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STATEMENT OF HARRY G. GUTHMANN, EMERITUS PROFESSOR OF FINANCE, NORTHWESTERN UNIVERSITY SCHOOL OF BUSINESS, EVANSTON, ILL.

Mr. Chairman and members of the Committee, my name is Harry G. Guthmann and I live at 718 Noyes Street in Evanston, Illinois. I am an emeritus professor of finance, Northwestern University in their School of Business, where I tanght from 1927 until June 1965. I have taught in other places, such as the University of California at Berkeley, the University of Texas, and Syracuse University.

I appreciate very much the opportunity of presenting testimony to your Conmittee upon a bill which has such an important bearing upon the future of the Rural Electrification Administration. I might add that this testimony represents material that I have gathered myself. The views are my own and not necessarily those of the University with which I have been affiliated or of anyone else.

The two purposes of this bill to amend the Rural Electrification Act of 1936 and provide for a Federal Bank for Electric Systems, should meet with general approval. They are to provide (1) a beginning of public financing to replace the present dependence upon the federal Treasury and (2) the objective that this bank and a similar one for rural telephone systems shall become entirely privately owned, operated, and financed corporations.

This statement is one of analysis and commentary on the Electric Bank only, which is the larger and more complex institution. The Rural Electrification system already greatly exceeds the Tennessee Valley Authority in electrie utility assets, revenues, and earnings. The Electric Bank proposed in this bill opens the prospect of an institution larger than any of the existing farm credit agencies. The first part of my testimony suggests changes that might improve the credit standing of the Bank and lead to a more ready acceptance of its securities by investors and lead to the earlier independence and complete ownership of the Electric Bank by its cooperative members.

Finally, brief reference will be made to certain features that are referred to in the bill, which, while they may not be essential to maximizing its financial standing and minimizing the cost of its credit, nevertheless deserve attention. Suitable provisions would bring the proposed Electric Bank more nearly into line with practices that have been found acceptable in other federal farm credit agencies. They would also accord with the general philosophy of such agencies of moving steadily away from an initial dependency upon support during the period of their promotion and uncertain financial standing towards independence as their successful performance established their ability to stand on their own feet.

PART I. CHANGES PROPOSED TO MAXIMIZE THE CREDIT STANDING OF THE ELECTRIC

BANK

1. All lending for the acquisition of property for both generating and distribution co-ops should be channeled into and be made by the Electric Bank. While the bill is not specific, there is a general implication that the Bank is primarily to serve the demand for generating and transmission loans and that distribution co-op loans may continue to be made from 2 percent advances from the U.S. Treasury. To continue the latter loans would ignore:

First, the increased security which the distribution loans would give to any Debentures issued by Electric Bank. They diversify the security behind the Debentures. Moreover, the distribution co-ops show the larger earnings relative to interest charged and they have accumulated a more substantial surplus of assets over debt.

Second, it would ignore the ability of the distribution borrowers to pay going market rates of interest. The distribution borrowers have shown increasing earnings and are earning substantially more than the 2 percent they now pay. As a system, they now earn six percent on their present debt. They should continue to enjoy a surplus over the present low 2 percent on existing loans and will only pay higher rates for loans to finance new utility property. Because they have substantially covered their respective areas, new customers will represent increased customer density and higher demand per customer both of which should be served at decreasing costs from those for the existing business. The favorable earnings situation for the distribution co-ops is reflected in the

following figures. For the power-type co-ops, earnings have grown but at a less rapid pace than debt.

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The problem of the co-op unable to earn interest charges is faced below. Third, to exclude the distribution co-ops would ignore the fact that the bulk of their new customers, who made additional funds necessary, are nonfarm customers. Some are rural but many are small town, suburban, commercial and industrial. Because they are added to an existing system, they should require little, or no, subsidy.

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 "eight times the paid-in capital and retained earnings" (page 18) to 15 or 20 times. This borrowing base could be further strengthened by providing 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 (page 16), which requires its purchase by borrowers equal to 5 percent of their loan. (All page references are to S. 3720 except where noted as from Rural Electric Financing Study Report, July 1963.)

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 16). The required amount might be between one and five percent of the maximum amount borrowed in the past. In cases of need this subsection 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. Even if the bill should limit debenture issues to eight times paid-in capital and retained earnings, an equity of $1,188 million would be sufficient to support the largest amount of financing projected by the Study Report (page 44), or $91⁄2 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, or $475 million, only some $713 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 in the amount of Class A stock would hasten the day when it 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 acquisition, 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 23):

"No loans for the construction, 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 32 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. 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 6).

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 subject 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 investorowned 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 Treausry. 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 anticipating such needs could lend them through the intermediation of their bank to fellowcooperatives.

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. 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 (pages 18-19) 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 Elecric 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.

STATEMENT OF SHEARON HARRIS, PRESIDENT, CAROLINA POWER & LIGHT Co., RALEIGH, N.C.

Mr. Chairman and gentlemen of the committee, our Company appears before you in opposition to the pending legislation proposing supplemental financing for rural electric cooperatives in its present form. Presentations analyzing these bills section by section have already been made. Thus, it shall be my purpose in this testimony to undertake to develop a clear understanding and appreciation in the minds of the members of the Subcommittee as to the extent of the subsidies now involved and proposed to be involved in the supplemental financing. With that premise established, I should like then to offer some suggestions concerning what I believe to be the best service of the total public interest in dealing with this subject.

Let me qualify the basis on which I make this presentation. Eighty-three percent (83%) of our operation is in North Carolina and 17 percent in South Carolina. The major investor-owned electric utilities serving North Carolina are Carolina Power & Light Company, Duke Power Company and Virginia Electric and Power Company. The major electric utilities serving the State of South Carolina are Carolina Power & Light Company, Duke Power Company and South Carolina Electric & Gas Company.

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