NMECG PRESENTATION TO THE NEW MEXICO PUBLIC REGULATION COMMISSION APRIL 3, 2012 THE FEDERAL COMMUNICATIONS COMMISSION’S ORDERS TO IMPLEMENT REFORM AND MODERNIZATION OF: UNIVERSAL SERVICE INTERCARRIER COMPENSATION VOICE AND BROADBAND SERVICES ADOPTED OCTOBER 27, 2011 – RELEASED NOVEMBER 18, 2011

KEY FACTS ABOUT RLECs IN NEW MEXICO NMECG Totals Access Lines 34,411 Square Miles Served 77,124 Customers per Square Mile 2.24 Number of Employees 526 Annual Payroll $28m Total State and Local Taxes Paid YE 2010 $4.8m 5 Year Capitol Investment Program $210m Outstanding Loans $225m Total Fiber Route Miles 6,322 Over 95% Customers Have Access DSL if they want it

Overview of Universal Service Steven D. Metts President New Mexico Exchange Carrier Group

Universal Service Concept Has Been In Place Since the Original Communications Act in 1934 Provide Basic and Essential Service to as Many People as Possible Comparable Rates in Urban and Rural Areas

Universal Service Originally Accomplished By Shifting Costs Away From Basic Local Service and To Long Distance Service Local Service Considered a Necessity and Priced Below Cost Long Distance Considered More of a Luxury and Priced Above Cost

Divestiture Introduced Competition in Long Distance Industry Customer Had A Choice of Long Distance Providers Local Exchange Carriers Began Charging Access Charges to Long Distance Carriers for The Use of the Local Network Access Charges Set Above Cost to Keep Local Rates Affordable

Subscriber Plant Factor Subscriber Plant Factor Was Used To Shift Local Loop And Some Switching Costs From State to Interstate Jurisdictions Weighting Allocated As Much As 85% of Local Loop Costs To Interstate Jurisdiction Weighting Was Done To Ensure Universal Service In High Cost Areas

Subscriber Plant Factor 1985 SPF Eliminated and Replaced With A 25% Gross Allocation Of Loop Costs To Interstate Jurisdictions Transition To The 25 % Gross Allocation Was Phased In From 1986 to 1993 Original Universal Service Fund Was Phased In Over The Same Period Increased End User Charges

Category 3 COE Weighting Separations Rules Changed To Make All Switching Costs Traffic Sensitive Switching Costs Were Shifted From The Intrastate Jurisdiction To The Interstate Jurisdiction Done In The Interest Of Universal Service Phased In From 1988 to 1993

Category 3 COE Weighting InterstateIntrastateLocal SLU Factor 20%32%48% Weighting3 Cat 3 Factor 60%25%15%

Switched Access Overview Switched Access Charges Are Intended To Compensate Exchange Carriers for: -Local Loop Costs -End Office Switching Costs -Transport Facilities

Telecom Act of 1996 Required “Implicit Subsidies” Be Removed From Rates and Made Explicit to Enhance Competition Expanded The Purposes Of The Federal Universal Service Fund Requires USF Support To Be Portable Among Eligible Telecommunications Carriers

MAG and CALLS Orders Implemented in 2001 and 2002 Eliminate Per Minute Charges For Carrier Common Line Increase Flat End User Charges New Elements of Federal USF  Interstate Access Support  Interstate Common Line Support

Elements of Federal USF High Cost Loop Fund Local Switching Support (LSS) Long Term Support (LTS) Interstate Common Line Support (ICLS) Interstate Access Support (IAS) Safety Net Additive

New Mexico USF Originally Established As Part of Commission’s ORP Order Legislature Established State Rural Universal Service Fund in Rural Telecom Act in 1999 Legislature Clarified SRUSF in 2005

Intrastate Access Charges Intrastate Rates Were Much Higher Than Interstate Rates Intrastate Rates Were Reduced to Interstate Rates With Companies Being Kept Whole By Payments From The Fund Instead of Passing it All On To Local Ratepayers

They Did What?! They Did What?! Out with the Old & In with the New An Overview of the FCC’s landmark Universal Service and Intercarrier Compensation Order on Rate of Return ILECs Doug Kitch, CPA

Outline  Brief History of the Proceeding(s)  Events leading to the Order  National Broadband Plan; Notice of Proposed Rulemaking; Industry Filings  What did happen  What didn’t happen  Universal Service (USF or CAF)  Intercarrier Compensation (ICC)  Reporting Requirements  Conclusion 19

Events Leading to Order  Growth of competitive markets  Wireless; IP; Broadband; Video  Growth in size of FUSF  CETC Identical Support Rule Less than $5M in 1999 to over $1.2B in 2010  Total fund = $2.6B in 2001 vs. $4.5B in 2011  FUSC assessment ~ 6.8% in 1Q2002 to 17.4% in 2Q2012  “A closer look at ILEC USF receipts reveals that ILEC’s non-access funding is down from $2.16 billion in 2003 to $1.37B in 2011” (Balhoff & Williams)  Other factors: growth of Rural Health Care USF program; E-Rate program 20

Events Leading to Order  Expanding availability of broadband  Behind as ranking world leader  Complicated hodge-podge of rules addressing various parts of the industry  Invites “gaming the system” 21

Brief History  The National Broadband Plan  Released March 16, 2010  Originated from American Recovery & Reinvestment Act (ARRA) – Congress directed the FCC to develop the NBP  Includes a plan for ensuring every American has access to broadband Capability 22

Brief History  USF/ICC Transformation Notice of Proposed Rulemaking  Released February 8, 2011  Proposed reforms to ICC and current USF  Designated broadband as supported universal service  Connect America Fund outlined  Order Released November 18 th,

What Did Happen in the Order  Extends universal service definition to include broadband  Establishes “firm” budget for USF ($4.5B)  Creates the Connect America Fund  Adopts Bill and Keep regime for all Intercarrier compensation  Begins phase-down of legacy universal service support  Addresses Access Stimulation and Phantom Traffic  FCC entry into traditionally state-level regulation 24

What Did Not Happen  Contribution reform  Long Term CAF considerations for RLECs  Increase in funding to reflect increased investment to meet NBP goals  Adoption of target speeds in rural areas of more than 4 meg/1meg 25

UNIVERSAL SERVICE Connecting America 26

Universal Service  Comprehensive Budget ($s in billions) 27 Total Fund$4.5 Price Cap $1.8 RoR $2.0 Mobility $0.5 Remote Areas $0.1

Universal Service – Rate of Return Carriers  Reforms to legacy support mechanisms  Framework to limit capital and operating expense recovery (separate slide)  New unsubsidized competitor rule (separate slide)  Phase out Safety Net Additive  Cap per-line monthly support at $250 (or $3,000 per line annually)  Eliminate Local Switching Support (effective 7/1/2012) 28

Capital and Operating Expense Limitation  Framework adopted  Subject to comment in FNPRM  Benchmarks for prudent levels of capital and operating costs for purposes of determining high- cost support amounts  Called “Quantile Regression Analysis”; to be implemented no later than 7/1/2012  Corporate operations expenses: extends current HCLS cap to ICLS 29

Unsubsidized Competitor Rule  Definition: “Facilities-based provider of residential terrestrial fixed voice and broadband service that does not receive high cost support”  Where an unsubsidized competitor is competing and covers 100% of a study area, no CAF funding will be available  Bureau is working on methodology to determine “100% overlap”  In study areas with 100% overlap, high cost support is frozen at 2010 levels or $3,000 times the number of lines, whichever is lower  Phased out over 3 years 30

INTERCARRIER COMPENSATION The road to bill and keep 31

Intercarrier Compensation  Immediate Actions – arbitrage practices  Access Stimulation  Phantom Traffic  Adopts uniform national bill and keep regime for all intercarrier compensation  In Bill and Keep, carriers look to their customer first, and then to support mechanisms  FCC adopts this framework for intrastate, as well as interstate, rates  States will continue to play a role 32

Recovery Mechanisms Key Concepts  Recovery will not be 100% revenue neutral  Recovery sources  Access Replacement Charge (ARC) to end user  Access Revenue Replacement Support from CAF (“ICC CAF”)  Eligible Recovery – the amount of ICC CAF revenue RoR LECs are allowed to recover  Recovery Baseline – based on calendar year 2011 interstate switched access revenue requirement and F/Y 2011 state terminating and reciprocal compensation amounts, reduced each year by 5% 33

ARC Recovery  If eligible (i.e. local rate plus surcharges is <$30), ARC surcharge of $.50/line/mo (residential and single line business) up to max of additional $3.00 and $1.00/line/mo (multi-line business) up to max of additional $12.20  The ARC charge is part of the $30 benchmark 34

ACCOUNTING & OVERSIGHT REQUIREMENTS Major changes 35

New Section  Applies to all high cost support recipients  Due April 2, 2012 and annually thereafter  Feb. 3 rd clarification Order: postponed until 4/1/2013 except for FCC- designated ETCs, which are required to file a progress report by 4/2/2012  State-designated ETCs that currently file information with states included with (a)(2-6) per below will now file that information with the FCC, USAC, etc earlier than 4/1/2013. New Mexico already requires this information 1.Progress report on 5-year service quality improvement plan 2.Detailed information on outages 3.Unfulfilled service requests 4.Complaints per 1,000 connections 5.Service quality standard certification 36

New Section Certification that carrier is able to remain functional in an emergency 7.Price offerings 8.Holding company information 9.Documentation of discussion with Tribal governments 10.Rate certification (starting 4/1/2013) 11.Results of network performance tests 37

Highlights of Feb. 3 rd Clarification Order  Local rate floor: only applies to HCLS, not ICLS ($10/$14 benchmark issue)  Financial reporting obligations: RUS reports will suffice in lieu of annual audit  High cost recipients still required to annually report ownership information, however compliance date not set yet for 2012  VoIP traffic: clarifies that “toll” VoIP traffic (mou-sensitive and flat rate) will be same as non-VoIP toll traffic  When state access rate is lower than interstate, state tariffs may NOT be modified to increase their access rates to interstate levels 38

Conclusion  Still Pending:  Final regression model  Whether regression analysis should apply to ICLS  Final ICLS corporate expense cap limitation formula  How to account for unsubsidized competitor rule if less than 100% terrestrial competitor presence  Specific transition of originating rates  Long term reform (ARC phase out; ICC CAF phase out)  Rate of return represcription  NACPL “recycling”  Next Steps  Further Notice follow up  Financial Analysis  State Impact Handout 39

Questions?

EFFECTS OF THE FCC’S USF AND ICC REFORMS ON RURAL CUSTOMERS IN NEW MEXICO AND THEIR RLEC PROVIDERS  Significant Reductions of Interstate Revenues for RLECs Without Alternate Revenues or CAF  Increased Operational Expenses  Forced Reductions of Capital Expenditures  Long Term Service and Network Degradation  Negative Economic Impacts  Increased Customer Rates  Increased Reliance on State Universal Service Funding

IMPACTS ON NMPRC Tariff Filings  Lifeline and Link-up  VoIP  Rate Increases for Services  Increased Contributions for New and Existing Customers – Aid-for-Construction  Access Recovery Charges – Interstate

IMPACTS ON NMPRC Consumer Complaints  Fewer Employees to Support Customer Requests and Requirements  Protracted Delays for Essential Network Upgrades, Replacements, and Maintenance

IMPACTS ON NMPRC Increased Requirements and Requests for NMUSF Support Careful Management of Regulatory Burdens  FCC’s Actions  HJM 9 – Inquiry for Streamlining Regulations for RLECs  Assure that consumers continue to have access to high quality and affordable services

IMPACTS ON NMPRC Competition –  Wireless Services are under FCC jurisdiction, but wireless carriers rely on RLECs to provide essential connections  Wireline Services remain under the NMPRC’s purview  Access Rates are prescribed by the FCC  Bill and Keep Rates will be developed by the NMPRC and the RLECs

IMPACTS ON NMPRC ETC Reporting Requirements  NMPRC is required to report expanded ETC requirements to comply with the FCC’s Order  Inclusion of Broadband matrices in addition to traditional Voice services