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If the Electric Bank is to become fully operative and provide loans at the lowest possible cost for the REA membership the paramount consideration is to establish the security of the system and convince the investment community of the adequacy of that security. Once security and the reputation have been established, federal agencies have been able to command large amounts of debenture financing and to meet those obligations successfully. Because the Electric Bank is serving a sector of the electric utility industry, which enjoys the highest credit rating of any division of investor-owned corporate activity, they start with a favorable situation. Many would be willing to regard the electric utility as providing more predictable investment security than farm real estate, rural residences, and farm business operations. Yet each of these latter areas has been successfully served by farm credit agencies that are now privately financed.

In this respect, the references to the standards for borrowing by investorowned utilities in the Rural Electric Financing Study Report might mislead the reader as to the restrictions necessary for a federal credit agency, such as the Electric Bank. Precedents in other federal credit agencies suggest that higher ratios of debt to ownership investment and lower margins of earnings over interest charges are commonly regarded as adequate to meet the standards of the investment bond market. The following recommendations with respect to security provisions that appear desirable to achieve one or both of the objectives stated at the outset are:

1. Because electric utility property is choice security, it might be possible to increase the permitted ratio of electric debentures from “ten times the paid-in capital and retained earnings (page 13, line 13)” to “20 times the paid-in capital" and that "any earnings shall be retained each year, to the extent earned, sufficient to increase the paid-in capital by one-half percent if at the end of the year the total paid-in capital and retained earnings, excluding any Class A stock, is less than 10 percent of the outstanding debentures.

This provision would tie in with the provision for Class B stock (pages 10-11), which requires its purchase by borrowers equal to 5 percent of their loan. (All page references are to H.R. 14837 except where noted as from Rural Electric Financing Study Report, July 1965.)

2. Since all member co-ops should have a permanent interest in the Bank so as to have a place in the control picture leading to final independence, each might be required to subscribe for a moderate amount of Class C stock (page 11). The required amount might be between one and five percent of the maxi. mum amount borrowed in the past. In cases of need this subscription might be paid for over a period of years if the percent is more than nominal.

3. With these two required classes of compulsory stockholders, the need for additional equity capital might be nil, depending upon the maximum ratio decided upon with respect to outstanding Debentures and owners' capital. Under such conditions, and the shift of distribution loans from the Treasury to the Electric Bank, only a small investment of Government funds would be needed to create a Class A stock (page 10). Even if the bill continued to limit deben. ture issues to ten times paid-in capital, an equity of $950 million would be sufficient to support the largest amount of financing projected by the Study Report (page 44), or $972 billion for the 15-year period 1965–1980. Because the borrowers would be required to supply equity capital equal to 5 percent of their borrowing, only some $475 million would be needed from other sources. Some would come from Class C and D stocks provided for in the bill and some from retained earnings. (The REA system earned $115 million after interest in 1965 and most of it was retained; its accumulated equity, mostly retained earnings, was $1,020,000,000.)

Instead, then, of requiring the Treasury to buy $50,000,000 of Class A stock each year for fifteen years, or a total of $750,000,000, a sensible provision would gear such purchases to the amount actually needed each year. Any reduction would hasten the day when the Class A could be retired and full ownership of the Electric Bank by its co-op members be achieved.

One criticism of the Class A stock is the absence of any provision for a stipulated return to the Treasury. It would be more equitable that the Class A stock receive a return equal to the cost of borrowing by the Treasury and that this return precede the claim of the Class B stock. Such a provision would be an incentive to retain earnings and retire the A stock at the earliest possible date. Under the present bill, the retirement of the Class A stock would wait until June 30, 1981, and no specific plans are made even then for its retirement. 4. Some are concerned that in spite of the prosperity of the REA system, individual borrowing cooperatives might be unable to meet higher interest rates on loans made by the Electric Bank. The solution would be to pinpoint Treasury aid by permitting direct loans, or even grants, to individual distribution co-ops when their earnings are insufficient to pay interest. Such aid would not be needed for generating co-ops since they can raise rates for power sold to their distribution co-ops. (Principal payments should not threaten a default under the changed amortization provisions suggested below.)

The record indicates that demands upon the Treasury under this suggested support for financially weaker co-ops would be small. The REA Report states that only two small co-ops out of more than a thousand borrowers have had to be foreclosed. The Study Report (p. 150) states that as of June 30, 1964, $1,802 million of principal had become due from electric borrowers but prepayments had brought the total of such payments to $2,039 million. And payments delinquent over 30 days at that date were only $120 thousand.

5. The power-type co-ops are few in number but typically require larger sums than distribution-type co-ops. They depend for their revenue upon power purchases by the distribution co-ops. Because they are so financially dependent upon the distribution co-ops, it would be reassuring to the investment community that it be stated in the bill that the distribution co-ops that buy the power explicitly agree to pay such rates for their power purchases as may be necessary to cover the full operating and financing costs of power-type co-ops.

6. The debentures of the Electric Bank will presumably run for a term of years, like those of investor-owned utilities, rather than provide for annual retirement. Consequently, the Bank would not need to require its borrowers to adhere to the present loan plan of rigid retirement over a 35-year period. Instead, borrowers could be given the option of using the amount of revenue collected to cover depreciation expense either for retiring their indebtedness or for the acquisition of new utility assets. This arrangement used in private finance, makes it unnecessary to borrow for minor property acquisitions, while maintaining the integrity of the amount of net depreciated utility property pledged for the mortgage debt.

7. Because generating and transmission loans are expected to be a major part of the business of the Electric Bank, a stronger provision for appraising their soundness before they are permitted should be incorporated in the bill. The bill now provides (page 19, paragraph 4):

“No loans for the continuation, operation, or enlargement of any generating plant shall be made unless the consent of the State authority having jurisdiction in the premises is first obtained."

Some states have no commission with jurisdiction over such matters. Some provision to cover this situation is essential. Investors hesitate to lend upon what may be uneconomic, or high cost facilities, even if supported by contractual guarantees of power buyers. They are uncomfortable if there is a possibility that power buying co-ops may find themselves bound to purchase power at rates higher than projected and possibly more than the wholesale price available from existing investor-owned companies, which may have committed funds to serve such co-ops.

The Annual Report (1965) on Energy Purchased by REA Borrowers shows States in which distribution co-ops are paying more for power purchased from generating co-ops than from investor-owned suppliers. Investors will prefer not to lend on the security of co-op power plants which, in spite of the subsidy of 2 percent money and very low tax expense, cannot supply power as cheaply as that offered by the investor-owned utilities in that locality. (In 1964, REA borrowers showed tax expense of 342 percent of revenues; investor-owned electric utilities, 21 percent of revenues.)

8. Finally, because “territorial integrity” is an important item for investor confidence, it would seem desirable that the matter should be covered in a way to minimize any future disputes. It will be recalled that when the Tennessee Valley Authority moved from Treasury to public financing, the legislation was drawn to settle this matter. Part II. Matters not major to insuring investor confidence in Electric Bank

securities but essential to sound public policy The last two points made as to adequate appraisal of major loans for generating and transmission and territorial integrity have importance that goes beyond the realm of investor confidence and successful Electric Bank financing.

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They involve extending accepted principles of public policy for electric utilities to cooperatives.

The matter of taxation, because it raises the costs of power sold by investorowned electric utilities, is also a matter of first-rate importance to public policy. In accordance with the policy established for other federal and federal agency obligations, the income from its debentures will not be exempt from federal income taxes. With regard to state and local governments, the Electric Bank is authorized to make payments in lieu of property taxes on property which was subject to such taxation before acquisition by the bank but that it "shall be guided by the policy of making payments not in excess of the taxes which would have been payable upon such property in the condition in which it was acquired." (page 16, line 11).

If the provision applies only to property acquired by the Bank, as by foreclosure, and not to property owned by borrowing co-ops, then it may be deemed to be protective of the investor interest. In general, all local taxpayers are also power users and it would seem reasonable to permit them to elect whether they should desire to raise tax revenue through the greater or less taxation of the utility which serves them, whether title is held by an investor-owned or a cooperative organization, so long as the extreme condition of foreclosure does not exist.

A precedent has been established for a federal agency to pay amounts in lieu of federal income taxes, and it raises the question as to whether it would not be equitable for this system to be made sụbject to equivalent levies as soon as its financial integrity has been established and the electric rates charged customers become reasonably comparable to those of similarly situated investor-owned utilities. The Federal National Mortgage Association pays an amount in lieu of federal income taxes that equals the full federal levy upon corporations, even while continuing to need and use the support of federally contributed equity funds.

Not only is the new Bank not subject to any income tax but the bill provides that its expense budget shall continue to be borne by the Treasury. The expenses of the REA system are not large. They were about one-tenth of the net income or net margin after interest expense of the system in 1964. To provide for ultimate independence, a gradual shift might be made over a ten or fifteen year period so that these expenses would be borne by the beneficiaries of the system. These expenses represent not merely financial but also management and engineering services essential to a scattered system of independent electric co-ops.

A final suggestion is that the co-ops use their new Electric Bank as a depositary of excess cash, with the resulting funds to be used for the intermediate loans referred to by this bill. These accumulations are reported to be invested currently in savings accounts with savings and loan associations and commercial banks and in U.S. Government obligations. They have been accumulated under standards recommended by the Rural Electrification Administration, which would be regarded as excessive by investor-owned utilities, namely, 15 percent of total utility plant. (Study Report, page 12. Their exact amount is uncertain because of the practice of the REA in lumping together all of the current assets of the borrower co-ops, under the heading of "current and accrued assets." This report states (page 12) that 40 percent of the distribution borrowers had general funds of 15 percent or more of total plant.) The pooling of any excess cash with the Bank would minimize the need for “reserves” of cash to meet emergencies and minor financing requirements. Those desirous of antcipating such needs could lend them through the intermediation of their bank to fellow-cooperatives.

In conclusion, let me add some personal reactions to this bill. I have made proposals aimed at making the system move to independence as rapidly as possible. These are necessarily somewhat tentative because of the shortness of the period available for study. Nevertheless, I have been impressed by the unfavorable reaction from some whose concern is for the rural consumer and others who are interested in the soundness of the financial arrangements.

They are puzzled by a bill which proposes in one sentence (page 13) that the Debentures of the proposed Electric Bank shall state that neither their principal or interest are guaranteed by the United States. Yet the succeeding paragraph states: "If there are insufficient funds in the assets of the electric bank available for the purpose to pay interest or principal on its electric debentures, the electric bank may obtain funds for this purpose by making and

issuing notes to the Secretary of the Treasury." It is difficult to see how this latter paragraph is less than a guarantee.

To confine the Treasury contribution to the amount of need, my own proposal is that advances be limited to a loan or grant to any individual distributor co-op that is unable to earn enough to meet its interest obligation to the Electric Bank without raising its rates to an unreasonable level. It is in such individual situations, in the absence of poor management, that our sympathies would lie.

Or to take another point, how can we reconcile the objective of ultimate independence with the requirement that the Treasury invest $50,000,000 each year, or a total of $750,000,000 over 15 years, regardless of the need for so much equity capital. The matter of its retirement is left for consideration after June 30, 1981, even though its prior retirement might be feasible.

Over fifty years ago, as a college student I made a class speech extolling the achievements of an ex-college teacher, Woodrow Wilson. One of those was the founding of the Federal Land Banks, I should like to see this bill follow the pattern of that institution which is found in later farm credit agencies: a close gearing of Treasury aid to actual need, a plan for insuring the soundness of loans, and a plan for transition to independence from Treasury support.

The CHAIRMAN. The next witness is Mr. C. A. Lilly, Jr., president, Gulf Power Co.

We will be glad to hear from you now.



Mr. LILLY. Mr. Chairman and members of the committee, My name is Clyde A. Liliy, Jr., president of the Gulf Power Co. Í reside in Pensacola, Fla.

The Gulf Power Co supplies electric service in that area of northwest Florida lying west of the Apalachicola River. I appreciate very much the oportunity of appearing before your committee.

My appearance is in opposition to H.R. 14000 and H.R. 14837.

I will file my more complete statement and will omit much of it from this oral presentation.

The CHAIRMAN. Withont objection, that may be done.

Mr. Lilly. As the REA cooperatives were formed in northwest Florida, Gulf Power Co. supplied their electric requirements at wholesale rates below the national average and for over 25 years the company and the cooperatives worked together to supply and develop the rurl areas of northwest Florida. As a result of these efforts of the company and cooperatives, almost every person in northwest Florida actually desiring electric service is supplied.

Several years ago with most of the persons in rural areas supplied with electric service, the REA controlled cooperatives began to deviate from the purposes for which they were created by Congress. A major concern is that under the bills being considered by this committee, Federal bank borrowers could serve municipalities and suburban areas irrespective of size or present service, while continuing free from control such regulatory agencies as the Federal Power Commission, even though they may be in interstate commerce.

In 1958 the company entered into negotiations with Choctawhat hee Electric Cooperative for a new contract covering the continuation of its supply of the electric power requirements at the four delivery points of the cooperative. During these negotiations and without our knowledge, the cooperative was constructing a transmission line from the system of the Alabama Electric Cooperative to supply the electric power requirements of two of its delivery points. Both of these deÎivery points were disconnected from Guif Power Co. and connected to Alabama Electric Cooperative in December 1958, even though Choctawhatchee was to pay more for the electrical energy from the Alabama Cooperative and still is paying more. The “26th Annual Report of Engery Purchased by REÅ Borrowers" for the fiscal year ending June 1964 (REA Bulletin 111-2) says that Choctawhatchee Cooperative paid Alabama Electric 8.4 mills per kilowatt-hour for power at the delivery points as contrasted with 6.6 mills per kilowatthour for power supplied at its other delivery points by Gulf Power Co. A later report, the 27th annual report, shows that the Choctawatchee Electric Cooperative is paying the Alabama Cooperative 8.8 mills per kilowatt-hour as contrasted with the 6.6 mills per kilowatthour being paid to Gulf Power.

The question is often asked why would a cooperative pay more for power than necessary.

In earlier hearings, Congressman Hlagen asked Mr. Person this question, and it is difficult to give a full answer, but from testimony before the Senate Agricultural Appropriations Subcommittee last year, there may be some light shed on the case, and I read from that testimony. Senator Holland asked the same question. This is from that testimony:

Senator HOLLAND. My question was whether any pressure had been exerted on you to get you to buy and continue to buy power from the Alabama co-op?

Mr. PENTECOST. There is some; yes.
Senator HOLLAND. From what source?

Another example of deviation by cooperatives from their mission of rural electrification, even under present law and congressional control, was the importation of out-of-State generation and transmission cooperative power to serve a nonrural load in our service area.

Within the 7,400 square-mile area served by Gulf Power is located Eglin Air Force Base with an area of approximately 800 square miles. Gulf Power Co. has furnished all the electric power requirements of this base since its inception prior to World War II and has several millions of dollars invested in lines, substations, and other facilities.

In October 1962, the Air Force invited Gulf Power and Choctawatchee Electric Cooperative to submit proposals to furnish the electric power requirements, some 4,000 kilowatts, of a radar tracking research installation to be installed by the Bendix Corp. and designed as a SPADAT “A” system. The specifications required a 115,000-volt line to the site with a capacity of 15,000 kv.-a. and substation capacity of 7,500 kv.-a. initially. The Air Force advised that service requirements were very critical as to variations of voltage and frequency and interruptions could not be tolerated. The cooperative had no 115,000volt lines and had never operated such a high-voltage system. At that time Gulf Power Co. had approximately 900 miles of such lines. Three separate Gulf Power Co. 115,000-volt lines already served the Air Force base loads. We had such lines along the north, east, and west boundaries of the Eglin reservation as shown by the sketch attached.

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