Does the Farm Bill Kill USDA Loans?

Today I feel like the Grinch, because I see the broadband provisions in the Farm Bill largely killing the USDA loan program and I don’t see anybody else writing about it. I’ve seen dozens of articles praising the new broadband programs created last week by the passage of the Farm Bill. To be fair, three of the announced programs are good news. The legislation created the following outright grants that, while small, are going to bring some solutions for rural broadband. The bill funds these three programs through 2023:

  • Funds the Community Connect grants at $50 million annually. These grants have been around for many years and distribute grants based upon an economic test, with grants intended for the poorest areas getting preference;
  • $10 million annually in a new program to fund middle mile fiber in rural areas;
  • $10 million annually for the grant program that was formerly called the “Rural Gigabit Network Pilot Program” but which has been relabeled as the “Innovative Broadband Advancement Program”. These grants are to be awarded to programs that demonstrate innovative technologies or methods of broadband deployment.

I’ve seen estimates that it might take as much as $60 billion in federal assistance to bring broadband everywhere in rural America and these three grants are barely a blip against the huge rural broadband shortfall – but they are better than nothing.

The flagship broadband announcement in the Farm Bill is the announcement that $350 million a per year will be given the existing USDA loan program, and that the loan awards can now also contain some portion of broadband grants, which might make it easier to build in high-cost areas.

But there is one killer provision of that new funding which I think might make it almost impossible to use. Any area receiving this funding can’t have more than 10% of households that can receive 10/1 Mbps broadband. That’s the same speed test that is being applied to the $600 million e-Connectivity grant program that I discussed in yesterday’s blog. This is a drastic change for USDA loans that currently can be awarded for areas where up to 85% of households can already get 10/1 Mbps broadband. Congress has decided to provide federal funding in the future only for those areas that have no broadband rather than spending money to upgrade inadequate broadband.

If the USDA strictly applies this 10% test I think it will become nearly impossible to get a USDA broadband loan starting in 2019. The 10% test will work for the e-Connectivity grants because ISPs can request funding for small pockets of homes that meet the 10% test. Companies that use the e-Connectivity grants to fund unserved homes can still use other funds to build the rest of a rural area.

But outright USDA loans don’t work that way. Anybody getting one of these loans has to pledge 100% of their company’s assets to the USDA and also give the USDA first lien over all other debt. Since other lenders won’t accept a second lien, then anybody going after a future loan from the program will have to get 100% of the funding from the USDA. And that’s where the 10% test will kill the loan program. There are very few places that still meet the 10% test – at least on paper. The big telcos are going to be claiming good DSL throughout rural America and in most places the big telco DSL is just good enough to cover more than 10% of homes in an area.

I’ve seen this legislation touted as a boon to rural electric cooperatives since many of them are considering building fiber to cover their whole service area. I would venture to say that there is no electric coop in the country that will pass the 10% test for their whole service area – and most of them don’t come even close.

An electric coop won’t be able to use the USDA money to build fiber everywhere – if they carve out USDA money to cover the areas that pass the 10% test, then nobody will loan them the money to build the rest. The 100% pledge and lien provisions of the USDA don’t allow for a secondary lender.

Huge swaths of rural America are now theoretically covered by the various CAF II programs, so those areas either now have 10/1 Mbps or are supposed to get it sometime over the next six years from the reverse auction awards. I believe all areas covered by CAF will be considered ineligible for these USDA loans.

I went back and read the law several times because I saw articles that got the facts of the new loan program wrong. The specific rules for the new programs can be found in the latest copy of the Farm bill, starting at Section 6101.

It’s obvious that the big telcos have gotten to the legislators who are writing this legislation. It looks like the 10% and 10/1 test will be the new norm for getting federal broadband funding. As each year goes by fewer and fewer places will qualify for this funding and monies will go unclaimed. Meanwhile, areas that have really crappy broadband, but where more than 10% of homes have fully inadequate 10/1 Mbps speeds will not be eligible for this funding. I saw articles where members of Congress are claiming that this bill will help to solve the rural broadband problem – but the actual provisions of the new USDA loan program tell a different story. This feels more like a sham than a plan to me.

Please see the attached comment that softens these comments. Turns out that 100 USDA loans in the future won’t have to pass the 10% test – that applies if an applicants wants any grant funding.

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.

The New e-Connectivity Pilot Grants

In March Congress passed a new $600 million grant/loan program to build rural broadband. The project has been labeled as the e-Connectivity Pilot and it’s expected that the specific rules for seeking the funding will be released early on 2019. The USDA sought public comments on the program in September and is now working out the details of how the awards will be made.

Anybody interested in these grants should get serious about it now, since it’s likely that the grant application window might not be any longer than 60 to 90 days. Getting ready means having a detailed and solid business plan as well as already having a source of funding for any parts of a project not covered by these grants. The grants are also likely to include provisions like getting a professional engineer to approve the network design – so designs need to be specific and not generic. It’s likely that the USDA will stick with their existing grant application process – and those forms have always been a bear to complete.

There is one huge hurdle to overcome for this program since an application can’t cover an area that has more than 10% of households with access to broadband speeds of at least 10/1 Mbps. Considering that the CAF II awards and more recent CAF II reverse auctions awards already will supposedly provide this kind of speed to huge swaths of the country, there are not a lot of areas left that will meet this requirement.

Claiming that an area meets the 90% unserved threshold will be also be difficult because grant applications can be challenged by carriers that serves the grant area today. I have to assume that CAF II reverse auction winners will also be able to challenge. The big rub is that the original CAF II award winners still have until 2020 to complete their build-out and they will certainly challenge awards for any CAF II area that has not yet been updated. The CAF II reverse auction winners have ten more years to complete their buildout. The USDA will likely be obligated to reject an application that encroaches on any of the CAF II footprint – even if those areas don’t have broadband today.

This gets even more complicated since the CAF II reverse auction awarded funding to fixed wireless and satellite providers. They were funded to serve specific little pockets of unserved homes, but it won’t be hard for them to claim that the CAF II award dollars will allow them to serve much larger areas than the tiny boundaries they bid on.

The process of proving a study area isn’t served will be further complicated by the USDA’s reliance on the FCC’s broadband maps, which we all know to be highly inaccurate in rural America. This all adds up to mean that an applicant needs to prove the area doesn’t have broadband today and will not be getting it over the next decade from one of the CAF winners. They will also need to overcome any errors in the FCC maps. This is going to be hard to prove. I expect the challenge process to be brutal.

From the instant I saw the 90% unserved test, I’ve assumed that the most likely candidates for these grants will be somebody that is already planning on building broadband across a large footprint. If such an applicant is careful to only identify the scattered homes that meet these grant rules, then this funding can help to pay for a project they were going to build anyway. The other natural set of applicants might be those companies that already took CAF II funding – they could use these grants to fill in unserved homes around those build-out areas. The industry is going to be in an uproar if a lot of this funding goes to the big incumbent telcos (who won’t challenge their own applications).

Another issue to consider is that the USDA can award funding as a combination of grants and loans. These awards will surely require matching funding from an applicant. Anybody that is already planning on funding that matching with bank or other financing might find it impossible to accept USDA loans for a portion of a project. USDA loan covenants are draconian – for example, USDA loans usually require first priority for a default, which will conflict with commercial lenders. It’s always been nearly impossible to marry USDA debt with other debt.

rant applicants should also be aware that the USDA is going to be highly leery of awarding money to start-ups or somebody that is not already an ISP. The agency got burned on such grants awarded with the stimulus grants and has indicated that they are looking for grant award winners to have a strong balance sheet and a track record of being an ISP. This will make it nearly impossible for local governments to go after the money on their own. Chances of winning will be greatly enhanced by public/private partnerships with an existing ISP.

I know my take on the grants sound highly pessimistic. Congress saddled these grants with the 90% unserved test at the coaxing of the big telcos who wanted to make sure these funds weren’t used to compete against them. Past USDA grants had the opposite requirement and could consider awards to areas that didn’t have more than 10% of houses with broadband. However, if you are able to identify a service area that can survive the challenge process, and if you have the matching funded lined up, these grants can provide some nice funding. I’m not taking any bets, though, on the USDA’s ability to award all of the money – there might not be enough grant applications that can make it through the gauntlet.

Using USDA’s New $600 Million

Earlier this year Congress passed an Omnibus Budget bill that okayed the US budget until this September. Buried in that bill was $600 million for rural broadband expansion, to be administered by the USDA. The USDA has dressed this up as an ‘E-Connectivity pilot program’ and is asking current borrowers and others for feedback on how to use the money. Comments are due to them by September 10.

This new program will be allowed to supply grants for up to 85% of the cost of building in an area. That might create a viable business case in rural areas if the loan recipient only has to come up with 15% matching funds.

However, Congress made it challenging for the USDA to use the money. Normal USDA programs broadband loans can be used to cover areas where as few as 15% of the homes in the coverage area don’t have access today to 10/1 Mbps broadband. It looks like big ISP lobbyists got to the author of the bill and this new $600 million flips that around and can only be used in areas where 90% of homes don’t have access to 10/1 Mbps.

That’s a difficult hurdle to overcome for a number of reasons. First, the big cellular companies report widespread coverage of cellular broadband that meets that threshold. Many such areas don’t really have that speed, and in many cases can’t even get a cell signal, but the presumption will be that such areas can get broadband. Second, the big telcos are supposedly busy implementing the CAF II program which will bring 10/1 Mbps speeds to millions of rural homes. Those homes will be counted as having sufficient broadband.

The CAF II reverse auction is underway and it’s going to fund building in the most remote places that were not covered by the CAF II program. Most of the reverse auction census blocks will not pass the 90% no-broadband test.

In most places in the country it’s going to be challenging to draw a contiguous study area that meets the 90% test. It doesn’t take too many homes with good cellular broadband or with a CAF II upgrade to fail the eligibility test. I’m sure such areas exist, but almost by definition somebody is going to have to ask for funding for small pockets of homes, or else jerry-rig a service footprint to try to meet the 90% test.

I have a hard time even seeing the big incumbent telcos meeting the 90% test in many places. There might be small telcos that didn’t accept ACAM money that might still have such pockets – but most small telcos upgraded to speeds greater than 10.1 Mbps many years ago.

The USDA is asking for the following feedback:

  • How to evaluate if rural homes have sufficient access to 10/1 Mbps speeds today. I think this gets at the heart of the FCC databases where homes are incorrectly shown to have broadband availability.
  • How to consider affordability and pricing.
  • How to demonstrate the benefits of projects using publicly available data.

The USDA didn’t ask about the speeds that must be provided to customers and I’d be surprised if they exceed the 10/1 Mbps speeds required by CAF II.

It’s possible I’m being pessimistic. It’s possible that this funding will make sense for building to small pockets of rural homes that meet the 90% no-broadband test. Perhaps the right strategy for an applicant is to apply for the funds for small clusters of ten or twenty homes – although that makes it hard to justify the overwhelming paperwork that must accompany a federal funding request.

Anybody that knows of areas that will meet this test ought to consider asking for the funds. I imagine the USDA will issue the rules near the end of this year. Getting what is effectively an 85% grant sounds attractive – but anybody who has asked for federal funding knows there will be nothing easy about the application process.

Taking Federal Broadband Funding

USDAThe USDA recently announced a new round of loan financing for the Rural Broadband Loan and Loan Guarantee Program as authorized by the 2014 Farm Bill. The loans are administered by the Rural Utility Service (RUS), a part of USDA.

The loans are available to bring or improve broadband in areas where at least 15% of the households do not have broadband today. The loans can be used to build technologies that are as slow as the old FCC definition of broadband – 4 Mbps download and 1 Mbps upload, although the RUS will strongly encourage building technology capable of meeting the new broadband definition of 25 Mbps down and 3 Mbps up. The projects can range between $100,000 and $20 million.

Over the years I have helped numerous clients acquire these loans, but I have seen more and more reluctance to use them in recent years for a variety of reasons. Following are some of the issues my various clients have with this loan program:

Slow Response Time. I don’t know what the current backlog is, but there have been times over the last five years when a loan application might wait 18 months or more for a decision from the RUS. Those kinds of wait times might have been acceptable back in the days of all-regulated telephony, when companies worked slowly on five and ten year capital plans. But the world has gotten more competitive for everybody and nobody is willing to wait that long for a yes or no answer on a major capital program.

Paperwork. The loans take a lot of paperwork. The application itself is like writing a book and my firm has historically charged up to $20k for writing one of these applications – it’s that much work. And the paperwork doesn’t stop with the application. Once you’ve taken the loan there is major annual compliance paperwork that can overwhelm the staff of smaller borrowers.

Engineering. The loan applications for larger projects must be signed by a professional engineer, and this means that projects must be nearly fully engineered just to apply for funding. That differs from the rest of the industry where projects typically are done with ‘pre-engineering,’ which means that an engineer has made a very good estimate of the cost of the project, and in my experience those pre-engineered estimates are usually pretty reliable.

Extra Costs. Sometimes the loans require extra steps that are not required for other financing. For example, I’ve seen federally-funded loans require an expensive environmental study. Nobody else ever does this because fiber is almost always built into existing public rights-of-way, which by definition have already been cleared for these purposes. Depending on the size of the loan there can also be some kind of customer survey required.

Mostly Still for Regulated LECs. Most of the loans still go to regulated telephone companies for a variety of reasons. For instance, the projects usually require 10% to 20% equity from the borrower and also first lien against the assets built with the loan. These requirements have largely stopped government entities from using these loans. Another issue that these loans entail is that they have loan covenants that can be burdensome. As an example, there might be limits on dividends that can be paid to company owners while one of these loans is outstanding.

Rates are Not that Attractive. There have been times in the past when the RUS interest rates were significantly lower than commercial bank rates and thus were very attractive. But with today’s low interest rates there is currently not a lot of difference between the government rates and commercial rates. By the time you factor in all of the extra costs of applying for and complying with these loans, the RUS loans might be more expensive.

At times in recent years the RUS has built up billions of uncommitted funds because not enough borrowers have been interested in the money. Over the last decade I have helped more clients refinance RUS loans with other lenders than I have helped people get new RUS loans. I’ve read other articles that say that the RUS is too conservative. That may or may not be true, because for the carriers I know it’s generally one or more of the above factors that have turned them off government money.

I don’t want to sound like I am trashing the program, because RUS loans have helped to fund many worthwhile projects. But a lender needs to weigh all of their options and consider all of the costs of borrowing money from different sources. Borrowing money is about a whole lot more than just the interest rate and you need to take all of the other aspects of any loan into consideration.