Banking Challenges for Fiber Builders

I’ve often mentioned in this blog that it’s gotten harder to finance fiber infrastructure. Today I want to discuss a few of the specific issues that fiber builders face when trying to find bank financing. There are two traditional sources of funding for the industry – the Rural Utility Service (RUS) and CoBank.  However, many fiber builders don’t qualify for this funding since both institutions favor established mature companies. Any company that doesn’t fit the profile of these two lenders must turn to the only other source of funding – local and regional banks. Following are some of the issues I see when trying to borrow from banks.

Familiarity with the Industry. Local banks often are leery about lending to telecom companies because they are not familiar with the business and they fear lending into an unknown industry. Local banks are much more comfortable lending to businesses they understand and make loans to car dealers, retail stores and the other kinds of local businesses that have been their long-term core borrowers.

Amount of Borrowing. Every bank has some pre-determined maximum amount they are willing to lend to any one borrower and it’s easy for a fiber overbuilder to quickly hit this limit. I’ve rarely met a fiber overbuilder who doesn’t see endless opportunities for expansion and it’s not hard to hit a bank’s maximum lending limit.

Loan Terms. Local banks are often uncomfortable with the longer-term loans needed to finance fiber.  Banks prefer to make loans for relatively short periods of time, with their preference being short loans of 2 – 5 years. Fiber builders are often forced to only chase projects that fit the short loan terms – which means cherry picking only the best opportunities. In doing so they will be passing up opportunities that would thrive and produce good returns with a longer loan terms of 5 – 15 years.

Collateral. Banks are often uncomfortable with a fiber network as collateral. It’s not hard to blame them for this. A fiber network, once in the ground or on the pole does not automatically have a liquidation valley equal to the cost of the construction. The real value of a fiber network is the revenues from customers who are added to the network – and banks have a hard time accepting this concept. A little research will show bankers that failed fiber ventures have often liquidated the physical fiber network for pennies on the dollar, and that rightfully frightens them.

Quantifying Risk. It can be difficult for a bank to understand the downside risks of building a fiber project. One of the key steps to making a loan is to understand the likelihood of the borrower not meeting the proposed business plan, and bankers have a hard time quantifying and getting comfortable with the potential downsides of the proposed business.

Meeting Metrics. Many banks are driven by metrics – meaning that they look for key financial performance metrics from a borrower. It’s hard to meet the typical metrics for a new fiber network. When a network is first built it boosts the balance sheet – but revenues then lag a few years behind until the new network has enough customers to meet expected metrics. This cycle of early losses followed by eventual gains does not fit easily into the expectations of a metric-driven bank.

Unfortunately, any one of these issues can convince a bank that the fiber loan is too risky or doesn’t fit their comfort zone. Many banks are comfortable with infrastructure loans, but there are infrastructure loans that better meet their expectations. Consider a loan to build an apartment complex. There is the same period of zero revenues while the buildings are constructed, but the expectation is that the borrower will then quickly reach full revenues within a relatively short period after the end of construction. An apartment building also provides comfortable collateral because there is an established market for selling repossessed buildings. Bankers in general understand the apartment complex operating model and are comfortable with the variables of operating an apartment building.

Fiber overbuilders need to be prepared to tell a story that can get a banker comfortable with each one of these concerns. I always advise fiber builders that they must put themselves into the banker’s shoes and look at their own business plan as a skeptic. I’ve often seen fiber builders who point to a business plan that eventually makes a lot of money and who can’t understand why a banker doesn’t see their plan the same way they do. Many of the misgivings that a banker might have about funding a fiber project are legitimate and the borrower must convince the banker that the overall level of risk is small – a tall task.

Maybe Coops are the Answer

I’ve been talking with a lot of rural counties lately and also with rural service providers. For the vast majority of rural broadband projects the biggest roadblock to getting started is almost always funding. Building fiber-to-the-home or even fiber backbones to extend fiber deeper into rural communities is expensive and there are not a lot of funding sources ready to support fiber projects. But there is one business structure that can sometimes make financing a little easier and perhaps it is time for more communities to consider forming a cooperative as a way to get a broadband solution.

Cooperatives are governed under federal law by the Capper Volstead Act. There are also state laws governing coops that differ a bit from state to state, but are mostly the same everywhere. A cooperative is a legal entity owned and controlled by its members and members generally are also the consumers of its products or services. Cooperatives are typically based on the cooperative values of self-help, self-responsibility, community concern, and caring for others. Cooperatives generally aim to provide their goods or services at close to cost and any excess earnings are generally required by law to be reinvested in the enterprise or returned to individual patrons based on patronage of the cooperative.

There are several advantages of coops that make them worth considering:

  • Coops are corporations and not municipal entities. Coops ought to be exempt from all of the many state laws that prohibit or discourage municipal ownership of broadband networks. If you’re in a place that makes it hard to create a municipal broadband solution then a cooperative might be a great alternative.
  • Cooperatives don’t have the same profit-motive as privately-owned entities. From a financing perspective this makes them look more like a municipal venture in that a coop is happy with cash flows that cover costs rather than having to also make a profit.
  • Cooperatives often have some tax advantages over other kinds of corporations. For example, ‘profits’ from serving their customers is often income-tax free. This can vary by state, but for the most part cooperatives pay little income taxes as long as they focus only on serving their own members.
  • The typical financing sources for broadband are used to working with cooperatives. The RUS, part of the Department of Agriculture has a long history of lending to cooperatives. CoBank, a bank that is part of the US Farm Credit System was established specifically to loan to agricultural, electric and telecom cooperatives. While the RUS was tasked a number of years ago to include municipalities under their umbrella, the nuances of that program make it nearly impossible for a municipality to borrow from them.
  • Cooperatives have a unique funding source that is not available to anybody else. Coops are allowed to loan excess cash to each other and I’ve seen new coops get low, or even zero interest loans from other cooperatives to help them get started. Many older electric and agriculture coops sit on big cash reserves that they might consider lending – particularly when the new telecom cooperative covers the same member territory.

But as you might expect, there are other issues that present challenges for new cooperatives:

  • Any lender to a new fiber venture is going to want to see some equity put into a new venture so that it is not 100% financed. It can be more of a challenge for a cooperative to raise equity compared to a commercial company because there is no way to guarantee that such equity will earn a good return or that it can be returned in any reasonable time frame. So this basically means that an equity drive means asking prospective members in the community for money. I’ve seen a few cooperatives get started and it can be done – but it’s not easy.
  • Cooperatives are governed by Boards elected from the membership base. Existing coops hire employees to operate the business and these employees provide the technical expertise that makes lenders trust lending to the business. But until a new cooperative is funded and can hire those employees there is a classic chicken-and-egg dilemma in that a lender can’t be positive that the cooperative knows how to operate their business.
  • The local acceptance of the cooperative idea varies by region. In some places in the Midwest a majority of local businesses are cooperatives, but there are other places where there are few if any cooperatives.

There are many situations where a cooperative might be the only reasonable operating structure for a rural area to get the broadband they want. If a community is not finding any solutions from a commercial provider and is unable to provide municipal funding, then a cooperative is well worth considering.