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Regulation - What is it Good For?

The Extra Costs of BEAD Funding

A few weeks ago, when I did my first summary of the $42.5 billion BEAD grant program, one of my observations was that there are a lot of extra costs for an ISP to accept BEAD funding. This is something that anybody taking the funding must understand. Some of those extra costs include:

Environmental and Historic Preservation Reviews. I’ve occasionally worked on a non-grant network project that required these reviews. For example, these are normal requirements for building networks through state and federal parks. Indian tribes require these if there is any chance of construction through historically sensitive areas. I would expect to take extra precautions if I was building fiber close to the Liberty Bell or some other historical place. But other than those examples, no commercial project I’ve ever worked with has voluntarily done these reviews. Most networks are built using existing rights-of-way along roads where the soil was excavated in the past. I can’t imagine the slightest reason why these reviews would be required for placing fiber on existing utility poles.

Letters of Credit. I’ve written a separate blog on this issue. The grants require an irrevocable letter of credit just to apply, and a second letter of credit from grant winners. I think the NTIA saw the criticism leveled at the FCC in the RDOF process and wants to exclude bad actors, but this jacks up the cost of applying for a grant and could add a few percent to the overall cost of a grant project. This will also likely deter small ISPs who want to fill in some of the neediest pockets but can’t get a bank to provide the line of credit.

Prevailing Wages. Projects over $5 million must use prevailing wages. The majority of the projects will be rural, and the folks who made this requirement don’t understand the rural contractor environment. Rural contractors already pay wages that are some of the best paying jobs in a rural economy. They must do so, or in this time of technician shortage, they wouldn’t have any workforce. But they don‘t pay the extra-high prevailing wage rates that are charged in urban areas. Those rates are higher because of the higher cost of living in urban areas. If prevailing wage studies were done correctly, they’d find a separate prevailing wage for urban and rural communities. To make things worse, rural contractors don’t want to be required to pay prevailing wages if they also have non-prevailing wage workers because it causes dissension between crews who want to all work on the higher-paying project. This is a case of a solution seeking a problem because the existing wages in rural areas are balanced by the lower cost of workers not having to live in cities.

Requirements on Contractors. The BEAD NOFO layers a few new requirements on contractors. As an example, a construction contractor working on a BEAD project must certify that it has a workforce development program that includes participation in an apprenticeship program. This requirement ignores an important characteristic of most fiber and tower contractors – many of these contractors have few direct employees. They instead hire small crews of specialty subcontractors – and these small subcontractors will walk away if asked to meet this requirement or do extra paperwork. My fear is the contractors who have historically worked in rural markets won’t take BEAD work if it puts extra burdens on them – there is plenty of non-BEAD work.

Heavy Reporting Requirements. I don’t have a problem with requiring follow-up reporting on the effectiveness of grants, and in the past, some programs like CAF II had almost no follow-up. But the reporting requirements for BEAD are more detailed than anything I’ve seen, so it’s going to cost more to comply.

Grants are Taxable. We can’t forget that grants are taxable income to any taxable entity that accepts the funding. I’m hearing rumors of a D.C. workaround on this issue, but without a solution, it’s going to be hard for a small commercial ISP to justify taking millions in grant money if that means having to somehow fund paying 21% of that back to the federal government plus whatever will be due to the state. It’s not comforting to know that the tax savings will roll back over the next twenty or thirty years as grant-funded assets are depreciated. This is not specifically a BEAD issue and applies to all grants from local, state, or federal sources.

Summary. One of the sentiments I loved in the grant NOFO is that the NTIA wants to get broadband to even the most remote places, and they used the example that funding should be available to reach even a single location. But I have to laugh when I look at these requirements and see that reaching that single remote location might get layered with hundreds of thousands of dollars of extra costs.

The biggest drawback of expensive grant compliance is that it drives up the cost of every grant project. And that means that the BEAD money won’t stretch as far to bring broadband to as many homes. For an individual grant applicant, the extra cost translates into the need for more out-of-pocket matching funds – which in some cases will be enough to make a project infeasible.

I fully understand the desire at the NTIA to not fund bad projects. I imagine there are folks there that still remember the agency being accused in 2009 of funding projects that were “fiber to nowhere”. But the many extra grant requirements feel like we’re applying a pound of prevention to solve an ounce of risk. Any one of the various grant requirements can probably be justified, but when taken as a whole, the grant requirements are adding extra cost and hassle that will make many ISPs pass on the opportunity.

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Regulation - What is it Good For?

The BEAD NOFO – Financial Issues

The NTIA has established basic rules for the $42.5 billion BEAD grants in the recent Notice of Funding Opportunity (NOFO). One of most important aspects of the rules that potential applicants need to understand relates to funding and financing. Note that the NOFO instructs the States what it expects to be included in each state’s broadband grant program for the BEAD funding.

The first set of rules concerns the amount of grant funding. Since the IIJA passed Congress, the industry has been talking about BEAD grants offering 75% grant funding. It’s not that simple.

The NOFO says that states are required to incentivize matches of greater than 25 percent from subgrantees. That means states must make every effort to award less than a 75% grant. In fact, if two entities request building fiber to the same geographic area, the one asking for the smaller amount of money will automatically win, assuming they meet the basic grant requirement. This makes sense and will stretch the grant money further, but ISPs should be prepared for a sliding scale where the less the borrowing the greater the grant points.

The original Congressional language also held out a big promise for the layering of grants. The legislation specifically promised that an ISP could use ARPA or CARES funding from states and localities as matching for the BEAD grants. But the NTIA rules turn that promise on its head. States are encouraged to require a match from the subgrantee rather than utilizing other sources where it deems the subgrantee capable of providing matching funds. If a grant applicant has the ability to fund the grant matching, the NOFO rules suggest states should not allow the layering of local monies as grant matching. When that sinks in, it’s going to put a lot of public-private partnership discussions on hold.

The more disturbing requirement in the grant is that applicants must provide an irrevocable letter of credit along with a grant application. During the application process, prospective subgrantees shall be required to submit a letter from a bank . . . committing to issue an irrevocable standby letter of credit, in the required form, to the prospective subgrantee. The letter shall at a minimum provide the dollar amount of the letter of credit.

I have to wonder if the folks at NTIA understand what an irrevocable standby letter of credit (SLOC) means. Consider a grant application for $40 million, with a $10 million grant match. A bank must treat an SLOC as if were a bank loan. When the bank issues the SLOC, it ties up the $10 million on its balance sheet in the same way it would if it made a loan. The bank can’t loan that money to anybody else – it is frozen. While the bank is still holding the cash, it is not treated as a bank’s cash reserve since it is pledged. The bank will charge a minimal amount of interest on the letter of credit. In recent years that’s been something like 2% – hard to know what that might be with rising interest rates. If the interest rate is 2%, and the grant process takes a year to process, the ISP will have spent $200,000 in interest expense – even if it doesn’t win the BEAD grant.

It gets worse. When an ISP wins a grant it must then produce an irrevocable letter of credit for the life of the grant. This is even worse than the first letter of credit. Bank loans for fiber projects typically use construction financing – the same kind of financing used if you build a house. For a project built over four years, the ISP would take a draw each month as it needs funds and would only start paying interest on money that has been drawn. If a letter of credit must be created on the first day of a grant award, then using my example, interest rates for the full $10 million of matching would start when the letter of credit is issued. That completely negates the primary advantage of bank construction financing. My back-of-the-envelope math tells me that for a $10 million matching, the two layers of letters of credits could add $1 million to the cost of the project – all flowed to banks in the form of interest. None of this money is recoverable from the grant funding and comes out of the grant winner’s pocket.

To make matters even worse, a lot of smaller ISPs will not be able to obtain the letter of credit needed to apply for the grant. It’s a typical chicken and egg scenario. A bank won’t give an ISP a SLOC unless their existing balance sheet supports that much of a loan. But the ISP’s balance sheet won’t justify the SLOC until it wins the grant. This rule will definitely discriminate against smaller ISP – and by smaller, I’m including some fairly large companies like regional telephone companies and cooperatives.

The NOFO says there will be additional language coming to describe how municipalities will deal with the letter of credit issue. The NTIA is probably struggling with this because bond financing is more complex than a bank loan. A bond doesn’t exist until the day that bond buyers agree to buy the bond. It’s always possible that a bond issue won’t sell, so there can be no bank guarantees tied to future bond issues. I can’t wait to see this solution.

I don’t want to be dramatic, but this seems like massive overkill. It would appear that the NTIA is so fearful of having a few grant winners who will default on projects that they are imposing a billion-dollar industry cost to solve a million-dollar problem.

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