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are used to finance pollution control facilities for small business. Such bonds are known as pollution control revenue bonds.
There is wide latitude in this type of financing under the laws of the various states, but a typical revenue bond financing for pollution control purposes would be as follows:
The public body and the business enter into an agreement, in which the business agrees to lease pollution control facilities from the public body. The public body, to obtain funds for the cost of the facility, then issues its bonds, which are secured by a lien on the lease payments made by the business. The facility may also be mortgaged to a trustee for the bondholders as additional security. The proceeds of the revenue bond issue are placed in a fund administered by a trustee. These funds are used to pay the costs of construction of the pollution control project as it is built. H.R. 78 provides that the Small Business Administration guarantee each lease separately.
No matter what form the transaction takes, payments to the public body must be sufficient to cover debt service on the revenue bonds and other expenses incurred by the public body. The credit of the municipality or state creating the public body is not pledged to support the bonds in any way. The sole source of revenue to cover debt service must come from the small business-H.R. 78 shifts this burden to the Federal SBA.
There are numerous variations on this basic plan, depending upon State law. In the most common variation the business purchases the facility from the public body at the end of the lease term for a nominal consideration, thereby being treated as the owner for tax purposes during the lease period. It is also possible for the transaction to be an ordinary lease, with lease payments deducted by the business as rental payments. Revenue Ruling 68–590 provides that a corporation that enters into the type of financing described above can be considered the owner of the facility for Federal tax purposes, although in the typical financing, bare legal title to the facility is in the public body. In addition to the leasing route, in some states the public body may make a direct loan of bond proceeds to the business, secured by a loan agreement or note. In other states, the public body may enter into an installment sale agreement with the business, secured by an installment sales contract.
Funds for repayment to bondholders are available through rental payments for the use of such facilities by small business. In the case of a direct loan to a small business for the purpose of purchasing pollution control facilities, bondholders are repaid through loan repayments.
The bondholders are represented in their dealings with the public body and the business by a trustee, almost always a local bank. The trustee, as representative of the bondholders, has many duties and tasks to perform. It acts in effect as the administrator under the terms of the agreement entered into between the public body and the trustee. The proceeds of the revenue bond issue are placed in a construction fund administered by a trustee. These funds are used to pay the costs of construction of the pollution control project as it is built. The trustee typically invests the unused portion of the funds at a rate sufficient to pay the interest on the bonds. Lease payments by the business are made directly to the trustee who performs the necessary bookkeeping and provides for the payment to the bondholders of principal and interest to the bondholders.
Depending upon State law, the trustee and the public body may contract to expand the duties and functions of the trustee to embrace matters considered necessary by the parties and not contrary to State law.
The basic credit problem revolves around the following fact: Because the nature of pollution control facilities is nonproductive, pollution control revenue bond rentals are yet another charge on skimpy revenues.
The major credit sources for funds to private industry are institutional. This is particularly true when it comes to financing pollution control equipment. The most significant institutional buyers of pollution control revenue bonds are banks and insurance companies. Both of these investors are under statutory and internal restraints as to the quality of the credit underlying the securities in which they invest. The obligations of very few, if any, small businesses would qualify for purchase by institutional investors. Accordingly, such obligations are either unmarketable, or marketable at interest rates which make repayment prohibitive.
To alleviate this condition we recommend that H.R. 78 be implemented wherein the Small Business Administration (SBA) guarantee lease payments or loan repayments to be made by small business for pollution control facilities financed with the proceeds of tax-exempt industrial revenue bonds issued by a public body. Such an SBA guarantee would make pollution control revenue bonds highly marketable at an interest rate substantially less than such industrial revenue bonds would bear without an SBA guarantee. These bonds would not compete for funds with other Government agency financings in the taxable market. Instead they would be issued as tax-exempt securities. Although rates fluctuate, in today's market, pollution control revenue bonds secured by an SBA guarantee on lease payments made by the small business would probably bear from one-third to one-quarter less interest than taxable Government issues. In this way small business could have access to relatively inexpensive financing for pollution control facilities.
As additional security for the bondholders, the trust agreement may require the establishment of a reserve fund. There are two ways to establish such a reserve fund. It can be funded from the proceeds of the bonds issued or it can be built by requiring additional payments from the business in the initial years of the lease. Such payments would be made as part of the normal lease payment. The reserve fund, regardless of how it is developed, can be used for such purposes as replenishing the SBA's actuarial fund in case of depletion of the fund by an unexpectedly high default ratio.
The obligation of the business to make lease payments would remain unaffected by the establishment and presence of such a reserve fund. In the event that the loss ratio was so favorable as not to require reimbursement from the reserve fund, the moneys within the reserve fund would either serve to pay off the final payment on the lease or would revert back to the business after the retirement of the bonds.
Within the limitation of State laws under which the public body is constituted, where possible, the lease and SBA guarantee thereof shall be structured so that in the event of default on lease payments by the business the SBA shall succeed to the rights and interests of the small business in the pollution control facility being financed, and will be entitled to proceed against the small business for any sums paid as guarantees by the SBA.
Section 102(c) (4) (f) of the Internal Revenue Code provides for a specific exemption from gross income of the interest on industrial revenue bonds which are issued to finance air and water pollution control facilities.
Tax exemption is one important incentive granted by Congress to those companies which invest in pollution control financing. This incentive, which is presently unavailable to many small businesses, can be extended to them through the proposed SBA guarantee route.
Additional savings may be available to those companies, both large and small, that finance with pollution control revenue bonds by exemptions from certain State and local taxes.
In keeping with the goal of providing lowest cost pollution control financing for small business, we suggest that a financing authority issue pollution control revenue bonds using the proceeds thereof to finance pollution control facilities for a plurality of small businesses. The small businesses would enter into lease agreements for their respective share of the pollution control facilities so financed. The aggregate of the obligations under such lease agreements would equal and secure the bonds issued by the public body. There would be one issue with multiple guarantees. The SBA would guarantee each of such leases separately.
For example, 10 small businesses in Ohio each need $500,000. The Ohio Air Quality Bond would issue $5 million of tax-exempt pollution control revenue bonds using the proceeds thereof to acquire and construct pollution control facilities for 10 small businesses. These 10 small businesses would enter into lease agreements with the Commission. The lease rentals thereunder would secure the bonds. The SBA would guarantee payments to the public body separately under each of the 10 lease agreements. If no statewide public body exists, then there is precedent to gather together small businesses in many different counties or cities into one single issue.
Mr. CONTE. Mr. Chairman, before we adjourn, I have here the Small Business Act that was written in 1970, and as we have been considering the various bills that have been referred to us, I notice in the committee print on the Small Business Act it is woefully out of date. It was printed, as I said, in 1970. A lot of changes have been made on it, and I would like to suggest, Mr. Chairman, if I can, that we request the full committee chairman to authorize a new committee print for the use of this subcommittee.
Mr. SMITH. Counsel tells us SBA is working on it now. That is a good idea.
If there is no objection, I will insert into the record at this point a jointly signed telegram from Jesse Unruh, treasurer of the State of California; Randolph Collier, a member of the California State Senate; and John Knox, a member of the California State Assembly, concerning the problem that is before us today.
[The material referred to follows:]
JUNE 16, 1975. Congressman JOHN J. McFALL, Rayburn Building, Washington, D.C.
DEAR JOHN: We deeply regret the impossibility of attending the subcommittee nearing this morning. The California Legislature is currently under deadline pressure to formalize the 1976–77 budget, which precludes any member of the State leadership from leaving the State. Our dilemma is compounded by the fact that the subcommittee members may take our absence as indicating a lack of concern or support for H.R. 78. Nothing could be further from the truth. Passage of H.R. 78 is essential to the survival of small businesses in California and for stemming the sharp rise in State unemployment. Small businesses in
California account for 72 percent of the State's industrial work force. If more small businesses are compelled to shut down because of an inability to finance their pollution control needs, the impact on the State's economy, our budget, and the employment rolls would be correspondingly severe.
The treasurer of the State of California presently serves also as chairman of the California Pollution Control Financing Authority. As chairman, I am in a direct position to appreciate and understand the scope of the pollution control problem, particularly as it affects small businesses. It is clear, from past history and to date, that under present law no small business has been or will be able to sell a tax-exempt industrial revenue bond for pollution control purposes while large businesses can readily obtain the benefits of such low-cost long-term financing. Small businesses are totally deprived of these advantages because of their size, lack of investor recognition, and uncertain financial condition.
H.R. 78 removes these obstacles to the use of pollution control revenue bonds by small businesses. Provision of a lease guarantee by the SBA will assure the credit worthiness of small-business borrowers to investors, and enable a pooling of their borrowing needs into single bond issues to be sold on a taxexempt basis by a State or local pollution control financing authority. Small businesses, in effect, would then be able to share in the same benefits that have been restricted exclusively to only the largest of our Nation's businesses.
Passage of H.R. 78 is vital to our State. It conforms legally and in spirit with the pollution control financing law which was passed by the California Legislature in 1972 and subsequently approved by the State's voters. Yet we are still unable to accommodate the needs of our small businesses, which are the backbone of the State's economy and work force. H.R. 78, assuredly, is the answer. We urge, accordingly, that H.R. 78 be enacted into law, for the viability and betterment of small businesses, the State of California, and the Nation. I only regret that I am unable to express these remarks in person because of a mandatory court appearance this morning in Los Angeles.
Member, California State Assembly. Mr. SMITH. The subcommittee will recess until 10 o'clock tomorrow morning.
[Whereupon, at 11:45 a.m., the subcommittee adjourned, to reconvene at 10 a.m., Monday, July 14, 1975.]