credit is. A letter of credit is a formal negotiable instrument – a promissory note like a check. A letter of credit is a promise that a bank will honor the obligation of the buyer of a letter of credit should that buyer fail to meet a specific obligation. The most normal use of LOCs is in international trade or transactions between companies that don’t know or trust each other. An example might be a company that agrees to buy $100,000 dollars of bananas from a wholesaler in Costa Rico, payable upon delivery of the bananas to the US. The US buyer of the bananas will obtain a letter of credit, giving assurance to the wholesaler that they’ll get paid. When the bananas are received in the US, the bank is obligated to pay for the bananas if the buyer fails to do so.
Banks consider letters of credits to be the equivalent of loans. The banks must set aside the amount of pledged money in case they are required to disburse the funds. Most letters of credit are only active for a short, defined period of time. It’s highly unusual for a bank to issue a letter of credit that would last as long as the six years required by the RDOF grant process.
Letters of credit are expensive. A bank holds the pledged cash in escrow for the active life of the LOC and expects to be compensated for the lost interest expense they could otherwise have earned. There are also big upfront fees to establish an LOC because the bank has to evaluate a LOC holder in the same way they would evaluate a borrower. Banks also require significant collateral that they can seize should the letter or credit ever get used and the bank must pay out the cash.
I’m having trouble understanding who the letter of credit would benefit in this situation. When the FCC makes an annual grant payment to an ISP, they expect that ISP to be building network – 40% of the RDOF network must be completed by the end of year 3 with 20% more to be completed each of the next three years. The ISP would be expected each year to have the cash available to pay for fiber, work crews, electronics, engineers, etc. You can’t buy a letter of credit that would be payable to those future undefined parties. I think the FCC believes the letter of credit would be used to fund the ISP so they could construct the network. No bank is going to provide a letter of credit where the payee is also the purchaser of the LOC – in banking terms that would be an ISP paying an upfront fee for a guaranteed loan to be delivered later should that ISP not find a loan elsewhere. It’s absurd to think banks would issue such a financial instrument. It’s likely that an ISP who defaults on a LOC is in financial straits, so having a LOC in place would have the opposite effect of what the FCC wants – rather than guarantee future funds a bank would likely seize the assets of the ISP when the LOC is exercised.
A letter of credit has significant implications for the ISP that buys it. Any bank considering lending to the ISP will consider an LOC to be the same as outstanding debt – thus reducing the amount of other money the ISP can borrow. A long-term LOC would tie up a company’s borrowing capacity for the length of the LOC, making it that much harder to finance the RDOF project.
The coalition writing the letter to the FCC claims correctly that requiring letters of credit would stop a lot of ISPs from applying for the grants. Any ISP that that can’t easily borrow large amounts of money from a commercial bank is not going to get a LOC. Even ISPs that can get the letter of credit might decide it makes it too costly to accept the grant. The coalition petitioning the FCC estimates that the aggregate cost to obtain letters of credit for RDOF could cost as much as $1 billion for the grant recipients – my guess is that the estimate is conservatively low.
One of the groups this requirement might cause problems for are ISPs that obtain their funding from the federal RUS program. These entities – mostly telcos and electric cooperatives, would have to go to a commercial bank to get a LOC. If their only debt is with the RUS, banks might not be willing to issue an LOC, regardless of the strength of their balance sheet, since they have no easy way to secure collateral for the LOC.
Hopefully, the FCC comes to its senses, or the RDOF grant program might be a bust before it even gets started. I’m picturing ISPs going to banks and explaining the FCC requirements and seeing blank stares from bankers who are mystified by the request.
AND did you know that the price-cap carriers (the big ISPs) were NOT required to provide a letter of credit for the CAF I and CAF II funds, AND they were paid annually BEFORE they built to a single home. It was only the reverse auction segment of CAF, when they started requiring the LOCs, and basically that was for the funds left over and for areas the big ISPs did not want to serve. As we’ve seen, a # of the big ISPs have announced they have failed to meet their deployment requirements on CAF II and they’ve already been paid by the govt for those segments.
As usual, this is extremely cavalier and almost dismissive by the FCC. The last time I asked for a letter of credit, I was told I must have matching funds deposited into the bank. Even with matching funds, they were reluctant to do it. Banks do not like writing letters of credit because, as you say, they are obligating the bank to an immediate outlay of cash when called. Naive, at best for anyone to insert this requirement. Ignorance? Or purposeful?
Clean out the FCC and bring in another/new agency. This one is quasi-governmental, co-opted and controlled by major carriers, hoping the whole $16 billion ends up in their pockets. With the letter of credit requirement, the FCC has once again, handed the major carriers another win. With over 100 years of opportunity to fix rural telephony problems, what will be different this time? We all know decades of subsidies have done nothing.
We learned this week that CenturyLink plans to be a major player in the RDOF grants. We cannot allocate more money to prop up their rural DSL a second time.
Not to take away from your main point, but LOCs used to ensure performance and compliance, as opposed to trade, are called Standby Letter of Credits. Asian countries sometimes require them in order to get a Telecom or ISP. If the licensee misbehaves the government informs the bank and grabs the money. Certainly expensive and a PITA. — Jim
I guess my timing was good – the FCC just voted today to eliminate the letter of credit requirement. They got enough comments to convice them this would have sent $1 billion to banks instead of for solving rural broadband.
Looks like someone from the FCC has confused a Line of Credit for a Letter of Credit. A company could prove the ability to complete a project by showing they have a Line of Credit large enuff to cover the outlay.