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.

The demand for service requires large amounts of funds to invest in new facilities, but the companies are not yet able to generate a large portion for these funds themselves. Neither is it likely that the REA will be able to supply their total future demand. Consequently, a method of obtaining supplemental capital is of vital importance for REA telephone borrowers.

The Kuhn Loeb report advocates the establishment of a separate telephone bank coupled with a vehicle to make available loans at an intermediate rate of interest which would have the effect of assisting companies who can afford to pay more than 2% interest but cannot afford to pay commercial rates.

The ideal solution to this problem of REA telephone financing from the standpoint of financial experts, the REA companies, the subscribers, and the government would be to:

(1) Make available 2% money where necessary

(2) Set up buffer between the commercial money market and the individual REA telephone borrowers in the form of a telephone bank, and

(3) An intermediate financing vehicle with interest rate less than that charged on the commercial market but at no additional cost to the government.

Both HR 14000 and HR 14837 now under consideration by this Committee would achieve these objectives with the additional advantage of eventually converting the financing of the REA telephone program from government to private control.

The passage of legislation involving the concept of intermediate financing and a separate telephone bank is vital if modern telephone service is to be part of the life of rural America.

For this reason the U.S. Independent Telephone Association strongly supports the passage of legislation which would supply the supplemental financing provided for in both HR 14000 and HR 14837.

Capital is the lifeblood of rural telephony. If it is in short supply, rural telephony will become anemic; without capital, it will die. We feel that the proposed legislation will supply the mechanism to provide the circulation of capital in sufficient amount to not only sustain life, but to provide for the health, growth, development, and advancement of rural telephony which in turn will provide communication service for rural America on a par with all parts of this country, despite the handicaps of rough terrain and sparsely settled areas. In addition, it has the desirable feature of eventually substituting private for government financing.

With regard to the major differences in HR 14000 and HR 14837, we would like to indicate which versions we support.

HR 14837 provides for seven members on the Board of Directors-four appointed from Agriculture, three non-government-all seven to be initially appointed by the Secretary of Agriculture. HR 14000 provides for ten members of the Board of Directors-five from Agriculture and five appointed by the President of the U.S. from among REA borrowers on a geographical basis. We support the provisions of HR 14000 in this regard because we feel that ten Directors are more desirable than seven and that further, the appointment of the minority of the Board by the President of the U.S. would give them added prestige.

With regard to capitalization provisions, HR 14837 provides for a total capitalization of $300 million at the rate of $20 million per year for 15 years. HR 14000 provides for a total capitalization of $250 million. However, the financial study made by Kuhn Loeb of the REA telephone borrower companies indicates that a total capitalization of $350 million would be the amount required to adequately finance the telephone bank.

The report as mentioned above shows that $3.5 billion will be needed over the next fifteen years. The $350 million total capitalization, therefore, assumes that the proposed telephone bank will be able to borrow up to the statutory limit of 10 to 1. We ask that the Committee raise the total, capitalization of the telephone bank up to $350 million.

HR 14837 requires annual authorization from Congress for the purchase of Class A telephone bank stock. HR 14000 does not require annual authorization to purchase Class A stock. We suport the provisions of HR 14000 in this regard. The requirements for annual authorization implies the possibility that it would

not be granted and might seriously hamper the ability of the bank to obtain sufficient funds in the commercial money market.

With regard to the retirement of Class A stock, we support the provision in HR 14000 indicating that this stock should be retired "as soon as possible" rather than the provision in HR 14837 indicating that Class A stock should be retired as soon as practicable after June 30, 1981.

As to Class C stock dividends, we support the provisions of HR 14000 which indicates that the dividends should be specified by the bank Board rather than the provisions of HR 14837 which limits Class C stock dividends by statute to the current average rate payable on the bank's telephone debentures. It would seem to be better banking procedure to leave dividend rates to the discretion of the bank Board rather than fix them by statute.

HR 14000 provides that the Class A stock shall be non-dividend bearing. HR 14837 provides that the Class A stock shall earn dividends to be paid into the miscellaneous receipts of the treasury. We support the provision of HR 14000 on the theory that if the Class A stock is non-dividend bearing, it can be retired at a more rapid rate.

HR 14000 sets a ceiling of 3% on intermediate loans while HR 14837 sets the ceiling at 4%. We support the 3% provision of HR 14000. The intermediate loan is designed to wean borrowers from 2% money to the bank rate of interest. It would seem logical that more borrowers would qualify for an intermediate loan at the rate of 3% than would qualify at an intermediate rate of 4%, leaving more 2% money available for companies having need for it and at the same time steering more borrowers in the direction of the financial maturity which would make them eligible to become borrowers from the bank. We feel the Committee should also consider vesting the Board of Directors of the Telephone Bank with authority to charge more than 3% interest where it is demonstrable that the borrower can afford to pay a higher rate.

We also support the provisions of HR 14837 which extends the definition of telephone service to include CATV. If our REA borrower telephone companies are to fulfill the objective of total communications, they must be authorized to provide this communication service. Due to the nature of television transmission, its reception is usually limited and of poor quality in areas remote from the transmitter or blocked by mountainous and hilly terrain. These conditions are found most commonly in the rural areas served by our REA telephone companies. The statute that brought rural telephones to rural America by making it economically feasible should not be a vehicle to hinder the expansion of CATV into the same rural areas.

The bills differ at the point in time where control will pass from government to private control. HR 14837 provides that the transfer of control will occur after all Class A stock is retired. HR 14000 provides that the point of transfer of control will arrive, without further legislation, when the total of B and C stock exceeds the A stock. We support HR 14000 in this regard because we feel that it provides an opportunity for private control at an earlier point in time and will tend to stimulate private investment in the telephone bank as well as achieve the budgetary objective of getting the government out of the loan business as soon as possible.

Mr. Chairman and Members of the Committee, I wish to express our appreciation and the appreciation of the U.S. Independent Telephone Association's REA telephone borrowers for the opportunity to appear before the Committee and to urge that the supplemental financing legislation be reported favorably out of Committee and that it will be supported to successful passage.

Mr. POAGE. Thank you very much.

Mr. Olson will introduce the next witness, and then we will hear from the next witness.

Mr. OLSON. I would like to introduce to the committee Mr. A. Harold Peterson. He is a native of the State of Minnesota and both Mr. Quie and I know him. He is a distinguished former member of the State Legislature of Minnesota and now the executive director and counsel of the National REA Telephone Association.

We are very pleased that he is here to present testimony on behalf of the National REA Telephone Association.

Mr. POAGE. We will be delighted to hear from you now, Mr. Peterson.

STATEMENT OF A. HAROLD PETERSON, EXECUTIVE DIRECTOR AND COUNSEL, NATIONAL REA TELEPHONE ASSOCIATION

Mr. PETERSON. Mr. Chairman and members of the committee, I appreciate very much the introduction on the part of Congressman Olson. The hour having passed noon, I am not going to take any more of the committee's time other than what I feel is necessary. My name is A. Harold Peterson, and I appear here today in the capacity of executive director and counsel for the National REA Telephone Association.

At this time, Mr. Chairman, I shall ask that there be included in the record the statement which I have prepared and which has been given to the staff of the committee.

Mr. POAGE. Without objection, it will be made a part of the record at this point.

(The statement referred to follows:)

STATEMENT OF A. HAROLD PETERSON, EXECUTIVE DIRECTOR AND COUNSEL, NATIONAL REA TELEPHONE ASSOCIATION

Mr. Chairman, Members of the Committee: My name is A. Harold Peterson and I reside at Chisago City, Minnesota. I am engaged in the practice of law at Chisago City and Minneapolis. Since 1955 I have been a director of the Chisago Lakes Telephone Company, an REA financed company, which serves eight small villages and the surrounding area in rural East Central Minnesota. I appear here today as Executive Director and Counsel of the National REA Telephone Association whose membership is comprised solely of REA telephone borrowers, mainly the commercial type.

On behalf of the members of the National REA Telephone Association may I say that we are grateful to the House Committee on Agriculture for your courtesy in permitting a personal appearance to testify, as well as to place into the record of your proceedings a prepared statement to support the passage of legislation which will provide supplemental financing for the REA telephone program.

EVENTS LEADING TO ENACTMENT OF REA TELEPHONE PROGRAM

A brief review of the REA telephone program since its inception in 1949 will, in our estimation, provide the background for a clearer understanding of the problems facing REA telephone borrowers today, as well as in the foreseeable years ahead. In 1949 much of rural America had already received electric service under the REA program. While this electric progress was being achieved, rural America was still being served by hundreds of antiquated telephone systems. For the most part they were either family owned or locally owned. In many instances, lines known as farmer switcher lines, owned by the farmers themselves, were connected to the small company systems. Twenty to twentyfive subscribers per line were prevalent in many rural areas. Service was less than adequate. Rural folks, in many instances drove their car into town to talk; they could no longer suffer such poor service from worn out and outdated rural telephone systems. On the other hand, America's cities and larger urban areas were gaining the benefits of modern telephony.

Having witnessed the successful experience of the REA electric program, the Congress in 1949, passed the telephone amendment to the Rural Electrification Act, stating "It is declared to be the policy of the Congress that adequate telephone service be made generally available in rural areas through the improve