It is rather obvious that three things are necessary if the REA telephone borrowers are to carry out the objectives of the REA Act. These are

(1) Capital;

(2) Manufactured products such as instruments, switchboards, cable, et cetera; and

(3) Personnel and training.

Our REA borrower companies together with the independent manufacturers can take care of the manufactured products and can take care of the personnel and training, but when it comes to the capital, their net worth superimposed by a Government mortgage makes them utterly dependent upon the REA for financing.

Capital is the Achilles heel of development in the telephone industry. Our customers are demanding that we keep pace. Our REA telephone borrower companies must find capital or die.

Last March, the U.S. Independent Telephone Association, in conjunction with the NTCA and the NRECA, conducted a survey of all REA telephone borrowers. This survey showed that for fiscal year 1966, ending on June 30, there would be a loan need of $293 million. As you know, the appropriation for fiscal year was $97 million. Thus, we have a carryover of $196 million into fiscal year 1967.

I would like to point out at this time that this survey is very accurate. The actual loans on hand at REA on May 1, unaccounted upon, was $196.5 million, and we come up with $196.2 million, so that the survey is accurate if not conservative.

Looking forward to the new loan requirements for 1967, our survey shows that we would be requiring $144 million. And you add the carryover from last year of $196 million to the new loan requirement of fiscal 1967 or $144 million, Mr. Chairman and members of the committee, we will have a total loan requirement for fiscal year 1967 of $340 million. And you contrast this with the budget requests for fiscal year 1967 of $85 million, it becomes startling apparent that supplemental financing is necessary for the REA telephone borrower companies.

It is also, I believe, obvious that for budgetary reasons or otherwise, the Congress will be unable to appropriate sufficient funds to complete the job of bringing modern telephone service to rural America as it should have been done when it passed the Telephone Amendment in

1949.

The U.S. Independent Telephone Association recently commissioned a well-known (and well mentioned at these hearings) financial firm of Kuhn, Loeb & Co. to do a financial survey of the needs of the REA telephone borrowers.

Mr. Chairman and gentlemen of the committee, this is the first time that an independent financial agency has conducted such a survey. We have just received it from the printers, on Tuesday, and I would like at this time, Mr. Chairman, to offer it for the record in the hope that it may be of some help to the committee.

Mr. POAGE. How long is it?

Mr. HARMON. About 34 pages, Mr. Chairman.

Mr. POAGE. I think that we will put it in the files of the committee. Without objection, that will be done.

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(The document will be found in the files of the committee.)

Mr. HARMON. The Kuhn Loeb report shows that our borrowers will need $3.5 billion over the next 15 years, graduating to $400 million a year by 1980.

Again, contrasting the appropriations for fiscal year 1966 or $97 million with the $85 million requested for fiscal year 1966 and the need for supplemental financing to prevent stagnation becomes obvious. It is not difficult to imagine the overloaded systems bursting at the seams with obsolescence if something is not done.

You might say: Why do these companies not go into the commercial market?

Well, a look at this study will indicate that the ratio of debt to total capitalization as compared with the REA borrowers, the independents and the Bell System is as follows:

REA borrowers have 87.6 debt-meaning 12.4 equity.

The independents, as a whole, have 52.9 and 47.1 equity.

You

And the Bell System has 31 percent debt and 69 percent equity. If our REA borrower companies, as individuals, try to go into the private money market with an equity of 12 percent, plus a first mortgage on all of their property, they will meet with little success. might say: Well, why do they, these companies, not generate these funds in themselves? Well, if you make a comparison of the cash from its earnings, and the percentage of net worth, again, with the REA borrowers, the independents and the Bell System, we find this: We find that the net income for the REA borrowers is 48.3 percent; all independents, 45.1 percent, and Bell, 53.8 percent net income.

It is this net income from which funds are generated. With this low net in, obviously, the demand of our REA borrowers are bound to be much larger.

Now, although our REA telephone borrowers are, obviously, in a less strong financial system condition than the independents or the Bell System, we find that they have a much faster growth rate in all categories.

For example, the number of telephones served-this is over a period of the last 5 years of the REA have increased at the rate of 12.3 percent annually; the independents, 5.8 percent annually; and the Bell System, 4.4 percent annually.

When we look at the plant investment, we find again that the REA borrowers are putting it in at a much more rapid growth rate. The REA increased annually in plant investments 11.8 percent; the independents, 11.6 percent; and the Bell System, 7.8 percent.

However, the annual increase in plant investment per telephone for the REA borrower was only 1.3 percent; 5.5, for the independents; and 3.3 for the Bell System. So, that despite the rapid increase in plant the REA borrowers are barely keeping pace with the demands for service.

Now, the ideal solution to this problem of the REA telephone financing would be:

No. 1, 2 percent money available when necessary;

No. 2, a buffer between the commercial money market and the individual corporation in the form of a telephone bank; and

No. 3, the independents' financial vehicle with lower than commercial interest rates.

Both H.R. 14000 and H.R. 14837 will achieve these goals, plus some help from the Government.

The United States Independent Telephone Association strongly supports the passage of legislation which would supply the supplemental financing provided for in both H.R. 14000 and H.R. 14837. We realize that there are differences between these two bills, and in our prepared statement we have indicated our preferences where these differences occur. However, I should like to point out at this time that the need for capital, available capital, is so vital to our REA telephone borrowers that no combination of these differences is of sufficient import to impede the passage of the legislation which will make capital available to the REA telephone borrowers.

Gentlemen, there is no opposition to this bill or this concept from the telephone industry. We have territorial integrity. We have no problems, such as we have heard mentioned here during the last few days.

So, at this point, I should like to thank the committee very much for the opportunity to appear in behalf of the United States Independent Telephone Association, REA borrowers, and to ask the legislation be voted out of the committee and supported to a favorable conclusion. Thank you very much.

(The prepared statement of Eugene J. Harmon reads in full as follows:)

STATEMENT OF EUGENE J. HARMON, DIRECTOR, USITA-REA TELEPHONE PROGRAM, UNITED STATES INDEPENDENT TELEPHONE ASSOCIATION

My name is Eugene J. Harmon and I am Director of the United States Independent Telephone Association's REA Telephone Program. With me is Mr. Harold Payne, who is one of the Directors of the United States Independent Telephone Association, Chairman of the United States Independent Telephone Association's REA Borrowers Committee and President of Telephone Utilities of Pennsylvania, Inc.

The United States Independent Telephone Industry operates in 49 of the 50 States and serves Hawaii, Alaska, as well as Puerto Rico and the Virgin Islands in their entirety. We have well over a thousand member companies representing 92% of all Independent telephones. When I say Independent Telephone Industry, I mean companies other than those in the Bell Telephone System.

The United States Independent Telephone Association numbers among its members over 420 companies that are REA Borrowers. Of these 420 companies, 66 are telephone cooperatives.

Back in 1949, Congress looked at the successful progress made by the REA in bringing electric power to rural America and concluded that there was a great need to extend modern telephone service into rural areas of the United States. As a result, it passed the telephone amendment to the Rural Electrification Act.

Both the Congress of the United States and the REA Telephone Borrower companies can be justly proud of their accomplishment to date in providing what in America is a necessity of life. No longer can modern telephone service in rural areas be considered a luxury.

It is important to note that while the electrical program has been in effect for 31 years, the telephone loan program has been operating only 16 years. Thus we are half as old and our development has not had the time to reach maturity financially or in telephone area coverage.

There are various forces working in this country all combining to create a tremendous growth in the overall telephone industry. Some of these are the population growth with the greatest rate rise in the 18 to 25 year age group. This group represents new homemakers and likewise the new telephone subscribers. There has also been a shift in population, not only geographical in

nature, but also from urban to suburban and rural. The American telephone usage habits coupled with direct distance dialing and other technical improvements tend to drive up the total telephone usage. This added usage has made obsolete the old multiparty service with ten and eight parties on one line. Thus, in addition to the new subscriber demand, there is a tremendous need to upgrade existing systems.

Three basic needs must be satisfied if the REA Telephone Borrower companies are to continue to carry out the objectives of the Rural Electrification Act. They are:

(1) Capital.

(2) Manufactured products such as instruments, switchboards, cable, etc. (3) Personnel and training.

The latter two can be handled by the individual REA Borrower companies and independent manufacturers but because of low net worth or equity coupled with a first mortgage held by the U.S. government, the REA Telephone Borrowers have had to depend upon the REA, their first mortgage holder, for their source of capital.

Capital is the achilles heel of development in the telephone industry. With technology exploding in our industry and customers demanding that service keep pace with progress, our companies must find capital or die.

I would like to quote from a talk given by Mr. R. A. Lumpkin, President of the Illinois Consolidated Telephone Company and a director of USITA before a group of Security Analysts and newsmen in Chicago on May 25, 1966:

"It takes a lot of capital to stay in the communications business-a lot more than is needed in manufacturing when we consider it from the standpoint of bringing in a dollar of revenue or sales. You probably know that the world's largest manufacturing company generates $5 in sales for ever dollar invested in plant. In communications, however, those figures are almost reversed. For us, it takes $4 in plant investment to produce $1 in gross revenues. Where the average capital investment in the nation's manufacturing industry as a whole is something like $9,000 per employee, Independent telephone companies have $63,000 invested for every employee on their payrolls. Bell figures are in this case quite similar to our own."

In order to demonstrate the critical need for capital, the United States Independent Telephone Association jointly with the National Telephone Cooperative Association and the National REA Telephone Association last March conducted a survey of all REA Telephone Borrowers.

Questionnaires were sent to 839 REA Telephone companies and returns were received from 617.

As of September 30, 1965, there were over two million (2,100,230) REA financed telephones. The survey resulted in replies from companies representing over a million and a half (1,574,513) or 75% of the total phones.

This high percentage (75%) represents a valid sampling and is used to project the actual totals received on the survey to a figure which would represent 100% if all had replied.

This survey showed that the total loan requirements-i.e.-need for capital for fiscal year 1966 ending June 30, 1966, would be $293.2 million. As you are well aware, the appropriations for fiscal year 1966 were $97 million. The unfunded loan requirements to be carried over to fiscal 1967 would be $196.2 million. The actual unacted upon loans on hand at the REA on May 1 were $196.5 million. This indicates that the survey is accurate, if a bit conservative.

The same survey showed that the new loan requirements for fiscal 1967 would be $144.6 million. This plus the carry-over makes the total loan requirements for fiscal 1967 $340.8 million.

The government budget request for fiscal 1967 for the REA telephone program was $85 million. Just recently, the House approved authorization for $97 million for the telephone loan program. Thus total loan requirements left unfunded at the end of fiscal 1967 will be $255.8 million or $243.8 million if the House authorization is approved by the Senate.

The problem is compounded in that all of the money authorized by Congress must be loaned out by the administrator at 2% interest. He has, under the current statute, no discretion in interest rate determination. Yet, it is also his duty to carry out the objectives and purposes of the Rural Electrification Act. We know that there are some telephone companies that could pay more than the 2% interest rate. These companies might very well need loans which are essential

to carry out the purpose of the Act. The result would be loans made at 2% even though a particular company could pay a higher rate. Thus there would be less 2% money available for companies that cannot pay more than 2% but with projects of lower priority in the accomplishment of the intent and purpose of the Rural Electrification Act. The overall amount of 2% money already in short supply is decreased for companies that cannot afford to pay interest rates in excess of 2%.

With the pressure of new subscriber demand (269,000 for REA telephone borrowers by the end of fiscal 1967) a tremendous requirement for upgrading, (over 50% of rural telephones have eight parties or more a line), the need for capital is desperate. It also appears obvious from budgetary and other considerations that the Congress will be unable to appropriate sufficient funds to complete the job of bringing modern telephone service to rural America, which Congress decreed should be done when it passed the telephone amendment to the Rural Electrification Act in 1949.

The U.S. Independent Telephone Association commissioned the well-known and highly reputed New York financial house of Kuhn, Loeb & Co. to conduct a survey of the financial needs of REA telephone borrowers. This is the first time that a study of this nature has been made by an Independent financial authority. The study was just recently completed. It is well done, comprehensive, and complete. In order that it may be available to assist the Committee, I offer it for inclusion in the record at this time.

The Kuhn Loeb report shows that the REA telephone borrowers will have borrowing needs totaling $3.5 billion over the next fifteen years with annual needs growing to $400 million by 1980. Contrasting these needs with the $97 million appropriated for fiscal 1966 and the requested authorization of $85 million for fiscal 1967, it becomes startingly clear that a program of supplemental financing is necessary if the growth of the rural telephone program is not to stagnate.

It is obvious from the Kuhn Loeb report that the commercial money market is not available to the overwhelming number of REA telephone borrowers. The report shows that the ratio of debt to total capitalization for REA borrowers is very high-87.6% or an equity of only 12.4%. This reflects the fact that the telephone program is only 16 years old and most borrowers are at a relatively early stage in their financial life. The Independents as a whole have debt that comprises 52.9% of total capitalization while the Bell System has a debt to total capitalization radio of only 31%.

With an equity of only 12.4% and a first mortgage held by the government, the opportunity to obtain money from the commercial money market on an individual company basis is not available to most REA borrowers.

A comparison is made in the Kuhn Loeb report of cash flow. Net income comprises only 28.3% of the total cash flow of REA borrowers. This figure contrasts sharply with the 45.1% that net income comprises of the total cash flow of all Independents and 53.8% net income for AT&T. As cash flow represents the source of internal financing, it is apparent that the loan demands of REA telephone borrowers must be correspondingly higher in order to make up for their present relatively small cash flow.

The report contrasts the relatively less strong financial condition of the REA telephone borrowers with a much faster growth in all categories than either all Independents or the Bell System. For example, in the past five years, the number of telephones served by REA borrowers has increased at an average annual rate of 12.3% compared to only 5.8% of all Independents and a relatively small 4.4% for the Bell System.

As to plant investment of REA telephone borrowers, the report indicates that it has also grown faster than all of the Independents and the Bell System. Between 1960 and 1964, plant investment increased 11.8% annually for REA telephone borrowers compared to 11.6% for all Independents and 7.8% for the Bell System.

However, the average annual increase in plant investment per telephone was only 1.3% for REA borrowers compared to 5.5% for all Independent and 3.3% for the Bell System. These figures indicate that despite the rapid increase in plant, the REA telephone borrowers are barely keeping pace with the demand for telephone service. The combination of a fast growth rate of telephone service demand with relatively immature financial condition places the REA telephone borrowers in a particularly critical position regarding capital needs.