Gotchas in the e-Connectivity Grant Program

The high-level rules came out on Thursday for the USDA e-Connectivity grants being administered by the RUS. This is $560 million of grants and loans that were authorized by Congress last spring – this was first announced as a $600 million program and I’m not sure where the other $40 million went. I’m not going to list all of the rules of the grants – I’ve seen a dozen websites already that have summarized the key grant requirements. Instead I’m going to talk about a few requirements that I think will be show stoppers for many potential applicants.

RUS Loans are Still Draconian. Only 1/3 of the funding will be outright grants, with the other 2/3 being outright loans or 50/50 loans and grants. This means that most of funding can only go to those who are already RUS borrowers or who are willing and able to accept the draconian RUS loan provisions.

Anybody accepting an RUS loan must pledge 100% of their existing assets to the RUS and also give the RUS an exclusive first lien position on the company. What this means is that anybody that already has a loan elsewhere is not going to be able to take these loans. Existing lenders like CFC. CoBank, or any commercial bank will not accept a second loan position to these new awards. A huge number of telcos and electric cooperatives that borrow elsewhere won’t be able to accept RUS loans, eliminating them from consideration for anything but the 100% grant portion of the program.

These same loan restrictions also make it unlikely that any government entity can accept an award that includes am RUS loan. I’ve worked with nearly a dozen government entities that have pursued RUS loans and none of them have successfully been able to overcome the pledge and other lending hurdles.

The 10% Test. The program has a gotcha slipped in by Congress that no more than 10% of the locations covered by the program can already have existing broadband 10/1 Mbps or greater speeds. This is a giant change from past RUS award programs that allowed up to 85% to have 10/1 speeds. Applicants need to take this requirement seriously and I expect any applications that can’t the lack of existing broadband will be quickly tossed out of consideration. This is not a flexible rule and was inserted into the grant rules by big telco lobbyists who don’t want to see any competition.

This means that any parts of the country previously covered by any federal funding program that required 10/1 Mbps speeds will not be eligible – including past award areas that haven’t yet been upgraded, like the areas recently awarded under the CAF II reverse auction. Applicants are going to have to be extremely careful in defining study areas, almost on a home by home basis. I fully expect RUS to test the study areas hard and I’m positive that outside parties (like incumbent telcos) will be able to intervene if they think an applicant fails this test.

The worst part of this is that we know that the rural broadband maps suck and that there are many places that the FCC considers to have 10/1 broadband that doesn’t have it. Applicants will have a big uphill battle to get funding in these areas.

Requires Two Years of Sound Audits. Applicants need to produce two years of audited solid historical financial performance – meaning start-ups need not bother with the grants. The RUS hasn’t forgotten the big problems they had with start-up companies during the stimulus grant program.

Environmental Impacts. Applicants must analyze the environmental and national historic preservation impacts of a grant request. It’s possible to get out of this requirement if a state official will declare that these tests aren’t required for applicants from their state. Applicants are also going to need affidavits from a state official to describe state broadband grant programs and to describe any conflicts with a grant filing.

Record Keeping. In order to meet the 10% rule I expect study areas to be disjointed –pocket of homes here and there scattered over a larger area. Applicants will somehow have to track costs of construction in these small pockets and not mingle costs with other nearby areas that were not included in a grant supplication. It’s going to be hard to show an audit trail of invoices that are just for the study area.

Prevailing Wage. The announcement doesn’t mention prevailing wage, but I expect this to apply. In past RUS grants this requirement has been included in the detailed descriptions of the grant process that hasn’t yet been released. Prevailing wage means paying construction labor at rates determine by each state, and which in many states reflect the cost of building in the largest cities and not in the rural areas. Prevailing wages can sometimes be so much higher than actual construction company rates that the difference in the wages can wipe out most of the benefit if getting a 50% grant.

Matching Funds Spent First. The grants require that matching funds must be 100% spent before any RUS money. That means the funding sources that incur the highest interest rates must be spent first, adding to the cost of the project. The source of the matching funds needs to be identified by the time of the grant filings.

I’m positive that many will be excited about a new large broadband grant program, but the above grant requirements are going to scare off or disqualify many potential applicants. These hurdles are not by accident – the big telcos really don’t want anybody competing against them and have stacked the deck with the nuances of the rules.

Progress on Federal Infrastructure Funding?

I’ve been continuing to follow the federal plans to launch a massive $1 trillion program to rebuild infrastructure, with an eye on possible funding for broadband.

The latest White House proposal includes $25 billion for broadband, spread over ten years. That’s obviously not enough to solve our broadband problem everywhere, but it certainly could put a big dent in it.

The first thing needed to understand the issue is a good estimate of the size of needed investment to build fiber. Back in 2013 an article in Forbes estimated the cost to build fiber everywhere at $140 billion, with the cost to get to most populated areas at half that. Just recently I saw a few news articles citing an estimated cost of $85 billion to bring ‘broadband’ to rural America. But I can’t track down who’s making that estimate or if ‘broadband’ means fiber everywhere or some mix of broadband technologies. But it’s obvious that the cost is going to be greater than $25 billion.

But there is another aspect of the White House proposal that we need to keep an eye on. They envision the government kicking in $200 billion with the rest of the $1 trillion coming from the private sector. Even if the entire $200 billion is in the form of outright grants, that means that a project funded under the federal plan would be getting a 20% grant and would have to somehow finance the other 80% of a project.

I’ve created a lot of rural business plans over the past few years and I can tell that a 20% grant is not going to work in financing rural fiber. That amount of grant might be sufficient when talking about rural county seats and other pockets of somewhat dense population. But all of the studies I’ve done show that it will require grants of 40% to 80% to finance building in rural America.

I also worry that part of the federal funding might also include loans, like was done a few years ago with the Stimulus broadband awards. Some of those projects got a mix of outright grants as well as long-term loans from the RUS. If the federal contribution is not all grants then its usefulness in rural America will be even more diminished.

This is not to say that the federal program might not offer different levels of grants and not stick to the overall 20% for everything. But if 20% grants are all that is offered there are not going to be many takers. A grant of that magnitude probably might bring fiber to suburbs and mid-sized towns, but not to rural America.

If the grants were set to 50% of the cost of a project it would stimulate a lot of rural fiber construction. We’ve seen this in action in programs like the DEED grants in Minnesota that have been funding $20M to $30M per year in the form of matching grants. In that state the various LECs, from the smallest up through CenturyLink, are using grant money to bring broadband to unserved rural customers. But Minnesota is unusual and is one of a handful of states where there are numerous telcos willing to branch out to serve the areas around them if these kinds of grants are available.

One of the biggest hurdles I see for building rural broadband is the availability of private capital. Even with a 50% grant the operators of these new networks will need to finance the other 50% of the projects. There is certainly cash available for this and having a federal infrastructure program might attract more lenders. But there is a natural lending limit on all telcos, big and small.

A large percentage of the smaller telcos I know have already been borrowing money to build fiber within their own operating areas, and those companies are not going to be able to borrow much more money even if it is available. Even the big companies have constraints. CenturyLink currently has an annual capital budget of about $3 billion per year and that is largely going towards building fiber in their urban markets. It’s hard to see them taking any real interest in building rural fiber if they have to borrow to do so. Many of the mid-sized telcos like Frontier and Windstream are already heavily leveraged and would have a hard time borrowing much. And Verizon and AT&T have made it very clear that they no longer want to be in the rural wire business. I’m not sure those companies would take on these networks if the federal government paid for all of it.

So having a federal broadband infrastructure program sounds great. But when you look a little closer at how it might work it starts to look troublesome. There are certainly a number of companies that would step up to build rural broadband if the grants are large enough to make the numbers work. But I’m not sure that there is any combination of companies that are able or willing to tackle all of the areas without broadband. It could end up being a program where there is more funding than takers.