Rural Telcos Canceling Broadband Projects in Wake of USF Reform

"We've been punished for investing in broadband,” said Rick Vergin, CEO of Mosaic Telecom. The rural telco has about 10,000 customers in northwest Wisconsin, and spent 2009 ensuring that 100 percent of its subscribers had access to broadband no slower than 10 Mbps. Half its customers have fiber to the home. The buildout put Mosaic in the top 10 percent of expenditures for “similarly situated” carriers. That runs them afoul of a new rule, passed as part of the FCC 2011 USF/intercarrier compensation order, limiting reimbursable capital and operating costs for high-cost loop support received by rate-of-return carriers. The order said the new framework would “create structural incentives for rate-of-return companies to operate more efficiently and make prudent expenditures.” An FCC further notice requested comments on whether the 90th percentile is the best cut off, or if it should be slightly higher or lower, and in any case, the rule is slated to take effect July 1.

"We've invested in broadband in our exchanges, which is the very thing that the FCC has claimed is their main focus: To extend broadband in rural areas,” Vergin said. “We've been impacted pretty significantly by the order and because of it, we've canceled projects and are in a mode of trying to adapt to the new normal.” Mosaic had projected $8 million in revenue this year, which would have given the company a “modest income” that, because it’s a cooperative, would have been reinvested and used to build out the infrastructure. With the new rules, Mosaic expects a 17 percent reduction in revenue. “It changes us from having a modest income to having a loss, both from a net income perspective, but also from a cash basis, which is significant,” Vergin said.

Beginning July 1, the telco expects an annual loss of about $1.3 million, and it has canceled projects because of it. Mosaic aborted plans to run fiber about 30 miles from Cameron to Ladysmith. The project would have connected five Verizon towers along the route, as well as several of Mosaic’s own towers, and it would have provided faster broadband in Ladysmith, one of Mosaic’s competitive carrier towns, the telco said. It also would have provided a backhaul for Verizon LTE towers.

Old System ‘Unsustainable'

"Our reforms replaced an unsustainable universal service and intercarrier payments system with stable, fiscally responsible support for rural voice and broadband,” the FCC said in a statement. “The Order was informed by months of comment and literally hundreds of meetings with all stakeholders, including rural carriers. Adopted unanimously, these reforms were carefully targeted to be fair to consumers paying into USF, who deserve fiscal responsibility and accountability for every dollar spent, while preserving existing service and expanding access to broadband and the jobs it provides for all rural Americans. The Order also initiated an efficient, data-driven process for carriers to seek waivers to address any unique circumstances."

Commissioner Mignon Clyburn emphasized the importance of the waiver process. “In terms of our policymaking and procedure, when you put forth policies, you cannot know what every single scenario will be -- you're making omnibus policy,” she said in an interview. “That is why we put a process in place, so those entities can come and make their case. I can’t say what the outcome will be, but our office was very involved in ensuring that there is a pathway for exchange from that perspective."

In providing for a waiver process, the order cautions would-be applicants that the commission does not “expect to grant waiver requests routinely.” The review process will be “rigorous, thorough, and searching,” the agency said. “In particular, we intend to take into account not only all revenues derived from network facilities that are supported by universal service but also revenues derived from unregulated and unsupported services as well,” the order said. “The intent of this waiver process is not to shield companies from secular market trends, such as line loss or wireless substitution."

The FCC’s new methodology will reduce HCLS payments to about 280 rural rate-of-return cost study areas by an estimated $110 million, and about $55 million would be redistributed to 340 cost company study areas, the order said. “We thus estimate that more study areas could see increases in HCLS than would see decreases."

That doesn’t assuage the small rural telcos who say they are being hurt by the USF order -- and state governments are taking notice. North Dakota Governor Jack Dalrymple wrote FCC Chairman Julius Genachowski last month, asking that the commission modify the order to fix “obvious and serious problems.” North Dakota citizens have relied for decades on rural telephone co-ops and small independent telcos, Dalrymple said, and those telcos in turn have relied on USF and ICC fees to support the infrastructure they've built. “Your recent order, together with a further notice of rulemaking the FCC has issued, threaten to eliminate incentives and opportunities for the rural telecom companies to continue building out new services,” Dalrymple wrote. “A number of these smaller, rural companies have put expansion plans on hold because there is no assurance in your recent order and further notice that they will have the funds to pay for the expansion of their service. Those decisions mean lost jobs and lost economic opportunities."

The Northwest Communications Co-op has put two projects on hold. “Two exchanges were going to go from copper to fiber-to-the-home,” CEO Dwight Schmitt said. “I informed the directors at our board meeting this week that these projects are on hold.” Replacing the copper with fiber was part of a three-year project set to start this year and cover six exchanges, he said. NCC had secured a $10 million loan from the Rural Utilities Service for the project, but after the USF order, RUS asked the company to resubmit its loan request with more detail on how the new rules would affect its solvency. “Our growth potential is huge,” Schmitt said, “but right now those projects, as of today, are shelved until we can secure funding.” It “would be irresponsible for either one of us to move forward without a good understanding of the impact of USF reform, Schmitt said. “It’s just a little frustrating."

NCC is in great shape, Schmitt says, so the reforms shouldn’t hit the company too hard. But some other companies in the state that have gotten RUS money are apprehensive to spend it, he said.

At the Dickey Rural Telephone Co-op in south central North Dakota, the major infrastructure projects are complete, so the USF reform will have more of a “social impact,” said General Manager Jeff Wilson. With reduced funding, Dickey will cut back on its community outreach programs like computer literacy training for seniors, an affordable PC program and an education program that teaches Internet safety in schools.

"It would have an impact on peoples’ lives,” Wilson said. Dickey will see “as much as a 50 percent reduction” in support over the next five years, and the built-in recovery mechanism designed to soften the blow of lost termination fees “won’t recover everything,” he said.

Much of Dickey’s loss is due to reforms of the FCC’s Safety Net Additive program. The USF order said the program was “no longer meeting its purpose” of encouraging new investment. Payments ballooned from $9.1 million in 2003 to $78.9 million in 2010. “The majority of incumbent LECs that currently are receiving the safety net additive qualified in large part due to significant loss of lines, not because of significant increases in investment, which is contrary to the intent of the rule to provide additional funding only for significant new investment,” the order said, eliminating the rule “immediately.” It grandfathered existing recipients of support, but declined to provide support for costs incurred after 2009. Dickey qualified for the SNA program regardless of line loss, Wilson said. “That’s what really bothered me,” he said, adding that his company had only about 1 percent line loss during that period.

Dickey made substantial investments in 2010, replacing antiquated cable with fiber. Under the old rules, in any year with an investment up more than 14 percent over the previous year in a location, the safety net gave financial support on a per-line basis. “We were supposed to start receiving it in January 2012, and it just went away,” Wilson said. “We are going to lose a substantial amount of money based on our investments.” In a footnote, the order acknowledged carriers like Dickey. “Since early 2010, the Commission has given carriers ample notice that we intended to undertake comprehensive universal service reform in the near term,” it said. “Thus, carriers that have not yet started receiving SNA but may have been anticipating such support based on 2010 and 2011 investments stand in a materially different position than companies that have already started receiving support based on earlier expenditures."

"People have been calling for reform of this program for literally a decade,” a top FCC aide said. “It’s not as if companies were somehow caught by surprise that reform was happening. We never could have reformed this program if all existing investments were completely exempt from increased accountability and fiscal responsibility.” That said, “we understand the concerns,” and that’s why there’s an “individualized, fact-intensive” waiver process built in to the order, the official said. So far, very few carriers have filed for waivers, he said.

Wilson said he doesn’t buy the argument that carriers should have known the funding was about to dry up. “If that’s the case, nobody would have invested in anything,” he said. Now, people are “scared about having to invest in anything,” fearing that the commission will retroactively change things again, and “there will be no way to recoup,” he said.

Waiver Requests

Telcos that requested waivers warn of dire consequences if they're not granted. Big Bend Telephone Co. covers a large, low-density, mountainous service area in west Texas of 17,000 square miles covering 25 percent of the U.S.-Mexico border, with “unique challenges,” its request said (http://xrl.us/bmxg2w). Higher construction costs to deploy facilities in the rocky terrain, and higher maintenance costs due to poor roads and extreme weather, mean BBTC depends on its USF support.

The company has “several outstanding loans,” including loans that refinanced debt it has held with RUS since 1991. It said the impending implementation of the HCLS regression analysis will be a “primary driver” of BBTC’s expected revenue loss, as it generates caps on recovery for investments the telco has made, and has contractual obligations to make payments on. The telco projected defaulting on loan covenants by 2013 and running out of cash by 2016. “Absent a waiver and the continuation of existing federal universal service funding most, if not all, communications services in West Texas would go dark,” the request said.

Allband, a co-op formed in late 2003 to serve a remote area in Michigan, wants a waiver (http://xrl.us/bmxg64). It owes RUS $8 million on loans that let it purchase and construct facilities to serve the previously unserved area. “No other service provider was willing to incur the very high costs per customer to provide service,” its filing said. The HCLS regression formula and the new $250 per-line monthly cap on universal service support will “irreparably and immediately harm Allband,” the company wrote. Federal USF revenue makes up 84 percent of its total regulated and non-regulated revenue. Absent the rule change, Allband would receive about $8,500 per line in 2012; the new monthly cap will reduce Allband’s regulated revenue by 55 percent, the waiver request said.

Allband customers paying about $20 monthly for basic phone service would have to pay $484.90 per month by July 1, 2014, to make up for the shortfall, the telco said: “Had Allband known that this Framework limiting its Federal USF revenues would be enacted, it very likely would not have undertaken forming the ILEC to provide service to customers in this unserved area.” Comments on Allband and BBTC’s requests are due March 14.

"If you look at it from the perspective of the rural telcos, the rules are obviously changing for them,” said Anna-Maria Kovacs of Georgetown University’s Center for Business and Public Policy. “Ones that had operations that were not as efficient as their peers are going to get hit by having to operate at a more efficient level. Their concerns are understandable, but I think it’s unfair to the FCC to look at it as being punitive. I think what they're saying is we have to be fair to all consumers -- those who are paying, as well as those who are benefitting.”