Look Out for those Grant Gotchas

One of the most disappointing things in the broadband world is when broadband grants have ‘gotchas’ that make it hard to use the money as intended. North Carolina has named its state broadband grant program the “GREAT” grants. That’s a pretty bold name, and I’m sure that the homes and businesses in the states that are getting broadband as a result of these grants think it’s great. But like other grant programs around the country, there are some gotchas in the grants.

Even though I live in North Carolina, I hadn’t looked into the details of the program until I got a call from a part-time professor at NC State. He was struggling while working at home due to COVID-19 and trying to hold remote college classes from a slow home broadband connection. He and his neighbors were upset because the State had awarded a grant in 2019 to bring broadband to his area of Caswell County, and yet nothing has happened. The rumor was that there was something amiss about the grant, but nobody locally knew why they weren’t getting broadband.

It didn’t take long to find that Open Broadband, a wireless ISP, had won a $1.54 million Great grant to bring broadband to 1,194 homes in the County – roughly one-fourth of the rural households in the county that the FCC says don’t have 25/3 broadband in the 2019 Broadband Deployment Report. This state grant was to have been matched with another $1.54 million from the ISP.

Open Broadband told me that the state had yanked the grant due to a change in the grant rules that was introduced after the grant award – a rule that had not been disclosed in the original grant rules. The state administrator of the grant, the Broadband Infrastructure Office, notified Open Broadband after the grant had been awarded that the ISP had to meet one of the following financial tests to receive the funds:

  • Letters from the applicant’s Board of Director or investors guaranteeing the total project cost.
  • A letter or actual statements from a bank or other financial institution verifying total available cash or lines of credit meet or exceed the anticipated total project costs.
  • Letters from a verifiable third-party entity guaranteeing the total project cost.

In case those rules didn’t sink in, the state is requiring an ISP to guarantee 100% of the cost of the project, including the portion of grant being supplied by the State. In this case, the state wants Open Broadband to guarantee over $3 million, even though they are only receiving $1.5 million of grant funding. Most grants that seek proof of financial viability would ask an ISP to guarantee their out of pocket costs – in this case that’s significantly less than $1.5 million since customer installation fees will cover a large portion of the ISP’s grant matching.

It’s ludicrous that the state wants an ISP to guarantee the portions of the grant paid by the State – is North Carolina worried that its own grant money is no good? The state wants Open Broadband to have $3.08 million in free cash or else a guarantee of that amount from a bank or a private investor. Whoever came up with this after-the-fact rule doesn’t understand ISPs or the banking industry.

ISPs don’t sit on much free cash – even fairly large ISPs. We are living at a time when every ISP I know is expanding – something that governments at all levels should support because government constantly says that the private sector should solve the broadband problems in rural America. Few ISPs are sitting on the free cash needed to make this guarantee.

The State will alternatively accept a guarantee from an owner or investor. This request is massively out-of-line with the nature of the project. A personal guarantee means putting your home and retirement savings on the hook. Many small and medium ISPs are already partially financed by personal loan guarantees by owners, and they can’t pledge this twice – even the rare owner that has over $3 million in net personal wealth.

The idea of an ISP having $3 million in an unused line of credit is even more absurd. Only a really large ISP would have a $3 million line of credit. A business line of credit is a loan that hasn’t yet been drawn. Banks are not like credit card companies and they don’t set big credit limits without an expectation that a borrower will use the money quickly.

The only other way to meet this requirement from a bank is with a bank letter of credit. 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 letter of credit should that buyer fail to meet a specific obligation. Banks consider a letter of credit to be the equivalent of a loan. 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 time. A letter of credit for a 2-year grant would be unusual and expensive – the ISP would likely to have to pay full interest expense as if this was a loan. The bottom line is that banks don’t issue a letter of credit for this kind of purpose.

I never heard of the concept of guaranteeing grants in this manner until last year. Out of the blue, the FCC suggested that winners of the $16.4 RDOF grants should be required to guarantee matching funds by either holding the cash or supplying a letter of credit. There was such an immediate outroar from the industry that this idea was killed in a matter of weeks. The industry conjectured that the idea came from the big ISPs, which have the FCC’s ear. The big ISPs know this requirement would stop most ISPs from applying for an RDOF grant – which would allow the incumbents to keep milking money out of rural properties with lousy and overpriced broadband. This may not be the reason for the North Carolina requirement, but the timing is suspicious.

This is not the only gotcha in the grant. The state also only reimburses funds that have been spent by a grant awardees once per quarter. Every other grant program I know of reimburses ISP expenses monthly. It’s a major financial penalty to make ISPs wait for months to get expenses reimbursed.

I was surprised to see major gotchas in North Carolina grants. This comes from a state that brags about its history of being first in broadband. For example, North Carolina says it was the first to have brought fast broadband to every school. I have no idea where the State got the idea for the grant guarantees, but it’s an absurd requirement that will do little more than discourage ISPs from investing in the state. ISPS can easily move across the border to nearby Virginia or Tennessee where the grant process is friendlier. North Carolina needs to kill this absurd rule. Those homes in Caswell County deserve the broadband they were promised, and it’s still not too late to make this grant work.

Letters of Credit

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.