News of the Week

Funding Status

The FY 2012 Form 471 filing window is closed and application reviews are underway.  USAC released a preliminary estimate of FY 2012 demand showing a total increase of 21.5% over the comparable figure for FY 2011 (see detailed discussion below).  The FCC approved USAC's PIA review procedures for FY 2012 applications.  This action sets the stage for the first FY 2012 funding wave in May.

No funding waves for either FY 2010 or FY 2011 are scheduled for this week.  As a side note, however, it should be noted that the SLD has proposed to the FCC that Priority 2 funding for FY 2011 be granted at 89% and above and denied at 80% and below.  We expect that the final threshold for FY 2011 will be much closer to 89% than to 81%.

90% Priority 2 Funding in Jeopardy for FY 2012

For the past several years, there have been sightings in the E-rate community of an old man with a white beard and robe carrying a sign saying "The End Is Near."  Now he has a new sign saying "The End Is Here."

Last week, USAC released its preliminary estimate of demand for FY 2012.  It showed total requests of $5.237 billion, up a whopping 21.5% from the comparable total for FY 2011.  Total Priority 1 demand rose 12.5% to $2.444 billion — an amount approaching the cap on new E-rate funds for the year.

Most significantly, this means that almost all Priority 2 funding would have to come from roll-over funds.  Currently — although we're a few months away from an expected FCC decision on roll-over funds — there is only $400 million available.  While this amount may ultimately increase by $100-200 million, the total available for roll-over looks to fall well short of the preliminary demand estimate for Priority 2 which, at 90% alone, is $1.379 billion.  For the first time in E-rate history, it looks like there will not be enough money to fully fund all Priority 2 requests at the 90% level.

The key questions are: How did we get here?  And what do we do now?

E-Rate Demand Trends:

As shown in the table below, the total preliminary demand for FY 2012 rose 21.5% from the preceding year to well over $5 billion — landmark highs in terms of both absolute demand and percentage gain.

One problem, which has been recognized for a while, is that the demand for Priority 1 services has been trending upward, reducing available funding for Priority 2 services.  Factors driving Priority 1 demand include the recent eligibility of fiber services provided by non-telecommunications carriers, the aggressive allocation of eligible Web hosting, and the eligibility of bundled mobile devices.  Most importantly, however, has been the insatiable demand for higher bandwidth services — a demand that is only likely to increase as more states move to online assessments.

The recent increases in Priority 1 demand are shown in the table below.  Again, FY 2012 represents highs in terms of both absolute demand and percentage gain.

Until this year, the critical comparison for high— but not 90% — discount applicants seeking Priority 2 funding has been the combined level of demand for Priority 1, in total, and Priority 2, at the 90% level.  This, together with an estimate of roll-over funding, is used to provide the best indication of the likely Priority 2 funding threshold for the coming year.  These numbers are shown in the table below.

The problem this year is that the total demand for Priority 1 and 90% Priority 2 funding is well above the annual funding cap and any current projections on available roll-over funding.  This means that, for the first time, there does not appear to be enough money to fully fund Priority 2 at 90%, much less any money to fund Priority 2 at any level below 90%.

One interesting sidelight to the demand analysis for FY 2012 was the increase in Priority 2 demand by applicants below 80%.  Last summer, the FCC unexpectedly used part of the available roll-over funding, which would normally have gone into FY 2011, to fund all Priority 2 discount levels for FY 2010.  At the time, we wondered what degree of false hope for future Priority 2 funding this would engender among lower discount applicants.  The answer was "quite a lot."  As shown in the table below, the demand for Priority 2 funding below 80% had been declining consistently for several years as prospects for funding at those levels appeared to be diminishing.  But the FY 2010 windfall renewed hope — unrealistically, as it turns out — and led to a four-fold increase in demand for FY 2012.

The Future of Priority 2 Funding:

Assuming that E-rate funding for Internal Connections is important, at least for high discount applicants, the FY 2012 demand estimate brings the issue of Priority 2 funding to the forefront.  Most analysts had realized that Priority 2 funding was gradually being squeezed, but most had hoped that a crisis was at least several years off.  But, as the prophet's sign now reads, "The End Is Here."

To date, proposed solutions to the looming Priority 2 funding shortage have involved one or more of the following approaches:

1. Reduce the number of products and services eligible for E-rate funding.  Possible targets for elimination that have been discussed include POTS (i.e., basic wireline telephone service), Web hosting, and basic maintenance.
2. Reduce discount matrix levels either across the board or for Priority 2 only.  Lower rates would not only reduce discount payouts on existing service demands, but would presumably reduce demand for these services as well.
3. Increase the size of the fund.  Inflationary increases have been in effect since FY 2010, but will have the effect in FY 2012 of raising the annual cap to only about $2.3 billion (from the original cap of $2.25 billion).  Roll-over funding has been helping in recent years, but increases due to reserve accounting adjustments now appear to be limited.  Major new funding for E-rate would take a concerted political effort.

Implementing one or more of these proposals is likely to take some time involving, at a minimum, a public comment period and probably some serious infighting.  The more immediate problem is what to do about Priority 2 funding in FY 2012 with the tools at hand.

The most likely approaches for FY 2012 are either to prorate Priority 2 funding at 90% or not to fund Priority 2 at all, at least for the time being.  Neither option bodes well for 90% applicants eager to begin Priority 2 projects.  And neither means any Priority 2 funding for applicants below 90%.

Existing E-rate rules provide an option to prorate available funds when funding is not sufficient to fully fund all applicants at a given discount rate.  So far, this option has never been used.  To see why, consider the situation that occurred in FY 2008.  For that year, the FCC set the Priority 2 threshold at 87%.  Most likely, assuming you could budget this closely, there might have been some funds available to cover a portion, but not all, of the FRNs at 86%.  In that year, Priority 2 requests at 86% totaled a little over $165 million.  Suppose USAC calculated that it had $100 million to fund at 86%.  If it prorated the commitments, the 86% applicants would get approximately 60% of what they requested.  As will be discussed in the proration discussion below, it's not clear if 60% is much better than nothing.  In any event, prorating at 86% would have been an administrative nightmare.  So the FCC decided not to prorate and simply not to fund anything at 86%.

Similar decisions were apparently made in every other year (except FY 1999 and FY 2010, in which all discount levels were or are being funded).  The difference between those other years and FY 2012, however, is that the demand immediately below the threshold accounted for, at most, a few hundred million dollars.  As a result, the financial impact of not prorating at these levels was significantly less than it would be for FY 2012 (which involves over a billion dollars in demand).  Nevertheless, precedent suggests that not funding anyone for Priority 2 in FY 2012 is a distinct possibility.

If the FCC decides to prorate in FY 2012, its rules do not precisely indicate how that would be accomplished.  There are two major decisions that would have to be made.

The first decision is mathematically how to prorate.  There appear to be two options.  Either the discount rate can be prorated or the pre-discount amount can be prorated.  In one sense, the two alternatives are similar.  But depending upon the applicant, the difference could be significant.  Consider, for example, the situation if the FCC decided that it could fund only 60% of the 90% Priority 2 demand.  At this level, each applicant's discount rate could be reset to 54%.  Alternatively, the requested pre-discount could be reduced by 40%, but any purchases up to that reduced amount could continue to be discounted at 90%.

For a single $100,000 project, the two approaches are equivalent.  Either the applicant gets a 54% discount on $100,000 or a 90% discount on $60,000.  The net discount is $54,000.  To do the project, the applicant is going to have to pay $46,000 net, rather than the $10,000 it was expecting when it filed its application.  It may not be able to afford the project.

But suppose the project was divisible — e.g., involving $10,000 in equipment for each of 10 schools.  If it has to do all schools, the situation is no different than above.  But if the project's scope could be narrowed so as to install equipment in only six schools, then an applicant would probably rather get a 90% discount on the lower pre-discount amount than receive only a 54% discount on any work done.

Our conclusion is that prorating the pre-discount amount, rather than prorating the discount rate, gives applicants more flexibility.  The one downside of this approach is that it might encourage applicants to inflate requests in future funding years.  At best, this might be a one-year solution.

The second decision that would have to be made is how and when to set the proration percentage.  To be absolutely precise in setting that percentage, USAC would first have to review all 90% Priority 2 applications.  A better approach might be to estimate, based on past experience, the proportion of requested funding likely to be ultimately approved (probably about 75%), then set the proration percentage accordingly.  Even this figure is likely to prove conservative from a final disbursements perspective since many of the awardees won't be able to afford their increased non-discounted share.  Regardless of the approach taken, we would expect Priority 2 funding awards to begin later in the year than has been experienced in the past.

The best decision the FCC might make at the moment is to stall.  Given that whatever funding option is adopted, FY 2012 Priority 2 funding would not likely be awarded soon, there appears to be no need to rush a final decision.  Waiting will give USAC and the FCC a better view of the magnitude of the potential shortfall.  In the interim:

1. The FCC needs to wait another quarter to determine the amount of funds available for roll-over into FY 2012.  Should the FCC decide to, it could even waive the normal roll-over calculation date and wait an additional quarter or two until more roll-over funds are available.
2. USAC could initiate a Form 500 campaign to encourage applicants to reduce and/or cancel unneeded funding for earlier years.  This would enhance the funding available for roll-over.  Similarly, USAC might also initiate informal discussions with the applicants (or even service providers) responsible for the largest increases in FY 2012 funding requests to determine the possibility of reductions and cancellations.

Only one thing is for certain: this is going to be an interesting year for E-rate.  If a longer-term solution cannot be found, FY 2013 funding is likely to be even more challenging.

E-Rate Updates and Reminders                       

Form 471 Reminder Letter Deadline:

As discussed in the SLD's News Brief for April 20, 2012 and in our newsletter of April 23rd, USAC mailed out over 8,500 urgent reminder letters to applicants who may not have already certified their FY 2012 Form 471 applications and/or submitted the associated Item 21 attachments.  The deadline for completing these final steps is May 9th.

Note that, as a result of a software glitch, there was an addressing problem in the mailing process for these letters.  Although the letters themselves are properly addressed to the contact person on each application, the address printed on the cover sheet — and thus the address shown through the envelope window — includes only the organization name and address, not the actual contact person's name.  E-rate contacts at larger applicants may want to check their mailrooms to make sure that no reminder letters have been received, but not distributed.

Digital Literacy NPRM:

Reply comments on the FCC's proposals (FCC 12-11) to establish a digital literacy training initiative, funded through the Low Income Fund, but administered through the E-rate program, are due Tuesday, May 1st.  For an overview of the proposals, see our newsletter of February 13th.  A summary of some of the more important initial comments are discussed in our newsletter of April 9th.

Schools and Libraries News Brief Dated April 27 – PIA Product Eligibility Review

Last week's SLD News Brief for April 27, 2012, provides a useful review on eligible products and services, on conditionally or partially eligible products and services, and on eligibility allocation procedures.