Page images
PDF
EPUB

have taken. Certainly your efforts and interest are going to contribute measurably to the deliberations of this subcommittee.

Mr. McFall. I hope it will provide a basis for some kind of solution that you gentlemen can come up with.

Mr. Smith. I want to thank you again, John, for bringing this specific proposal to our attention. I think you recognize that one of the problems that we will have is one of increasing revenue exemptions. We will ask the other witnesses.

You certainly have brought forth a proposal here that gives us something to work with.

Mr. CONTE. May I ask one more question, Mr. Chairman?
Mr. Smith. Yes.

Mr. CONTE. Your bill also gives the SBA Administrator a great deal of discretion in setting fees. You use the term "reasonable and necessary.” I am somewhat concerned that the OMB may get involved in this and force SBA to set fees that are so high that the attractiveness of the package may be diminished.

I wonder if you share that concern. You know the trouble we have with OMB.

Mr. McFall. I certainly do.

You have to look into that and see whether or not there is some way of defining what is reasonable and necessary that will provide some standard for them.

Mr. CONTE. Maybe we are better off leaving this to the negotiation between SBA and the local government. Perhaps we should have a mechanism for congressional disapproval of fee schedules. Do

you think we should provide some sort of veto mechanism, or do you feel that committee oversight can do the job in avoiding excessive fees?

Mr. McFall. My personal opinion is that I think committee oversight can do it if you put some sort of standards in there that would permit some sort of reasonable determinination of fees. I do not pretend to be any kind of an expert in this field. I leave that up to your judgment.

Mr. CONTE. Thank you.
Mr. HANLEY. Mr. Chairman?
Mr. Smith. Yes?

Mr. HANLEY. I assume, for instance, that your bill would assist in meeting air pollution standards. One particular business in my district invested heavily to conform with pollution requirements and subsequently because of natural gas shortages now finds itself in a position where now it has to shift gears and reconvert to the possible use of coal. In this particular instance the cost factor is so great that it could drive this little business out of business.

I assume that your intent would be to care for a situation of that nature, also.

Mr. McFall. That would be a perfect example, I would think, of some kind of need for small business to meet a pollution requirement. I personally think it would be. Mr. HANLEY. Thank you. Mr. Smith. Thank you very much. Mr. McFall. Thank you, Mr. Chairman.

Mr. Smith. Our next witness is Mr. Arnold Mazotti from the Bank of America National Trust & Savings Association, San Francisco, Calif.

Do you have others with you?

Mr. Mazotti. I would like to bring Mr. Aldrich from L. F. Rothschild to assist me.

Mr. Smith. Please proceed.

TESTIMONY OF ARNOLD F. MAZOTTI, SENIOR RESEARCH OFFICER,

BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION, SAN FRANCISCO, CALIF.; ACCOMPANIED BY ROBERT H. ALDRICH, L. F. ROTHSCHILD & CO., NEW YORK, NY,

Mr. MAZOTTI. Mr. Chairman, we have presented before you a position paper from the Bank of America which covers our background study and history of H.R. 78. It is our intent at this time to highlight certain aspects of that paper, and to answer any questions as they arise.

We appreciate this opportunity to discuss H.R. 78 with you and members of the subcommittee. This bill would empower the Small Business Administration to guarantee the lease payments between a small business and a public pollution control authority in connection with the financing of pollution control equipment through the issuance of industrial revenue bonds. We support this legislation because it would enable small businesses both to meet prevailing environmental regulations and sustain their solvency. Without the passage of H.R. 78, there is a real and increasing probability that many of our Nation's small businesses will be forced to close down.

A narrowing time frame exists for compliance with the pollution abatement standards established by the Federal and State governments. The costs of compliance will be high, amounting to more than $30 billion over the next 10 years. It is estimated, moreover, that approximately one-third of the costs for pollution control facilities will have to be borne by small businesses. Such facilities, however, are essentially nonproductive in a functional sense, and represent a negative expenditure operationally considering that no offsetting income is realized through the use or product of the installed facilities. Yet the impact, in the real world, is inequitable because of the uneven effect on large versus small businesses. Unlike the majority of large businesses, the smaller firm lacks access to long-term, low-cost funds. The drain on cash flow for small businesses is therefore more burdensome. As a result, smaller firms experience a disproportionate impairment of operating flexibility and creditworthiness.

Another problem faced by small businesses is that their pollution control expenditures per employee and as a percentage of sales are greater than those of large businesses which benefit from economies of scale. For example, the pulp and paper industry consists of 259 companies employing 358,020 people. The average work force is 1,382 employees per company. The cost of bringing existing facilities up io environmental standards is estimated at $1.98 billion, or $5,530 per worker. Assuming a linear relationship between capital requirements and the number of workers, some 6 percent of all the companies would account for approximately 86 percent of the industry's pollution control expenditures. Pollution control cost on a per-employee basis, however, is not a constant relationship. These costs, rather, have an inverse, geometric relationship to the size of the company.

To demonstrate the impact which this variable cost factor can have on small businesses, table I breaks out pollution control costs for companies according to size. It can be seen from the table that pollution control expenditures range from a low of $5,054 per employee for very large firms, that is 2,500-plus employees, to $18,000 per employee for firms with 20–49 workers. While costs on a constant relationship basis would indicate an anticipated expenditure of $180,000 for a company having 32 employees, the actual cost for such a company would be $583,000, giving effect to the geometric impact on costs which arises from differences in size of company.

Table II further illustrates the differences in pollution control costs between large and small businesses.

It is clear, therefore, that the financial impact on small business will be significantly higher than on the large corporations in industries where the per-unit cost_varies with the plant size and sales. Bank America together with Rothschild has been working with the SBA concerning the financial problems faced by small businesses in financing pollution control equipment. Mr. Aldrich of L. F. Rothschild will provide a few examples after I conclude my remarks.

Currently there are four alternatives which a small business may consider to develop financing for pollution control. There is a detailed explanation in the text of each of these alternatives, which I will describe only briefly here.

The direct SBA loans. The problem here is that it requires higher financial output for small businesses and larger Federal manpower requirements. We consider that an unworkable solution.

ŠBA guaranteed loans and bonds—once more, we have high interest costs plus generally short maturities which increase the cost to the small businessman and makes it impossible for him from a cash flow basis to generate sufficient funds to meet the debt service on an obligation of this kind.

Mr. Smith. You said it requires higher output?

Mr. MAZOTTI. Financial output, because of the shorter maturity of the term of the loan to cover the equipment.

Mr. ALDRICH. Guaranteed loans have a maturity of roughly 5 to 7 years.

Mr. Smith. I see.
What was the other thing you said?

Mr. MAZOTTI. Short on maturity—which means that the loan becomes payable within a short period of years. Conventional long-term financing for the major corporations goes out 20 years or more for pollution, which reduces debt-service costs considerably on an annual basis. The cash flow problems are not as acute. Instead of paying $5,000 a month for a facility, when you shorten it from 20 down to 5 years you are up into the $20,000 to $25,000 a month. Small businesses do not generate enough cash flow to meet that kind of obligation.

Mr. SMITH. Although the general rule that you lay down would apply, to what extent would this be moderated by the recent passage of the 10-percent investment credit and by the 20-percent first year depreciation?

Mr. ALDRICH. The impact here would be in terms of favoring a lease type of proposal. Generally you find that the small businesses are not in a position for this size pollution control investment to take full advantage of investment tax credit. This certainly assists the small business relative to his financial needs; couple that with the long-term

financing available via H.R. 78, and you have a very attractive package for the small business. That enables him, cash flowwise, to maintain some parity with his larger competitor. This has the advantage of lengthening out the term of the financing to that now available to large business. It is a major plus and a distinct advantage to the small business and, of course, to the large.

Mr. Smith. There is a quorum call and the subcommittee will recess for a few moments.

(A brief recess was taken.)
Mr. Smith. Mr. Mazotti, would you like to continue?

Mr. Mazotti. Yes, sir. We were talking about the four methods available for small businesses to finance their pollution control equipment. There is a technical explanation in the text and we are just highlighting for the sake of brevity here the principal reasons why they do not work.

We have taken the first one, the direct SBA loan, which requires higher financial output and larger Federal manpower requirements. It is simply not a workable method. SBA guaranteed loans-whose effectiveness is impaired by their high interest cost plus generally short-term maturities. Small businesses must look at a loan of 5 years to finance major capital improvement for pollution control, while large corporations can obtain 20-year maturities for the same kind of financing. Small businesses, with limited cash flow from relatively small operations, simply cannot fund a major nonincome generating expenditure within 5 years. Commercial bank loans also have the problem of high interest rates and short-term maturities. Bank loans to small businesses command rates of 12 percent and more for 5-year maturities. Small businesses simply cannot generate sufficient cash flow from their operations to justify this kind of payback on equipment which returns little or nothing on their investment. And finally, the tax exempt pollution control revenue bonds, which generally have not been available to small businesses.

Industrial revenue bonds issued by State and local governments for pollution control purposes in 1973 and 1974 amounted to a reported $1.8 billion and $1.6 billion, respectively. Attachment A, which enumerates the beneficiaries of these financings, reveals not a single small business on the list. If you would take a quick look at the schedule, attachment A, it shows the first issue back in January of 1973. Now run down the list of corporations. That looks like a Fortune 500 list of every company. There is no small business by SBA definition on that list.

The reason for the absence of pollution control revenue bonds for small business is they simply have been unable to market their issues. Neither the full faith nor taxing power of the public issuer is pledged to support the bonds. Accordingly, bondholders may look only to the corporation for payment of debt principal and interest.

Bonds issued for large corporations have found broad acceptance among institutional investors because of the national recognition and established creditworthiness of such businesses, as evidenced by investment-grade credit ratings from Moody's and Standard & Poor.

That is another point. Moody's and Standard & Poor, which are the accepted credit rating authorities in the United States, grade both tax-exempt and corporate bonds in assigned letter ratings. The impact of these ratings is such that if an issuer has an acceptable credit rating, there will be a market for the bonds. The rating services

have been unable to rate very small companies because the companies lack adequate financial statements, operating history, and associated documents. The major corporations that use this method of financing can readily obtain bond ratings. You simply cannot sell unrated bonds in the general market.

Small businesses have been effectively eliminated from the long-term, tax-exempt bond market because there is no institutional investor support for small, unrated issues of local corporations, nor sufficient investment banking interest to develop business and arrange the financing.

This discussion of financing alternatives available to small business for pollution abatement, should fully demonstrate that there is no feasible way at present of accommodating their needs without developing a new approach to the problem. H. R. 78, in our view, provides just such an approach, and the best solution as well. This legislation, in brief, calls for grouping into individual bond issues the financial requirements of a number of small businesses having a common geographic or industry relationship. These issues would be sold by the appropriate State or local authority. Proceeds of the bond sales would be used to construct the necessary pollution-abatement facilities. These facilities would then be leased back to the small businesses whose lease payments provide the funds to meet bond principal and interest. The SBA, under authority of this legislation, would insure the individual lease payments for a fee adequate to cover operating costs and projected losses.

The attached three flow charts graphically display the processes associated with loan assembly and credit evaluation, the responsibilities and contractual commitments of each participant, and the mechanism for sale of the bond issues.

It is clear, in order to make such a program function, that the Small Business Administration, commercial banks, and investment dealers would have to work in close harmony. Given the enormity of the pollution-control financing needs of the Nation's small businesses, there would be little hope of properly developing or evaluating loan applications by the Small Business Administration without massive increases in staff. Accordingly, it would be incumbent upon the commercial banks within each industrial State to bring together the needs of their clients and process them appropriately, in line with Federal regulatory standards and requirements. Having assembled the qualified candidates list, the investment banker could bring his engineering and planning expertise to bear on those industries which have similar or related problems. In this way, the small businesses would save not only in tax-exempt borrowing costs, but also in the associated costs of pollution-control financing. The incentive for the investment banker, apart from the socially necessary aspect of his involvement, would be the marketable size of a pooled-loan bond issue and its likely appeal to institutional investors. For those small businesses which may be unable to qualify under the loan guarantee program of the Small Business Administration, the necessary financing could be provided nonetheless through the low-cost emergency loan program of the SBA or favorably disposed commercial banks.

It is our conclusion, therefore, that the SBA insured tax-exempt pollution control revenue bond program for small businesses is clearly the cheapest and most efficient method of accommodating their pollution-control financing needs. Creditworthiness, and a prime

« PreviousContinue »