For its capital needs in excess of funds generated from operations,  TVA was authorized to borrow by issuing bonds and notes. To determine whether TVA is properly accounting for the lease-leaseback  arrangements for financial reporting purposes, we reviewed authoritative  accounting literature related to accounting for leases. TVA has used lease-leaseback  financing arrangements to refinance 24 combustion turbine power  generators that are used during periods of peak demand for power. TVA Retains Legal Ownership of Assets, but Both TVA and the Private Equity Investors Are at Financial Risk

The lease-leaseback financing arrangements allow TVA to retain legal title  to the assets while transferring sufficient property interest in the assets to  the private equity investors so that they may claim tax deductions that can  be used to offset the taxable income from the lease payments and any  potential gain on the sale of the assets. Under the lease-leaseback arrangements, TVA retains legal title to the  assets but relinquishes sufficient interest in the assets so that the equity  investors are entitled to certain tax benefits that are not available to TVA. In large part, who will benefit from this arrangement depends on the fair  market value of these generating units at the end of the 20-year leaseback  period. For example, if at the  time of the 2017 early buyout option date, the fair market value of the  assets is higher than expected, TVA can purchase the equity investor’s  remaining interest in the assets at a set price established in the lease  arrangement and avoid the possibility of paying additional value for the  assets 4 years later at the end of the 20-year leaseback period. In addition, the lease-leaseback arrangements could have implications for  the federal treasury. Lease-Leaseback Accounting Complies with Applicable Standards and Requirements

TVA’s lease-leaseback arrangements are classified as liabilities in TVA’s  financial statements, as required by GAAP, and are classified as debt for  budgetary reporting purposes, as required by OMB guidance. All of TVA’s lease-leaseback  arrangements are now treated as debt in the President’s Budget. Therefore,  TVA’s decision that its lease-leaseback arrangements should not be treated  as debt for purposes of the debt cap in section 15d(a) of the TVA Act is not  unreasonable, even though these arrangements have the same impact on  TVA’s financial condition and future competitiveness as traditional debt. Conclusions

TVA has entered into substantial (about $945 million) lease-leaseback  arrangements with private investors and is considering expanding its use of  these and other nontraditional financing arrangements. While the lease- leaseback arrangements provide TVA with a lower cost of financing over  the first 20 years, they also pose risks. Legal Ownership and Risk If the Lease- Leaseback Arrangements Do Not Work Out as Planned

To determine who has legal ownership of the assets financed by lease- leaseback transactions, and who is at financial risk if the projects do not  work out as planned, we  obtained and reviewed copies of the fiscal years 2000 and 2002, and  December 2002 lease-leaseback arrangements covering 20 of 24 power  generating units;  interviewed officials of TVA’s IG, Chief Financial Officer (CFO)
Organization, and Office of General Counsel (OGC),  OMB, and CBO;   reviewed summary documents prepared by TVA’s OGC and IG that  identify and explain the responsibility of the different parties to the  agreements;  reviewed an economic analysis of the fiscal year 2002 lease-leaseback  arrangement prepared by TVA to compare its borrowing cost under  traditional debt financing with its cost under the lease-leaseback  arrangements;  compared TVA’s cash flow under the fiscal year 2002 arrangement to  traditional debt financing if TVA were to exercise the early buyout and  termination options in the fiscal year 2002 arrangement; and  analyzed the equity investor’s cash flows under the fiscal year 2002  arrangement.
Why GAO Did This Study

Concern about the implications of the Tennessee Valley Authority's (TVA) debt on its future competitiveness prompted Representative Richard Baker to ask GAO to determine TVA's planned and actual use of nontraditional financing arrangements (which, to date, has consisted primarily of lease-leaseback arrangements), who is at risk under TVA's lease-leaseback arrangements, and whether TVA's accounting for the lease-leaseback arrangements complies with applicable standards and requirements.

What GAO Found

TVA has traditionally financed its operations with cash generated from operations, the issuance of bonds and notes, and in the past, appropriations. However, in fiscal year 2000, it began to use alternative forms of financing (primarily lease-leaseback arrangements) and is considering expanding their use. The lease-leaseback arrangements involve the refinancing of 24 combustion turbine power generators that are used during periods of peak demand for power. The lease-leaseback arrangements accounted for about $945 million of the $992 million raised by alternative financing arrangements as of May 31, 2003. After the power generators were constructed, TVA leased them to private investors for 50 years and simultaneously leased them back for 20 years. Under these lease-leaseback arrangements, TVA received cash from the private investors, which was obtained by issuing debt in the public market and through the investors' own equity. TVA is responsible for making lease payments for 20 years, at the end of which it has the option to purchase the private investors' interest in the assets. TVA retains legal title to the assets under the arrangements but relinquishes sufficient interest in the assets so that the equity investors are entitled to certain tax benefits. The equity investors pass on some of these benefits to TVA in the form of more favorable financing rates. As a result, TVA is able to lower costs over the first 20 years of the arrangement. However, to retain use of the assets after the 20-year period, TVA would have to purchase the equity investors' remaining interest in the assets at the assets' fair market value at that time. Depending on the fair market value, TVA is at risk of incurring higher overall costs than under traditional debt financing. In large part, the determination as to who will be the net beneficiary of these arrangements and the implications to the federal treasury will hinge on the future value of the assets. TVA's lease-leaseback arrangements have been accounted for and reported in compliance with applicable standards and requirements for financial reporting, budgetary reporting, and debt cap compliance. TVA's lease-leaseback arrangements are treated as liabilities in its financial statements and classified as debt in the President's Budget. However, they are not counted against the debt cap in the TVA Act. While the lease-leaseback arrangements are not considered debt for purposes of financial reporting and debt cap compliance, they have substantially the same economic impact on TVA's financial condition and future competitiveness as traditional debt financing.