This is the accessible text file for GAO report number GAO-04-647 
entitled 'Rural Utilities Service: Opportunities to Better Target 
Assistance to Rural Areas and Avoid Unnecessary Financial Risk' which 
was released on July 06, 2004.

This text file was formatted by the U.S. General Accounting Office 
(GAO) to be accessible to users with visual impairments, as part of a 
longer term project to improve GAO products' accessibility. Every 
attempt has been made to maintain the structural and data integrity of 
the original printed product. Accessibility features, such as text 
descriptions of tables, consecutively numbered footnotes placed at the 
end of the file, and the text of agency comment letters, are provided 
but may not exactly duplicate the presentation or format of the printed 
version. The portable document format (PDF) file is an exact electronic 
replica of the printed version. We welcome your feedback. Please E-mail 
your comments regarding the contents or accessibility features of this 
document to Webmaster@gao.gov.

This is a work of the U.S. government and is not subject to copyright 
protection in the United States. It may be reproduced and distributed 
in its entirety without further permission from GAO. Because this work 
may contain copyrighted images or other material, permission from the 
copyright holder may be necessary if you wish to reproduce this 
material separately.

Report to the Chairman, Subcommittee on Energy Policy, Natural 
Resources and Regulatory Affairs, Committee on Government Reform, House 
of Representatives:

United States General Accounting Office:

GAO:

June 2004:

Rural Utilities Service:

Opportunities to Better Target Assistance to Rural Areas and Avoid 
Unnecessary Financial Risk:

GAO-04-647:

GAO Highlights:

Highlights of GAO-04-647, a report to the Chairman, Subcommittee on 
Energy Policy, Natural Resources and Regulatory Affairs, House 
Committee on Government Reform 

Why GAO Did This Study:

The Agriculture Department’s Rural Utilities Service (RUS) makes loans 
and provides loan guarantees to improve electric service to rural 
areas. Beyond guaranteeing loans, under a yet-to-be-implemented 
provision of the 2002 Farm Bill, RUS is also to guarantee the bonds 
and notes that lenders use to raise funds for making loans for 
electric and telecommunications services. Fees on these latter 
guarantees are to be used for funding rural economic development loans 
and grants. GAO was asked to examine (1) the extent to which RUS’ 
borrowers provide electricity service to nonrural areas and (2) the 
potential financial risk to taxpayers and amount of loans and grants 
that the guarantee fees will fund. GAO also identified an alternative 
for funding rural economic development.

What GAO Found:

While the Rural Electrification Act authorizes RUS’ lending only in 
rural areas, borrowers that receive RUS loans and loan guarantees serve 
not only rural areas but also highly populated metropolitan areas. This 
condition stems from RUS’ loan approval practices. RUS requires that 
borrowers serve rural areas when they apply for their first loans, but 
it approves subsequent loans without applying this criterion. Thus, RUS 
applies a “once a borrower, always a borrower” standard. Since the 
1930s when the program began, substantial population growth has 
occurred in areas served by many RUS borrowers; 187 of the counties in 
which RUS borrowers provide service are in metropolitan areas with 
populations of 1 million or more. For example, three borrowers that 
received over $400 million in loans in fiscal years 1999 through 2003 
distribute electricity in the immediate vicinity of Atlanta, Georgia. 
In contrast, about 24 percent of the counties served by RUS borrowers 
are completely rural, while the remainder have a mix of rural and urban 
populations.

RUS estimates, in a worst-case scenario, that the requirement to 
guarantee lenders’ debt could lead to taxpayer losses of $1.5 billion—
and GAO estimated that in return for this risk, fees on the guarantees 
would add about $15 million per year in rural economic development 
loans and grants. RUS officials believe that while risks are involved, 
losses are unlikely given the past stability of both the electricity 
market and the lender that might receive the guarantees. Only one 
lender is both qualified and interested in obtaining these guarantees. 
According to financial rating services, that lender is well-regarded, 
but worked through financial concerns in 2002 and 2003, and faces 
longer-term risks associated with the changes taking place in the 
electricity and telecommunications markets that it serves. Recognizing 
the risks of guaranteeing this lender’s debt, RUS proposed certain risk 
mitigation requirements, such as a reserve against losses. However, the 
lender’s officials have stated that RUS’ proposed requirements would 
make the program unattractive.

GAO identified an alternative with no additional taxpayer risk to add 
funds for rural economic development loans and grants. If RUS were 
authorized to charge borrowers a small loan-origination fee of one-
fourth of 1 percent on loans it expects to make and guarantee in fiscal 
year 2005, $24 million in rural economic development loans and grants 
might be made available. This amount is almost equal to the level 
provided by USDA’s 2005 budget request for rural economic development 
loans and grants, and would likely have a minimal cost impact on 
customers of distribution borrowers. This alternative would not include 
guarantees of lenders’ debt. Furthermore, the lender expected to use 
the guarantees has indicated that, even without such guarantees, it 
expects to continue being very successful at accessing capital for 
lending.

What GAO Recommends:

To better target RUS’ lending, Congress may wish to consider specifying 
that the rural area criterion apply to subsequent loans. To provide 
added funding for rural economic development while avoiding risk, 
Congress may wish to consider adding a small fee on electricity and 
telecommunication loans, and repealing the debt guarantee provision. 
USDA said that Congress has been aware of its lending practices but has 
not changed them, and that its budget proposes borrowers recertify they 
serve rural areas; it did not comment on GAO’s rural development 
funding suggestions.

www.gao.gov/cgi-bin/getrpt?GAO-04-647.

To view the full product, including the scope and methodology, click on 
the link above. For more information, contact Larry Dyckman, 
202-512-3841, dyckmanl@gao.gov.

[End of section]

Contents:

Letter:

Results in Brief:

Background:

RUS' Electricity Loans Are Often Made to Distribution Borrowers Serving 
Highly Populated Metropolitan Areas:

Taxpayers Face Risk of Losses in Return for Loans and Grants Estimated 
at about $15 Million Annually:

Alternative for Funding Loans and Grants without Additional Taxpayer 
Risk:

Conclusions:

Matters for Congressional Consideration:

Agency Comments and Our Evaluation:

Appendix I: Objectives, Scope, and Methodology:

Appendix II: Customers and Examples of Urban Counties Served by RUS 
Borrowers:

Appendix III: Comments from the U.S. Department of Agriculture:

GAO Comments:

Appendix IV: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Acknowledgments:

Tables:

Table 1: Electricity Loans Made or Guaranteed by RUS to Distribution 
and Power Supply Borrowers, Fiscal Years 1999-2003:

Table 2: Rural-Urban Classification of Counties in the United States 
and Those Served by Electric Distribution Borrowers That Received RUS 
Direct or Guaranteed Loans, October 1, 1998, to September 30, 2003:

Table 3: Direct and Guaranteed Electricity Loans Made to Distribution 
Borrowers from Fiscal Years 1999 through 2003, by Range of Residential 
Customers Served:

Table 4: Population Profile of 12 Counties That Are Entirely or 
Predominantly Served by Electric Cooperatives That Received RUS 
Electricity Loans between Fiscal Years 1999 and 2003:

Abbreviations:

CFC: National Rural Utilities Cooperative Finance Corporation: 
GAO: General Accounting Office: 
RE Act: Rural Electrification Act of 1936, as amended: 
RUS: Rural Utilities Service: 
USDA: U.S. Department of Agriculture: 
2002 Farm Bill: Farm Security and Rural Investment Act of 2002:

United States General Accounting Office:

Washington, DC 20548:

June 18, 2004:

The Honorable Doug Ose: 
Chairman, Subcommittee on Energy Policy, Natural Resources and 
Regulatory Affairs: 
Committee on Government Reform: 
House of Representatives:

Dear Mr. Chairman:

The U.S. Department of Agriculture's (USDA) Rural Utilities Service 
(RUS) has rapidly increased its lending for electricity service 
projects in recent years. In fiscal year 1999, RUS made loans and 
provided guarantees on loans made by other lenders totaling $1.6 
billion, while in fiscal year 2003, RUS made and guaranteed more than 
twice that amount--about $4 billion. Overall, during fiscal years 1999 
through 2003, RUS made or guaranteed $14.3 billion in loans for 
electricity service.

Under the Rural Electrification Act of 1936, as amended (the RE Act), 
RUS is authorized to make and guarantee such loans to furnish and 
improve electric service in rural areas.[Footnote 1] For electricity 
purposes, the act states that an area is rural if it is not part of 
areas that the Bureau of the Census defines as urban--that is, densely 
populated areas having 2,500 or more inhabitants.[Footnote 2] RUS 
requires borrowers to establish that they serve rural areas when they 
apply for their first loan. However, RUS' regulations and long-standing 
practice allow borrowers to receive subsequent loans without having to 
meet this test.[Footnote 3] Thus, RUS applies a "once a borrower, 
always a borrower" standard.

Borrowers that receive RUS loans or guarantees on loans for electricity 
service projects are primarily nonprofit cooperatives. Most of these 
borrowers are "distribution borrowers" that use the loans to construct 
and maintain the facilities that provide electricity to users; such 
borrowers received $9 billion of the $14.3 billion in loans during the 
period we examined. RUS also provides guarantees on loans to "power 
supply borrowers," which received the remainder of the $14.3 billion to 
finance the construction of electricity generation and transmission 
facilities.

The Farm Security and Rural Investment Act of 2002--commonly referred 
to as the 2002 Farm Bill--provides RUS with a new program 
responsibility that would increase funds for rural economic development 
loans and grants.[Footnote 4] It directs RUS to guarantee payments on 
bonds or notes issued by cooperative or other nonprofit lenders, under 
certain conditions, if the proceeds of the guaranteed bonds or notes 
are used to make loans for the electricity or telecommunications 
purposes of the RE Act, which can include refinancing, but not 
electricity generation. A lender that receives such a guarantee would 
pay an annual fee of three-tenths of 1 percent on the outstanding 
guaranteed principal. These fees are to be used to fund rural economic 
development zero-interest loans and grants that are available from 
USDA's Rural Business-Cooperative Service, as well as to cover the 
subsidy costs of the guarantees. The Rural Business-Cooperative Service 
provides rural economic development loans and grants for financing 
economic development and job creation projects in rural areas, such as 
new business start-ups, existing business expansions, and community 
improvement projects. RUS has issued proposed regulations on the 
program and, as of mid-June 2004, was awaiting the completion of the 
Office of Management and Budget's review of the proposed final 
regulations for this program.

As we have previously reported, the federal government has had a long 
and successful role in contributing to the development of the utility 
infrastructure in the nation's rural areas. In the mid-1930s, when 
federal assistance for rural utilities began, most utilities served 
high-density areas and their service lines did not extend to farmers 
and other rural residents. This, however, is no longer the case, and we 
found that RUS lending practices can often result in loans to borrowers 
serving heavily populated areas, and to borrowers capable of using 
their own resources or of obtaining private sector loans to fund their 
utility projects. To address these conditions, we presented options to 
Congress for better targeting RUS' lending to rural areas and making 
its loan programs more effective and less costly.[Footnote 5]

In this context, you asked us to examine (1) the extent to which RUS 
distribution borrowers provide electricity service to nonrural areas 
and (2) the potential financial risk to taxpayers of the 2002 Farm Bill 
requirement to guarantee lenders' debts, and the amount of rural 
economic development loans and grants that could be funded by fees on 
the guarantees. In addition, we reviewed the RE Act to determine 
whether there might be an alternative way to provide funds for rural 
economic development loans and grants with less risk. In the course of 
our work, we reviewed the RE Act and RUS' implementation policies, 
financial reports on RUS loans for fiscal years 1999 through 2003, and 
data on counties and metropolitan areas that the borrowers serve. We 
used counties served by the distribution borrowers as an indicator of 
areas being served by those borrowers that obtain RUS electricity 
loans. We also reviewed the relevant portion of the 2002 Farm Bill, the 
legislative record, and RUS' proposed program regulations and economic 
analysis of guaranteeing lenders' debt. We conducted our work from 
October 2003 to June 2004 in accordance with generally accepted 
government auditing standards. Appendix I describes the scope and 
methodology of our review in more detail.

Results in Brief:

While the RE Act authorizes RUS to make loans to assist in the 
development of electric infrastructure only in rural areas, RUS 
borrowers serve not only rural areas but also highly populated 
metropolitan areas. This disparity between the act's requirement to 
serve rural areas and its implementation results from RUS applying its 
"once a borrower, always a borrower" standard, which allows borrowers 
to continuously receive RUS assistance regardless of the extent of 
population growth within their service territories. When we analyzed 
the areas served by the 530 distribution borrowers that received RUS 
loans or guarantees on loans over the 5 years of our analysis, we found 
that 24 percent, or 485 of the 1,988 counties served by these 
borrowers, are classified as being completely rural or having only 
nominal urban populations. In contrast, 29 percent, or 581 of the 
counties, are classified as being in metropolitan areas; and of these, 
187, or 9 percent of the 1,988 counties, are in metropolitan areas with 
populations of 1 million or more. For example, loans were made to 
cooperatives that provide electricity in suburban Atlanta, Georgia, and 
in the vicinity of Washington, D.C. Three cooperatives that provide 
service in the immediate vicinity of Atlanta received a total of more 
than $400 million in loans during this period, and one borrower in the 
Washington, D.C., area received over $25 million in loans.

The 2002 Farm Bill requirement to guarantee lenders' debts could lead 
in a worst-case scenario to taxpayer losses of $1.5 billion, according 
to RUS' estimate. In return, fees on the guarantees could, we estimate, 
provide only about $15 million annually in rural economic development 
loans and grants. RUS based its estimate of maximum potential losses on 
the assumption that it would guarantee $3 billion and recover at least 
one half of that amount if the lender defaulted. RUS officials believe 
that such losses are unlikely given the past stability of both the 
electricity market and the one current lender that might receive the 
guarantees. That lender is the National Rural Utilities Cooperative 
Finance Corporation (CFC)--a privately owned cooperative lender, which 
is highly rated and has had a favorable loan history going back over 30 
years. However, in 2002 and 2003 three financial rating services 
expressed concerns about certain financial weaknesses in its portfolio. 
These services also noted that CFC faces some investment risks 
associated with the volatility of natural gas prices, competition among 
adjoining electric utility systems, and competition in the 
telecommunications industry. In recognition of the risks of 
guaranteeing lenders' debt, RUS has proposed to add certain risk 
mitigation requirements, such as the establishment of a reserve against 
losses, as conditions for obtaining the guarantees. In response, CFC 
officials stated that CFC does not need the guarantees to secure 
capital and that the proposed requirements would make the guarantees 
unworkable for them.

We identified an alternative way to raise funds for the Rural Business-
Cooperative Service's rural economic development program that avoids 
the additional risks involved in providing guarantees on lenders' debt, 
in the event that the lender debt guarantee requirement is not 
implemented. If RUS started charging borrowers a loan-origination fee 
of, for example, 25 basis points (one-fourth of 1 percent) on loans 
made and guaranteed in fiscal year 2005, there is the potential to fund 
an additional $24 million in rural economic development loans and 
grants. This program level, which is more than the level of loans and 
grants that would result under the new guarantee program, is almost 
equal to the budget level that the Rural Business-Cooperative Service 
requested for 2005. Adopting this alternative would require changing 
the RE Act, which states that RUS is not allowed to charge a loan-
origination fee on its electricity or telecommunications loans. Such a 
fee, which is consistent with fees charged on some other USDA loans, 
would likely have a minimal effect on many of the customers of RUS 
distribution borrowers. RUS officials agreed that this alternative 
would be a feasible way to fund rural economic development loans and 
grants. The alternative would not include guarantees of debt for CFC. 
Moreover, CFC officials said that they have been and expect to continue 
to be very successful at securing capital for lending to rural 
utilities, even without such guarantees.

To better target RUS' lending to borrowers serving rural areas, 
Congress could consider specifying that the criterion defining rural 
areas applies to both initial and subsequent loans. In addition, to 
provide additional funds for rural economic development loans and 
grants without risk to taxpayers, Congress could consider authorizing a 
small loan-origination fee on RUS' electricity and telecommunications 
loans while repealing the provision in the RE Act to guarantee the debt 
of lenders.

In commenting on a draft of this report, USDA did not express agreement 
or disagreement with our matters for congressional consideration. USDA 
stated that Congress has not accepted previous recommendations made by 
us and others to address its practice of lending to borrowers once an 
initial borrowing relationship was established. However, USDA noted 
that the President's budget contains a proposal that borrowers 
recertify they serve rural areas, not urban or suburban areas. We 
believe that this proposal may provide a starting point for improving 
the focus of this program. USDA also said that our report did not 
provide an accurate picture of the extent to which RUS borrowers serve 
consumers who are not in rural areas, and disagreed with our use of the 
Economic Research Service's county classification system in performing 
our analysis. We believe that our analyses provide insights into areas 
being served by RUS borrowers, and that our use of the Economic 
Research Service's classification system is reasonable. Our purpose was 
to describe the characteristics of areas served by RUS electricity 
distribution borrowers, and the Economic Research Service's 
classification system is useful for that purpose. Furthermore, the 
population has increased in many areas served by RUS distribution 
borrowers that originally qualified for loans under the requirement 
that they serve sparsely populated rural areas. Also, during our 
review, RUS officials agreed that many of its borrowers would no longer 
meet the RE Act population test for service to rural areas if that 
criterion were applied.

USDA asked that the report be revised to distinguish between criticism 
of the legislation authorizing the new guarantee program and RUS' 
efforts to implement the program. In our view, our report supports the 
purpose of the legislation and does not criticize RUS' implementation; 
it provides an alternative for funding rural economic development that 
avoids risk. Our report describes the results of RUS' economic analyses 
of the legislation, and states factually that RUS' economic analysis 
did not include a discussion of risks facing CFC in the electricity and 
telecommunications markets. Our report also describes RUS' proposals to 
address the risks involved in guaranteeing lenders' debts.

Background:

In 1935, the Rural Electrification Administration was created by 
executive order to make loans to electrify rural America. RUS was 
established by the Federal Crop Insurance Reform and Department of 
Agriculture Reorganization Act of 1994 to replace this agency and now 
administers the electricity program.[Footnote 6] It is located in 
USDA's Rural Development mission area.[Footnote 7]

RUS' loans for electricity purposes are made primarily to nonprofit 
cooperatives. Cooperatives are organizations owned by their customers 
and operated for the benefit of those using their services. The 
customers elect boards of directors responsible for policy and 
operations. Most RUS-financed utility systems have a two-tiered 
structure covering electricity distribution and power supply. Retail 
customers are members of the distribution cooperative that provides 
electricity directly to their homes and businesses. Most distribution 
cooperatives, in turn, are members of power supply cooperatives, which 
generate and transmit electricity to their members.

Currently, RUS makes three types of direct loans for electricity 
purposes. These direct loans are (1) hardship rate loans with a 5 
percent interest rate made to borrowers that have a relatively high 
cost of providing service, as indicated by a high average revenue per 
kilowatt-hour sold, and that serve customers with below-average income, 
or at the discretion of RUS' Administrator; (2) municipal rate loans 
with an interest rate tied to an index of municipal borrowing rates, 
resulting in interest rates ranging from 1.1 percent to 4.6 percent 
during the first quarter of calendar year 2004; and (3) Treasury rate 
loans with an interest rate matching the government's cost of money, 
which ranged from 1.2 percent to 4.4 percent in mid-March 2004. In 
addition to making direct loans, RUS places a USDA 100 percent 
repayment guarantee on loans made by the Treasury's Federal Financing 
Bank, which makes loans at an interest rate equal to the Treasury's 
cost of money plus one-eighth of 1 percent, as well as on loans made by 
CFC and by CoBank--a member bank of the Farm Credit System, which is a 
government-sponsored enterprise. Most borrowers seeking a loan 
guaranteed by RUS choose to have the loan made by the Federal Financing 
Bank because of lower interest rates than those available from the 
other lenders.

The outstanding principal owed by borrowers with RUS direct and 
guaranteed loans totaled $28.3 billion as of September 30, 2003: $9.5 
billion in direct loans, $15.3 billion in guaranteed loans made by the 
Federal Financing Bank, $0.4 billion in guaranteed loans made by CFC, 
$0.2 billion in guaranteed loans made by CoBank, and $2.9 billion in 
restructured loans.[Footnote 8] During fiscal years 1999 through 2003, 
RUS made or provided guarantees on 936 electricity loans, which totaled 
more than $14.3 billion.[Footnote 9] Table 1 shows the level of loans 
for each type of electricity loan.

Table 1: Electricity Loans Made or Guaranteed by RUS to Distribution 
and Power Supply Borrowers, Fiscal Years 1999-2003:

Dollars in millions.

Loan type: Direct: Hardship rate; 
Total number of loans: 106; 
Total dollar amount of loans: $558.4; 
Average dollar amount of loans: $5.3.

Loan type: Direct: Municipal rate; 
Total number of loans: 175; 
Total dollar amount of loans: $1,485.6; 
Average dollar amount of loans: $8.5.

Loan type: Direct: Treasury rate; 
Total number of loans: 166; 
Total dollar amount of loans: $2,400.0; 
Average dollar amount of loans: $14.5.

Subtotal direct; 
Total number of loans: 447; 
Total dollar amount of loans: $4,444.0; 
Average dollar amount of loans: $9.9.

Loan type: Guaranteed: Made by the Federal Financing Bank; 
Total number of loans: 472; 
Total dollar amount of loans: $9,637.9; 
Average dollar amount of loans: $20.4.

Loan type: Guaranteed: Made by CFC; 
Total number of loans: 17; 
Total dollar amount of loans: $262.1; 
Average dollar amount of loans: $15.4.

Subtotal guaranteed; 
Total number of loans: 489; 
Total dollar amount of loans: $9,900.0; 
Average dollar amount of loans: $20.2.

Total number of loans: 936; 
Total dollar amount of loans: $14,344.0; 
Average dollar amount of loans: $15.3. 

Source: GAO analysis of RUS data.

Note: RUS did not make Treasury rate loans in fiscal years 1999 and 
2000. Also, the agency did not provide guarantees on CFC loans in 
fiscal years 2002 and 2003 or on CoBank loans during this 5-year 
period. Distribution borrowers received 444 direct loans totaling more 
than $4.4 billion and 420 guaranteed loans totaling more than $4.5 
billion. Power supply borrowers received 3 direct loans totaling $21.4 
million and 69 guaranteed loans totaling $5.4 billion.

[End of table]

As we have reported in the past, RUS has had problems with some 
borrowers. During fiscal years 1999 through 2003, RUS wrote off more 
than $3.2 billion on loans to three borrowers--$3 billion and $73.2 
million for two borrowers under bankruptcy liquidation and $159.3 
million for a borrower with unsecured debt. Also, it wrote off $7.2 
million for another borrower that had been restructured.

The Rural Business-Cooperative Service, which like RUS, is in USDA's 
Rural Development mission area, operates loan and grant programs that 
are intended to assist in the business development of the nation's 
rural areas and the employment of rural residents. Among these programs 
is the rural economic development program, which is authorized by 
section 313 of the RE Act, 7 U.S.C. § 940c. Under the program, the 
Rural Business-Cooperative Service makes direct loans to entities that 
have outstanding RUS electricity or telecommunications loans or to 
former RUS borrowers that repaid their electricity loans early at a 
discount. Rural economic development loans are not available to former 
RUS borrowers that repaid their loans with scheduled payments.

All rural economic development loans are made for relending, and the 
loan funds are targeted to specific projects. Rural economic 
development loan funds are deposited into a fund that a RUS borrower 
has established, and the RUS borrower then relends the money to other 
borrowers, which may be any public or private organization or other 
legal entity, for an economic development and job creation project. 
Such projects include new business creation, existing business 
expansion, community improvements, and infrastructure development. 
Rural economic development loan funds, however, cannot be used for 
certain purposes, including the RUS borrowers' electricity or 
telecommunications operations or a community's television system or 
facility, unless tied to an educational or medical project.

The Rural Business-Cooperative Service also provides rural economic 
development grants to RUS utility borrowers to establish revolving loan 
funds to promote economic development in rural areas. The revolving 
loan funds provide capital to nonprofit entities and municipal 
organizations to finance community facilities that promote job creation 
or education and training to enhance a marketable job skill or that 
extend or improve medical care.

An unusual source of funding is available for rural economic 
development loans and grants. The RE Act provides that RUS' electricity 
and telecommunications borrowers can make advance payments on their RUS 
loans, referred to as "cushion-of-credit" payments, and earn interest 
at a rate of 5 percent on the advance payments. The Rural Business-
Cooperative Service is allowed to use the differential between the 
earnings on these advance payments and the 5 percent interest to cover 
the subsidy costs of rural economic development loans and the cost of 
rural economic development grants. During fiscal years 1999 through 
2003, the Rural Business-Cooperative Service made 233 rural economic 
development loans, which totaled $82.5 million. Also, 117 rural 
economic development grants were made, which totaled $24.6 million. On 
average, the loan amounts were about $354,000 and the grant amounts 
were about $211,000. The outstanding principal owed by borrowers with 
rural economic development loans totaled $155.2 million as of September 
30, 2003.

RUS' Electricity Loans Are Often Made to Distribution Borrowers Serving 
Highly Populated Metropolitan Areas:

Although the RE Act requires that borrowers serve rural areas, RUS 
borrowers serve not only rural areas but also highly populated 
metropolitan areas.[Footnote 10] This situation results from RUS 
applying its "once a borrower, always a borrower" standard, which 
allows borrowers to continuously receive RUS assistance regardless of 
the extent of population increases within their service territories. 
Since the electricity program began in the 1930s, substantial 
population growth has occurred in the areas served by many RUS 
borrowers. We analyzed the areas served by the 530 distribution 
borrowers that received RUS loans or guarantees on loans between 
October 1, 1998, and September 30, 2003.[Footnote 11] These borrowers 
serve customers in part or all of 1,988 counties in 46 states, and they 
received 864 RUS loans or guarantees on loans during this period valued 
at almost $9 billion.

Overall, RUS distribution borrowers provide service in more than half 
the counties in the country that are classified as metropolitan. In 
general, these metropolitan areas contain a substantial core 
population, together with adjacent communities having a high degree of 
social and economic integration with the core. About 29 percent, or 581 
of the 1,988 counties served partly or completely by RUS borrowers, are 
in metropolitan areas; and, in fact, 9.4 percent, or 187 of the 1,988 
counties, are in metropolitan areas with populations of 1 million or 
more. The following examples illustrate cooperatives whose service 
territories include highly populated areas.

* Three cooperatives that received loans during the fiscal year 1999 
through 2003 period provide electricity in the immediate vicinity of 
Atlanta, Georgia. These three borrowers received a total of more than 
$400 million of loans during this period.

* A Maryland electric distribution cooperative that serves 
approximately 115,000 residential customers in four counties in the 
vicinity of Washington, D.C., received over $25 million in loans in 
fiscal years 1999 and 2001. Three of these counties are in a 
metropolitan area with a population of more than 1 million people.

* A Florida cooperative that serves roughly 150,000 customers in parts 
of five counties that are located to the north of Tampa received RUS 
loans in fiscal years 2000 and 2002 totaling $66 million. Four of these 
counties have a population of more than 100,000 residents, including 
two with a population of more than 300,000.

On the other hand, about 24 percent, or 485 of the 1,988 counties 
served by RUS borrowers are completely rural or have only nominal urban 
populations. The remaining counties are in nonmetropolitan areas, but 
with urban populations of 2,500 or more.[Footnote 12] Table 2 shows the 
classifications of the counties being served partly or completely 
through RUS electricity loans.

Table 2: Rural-Urban Classification of Counties in the United States 
and Those Served by Electric Distribution Borrowers That Received RUS 
Direct or Guaranteed Loans, October 1, 1998, to September 30, 2003:

Classification categories: Counties in metropolitan (metro) areas: 
Counties in metro areas with population of 1 million or more; 
Counties served by RUS distribution borrowers: Number: 187; 
Counties served by RUS distribution borrowers: Percent of total: 9.4%; 
Counties in the United States: Number: 413; 
Counties in the United States: Percent of total: 13.1%. 

Classification categories: Counties in metropolitan (metro) areas: 
Counties in metro areas with population of 250,000 to 1 million; 
Counties served by RUS distribution borrowers: Number: 177; 
Counties served by RUS distribution borrowers: Percent of total: 8.9%; 
Counties in the United States: Number: 325; 
Counties in the United States: Percent of total: 10.3%. 

Classification categories: Counties in metropolitan (metro) areas: 
Counties in metro areas with population of less than 250,000; 
Counties served by RUS distribution borrowers: Number: 217; 
Counties served by RUS distribution borrowers: Percent of total: 10.9%; 
Counties in the United States: Number: 351; 
Counties in the United States: Percent of total: 11.2%. 

Classification categories: Counties in metropolitan (metro) areas: 
Subtotal; 
Counties served by RUS distribution borrowers: Number: 581; 
Counties served by RUS distribution borrowers: Percent of total: 29.2%; 
Counties in the United States: Number: 1,089; 
Counties in the United States: Percent of total: 34.7%. 

Classification categories: Counties in nonmetropolitan areas with an 
urban population of 2,500 or more: Urban population of 20,000 or more, 
adjacent to a metro area; 
Counties served by RUS distribution borrowers: Number: 139; 
Counties served by RUS distribution borrowers: Percent of total: 7.0%; 
Counties in the United States: Number: 218; 
Counties in the United States: Percent of total: 6.9%. 

Classification categories: Counties in nonmetropolitan areas with an 
urban population of 2,500 or more: Urban population of 20,000 or more, 
not adjacent to a metro area; 
Counties served by RUS distribution borrowers: Number: 55; 
Counties served by RUS distribution borrowers: Percent of total: 2.8%; 
Counties in the United States: Number: 105; 
Counties in the United States: Percent of total: 3.3%. 

Classification categories: Counties in nonmetropolitan areas with an 
urban population of 2,500 or more: Urban population of 2,500 to less 
than 20,000, adjacent to a metro area; 
Counties served by RUS distribution borrowers: Number: 421; 
Counties served by RUS distribution borrowers: Percent of total: 21.2%; 
Counties in the United States: Number: 609; 
Counties in the United States: Percent of total: 19.4%. 

Classification categories: Counties in nonmetropolitan areas with an 
urban population of 2,500 or more: Urban population of 2,500 to less 
than 20,000, not adjacent to a metro area; 
Counties served by RUS distribution borrowers: Number: 307; 
Counties served by RUS distribution borrowers: Percent of total: 15.4%; 
Counties in the United States: Number: 450; 
Counties in the United States: Percent of total: 14.3%. 

Classification categories: Counties in nonmetropolitan areas with an 
urban population of 2,500 or more: Subtotal; 
Counties served by RUS distribution borrowers: Number: 922; 
Counties served by RUS distribution borrowers: Percent of total: 46.4%; 
Counties in the United States: Number: 1,382; 
Counties in the United States: Percent of total: 44.0%. 

Classification categories: Counties in nonmetropolitan areas with an 
urban population of less than 2,500: Completely rural or less than 
2,500 urban population, adjacent to a metro area; 
Counties served by RUS distribution borrowers: Number: 169; 
Counties served by RUS distribution borrowers: Percent of total: 8.5%; 
Counties in the United States: Number: 235; 
Counties in the United States: Percent of total: 7.5%. 

Classification categories: Counties in nonmetropolitan areas with an 
urban population of less than 2,500: Completely rural or less than 
2,500 urban population, not adjacent to a metro area; 
Counties served by RUS distribution borrowers: Number: 316; 
Counties served by RUS distribution borrowers: Percent of total: 15.9%; 
Counties in the United States: Number: 435; 
Counties in the United States: Percent of total: 13.8%. 

Classification categories: Counties in nonmetropolitan areas with an 
urban population of less than 2,500: Subtotal; 
Counties served by RUS distribution borrowers: Number: 485; 
Counties served by RUS distribution borrowers: Percent of total: 24.4%; 
Counties in the United States: Number: 670; 
Counties in the United States: Percent of total: 21.3%. 

Classification categories: Total; 
Counties served by RUS distribution borrowers: Number: 1,988; 
Counties served by RUS distribution borrowers: Percent of total: 
100.0%; 
Counties in the United States: Number: 3,141; 
Counties in the United States: Percent of total: 100.0%. 

Source: GAO analysis of RUS data and USDA's Economic Research Service 
rural-urban classification codes.

[End of table]

RUS officials pointed out that many metropolitan areas contain rural 
sections. In addition, they agreed that its borrowers now provide 
service to a mix of areas including rural areas and heavily populated 
areas, and that many of its borrowers would not meet the population 
criterion of the RE Act if it were applied. RUS officials also told us 
that they had drafted legislation consistent with the President's 
fiscal year 2005 budget, which would require borrowers to recertify 
that they are serving rural areas, rather than urban or suburban areas.

Taxpayers Face Risk of Losses in Return for Loans and Grants Estimated 
at about $15 Million Annually:

RUS estimated that guarantees on lenders' debt under the 2002 Farm Bill 
provision could result in losses of up to $1.5 billion on guarantees of 
$3 billion, although RUS does not expect such losses. RUS officials 
believe that while risks are involved, losses are unlikely given the 
past stability of both the electricity market and the lender that might 
receive the guarantees. In return for taxpayers assuming the risks of 
guaranteeing payment on $3 billion of debt, we estimated that the fees 
paid on the guarantees would only fund $15 million in rural economic 
development loans and grants annually. The one cooperative lender that 
is currently qualified and interested in obtaining a guarantee on its 
debt generally has had a favorable financial history going back over 30 
years. However, the lender faces risk associated with the electricity 
and telecommunications markets. Recognizing risks to taxpayers, RUS 
proposed to add certain risk mitigation requirements, but the lender 
commented that these requirements would make the guarantees unworkable.

Financial Losses Estimated by RUS. Under the debt guarantee program, 
taxpayers would be at risk for the value of guaranteed debts. RUS 
estimated this value at $3 billion in an economic analysis of the 
program.[Footnote 13] The estimate was based on the act specification 
that the full guarantee level is the amount of principal owed on loans 
that eligible lenders had made concurrently with RUS' electricity and 
telecommunications loans. Although taxpayers would be at risk for the 
full amount, RUS estimated that in the event of a default, likely 
maximum losses could be as much as $1.5 billion. This maximum is based 
on the expectation that the government could recover at least one-half 
of defaulted amounts. The $3 billion amount is approximately the amount 
of concurrent loans that RUS has made in conjunction with CFC, the only 
lender currently qualified and interested in participating in the 
program.[Footnote 14] RUS identified CoBank as the only other lender 
that would be eligible for the guarantees.[Footnote 15] However, CoBank 
is part of a government-sponsored enterprise, and CoBank does not need 
the guarantees and does not plan to participate in the program, 
according to CoBank officials.

Although RUS does not believe CFC will default on the guaranteed bonds 
or notes, there would be a subsidy cost, according to Congressional 
Budget Office and RUS officials.[Footnote 16] However, RUS has not 
completed a subsidy cost estimate for the program. In addition, RUS' 
economic analysis did not discuss CFC's financial history, its current 
condition, or the risks in the electricity and telecommunication 
markets in which CFC operates.

Fees on Guarantees Could Provide about $15 Million Annually in Rural 
Economic Development Loans and Grants. We estimated that in return for 
the risk to taxpayers, fees on the guarantees could provide about $15 
million annually of additional loans and grants through the Rural 
Business-Cooperative Service's rural economic development program. Our 
calculation is based on the $3 billion guarantee level RUS identified, 
the details provided in the act about the annual fees that would be 
paid by a lender receiving a guarantee, and the use of the funds 
generated by the fee. The act provides that a lender receiving a RUS 
guarantee would pay an annual fee of 30 basis points (three-tenths of 1 
percent)[Footnote 17] based on the amount of unpaid principal on the 
bonds or notes that are guaranteed, and that at least two-thirds of the 
funds collected are to be used for rural economic development loans and 
grants.[Footnote 18] The other one-third can be used for the cost 
associated with providing guarantees. On the basis of a $3 billion 
guarantee level, 30 basis points would yield fees of $9 million, of 
which $6 million would be available for rural economic development 
loans and grants. Of this, we assumed that $4 million would be used for 
additional grants, which is equal to the amount of grants in the Rural 
Business-Cooperative Service's fiscal year 2004 budget. We assumed the 
remaining $2 million would be used to subsidize additional loans. Based 
on the fiscal year 2004 subsidy rate for the rural economic development 
program of 18.6 percent, a $2 million level would provide about $11 
million in additional rural economic development loans.

Lender That Likely Would Receive Guarantees Has Successful History but 
Faces Some Risks. CFC has had a solid operating record for over 30 
years, a high rating, and CFC officials said that CFC does not require 
federal guarantees on debt to raise capital for lending. While 
recognizing CFC's financial strength, in February 2004, its president 
noted that CFC had possibly faced some of the most difficult times in 
its history. In early 2002, CFC's long-term debt ratings had been 
downgraded by three credit rating services (Moody's Investors Service, 
Fitch Ratings, and Standard & Poor's) and the services also rated CFC 
as having a negative outlook.[Footnote 19] Subsequently, these services 
raised CFC's outlook to stable because CFC had taken various positive 
actions including restructuring $1 billion of loans for its largest 
borrower, which was emerging from bankruptcy; reducing its exposure to 
speculative-grade telecommunications loans; reducing its reliance on 
short-term debt; and increasing its loan loss reserves to $565 
million.[Footnote 20]

Even as the rating services raised CFC's outlook, they cautioned about 
certain risks. For example, one rating service stated that half of 
CFC's 10 largest borrowers exhibit speculative-grade characteristics. 
Each also expressed concern about CFC's concentration in the 
electricity and telecommunications markets. One service cited the 
probability that natural gas prices will be volatile, and another 
stated that cooperatives operating in service territories adjacent to 
lower-cost systems might eventually be forced to compete. While most 
cooperatives have avoided competition, CFC has a fund to help defend 
its member cooperatives against territorial threats. In addition, one 
ratings service stated that competition from wireless carriers is a 
longer-term threat to rural telecommunications systems. CFC officials 
recognized that there are business risks in CFC's loan portfolio that 
they continually address but said they believe the risks of the loan 
guarantee program are very low given CFC's stable financial history, 
its access to capital markets, the restriction preventing lenders from 
using the proceeds of their guaranteed debt to fund electricity 
generation, and the relatively small portion of CFC's overall loan 
portfolio that the guarantee would cover.

In its proposed regulations, RUS included certain risk mitigation 
measures including requirements for a bankruptcy trust, pledges of 
collateral, a 5 percent limit on cash patronage refunds,[Footnote 21] 
and the use of certain standards that apply to depository financial 
institutions. CFC, the National Rural Electric Cooperative Association, 
and others commented that these proposals would make the program 
unworkable, and that the only requirement authorized by the act is that 
the securities of the lender receiving a guarantee be investment grade. 
Also, CFC stated that the ratings of the nationally recognized 
financial ratings services should be sufficient to assure its credit 
quality, and that if its financial rating becomes downgraded below 
investment grade, then that event could reasonably trigger RUS to 
partially limit its distribution of patronage capital. As of mid-June 
2004, RUS officials said they were awaiting the completion of the 
Office of Management and Budget's review of the proposed final 
regulations for the program.

Alternative for Funding Loans and Grants without Additional Taxpayer 
Risk:

We developed an alternative approach that could provide funding for 
rural economic development loans and grants without added risk to 
taxpayers. Specifically, if Congress amended the RE Act to provide for 
RUS to charge a loan-origination fee on its direct and guaranteed 
electricity and telecommunications loans, and repealed the new lender 
debt guarantee requirement, the resulting funds from the loan-
origination fee could be targeted to the rural economic development 
loan and grant program. Doing so would accomplish the stated purpose of 
the debt guarantee program--that is, to provide an alternative funding 
source for the Rural Business-Cooperative Service's rural economic 
development loans and grants--while avoiding additional risk to 
taxpayers.

RUS' fiscal year 2005 budget request is for slightly more than $3.1 
billion in electricity and telecommunications loans, and the Rural 
Business-Cooperative Service's request is for $25 million in rural 
economic development loans and $4 million in grants. At RUS' 2005 
lending level, if RUS started charging a loan-origination fee of 25 
basis points (one-fourth of 1 percent), the fee could result in an 
additional $7.8 million in funds to support rural economic development 
loans and grants, which, we estimate, could amount to an additional 
$20.4 million in loans and $4 million in grants. In effect, such an 
increase would be more than an 80 percent increase in the level of 
rural economic development loans and a doubling in the level of rural 
economic development grants that the Rural Business-Cooperative Service 
proposes making in fiscal year 2005, recognizing that different 
electricity and telecommunications loan levels would result in varying 
amounts of funds.

The appropriate fee level would, in part, be based on amounts that are 
needed to fund rural economic development loans and grants. Since 
enactment of the 2002 Farm Bill, millions of dollars have become 
available for this purpose through interest earnings on the cushion-of-
credit payments on loans by RUS electricity and telecommunications 
borrowers. While the Rural Business-Cooperative Service had $6.9 
million at the start of fiscal year 2002 to cover the subsidy costs of 
rural economic development loans and the cost of grants, by the start 
of fiscal year 2004, the amount had increased to $40.2 million--roughly 
six times the estimated cost for the program in fiscal year 2004.

The impact of a loan-origination fee would likely be relatively minor 
for many of the customers of the distribution borrowers that receive 
RUS' loans. For example, during fiscal year 1999 through 2003, RUS made 
or guaranteed 864 electricity loans to distribution borrowers; 264 
borrowers received one loan and 266 borrowers received more than one 
loan over this period. If a 25 basis point fee had been charged on 
these distribution loans and fully passed on to the borrowers' 
customers, we estimate that the average one-time cost for the customers 
would have been approximately $2.39.[Footnote 22] Such a fee would be 
consistent with the fees charged on some other USDA loans. In 
comparison, USDA charges a loan-origination fee of 2 percent on 
guaranteed business and industry loans, 1 percent on guaranteed water 
and waste disposal loans, and 1 percent on most guaranteed farm 
ownership and operating loans.

Although this alternative does not provide for guarantees on CFC's 
debt, CFC's access to capital for financing projects would not be 
jeopardized. CFC's history and financial reports show that CFC is 
capable of raising the capital required for financing projects. In 
CFC's 2003 annual report, CFC reported that it had about $21 billion in 
loans outstanding, including $16.4 billion in electricity loans and 
$4.9 billion in telecommunications loans. CFC stated that despite 
significant short-term financing risk in energy trading and power 
marketing, it has continued to be successful in securing long-term 
sources of capital. For example, CFC reported that it had sold bonds in 
Australia, which demonstrates its ability to raise capital in major 
money centers of the world. CFC also reported that just after the 2003 
fiscal year ended, it had access to $3.9 billion through revolving 
credit lines.

We discussed the guarantee provision and our alternative option with 
RUS officials. RUS' Administrator and officials commented that they had 
originally viewed the provision to guarantee lenders' debt as 
unnecessary because appropriations could be made available for funding 
the rural economic development program. Nevertheless, they stated that 
they are now engaged in implementing the guarantee provision. They 
agreed that the alternative option we raised is consistent with the 
loan-origination fees USDA places on some other loans, would be a 
feasible way to fund rural economic development loans and grants, and 
would likely have a very small effect on the customers of borrowers 
that receive RUS loans.

Conclusions:

The rural electricity program is no longer operated in a manner fully 
consistent with the concept of service to rural areas. RUS policies 
allowing loans and guarantees to be provided to borrowers whose 
customer base has grown significantly and that provide service in urban 
metropolitan areas go beyond the original intent of the program. 
Consequently, the program's focus on service to rural residents has 
been blurred, and the federal goals now being served by the program are 
not fully transparent. Better targeting of loans to borrowers that 
provide service in rural areas would result in more consistent use of 
RUS' funds and reduce the government's lending costs. Such targeting 
could be accomplished by recognizing that there have been population 
increases in previously rural areas and applying a population criterion 
to both initial and subsequent loans, thereby ensuring that lending 
remains focused on rural areas.

We are also concerned about the proposed guarantee of lenders' debt 
because it would unnecessarily increase taxpayer risk. Guarantees on 
lenders' debt are not needed to raise capital for lending to 
electricity service providers. In addition, the stated purpose of the 
debt guarantee program--raising funds for rural economic development 
loans and grants--could be accomplished through a no-risk alternative 
that we have identified.

Matters for Congressional Consideration:

We are presenting three matters for congressional consideration. To 
better target RUS' lending to borrowers serving rural areas, Congress 
may wish to consider specifying that the program criterion for rural 
areas applies to both an initial loan and any subsequent loans that 
borrowers seek. In addition, to provide additional funds for rural 
economic development loans and grants without risk to taxpayers, 
Congress may wish to consider amending the RE Act to authorize a small 
loan-origination fee on RUS' electricity and telecommunication loans 
and direct that fees collected on such loans be used for rural economic 
development loans and grants, and simultaneously repeal the new lender 
debt guarantee requirement.

Agency Comments and Our Evaluation:

We provided a draft of this report to USDA for review and comment. We 
received written comments from the Acting Under Secretary for Rural 
Development, which are presented in appendix III together with our 
detailed responses.

USDA did not express agreement or disagreement with our matters for 
congressional consideration. USDA commented that the report challenges 
the long-established RUS practice of determining the rural or nonrural 
nature of areas at the time RUS made the loan for initial service, but 
not doing so for subsequent loans. In this regard, USDA also said that 
this issue has been raised with Congress many times before, and that 
while Congress has revised the RE Act, it has not accepted previous 
recommendations from us and others to address RUS' lending practices. 
However, USDA pointed out that the President's budget recommends that 
the rural status of borrowers be recertified. According to USDA's 
budget summary for fiscal year 2005, RUS' borrowers would be asked to 
recertify that they are serving areas that are rural, rather than urban 
or suburban areas. In addition, RUS officials told us that they drafted 
legislation along these lines, but that USDA has not sent this proposal 
to Congress for consideration. Given this apparent recognition by USDA 
of the need to address RUS' lending practices, there may be an 
opportunity for improving the focus of RUS' program.

USDA also commented that it believes the methodology used in the report 
does not accurately portray the extent to which its borrowers serve 
consumers who are not in rural areas. USDA referred to the definition 
of rural in the RE Act and said it believes that any methodology used 
to characterize a borrower's service territory should be based directly 
on Bureau of the Census data as applied to the service territory maps 
of its borrowers. USDA also stated that our use of the Economic 
Research Service's county classification system is inappropriate and 
that the Office of Management and Budget has said that it is not 
correct to use statistical information about metropolitan areas for 
determining eligibility for federal programs. The service territory 
maps of the 530 distribution borrowers included in our analysis were 
not available at RUS; collecting these maps and applying census data to 
each one would have precluded us from providing a timely response to 
our requester. While RUS does not collect comprehensive data on the 
areas served by its distribution borrowers, nor maintain current 
service territory maps of its borrowers, RUS identified for us the 
counties each borrower serves. This information enabled us to use the 
Economic Research Service's rural-urban classification system to 
characterize the areas served by RUS borrowers. Also, our report makes 
no specific determinations about the eligibility of any RUS borrower to 
participate in the program. We disagree with USDA's objection to the 
use of the rural-urban classification method developed by the Economic 
Research Service. USDA's Economic Research Service classification 
system is based on Bureau of the Census data, and it classifies areas, 
including counties, by degree of rurality. According to the Economic 
Research Service, its system captures the diversity of rural America in 
ways that are meaningful for developing public policies and programs. 
We agree that these classifications are not the criteria of the RE Act. 
Our purpose, however, was to describe the characteristics of areas 
served by RUS electricity distribution borrowers, and the Economic 
Research Service's classification system is useful for that purpose. We 
believe our analyses, taken together, provide insight into the extent 
of service provided by borrowers in counties with large urban 
populations within metropolitan areas, which we have emphasized in our 
results. Furthermore, the population has grown in many areas served by 
RUS distribution borrowers that originally qualified for loans under 
the requirement that they serve sparsely populated rural areas. During 
our review, RUS officials agreed that many of its borrowers would no 
longer meet the RE Act population test for service to rural areas if 
that criterion were applied.

USDA also discussed the general location of places where rural 
residents reside and stated that the majority live in metropolitan 
counties. Accordingly, USDA said that the report would classify service 
to these consumers as evidence that a distribution borrower was serving 
nonrural areas. We did not use our results in this manner and our 
leading observation, based on several analyses and our previous 
reports, is that RUS distribution borrowers serve not only rural areas 
but also highly populated areas. At the same time, we reported that 
about 24 percent of the counties served by RUS distribution borrowers 
are completely rural or have only nominal urban populations. However, 
it should be recognized that, according to USDA's Economic Research 
Service, rural areas, particularly those rich in natural resources, 
have experienced economic transformation and rapid population growth, 
while other areas face declining job opportunity and population loss. 
We believe that suggestions to better target RUS lending could respond 
to these changed conditions.

Finally, USDA commented that it is important to recognize, and not 
criticize, RUS' efforts to implement the 2002 Farm Bill provision to 
guarantee the bonds and notes that lenders could use to raise funds for 
making loans for electricity and telecommunications services. USDA 
asked that the report be revised to distinguish between criticism of 
the legislation and RUS' efforts to implement it. We believe that our 
report properly describes RUS' efforts to implement the legislation in 
a factual manner and supports the purpose rather than criticizes the 
legislation in the 2002 Farm Bill calling for the new guarantee program 
or RUS' efforts to implement the legislation. It does, however, provide 
an alternative for funding rural economic development that avoids risk. 
Our report notes RUS' view that guaranteeing bonds and notes may not 
result in losses, although providing such guarantees would include some 
risks to taxpayers and, in a worst-case scenario, could result in 
potential losses of $1.5 billion. We stated that, recognizing the 
potential risks, RUS included in its proposed regulation certain risk-
mitigation requirements not specified in the 2002 Farm Bill. However, 
we also noted that CFC commented that these proposals would make the 
program unworkable. In addition, we stated that RUS' economic analyses 
do not include a discussion of risks facing CFC in the electricity and 
telecommunications markets.

As agreed with your office, unless you publicly announce its contents 
earlier, we plan no further distribution of this report until 15 days 
from the date of this letter. We will then send copies to interested 
congressional committees; the Secretary of Agriculture; the 
Administrator of RUS; the Director, Office of Management and Budget; 
officials at CoBank and CFC; and other interested parties. We will make 
copies available to others on request. In addition, this report will be 
available at no charge on the GAO Web site at http://www.gao.gov.

If you or your staff have any questions about this report, please call 
me at (202) 512-3841. Key contributors to this report are listed in 
appendix IV.

Sincerely yours,

Signed by: 

Lawrence J. Dyckman: 
Director, Natural Resources and Environment:

[End of section]

Appendix I: Objectives, Scope, and Methodology:

The Chairman of the Subcommittee on Energy Policy, Natural Resources 
and Regulatory Affairs, House Committee on Government Reform asked that 
we report to him on (1) the extent to which RUS distribution borrowers 
provide electricity service to nonrural areas and (2) the potential 
financial risk to taxpayers of the 2002 Farm Bill requirement to 
guarantee lenders' debts, and the amount of rural economic development 
loans and grants that could be funded by fees on the guarantees. In 
addition, we identified an alternative that could provide funds for 
rural economic development loans and grants.

In the overall course of our work, we reviewed the basic statutory 
authority for RUS programs--the Rural Electrification Act of 1936, as 
amended (RE Act); USDA's Budget Explanatory Notes for Committee on 
Appropriations for fiscal years 1999 through 2005; prior GAO reports; 
and RUS reports and publications. To provide relatively current 
information on RUS' electricity program, we focused on the loans RUS 
made, guaranteed, and wrote-off in fiscal years 1999 through 2003. We 
interviewed RUS officials, including the Administrator and Assistant 
Administrator for the electricity program. For the Rural Business-
Cooperative Service's rural economic development loan and grant 
program, we used similar sources, including agency publications and 
reports, its annual financial report containing information on loans 
and grants made from fiscal year 1999 through 2003, the budget 
explanatory notes, and our prior reports. We also interviewed USDA's 
Deputy Administrator for the business programs. We did not verify the 
accuracy of the financial information contained in the Rural Business-
Cooperative Service's annual financial report.

To address the extent to which RUS distribution borrowers provide 
electricity service to rural and nonrural areas, we obtained 
information about RUS' lending policies by reviewing provisions of the 
RE Act; RUS regulations; and our prior reports; we also interviewed RUS 
officials.[Footnote 23] We obtained automated financial reports from 
RUS that covered all direct and guaranteed electricity loans made 
between fiscal years 1999 and 2003. We took steps to verify the 
accuracy of the information contained in the automated financial 
reports, and performed some data reliability testing and found that the 
data were reliable enough for our purposes. We also obtained from RUS a 
list of the counties served by its active electricity borrowers, which 
we compared to the Economic Research Service's 2003 rural-urban 
continuum codes. These codes classify all U.S. counties along a 9-point 
scale that distinguishes metropolitan counties by the population size 
of their metropolitan area and nonmetropolitan counties by the degree 
of urbanization and adjacency to a metropolitan area. The metropolitan 
and nonmetropolitan classifications are based on the Office of 
Management and Budget's June 2003 groupings. Metropolitan counties are 
distinguished by the population size of the metropolitan statistical 
area of which they are part. Nonmetropolitan counties are classified 
according to the aggregate size of their urban population and by 
whether they are adjacent to a metropolitan area. Using this 
information, we coded the counties where RUS' electricity borrowers 
that received loans between fiscal years 1999 and 2003 provide 
service.[Footnote 24] To avoid overstating the number of counties 
served by RUS borrowers, we did not code the same county twice, in the 
event that two different borrowers served customers in the same county. 
We then analyzed county-level data from the 2000 census. Specifically, 
we analyzed the number of residents in counties that the Bureau of the 
Census classifies as residing in rural and urban areas. In general, the 
Bureau of the Census historically defined rural areas as cities, 
villages, boroughs, or towns with fewer than 2,500 inhabitants. The 
Bureau of the Census revised the definition for the 2000 census to 
focus on population density within areas while retaining the 2,500 
population criterion. Thus, for this part of our analysis, we used 
counties served by the distribution borrowers as an indicator of areas 
being served by borrowers that obtain RUS electricity loans. We also 
analyzed the service area maps of selected RUS borrowers.

We also cross-referenced the loan information we obtained from RUS 
against data that the distribution borrowers report to the agency 
annually on the number of customers that they serve. We then 
categorized the borrowers that received loans by various incremental 
ranges of residential customers served. These ranges generally 
correspond with the population criteria for various USDA rural 
development programs--for example, a population of less than 2,500 for 
electricity loans, 10,000 or less for water and waste disposal loans 
and grants, and 20,000 or less for community facility loans and grants. 
We used the most recently available customer data at the time a loan 
was approved for our analysis. Thus, if a loan was approved in calendar 
year 2000, we used customer data as of December 31, 1999. We took this 
approach because the agency does not collect data on the number of 
customers in each county that the borrowers serve. We recognize that 
most borrowers serve multiple areas, which could result in their having 
a high number of customers. However, we noted that the residential 
customer data are counted as individuals responsible for paying the 
electricity bills; a household is generally counted as one customer. 
Thus, the customer count data would be less than the number of 
inhabitants.

To address the potential financial risk to taxpayers of the 2002 Farm 
Bill requirement to guarantee lenders' debts, and the amount of rural 
economic development loans and grants that could be funded by fees on 
the guarantees, we reviewed the relevant portion of the act and its 
legislative record. During the initial portion of our review, RUS had 
not issued a proposed or implementing regulation. Because the Rural 
Business-Cooperative Service's Deputy Administrator for the business 
programs told us the agency had not yet developed a program-level 
estimate of the additional loans and grants that could be funded under 
the new program, we made such an estimate using RUS' estimated level of 
guaranteed debt and the resulting available fee proceeds, if that level 
were achieved, and the Rural Business-Cooperative Service's fiscal year 
2004 budget figures for rural economic development loans and grants. To 
obtain information on RUS' efforts and plans to implement the new 
guarantee program, we interviewed RUS officials, including the 
Assistant Administrator for the electricity program. A proposed 
regulation was published in the Federal Register on December 30, 2003. 
We reviewed this document to determine how the agency was proposing to 
implement the new program and the agency's description of the program's 
risk, impact, and benefits. We interviewed officials of CFC and CoBank 
to obtain their views on the proposed new program, and reviewed 
financial and business reports on these entities and the electric and 
telecommunications industries.

To determine whether an alternative mechanism might be available to 
fund the rural economic development program with less risk, we analyzed 
RUS' fiscal year 2005 budget request for electricity and 
telecommunications loans and the Rural Business-Cooperative Service's 
request for rural economic development loans and grants to determine 
what level of fees would be needed to cover the costs of the Rural 
Business-Cooperative Service's program. For this part of our analysis, 
we focused on a fee level that could result in a level of funds to 
support rural economic development loans and grants that approximately 
doubles the Rural Business-Cooperative Service's fiscal year 2005 
requested program levels. Moreover, we obtained from the Rural 
Development mission area's finance office information on the level of 
funds in the cushion-of-credit account and available to cover the 
subsidy costs of rural economic development loans and the cost of rural 
economic development grants.

We conducted our review from October 2003 to June 2004 in accordance 
with generally accepted government auditing standards.

[End of section]

Appendix II: Customers and Examples of Urban Counties Served by RUS 
Borrowers:

This appendix contains two tables: table 3 provides information about 
the numbers of customers served by RUS distribution borrowers included 
in our analysis; table 4 provides information about 12 counties with 
substantial urban populations that are served entirely or predominately 
by RUS electricity borrowers. These counties are located in the 
vicinity of Atlanta, Georgia; Charlotte, North Carolina; Tampa, 
Florida; and Washington, D.C.

Table 3: Direct and Guaranteed Electricity Loans Made to Distribution 
Borrowers from Fiscal Years 1999 through 2003, by Range of Residential 
Customers Served:

Dollars in millions.

Less than 2,500; 
Loans: Number: 54; 
Loans: Percent of total: 6.3%; 
Dollars: Amount: $90.0; 
Dollars: Percent of total: 1.0%; 
Average number of customers served: Residential customers: 1,561; 
Average number of customers served: Nonresidential customers: 369.

2,500-10,000; 
Loans: Number: 354; 
Loans: Percent of total: 41.0%; 
Dollars: Amount: $1,530.1; 
Dollars: Percent of total: 17.1%; 
Average number of customers served: Residential customers: 5,724; 
Average number of customers served: Nonresidential customers: 926.

10,001-20,000; 
Loans: Number: 211; 
Loans: Percent of total: 24.4%; 
Dollars: Amount: $2,184.6; 
Dollars: Percent of total: 24.4%; 
Average number of customers served: Residential customers: 14,280; 
Average number of customers served: Nonresidential customers: 1,520.

20,001-50,000; 
Loans: Number: 195; 
Loans: Percent of total: 22.6%; 
Dollars: Amount: $3,401.2; 
Dollars: Percent of total: 38.0%; 
Average number of customers served: Residential customers: 30,319; 
Average number of customers served: Nonresidential customers: 3,093.

50,001 or more; 
Loans: Number: 50; 
Loans: Percent of total: 5.8%; 
Dollars: Amount: $1,751.2; 
Dollars: Percent of total: 19.6%; 
Average number of customers served: Residential customers: 75,731; 
Average number of customers served: Nonresidential customers: 7,520.

Total; 
Loans: Number: 864; 
Loans: Percent of total: 100.0%; 
Dollars: Amount: $8,957.1; 
Dollars: Percent of total: 100.0%; 
Average number of customers served: Residential customers: 17,156; 
Average number of customers served: Nonresidential customers: 1,907.

Source: GAO analysis of RUS data.

Note: The percentage of dollars is based on whole numbers and the 
totals may not add due to rounding.

[End of table]

Table 4: Population Profile of 12 Counties That Are Entirely or 
Predominantly Served by Electric Cooperatives That Received RUS 
Electricity Loans between Fiscal Years 1999 and 2003:

County: Calvert, Maryland; 
Total population of county: 74,563; 
Urban population of county: 40,429; 
Rural population of county: 34,134; 
Percent rural within county: 46%. 

County: Charles, Maryland; 
Total population of county: 120,546; 
Urban population of county: 79,874; 
Rural population of county: 40,672; 
Percent rural within county: 34%. 

County: Citrus, Florida; 
Total population of county: 118,085; 
Urban population of county: 67,791; 
Rural population of county: 50,294; 
Percent rural within county: 43%. 

County: Coweta, Georgia; 
Total population of county: 89,215; 
Urban population of county: 48,586; 
Rural population of county: 40,629; 
Percent rural within county: 46%. 

County: Douglas, Georgia; 
Total population of county: 92,174; 
Urban population of county: 73,467; 
Rural population of county: 18,707; 
Percent rural within county: 20%. 

County: Fayette, Georgia; 
Total population of county: 91,263; 
Urban population of county: 71,391; 
Rural population of county: 19,872; 
Percent rural within county: 22%. 

County: Forsyth, Georgia; 
Total population of county: 98,407; 
Urban population of county: 64,243; 
Rural population of county: 34,164; 
Percent rural within county: 35%. 

County: Hall, Georgia; 
Total population of county: 139,277; 
Urban population of county: 93,066; 
Rural population of county: 46,211; 
Percent rural within county: 33%. 

County: Hernando, Florida; 
Total population of county: 130,802; 
Urban population of county: 99,591; 
Rural population of county: 31,211; 
Percent rural within county: 24%. 

County: Pasco, Florida; 
Total population of county: 344,765; 
Urban population of county: 293,288; 
Rural population of county: 51,477; 
Percent rural within county: 15%. 

County: Spalding, Georgia; 
Total population of county: 58,417; 
Urban population of county: 34,745; 
Rural population of county: 23,672; 
Percent rural within county: 41%. 

County: Union, North Carolina; 
Total population of county: 123,677; 
Urban population of county: 62,039; 
Rural population of county: 61,638; 
Percent rural within county: 50%. 

Source: GAO analysis of electricity cooperative service area maps and 
2000 census data.

[End of table]

[End of section]

Appendix III: Comments from the U.S. Department of Agriculture:

Note: GAO comments supplementing those in the report text appear at the 
end of this appendix.

USDA:

United States Department of Agriculture:

Office of the Secretary: 
Washington, D.C. 20250:

MAY 24 2004:

Mr. Lawrence J. Dyckman:
Director, Natural Resources and Environment: 
United States General Accounting Office: 
441 G Street, NW:
Washington, DC 20548:

Dear Mr. Dyckman:

Thank you for providing the United States Department of Agriculture 
(USDA), Rural Development, with a draft of your report on Opportunities 
to Better Target Assistance to Rural Areas and Avoid Unnecessary 
Financial Risk (Audit No. GAO-04-647). I would like to offer the 
following comments for your consideration and ask that a copy of this 
response be included in your final report.

The draft report notes that the Rural Utilities Service (RUS) issued a 
proposed rule to implement Section 6101 (7 U.S.C. 313A) that was 
provided in the Farm Security and Rural Investment Act of 2002 (Pub. L. 
107-171) (Farm Bill). Specifically, this section requires the Secretary 
to guarantee payments on bonds or notes issued by certain cooperative 
or nonprofit lenders that make electric and telephone loans. The draft 
report is critical of this legislation and suggests that Congress may 
wish to consider repealing it.

It is important to recognize that RUS' responsibility for administering 
this legislation requires that the agency proceed with due diligence in 
accordance with the intent of Congress in its passage of the 
legislation. RUS has taken this responsibility seriously. We would ask 
that GAO's draft report be revised to distinguish between its criticism 
of the legislation and RUS' efforts to implement it.

RUS and National Rural Utilities Cooperative Finance Corporation (CFC) 
have a long history of working together to provide credit for rural 
electrification and telecommunications. This relationship is grounded 
in Section 306 of the Rural Electrification Act of 1936, (RE Act) as 
amended (7 U.S.C. 901 et Seq) which explicitly mentions CFC in 
conferring authority to RUS to guarantee loans made by CFC for RE Act 
purposes. CFC is second only to RUS in providing credit for these 
sectors.

RUS contracted for, and obtained, a sophisticated, independent 
empirical analysis from Bearing Point to the degree of risk of loss in 
the case of investment grade bonds. The Bearing Point analysis shows 
that the probability of incurring any loss under the 313A program is 
unlikely. We believe that the report should acknowledge what the data 
shows.

The report also challenges the long-established RUS practice of 
determining the rural or non-rural nature of areas as of the time RUS 
made the loan for initial service. Generally speaking, this practice, 
which the report refers to as "once a borrower always a borrower", has 
meant that once an applicant has established a borrowing relationship 
with RUS, subsequent population growth in its service territory does 
not preclude eligibility for further RUS financial assistance. We note 
that GAO and others have brought this matter to the attention of 
Congress many times before. In addition to the 1998 and 1996 GAO 
reports cited in this latest report, the Congressional Research Service 
(CRS) analyzed this same issue in 1991 in CRS Report for Congress, The 
Rural Electrification Administration: Background and Current Issues 
(91-614 ENR, August 12, 1991). Although Congress has amended the RE Act 
several times in the intervening years, instead of accepting these 
recommendations, Congress has continued to support the current electric 
distribution program. However, the President's budget recommends that 
the rural status of borrowers be re-certified.

We also believe that the methodology used in the report does not 
present an accurate picture of the extent to which RUS borrowers serve 
electric consumers that are not in rural areas. The RE Act defines 
rural as being any area not included within the boundaries of any urban 
area as defined by the Bureau of the Census. We believe that any 
methodology attempting to measure the current demographic 
characteristics of an RE borrower's service territory should be based 
directly on Bureau of the Census data. This data can be projected on to 
maps of borrowers' service territory to ascertain their demographics. 
This seems to be what was done in the case of six specific borrowers 
named in the report. However, different and inappropriate standards 
were used for characterizing the remainder of RUS borrowers. Instead 
the Report used techniques used by Economics Research Service (ERS) 
researchers and others who discuss conditions in "rural" America by 
referring to conditions in "nonmetropolitan" areas.

Metropolitan statistical areas are defined on the basis of whole 
counties. Metropolitan statistical areas are defined by the Office of 
Management and Budget (OMB) to provide nationally consistent 
definitions for collecting, tabulating and publishing Federal 
statistics for geographic areas. OMB has expressly characterized the 
use of these definitions "for implementing nonstatistical programs and 
determining program eligibility" as being "inappropriate." (65 FR 
82228) (December 27, 2000). This is because "OMB establishes and 
maintains these areas solely for statistical purposes." Id.

When these terms are applied to the 59.1 million rural residents 
counted by Census 2000, the majority of rural residents lived in metro 
counties. (Source: Economic Research Service, USDA: "Measuring 
Rurality: What is Rural?"). Accordingly, it is possible for systems to 
serve consumers who are "rural residents" for Census 2000 and RE Act 
purposes even though those same consumers are classified as "metro 
residents" for Federal statistical purposes. Nevertheless, the report 
would classify service to these consumers as evidence that a 
distribution cooperative was serving nonrural areas. Under the county-
based methodology used in the report, a system that served only a 
handful of consumers living in a county listed as "metro" would be 
considered to be a borrower serving a non-rural area regardless of the 
actual demographic characteristics of its service territory or the 
amount of infrastructure it has located in the metro county.

The report raised the issue of targeting of loan funds. We would note 
that targeting of loans would not reduce the Government's subsidy cost 
for the electric program, contrary to GAO's statement on page 19 of the 
draft report. The fact of the matter is the electric loan program 
involves very little subsidy cost. For example, the President's 2005 
budget includes $2.6 billion in electric loans at the subsidy cost of 
only $4 to $5 million. Moreover, this subsidy cost is limited to 
direct loans made for "hardship" and "municipal rate" purposes. The 
majority of the electric loan program actually operates at a negative 
subsidy cost.

Further we would note that GAO raised the issue on targeting of the 
electric loan program in its 1998 report entitled Rural Utilities 
Service; Opportunities to Operate Electricity and Telecommunications 
Loan Programs More Effectively, GAO/RECD-98-42). GAO's current draft 
report does not provide any new information on the matter, except for 
citing more recent examples of where loans have been made.

The report indicates that the 5 percent hardship rate program is for 
borrowers that serve financially distressed areas. This statement is 
incorrect. By Congressional mandate the 5 percent hardship rate program 
is limited to borrowers who meet certain rate criteria and whose 
members meet certain income level criteria as measured against State 
averages. While arguably the per capita income may tie to financially 
distressed areas the rate criteria does not. Specifically, Congress 
provided that a borrower would qualify for a hardship rate loan if it 
met the rate disparity and consumer income test or met the extremely 
high rate test. Congress also provided that a hardship rate loan could 
be made at the Administrator's discretion. The criteria established by 
Congress are as follows:

Rate Disparity Test for Hardship:

A borrower meets this test if its average revenue per kWh sold is not 
less that 120 percent of the average revenue per kWh sold by all 
electric utilities in the State in which the borrower provides service, 
and its average residential revenue per kWh is not less than 120 
percent of the average residential revenue per kWh sold by all electric 
utilities in the State in which the borrower provides service.

Consumer Income Test:

A borrower meets this test if either the average per capita income of 
the residents receiving electric service from the borrower is less than 
the average per capita income of the residents of the State in which 
the borrower provides service or the median household income of the 
residents receiving electric service from the borrower is less than the 
median household income of the households in the State.

Extremely High Rates Test:

The Administrator shall make an insured electric loan at the hardship 
rate to any borrower whose residential revenue exceeds 15 cents per kWh 
sold.

Administrator's Discretion:

The Administrator may make a hardship rate loan if, in the sole 
discretion of the Administrator, the borrower has experienced a severe 
hardship.

Thank you for this opportunity to comment on the report. If you have 
any questions, please contact John M. Purcell, Director, Financial 
Management Division at (202) 692-0080.

Sincerely,

Signed by: 

GILBERT GONZALEZ 
Acting Under Secretary 
Rural Development:

The following are GAO's comments on the U.S. Department of 
Agriculture's letter dated May 24, 2004.

GAO Comments:

1. We do not criticize the legislation in the 2002 Farm Bill calling 
for the new guarantee program, and offer Congress an alternative for 
funding rural economic development loans and grants that does not 
provide added risk exposure to the nation's taxpayers. Our report 
recognizes that a key feature of the new program, as specified in the 
bill report of the Senate Committee on Agriculture, Nutrition, and 
Forestry and in the conference report, is to provide an additional 
funding mechanism for rural economic development loans and grants.

2. The report recognizes that RUS has taken steps to implement the new 
guarantee program and does not criticize the agency's actions. 
Moreover, we recognize in the report that RUS proposed steps to 
mitigate risk in the new program, including the requirements for a 
bankruptcy trust, pledges of collateral, a 5 percent limit on cash 
patronage refunds, and the use of certain standards that apply to 
depository financial institutions.

3. We reviewed a January 2004 Bearing Point report prepared for RUS 
that lays out credit subsidy rate options, which suggest some risks 
with the new guarantee program. This Bearing Point report does not 
state or otherwise show that the probability of incurring any loss 
under the program is unlikely; it does, however, contain various 
estimated subsidy rates assuming defaults. We also reviewed a December 
2002 Bearing Point report prepared for RUS on credit subsidies; this 
report also has no statement about losses being unlikely. These two 
Bearing Point reports are Guarantee Program for Bonds and Notes Issued 
for Electrification or Telephone Purposes, Credit Subsidy Input and 
Output Sheets for 15-Year Bond Scenarios (January 9, 2004), and Bond 
and Note Guarantee Program, Credit Subsidy Research Final (December 16, 
2002). In addition, our report states that RUS estimated, in the 
economic analysis section of its proposed program regulations, maximum 
potential losses at $1.5 billion, but that RUS does not expect losses 
to occur.

4. Contrary to USDA's assertion, we do not challenge RUS' practice of 
determining eligibility when a borrower first applies for a loan to 
provide electricity service in a rural area. In our opinion, this 
practice is called for and meets the provisions of the RE Act. We do 
question, however, RUS' practice of providing subsequent loans for 
service to areas that are no longer rural.

5. We agree with USDA that there has been prior reporting on 
electricity loans being made by RUS to borrowers that have experienced 
population growth in their service territories and on RUS' policy of 
allowing such lending. However, we have an obligation to report on the 
continuation of these conditions because we were specifically requested 
to do so. We believe it is important to highlight these conditions for 
Congress given the purpose of the RE Act--that is, providing loans to 
assist in the electricity infrastructure development of sparsely 
populated rural areas.

6. In discussing the results of our analyses with RUS officials, they 
told us that legislation had been drafted that is consistent with the 
President's fiscal year 2005 budget to require borrowers to recertify 
that they are serving rural areas. We added this statement to the 
report.

7. We used various methodologies to characterize the areas served by 
RUS distribution borrowers because the agency does not collect 
comprehensive data on the areas they serve. For example, RUS does not 
maintain up-to-date service territory maps or current population data 
within those service areas. We recognize that urban-rural continuum 
codes of USDA's Economic Research Service are not the criteria the RE 
Act specifies RUS use to determine program eligibility. We also 
acknowledge that all the metropolitan counties served by RUS 
electricity distribution borrowers have at least some parts that the 
2000 census classifies as rural, and that many of these counties are 
only partially served by a RUS borrower. Our point, however, is to 
generally describe the characteristics of areas served by RUS 
electricity distribution borrowers. Moreover, our analysis of the 
Economic Research Service's system was one of various methodologies we 
used; the others were our analyses of specific borrowers serving highly 
populated areas, counties with substantial urban populations served by 
RUS' distribution borrowers, and the numbers of customers served by 
these borrowers. More specifically, as USDA's letter acknowledges, the 
report provides information on five borrowers that serve highly 
populated areas. In addition, table 4 in appendix II lists the total 
population, urban population, and rural population based on the 2000 
census of 12 counties that are exclusively or predominantly served by 
RUS electricity distribution borrowers. This table shows conclusively 
that urban populations are benefiting from RUS electricity loans. 
Furthermore, table 3 in appendix II disaggregates RUS electricity 
borrowers by the number of customers served.

8. Neither the draft reviewed by USDA, nor this report, suggests that 
metropolitan statistical areas be used as eligibility criteria for 
participating in the electricity loan program. Rather, we state in 
appendix I of our report that we used counties served by the 
distribution borrowers as an indicator of areas being served by 
borrowers that obtain RUS electricity loans. Our purpose in providing 
information on the metropolitan counties served by RUS borrowers was to 
illustrate how some borrowers now provide service to largely populated 
areas, rather than providing service solely to sparsely populated rural 
areas.

9. We agree that the electricity loan program involves relatively 
little subsidy cost. Our concern with the actual and potential cost of 
the program stems from the fact that RUS has experienced a high level 
of losses in recent years. Specifically, the background section of this 
report notes that RUS wrote off more than $3.2 billion during fiscal 
years 1999 through 2003. Our 1998 report noted that RUS wrote off more 
than $1.7 billion during fiscal year 1994 through June 30, 1997. In 
addition, it is likely RUS will incur additional losses in the near 
future. For example, at the end of fiscal year 2003, the assets of two 
borrowers that owed a total of more than $22 million were being 
liquidated by bankruptcy trustees, and the agency's officials told us 
they anticipate losses.

10. We disagree. This report contains new information highlighting that 
loans are being made to borrowers providing service in highly populated 
metropolitan areas; it provides examples of specific counties in highly 
populated areas that are served by borrowers; and it contains a 
nationwide analysis of counties that are served by borrowers that 
obtained loans from RUS in recent years. The report also contains in 
appendix II updated information on loans made to borrowers that have a 
high number of customers.

11. We revised the report to recognize that hardship rate loans are 
made to borrowers that have a relatively high cost of providing 
service, as indicated by a high average revenue per kilowatt-hour sold, 
and that serve customers with below-average income, or at the 
discretion of RUS' Administrator. However, we note that in the current 
period of low interest rates, the rate charged on hardship rate loans, 
which is set at 5 percent, has been higher than the rates charged by 
RUS on its municipal rate loans and Treasury rate loans. Specifically, 
as the report states, the interest rate on municipal rate loans ranged 
from 1.1 percent to 4.6 percent during the first quarter of calendar 
year 2004, and on Treasury rate loans ranged from 1.2 percent to 4.4 
percent in mid-March 2004.

[End of section]

Appendix IV: GAO Contacts and Staff Acknowledgments:

GAO Contacts:

Lawrence J. Dyckman (202) 512-3841 Charles M. Adams (202) 512-8010:

Acknowledgments:

In addition to the individuals named above, Jonathan C. Altshul, 
Vondalee R. Hunt, Cynthia C. Norris, Patrick J. Sweeney, and Amy E. 
Webbink made key contributions.

FOOTNOTES

[1] The RE Act (7 U.S.C. §§ 901 et seq.) also authorizes RUS' 
telecommunications program in which direct and guaranteed loans are 
used for furnishing and improving telephone service.

[2] In general, the Bureau of the Census historically defined urban 
areas as cities, villages, boroughs, or towns with 2,500 or more 
inhabitants. The Bureau of the Census revised the definition for the 
2000 census to focus on population density within areas while retaining 
the population criterion of 2,500 inhabitants.

[3] RUS' regulations state that an area determined to be rural for an 
initial loan prior to November 1, 1993, shall continue to be considered 
rural, and for an initial loan made on or after November 1, 1993, RUS 
will rely on the Bureau of the Census' designation.

[4] 7 U.S.C. § 940c-1, added by Section 6101 of the 2002 Farm Bill, 
Pub. L. No. 107-171, 116 Stat. 134, 413 (2002).

[5] U.S. General Accounting Office, Rural Utilities Service: 
Opportunities to Operate Electricity and Telecommunications Loan 
Programs More Effectively, GAO/RCED-98-42 (Washington, D.C.: 
January1998) and U.S. General Accounting Office, Congressional 
Oversight: Opportunities to Address Risks, Reduce Costs, and Improve 
Performance, GAO/T-AIMD-00-96 (Washington, D.C.: February 2000).

[6] Pub. L. No. 103-354, 108 Stat. 3221 (1994).

[7] RUS also administers USDA's other utility programs, such as the 
telecommunications loan and the water and waste disposal loan and grant 
programs. These programs define "rural" differently. A "rural area" for 
RUS telecommunications loans is any area not included in a city, 
village, or borough with a population in excess of 5,000 inhabitants. 
"Rural" and "rural area" for RUS' water and waste disposal loans and 
grants are a city, town, or unincorporated area that has a population 
of no more than 10,000 inhabitants.

[8] Restructured loans are loans for which the original loan agreements 
have been altered, including loans that had been owed by borrowers now 
assumed by other utilities. The amount covers the principal and the 
capitalized interest owed on the loans. Also, the loan amounts in this 
category are not included in the other direct and guaranteed loan 
categories.

[9] RUS also made or guaranteed more than $2.3 billion of 
telecommunications loans over this 5-year period.

[10] This report section covers distribution borrowers but not power 
supply borrowers, which do not directly serve residential or business 
customers.

[11] For this analysis, we examined RUS data on the counties served by 
distribution borrowers, USDA's Economic Research Service 9-point scale 
that classifies counties, which is based on the Office of Management 
and Budget's classification of metropolitan counties, and census data 
on county populations.

[12] Appendix II contains additional data on RUS distribution 
borrowers, and examples of the urban counties they serve.

[13] RUS' economic analysis was included with its proposed program 
regulations. Guarantees for Bonds and Notes Issued for Electrification 
or Telephone Purposes, 68 Fed. Reg. 75153 (to be codified at 7 C.F.R. 
pt. 1720) (proposed Dec. 30, 2003).

[14] CFC's principal purpose is to provide cooperative utility systems 
with financing to supplement RUS programs. CFC competes with CoBank of 
the Farm Credit System to provide lending to projects partially funded 
by RUS, and for projects involving cooperatives in which RUS is not a 
participant.

[15] The Department of the Treasury's Federal Financing Bank, which 
makes most electricity and telecommunications loans guaranteed by RUS, 
is not eligible because it is a federal entity.

[16] The Federal Credit Reform Act of 1990, 2 U.S.C. §§ 661-661f, 
requires agencies entering into new loan guarantee commitments to first 
obtain budget authority to cover the "cost" of the loan program. The 
subsidy cost of guarantees is generally the net present value of 
estimated payments by the government to cover defaults and 
delinquencies, interest subsidies, or other payments, offset by any 
payments to the government, including origination and other fees, 
penalties, and recoveries.

[17] One basis point equals .01 percent.

[18] The fees are to establish an additional funding mechanism to be 
used by the Rural Business-Cooperative Service to cover the costs of 
rural economic development loans and grants. See S. Rep. No. 107-117, 
at 23 (2001); H. R. Rep. No. 107-424, at 588 (2002).

[19] National Rural Utilities Cooperative Finance Corporation, Form 10-
K, Annual Report Pursuant to Section 13 or 15(d) of the Securities and 
Exchange Act of 1934, Fiscal Year Ended May 31, 2003 (Washington, D.C.: 
August 2003).

[20] CFC is intent on maintaining a high credit rating. For example, 
according to CFC's May 2003 report to the Security and Exchange 
Commission, bonuses are authorized for key executives if CFC improves 
its financial ratings.

[21] Nonprofit lenders and RUS refer to profits as "net margins" and 
the distribution of profits to the cooperatives' owners as "patronage 
refunds."

[22] As this is an average, we recognize that differing loan amounts 
and customer bases would result in a higher cost for the customers of 
some borrowers and less for others. Funds obtained through a loan-
origination fee to power supply borrowers would likely result in a 
slight additional cost for each customer.

[23] We did not include power supply borrowers in this part of our 
analysis because they do not directly serve retail customers.

[24] We did not include data on distribution borrowers serving Puerto 
Rico or American Samoa in this part of our analysis because the 
Economic Research Service does not classify counties in U.S. 
territories.

GAO's Mission:

The General Accounting Office, the investigative arm of Congress, 
exists to support Congress in meeting its constitutional 
responsibilities and to help improve the performance and accountability 
of the federal government for the American people. GAO examines the use 
of public funds; evaluates federal programs and policies; and provides 
analyses, recommendations, and other assistance to help Congress make 
informed oversight, policy, and funding decisions. GAO's commitment to 
good government is reflected in its core values of accountability, 
integrity, and reliability.

Obtaining Copies of GAO Reports and Testimony:

The fastest and easiest way to obtain copies of GAO documents at no 
cost is through the Internet. GAO's Web site ( www.gao.gov ) contains 
abstracts and full-text files of current reports and testimony and an 
expanding archive of older products. The Web site features a search 
engine to help you locate documents using key words and phrases. You 
can print these documents in their entirety, including charts and other 
graphics.

Each day, GAO issues a list of newly released reports, testimony, and 
correspondence. GAO posts this list, known as "Today's Reports," on its 
Web site daily. The list contains links to the full-text document 
files. To have GAO e-mail this list to you every afternoon, go to 
www.gao.gov and select "Subscribe to e-mail alerts" under the "Order 
GAO Products" heading.

Order by Mail or Phone:

The first copy of each printed report is free. Additional copies are $2 
each. A check or money order should be made out to the Superintendent 
of Documents. GAO also accepts VISA and Mastercard. Orders for 100 or 
more copies mailed to a single address are discounted 25 percent. 
Orders should be sent to:

U.S. General Accounting Office

441 G Street NW,

Room LM Washington,

D.C. 20548:

To order by Phone: 	

	Voice: (202) 512-6000:

	TDD: (202) 512-2537:

	Fax: (202) 512-6061:

To Report Fraud, Waste, and Abuse in Federal Programs:

Contact:

Web site: www.gao.gov/fraudnet/fraudnet.htm E-mail: fraudnet@gao.gov

Automated answering system: (800) 424-5454 or (202) 512-7470:

Public Affairs:

Jeff Nelligan, managing director, NelliganJ@gao.gov (202) 512-4800 U.S.

General Accounting Office, 441 G Street NW, Room 7149 Washington, D.C.

20548: