Tag Archives: letter of credit

Relaxing Letter of Credit Rules

The FCC issued a Notice of Proposed Rulemaking (NPRM) that looks to ease some issues with the letters of credit that must be maintained by ISPs that have accepted FCC grants or subsidy awards. This applies to programs like RDOF, the CAF II Reverse auction, and the upcoming 5G Fund. These changes will not apply to BEAD recipients.

The NPRM recognizes some issues with the current letter of credit process. One key issue is nearly half of the banks that were eligible to issue a letter of credit two years ago no longer meet the FCC’s criteria. A bank must have a Weiss bank safety rating of at least B- in order to qualify for issuing a letter of credit. Weiss Ratings is an independent rating agency that analyzes and provides a rating for over 8,500 commercial banks, savings banks., and S&Ls.

According to the FCC NPRM, there were 3,600 banks that had a B- or better rating from Weiss when the FCC first adopted the Letter of Credit rules. Almost half of those banks now have a lower rating or have failed in the last few years.

Most people don’t understand the stress that higher interest rates put on smaller banks. The natural assumption is that higher interest rates are good for banks – and it is good for the giant national banks. However, smaller banks experience several negative impacts from higher interest rates. While they can charge more for loans they make, the volume of new loans generally drops significantly when interest rates are higher. Smaller banks also don’t use their own money for many of the loans they make and borrow the funds for making loans at an interbank rate from larger banks. The profit margin on such loans doesn’t improve from higher interest rates and can actually shrink. Finally, when interest rates are higher, banks also have to pay higher interest rates to depositors – something that comes out of their own bottom line. All of these various impacts of higher interest rates contribute to banks now failing the Weiss rating test.

The FCC also noted one of the biggest problems for letters of credit. When a bank gives a letter of credit to an ISP, the bank expects the ISP to keep a large percentage of the guaranteed funds on deposit. That is mind-boggling if you think about it. An ISP wins a grant, gets a letter of credit for something like half that amount, and is then expected to have a deposit in the bank for the amount of the letter of credit. Anybody who knows anything about small ISPs should understand that they don’t hoard cash. ISPs generally roll excess cash back into investing in infrastructure. The letter of credit rules are particularly insidious because grant recipients have to somehow use the grant funding to build the promised infrastructure while also finding other cash to deposit in the bank that gave the letter of credit.

You probably wonder why banks charge interest on a letter of credit if the ISP must maintain collateral equal to the amount of the letter of credit. A letter of credit is a guarantee by a bank to repay the FCC for grant funds if a grant project goes sour. A bank that issues a letter of credit is forced to set aside the guaranteed cash, almost the same as if they had made a loan. That money sits without earning interest. Worse, on the bank’s balance sheet, this is categorized as money that has been loaned, not as cash in the bank. To some degree, a large volume of letters of credit contributes to banks having lower ratings.

The purpose of an NPRM is for the FCC to consider alternatives to its current letter of credit rules. The document asks the following types of questions to the industry:

  • Should the FCC have easier letter of credit rules for small ISPs versus large ones?
  • Should the FCC consider something other than Weiss ratings. There are other rating agencies that are subject to SEC regulation, which Weiss is not.
  • Are the letter of credit amounts set too high? For example, RDOF recipients must have a letter of credit to cover all future RDOF subsidies. Should this be reduced to a letter of credit to only guarantee the current year RDOF subsidy? Should ISPs be able to lower the amount of the letter of credit as the project in constructed?

Most ISPs don’t follow FCC proceedings and rarely file comments. But if you are an RDOF recipient you should tell the FCC your story if letters of credit are harming your business. The FCC has opened the door to hear alternate ideas, so this is the chance to be heard.

Will Small ISPs Pursue BEAD?

In a recent article in FierceTelecom, U.S. Commerce Secretary Gina Raimondo was quoted as urging small ISPs to participate in the upcoming BEAD grants. She was quoted in the article in a speech made to small ISPs saying, “We want you to apply. We need you to apply. We will work with you and hold your hand so that you can apply. The message is: Prepare to compete and win. You can win.” She went on to say that small ISPs are the only ones who will likely be interested in serving some of the most remote places in the country.

I was honestly floored by these quotes. I’ve been working with broadband grant programs for decades, and the requirements for BEAD are massively over the top compared to other broadband grant programs. Raimondo is quoted as saying that the grant requirements have been crafted to “protect taxpayers.” The first day I read the legislation I knew that small ISPs would have huge problems making these grants work.

I’ve been hoping that State Broadband Offices would soften the harsh requirements that were suggested or mandated by NTIA. Unfortunately, most State Broadband Offices did just the opposite and doubled down and made it even harder to justify pursuing a BEAD grant. As an example, the legislation offered that BEAD grants could fund as much as 75% of the cost of building a rural project. However, most state grant scoring rules are pushing that number a lot lower. There are states that only give worthwhile grant points to somebody taking a 35% or 40% grant. It’s not hard to understand the reason for this. A lot this comes from pressure from the NTIA to make sure that the BEAD money can be spread around enough to serve all unserved locations. But all of the policy folks don’t seem to understand the basic financial fundamentals of serving broadband in rural areas. This one issue alone is making it impossible for many ISPs to even contemplate a BEAD grant.

But it doesn’t end there. The requirement to have an irrevocable letter of credit that feels like punishment to small ISPs. I have one client that would struggle to somehow come up with $3 million needed for the BEAD matching requirement. The letter of credit adds over $1 million in additional investment for this small ISP – and that breaks the financial model. The folks who made this requirement don’t seem to realize that a lot of small ISPs could never qualify for a letter of credit of this magnitude.

The most expensive requirement might be the requirement to pay prevailing wages that are being required by many states. In all of the business plans we’ve examined, this requirement increases the cost of building a network by 15% to 20% (which then also inflates the matching and the letter of credit).

I understand the federal goal of the NTIA to protect the public, but are they really protecting the public when the grant rules favor huge companies over small ones? It was clear from the first day of the process that NTIA is more worried about not having any BEAD failures than it is about having wide participation by ISPs – you can’t have both. The funny thing is that the three items listed above have added so much cost to building a BEAD-funded network that the chance of an ISP failing is far higher than it would have been without these requirements. Networks that cost too much to build are going to be at risk in future years when ISPs realize that it was a mistake to take the grants.

In addition to the high costs that come from the NTIA being super-cautious, the paperwork process for reporting on the grants is also way over-the-top. A lot of ISPs who take this money are going to regret it when they see the volume and frequency of reports that are going to be due for years after taking the money.

On top of all of this, the grant maps are a mess in many places due to the decision to allow licensed fixed wireless ISPs to claim a monopoly for rural locations simply by reporting a speed of 100/20 Mbps to the FCC. It’s virtually impossible to dispute this kind of claim in areas where the WISPs don’t have many active customers. The FCC BEAD map in many rural areas is a jumbled mix of served, underserved, and unserved households in the same rural neighborhoods. It’s almost impossible to make a workable business plan out of the mess that has been created by the FCC maps along with the residual mess created by RDOF.

There are going to be small ISPs who will brave BEAD and win grants. But a lot of ISPs cannot tackle BEAD even if they wanted to. Their balance sheets are not iron-clad enough, and they don’t have the borrowing power for the matching and letter of credit. Many can’t find a coherent service area due to the mess created by the maps.

I had to laugh at the “we will hold your hand” quote. Is the NTIA going to go to the bank with a small ISP to convince the banker that they should take a chance on lending a lot of money to a small company? There is only one way that the NTIA could increase participation in BEAD – and it’s something that other grant programs have done. If NTIA wants small company participation, it could give State Broadband Offices the ability to waive the harshest rules for smaller ISPs. I’m pretty certain that is not being discussed.

NTIA Modifies the Letter of Credit Requirements

For the first time in the BEAD process, the NTIA has bent to outside pressure and modified one of the grant rules. I almost labeled this blog as “NTIA Relaxes Letter of Credit Requirement,” but I still need to do more digging before I’m convinced that this makes a difference for smaller ISPs compared to the previous rules.

The specific modified  rules can be found here. Following is a summary of each change, shown in italics, followed by some of my continuing concerns.

A BEAD grant bidder can now obtain its Letter of Credit from a credit union that is insured by the National Credit Union Administration and has a credit union safety rating issued by Weiss of B- or better.

I am not sure of the genesis of this idea, but this opens the door to more financial institutions that can provide the Letter of Credit. There must be some subset of potential grant applicants that asked for this. A lot of the BEAD projects are going to be large, and I have to wonder how many credit unions will be willing to tie up cash reserves of many millions of dollars for a Letter of Credit. Financial institutions must keep any cash pledged to a Letter of Credit in reserve, meaning that money can’t be used to make other loans. That’s why the interest rate and the cost of a Letter of Credit are substantial – because money pledged to a Letter of Credit can’t be used to make other loans.

A grant bidder will not have to provide a bankruptcy opinion letter if they obtain a performance bond for 100% of the awarded grant amount.

One of the big gotchas for using a Letter of Credit is that a grant applicant must also obtain a legal opinion that the Letter of Credit will not be considered to be property if the grant applicant undergoes bankruptcy. That’s a hard legal opinion to obtain since bankruptcy courts tend to snag every asset with any perceived value. This is not a meaningless provision since large ISPs like Charter, Frontier, and Windstream have gone through bankruptcy.

The more important change is that a grant applicant can substitute a performance bond for a letter of credit. However, the performance bond is for the amount of the award. In the typical BEAD grant, the performance bond would have to cover the 75% grant, while the Letter of Credit covers only the 25% grant matching. I’m going to have to do some checking, but a performance bond that covers a larger dollar amount might not be much cheaper than a Letter of Credit that covers only the matching.

Additionally, a grant applicant must have proof of the performance bond before applying for the grant. This ignores the way that companies that give a performance bond operate. I have never worked with one who would give a bond for a theoretical project – only for an actual shovel-ready project that already has the funding and subcontractors under contract. It might be extremely difficult or impossible to get a performance bond for a theoretical grant project that might never come to fruition, or that might be materially different than what was contemplated when the performance bond was created.

A grant winner will be able to ratchet down the letter of credit as they meet specified buildout milestones. A grant winner using a performance bond will have the same option to reduce the size of the bond for meeting specific buildout requirements.

This sounds great in that the Letter of Credit or the performance bond can be reduced in size as the project gets constructed. However, this ignores the way that financial institutions work. Changing a Letter of Credit will likely be treated by a bank as a whole new transaction. They are going to do a complete new review of the borrower and the project and will charge a significant fee to make this change – much like having to undergo a credit check, pay for a new inspection, and pay points when you refinance a home loan. I’ve never been part of a project that reduced the amount of a performance bond, but I have to imagine the process is similar.

It is good to see the NTIA willing to make changes. They have been hounded by a wide range of industry folks and politicians to make changes to the Letter of Credit. Unfortunately, the change that was really needed was to get rid of the Letter of Credit requirement since it strongly favors big ISPs over small ones. I don’t want to sound skeptical, but I still see red flags in the practical application of the new rules that will be expensive and perhaps impossible for anybody but giant ISPs to meet. This feels more like a band-aid than a fix.

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.