Small Business Size Standards; Surety Bond Guaranty Assistance Program

SMALL BUSINESS ADMINISTRATION

13 CFR Part 121

Small Business Size Standards; Surety Bond Guaranty Assistance

Program

AGENCY: Small Business Administration.

ACTION: Final rule.

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SUMMARY: The Small Business Administration (SBA) is adopting as final a

size standard for the Surety Bond Guaranty Program of $5.0 million in

average annual receipts for firms in the construction and services

industries. This size standard is being adopted in order to take into

consideration the effect of inflation since 1978 on the current size

standard and to expand eligibility for SBA surety guarantees to firms

in the construction and services industries above $3.5 million that are

experiencing difficulties in obtaining surety bonding in the private

market.

DATES: Effective July 1, 1994.

FOR FURTHER INFORMATION CONTACT:

Gary M. Jackson, Director, Size Standards Staff, Tel: (202) 205-6618.

SUPPLEMENTARY INFORMATION: The SBA has administered a program of

contract surety bond guarantee assistance for small businesses since

1971. The SBA guarantee enables participating surety companies to

furnish surety bonds on behalf of small contractors that would be

unable to obtain bonding on reasonable terms and conditions without an

SBA guarantee. The SBA guarantees the surety company against a

percentage of loss it may incur under an eligible contractor's bond.

This final rule will increase the surety bond guarantee size

standard to $5.0 million in average annual receipts from $3.5 million

for firms in the construction and services industries which apply for

such guarantees. This adopted size standard is lower than the $6

million size standard the SBA had proposed on August 27, 1993 (58 FR

45300). As stated in the proposed rule, the SBA believes the current

$3.5 million size standard, established in 1978 (43 FR 21689), should

be increased for three reasons: (1) to account for the effects of

inflation since 1978, (2) to bring the surety size standard closer to

the size standards established for other program purposes for the

construction industries ($7 million for special trades and $17 million

for general and heavy construction), and (3) to extend assistance to

firms above $3.5 million who otherwise could not obtain surety bonds on

reasonable terms and conditions. Further consideration of the proposed

size standard by the SBA in light of comments received to the proposed

size standard has led to the conclusion that a size standard of $5

million is more appropriate for purposes of the surety bond guaranty

program.

The SBA received a total of thirty-eight comments in response to

the August 27, 1993 proposed rule. The comments received show

approximately half in favor and half opposed to the proposed increase

to $6.0 million. Twenty of the thirty-eight comments supported the

proposed rule. The affirming comments, fourteen from surety companies

and surety associations and six from contractors and contractor

associations, agreed that inflation over the past 15 years has reduced

the availability of surety bonds for small contractors by not being

eligible for an SBA guaranteed surety bond due to their business size.

These commenters agreed that the Surety Bond Guaranty size standard

should be revised to $6.0 million based on inflation.

The SBA received eighteen comments opposing the proposed increase

to $6.0 million in annual receipts. All eighteen comments were from

surety companies and surety associations (SBA's partners in the surety

bonding process). These comments disagreed with the need for the

proposed rule and expressed concern about its impact on the Surety

Guaranty Program.

All eighteen of the respondents commenting negatively on the

proposed Surety Bond Guaranty size standard disagreed with the Agency

position that $6 million in revenues should define a small business in

the construction and service industries, and contended that the size

standard should remain at the current level of $3.5 million. The

commenters argued that, based on a recent study by the National

Association of Surety Bond Producers, surety bonds are readily

available for small firms with less than $2.0 million in revenues. The

commenters emphasized that if the purpose of the SBA surety bond

program is to assist small businesses in obtaining bonds, the current

market availability of surety bonds is such that assistance is not

necessary. Therefore, they claimed that the SBA need not increase the

size standard. Furthermore, several of the comments indicated that 97.4

percent of all construction enterprises meet the existing $3.5 million

size standard. These commenters felt that the proposed rule would make

the Surety Bond Guaranty size standard so large that it would include

large businesses and, therefore, diminish the benefit to small

businesses. According to these commenters, this action would defeat the

original purpose of support for small contractors.

The SBA is aware that many firms with revenues between $3.5 million

and $6 million have no difficulty obtaining bonds. Nonetheless, there

exists a segment of firms over $3.5 million in revenues that are not

able to obtain a surety bond on reasonable terms and conditions without

an SBA guarantee. These firms are denied bonding because they are

viewed by a private surety as presenting too great a risk. These firms

may lack a track record because of their infrequency of seeking bonding

or they may have been in business for a relatively short period of

time. However, with an SBA guarantee, the risk is reduced to a level

where the surety will issue a bond. The SBA believes the Surety Bond

Guaranty Program should also be available to these firms so long as

they meet other program and bonding criteria. It should be emphasized

that many of these firms were at one time small businesses eligible for

a surety bond guaranty, but inflation over the years has effectively

increased their nominal size to a level exceeding the current size

standard without a corresponding growth in real terms relative to other

businesses.

The SBA agrees that the vast majority of construction firms are

already included under the existing size standard. The SBA estimates

that approximately 95 percent of existing companies fall within the

existing standard. However, the more significant statistic is that

these construction firms account for only about 40 percent of the total

construction receipts. An increase in the size standard will continue

to define as a small business, firms whose total combined receipts

represent less than half of total construction receipts.

After considering the arguments presented by the public comments

received opposing an increase in the current size standard, the SBA

continues to believe that an increase in the Surety Bond Guaranty size

standard is appropriate. It is being increased, however, to $5 million

in annual receipts rather than the proposed $6 million size standard.

The SBA is now persuaded, based on the negative comments to the

proposal, that $5 million is a more appropriate size standard than $6

million for purposes of this surety bond guaranty program.

As a lower but needed increase to the surety guarantee size

standard, the level of $5 million is being adopted. The SBA believes an

increase in the size standard to $5 million is appropriate for several

reasons. First, this increase makes the surety guarantee bond size

standard consistent with increases recently adopted by the SBA for

other program purposes in industries having a $3.5 million size

standard (59 FR 16513). Under that action, size standards were adjusted

for inflation occurring between the third quarter of 1982 through the

fourth quarter of 1993. At the time of the last general inflationary

adjustment effective in 1984, SBA made no adjustment to the surety bond

guaranty program size standard of $3.5 million, even though that

standard was established in 1978. The SBA believed at that time that

the existing surety size standard continued to be appropriate for the

Surety Bond Guaranty Program, but the effect of another ten years of

inflation has now significantly eroded the base of firms eligible for

the program. Although the $5 million size standard does not represent a

full inflationary adjustment since 1978, it does take into account most

of the effects of inflation, while still retaining a size standard at

an acceptable level. Second, the $5.0 million level is, with few

exceptions, the lowest size standard established by the SBA for

nonmanufacturing industries, including the services industries to which

the surety guarantee size standard also applies. Third, two major

associations representing a large number of contractors and specialty

sureties recommended an alternative size standard of $5 million to

account for inflation and to meet the surety bonding needs of small

``hard to place,'' minority and emerging contractors. The SBA believes

the $5 million size standard is needed to assist such firms toward

participation in the standard surety market by enabling them to remain

eligible for SBA surety guarantees for an additional period of business

growth, which can be critical to a firm's economic strength.

SBA considered carefully the nature and extent of the opposition to

an increase to $6 million contained in the comments, and has concluded

that its objectives in adjusting for inflation, achieving consistency

with its overall system of size standards, and improving availability

of program benefits for particularly vulnerable firms can be adequately

met by raising the standard to only $5 million. Additionally, SBA now

believes that a $6 million standard for this program would have

unacceptable adverse consequences in terms of diminishing a market that

a significant portion of the surety industry relies upon, and in terms

of the willingness of all sureties to utilize the SBA guaranty rather

than simply denying a bond to a contractor.

Some negative comments received on the proposed size standard

pointed out that expanding the size standard would provide additional

demand on the program. Some expressed fear that as larger companies

participate in the program, the agency's limited resources would

ultimately be unavailable to those small contractors that most need the

assistance. This concern is underscored by the view that construction

firms with receipts over $3.5 million have ample access to standard

surety markets.

The SBA analysis of the Surety Bond Guaranty Program does indicate

that the revised size standards will increase the demand on the

Program. The SBA estimates that this additional demand could be as much

as $200 million. However, a review of the program usage for the last

three years indicates that the Program has been operating well below

its appropriated limit. Therefore, the SBA concluded that the increased

demand based on a $5.0 million Surety Bond Guaranty size standard could

be accommodated with the existing funding levels appropriated by the

Congress.

A final issue raised by several negative commenters expressed the

concern that increasing the size standard would, of necessity, increase

the government's potential for loss. These comments pointed out that

contractors with receipts of $3.5 million to $6.0 million tend to

perform larger jobs requiring more sophisticated levels of management

control. These larger companies sometimes experience declines in

bonding credit where management talents are not proven. The insurers

point out that increasing the size standard would demand more oversight

on the part of the SBA to ensure that larger contractors have the

management expertise to perform these large contracts. They argue that

in the absence of this additional oversight, the potential for

government loss would be unduly increased.

The SBA recognizes that there is a valid concern when the potential

for greater loss to the government is increased. The SBA notes that

currently most of the contractors requiring assistance in obtaining

surety bonds have annual receipts of less than $2 million, and that the

average surety bond is a little greater than $100,000. The Agency

believes that the increase in the Surety Bond Guaranty size standard

would not demand more oversight on the part of the SBA to ensure that

larger contractors have the management expertise to perform. Because

SBA is the guarantor to the participating sureties, SBA expects

participating sureties to adhere to the SBA and industry general

principles and practices used in evaluating credit, capacity, and the

surety business. Prudent underwriting performed by the surety prior to

obtaining SBA guarantee provides a reasonable expectation that the

principal will perform according to the covenants and conditions of the

contract. In addition, the terms and conditions of the surety bond are

reasonable in light of the shared risks involved and the extent of the

surety/SBA participation and monitoring of contract performance.

The SBA believes that the $5 million size standard will accomplish

the purposes stated in the proposed rule for increasing the size

standard. Those reasons were to take into consideration, as

appropriate, inflation on the eligibility of firms for the Surety Bond

Guaranty Program, to bring the Surety Bond Guaranty size standards

closer to the size standards used in the construction industries for

SBA's procurement and loan programs, and to extend assistance to

contracting firms above $3.5 million in size who otherwise could not

obtain surety bonds on reasonable terms and conditions without an SBA

guarantee.

Compliance With Regulatory Flexibility Act, Executive Orders 12612,

12778, and 12866, and the Paperwork Reduction Act

General

SBA considers that this final rule will impact, in terms of

eligibility, on a substantial number of small entities for purposes of

the Regulatory Flexibility Act (5 U.S.C. 601 et seq.), and will have a

significant economic impact on a substantial number of small entities

for purposes of this Act. Eligible contractors remit to the SBA a

guarantee fee of $6 per $1,000 of the awarded contract price. The

amount estimated below in (1) would represent an impact upon newly

eligible contractors of approximately $1.1 million, at the estimated

participation level. However, since the contemplated economic impact in

terms of the amount of SBA guarantee utilization is approximately $200

million [see (1), below], it constitutes a significant rule for the

purpose of E.O. 12866. Immediately below, the SBA has set forth a

summary regulatory impact analysis and a final regulatory flexibility

analysis of this rule.

(1) Description of Entities to Which the Rule Applies

SBA estimates that 11,500 additional firms (or an additional 2.2

percent), out of a total of 529,000 firms in the construction

industries, will gain small business status for the Surety Bond

Guarantee Program by adopting this final rule. There were approximately

11,500 firms in the construction industries with between $3.5 and $5.0

million in annual sales according to a special tabulation prepared by

the Census Bureau for the SBA using 1990 data. These 11,500 firms

accounted for approximately $44 billion in sales (8.5 percent of total

construction receipts). With the adoption of this rule, they become

eligible for SBA's surety bond assistance, provided they meet the other

program requirements.

While an estimated 11,500 firms will be newly eligible as a result

of this rule, the number of additional firms actually receiving

assistance will be much fewer. The SBA estimates that 104 additional

firms will receive assistance in an average year. This estimate is

based on the fact that less than one percent (4,532 in FY 1991) of the

503,000 construction firms that are currently eligible now receive SBA

guaranteed surety bonds, and it also assumes that a similar percentage

of the newly eligible firms in the $3.5 million to $5.0 million size

range would receive SBA guaranteed surety bonds.

SBA estimates of $200 million in additional guarantees will occur

based on its experience with those firms that in the past have received

SBA guaranteed bonds. SBA has observed that these users have obtained

SBA guarantees on contract bonds representing approximately 61 percent

of their gross revenue. Construction firms in the $3.5 to $5.0 million

sales range generate nearly $44 billion in annual sales, or an average

of $3.85 million per firm ($44 billion11,500 firms). One

hundred and four of those newly eligible construction firms (less than

1 percent) are projected to utilize the SBA Surety Bond Guarantee

Program. These firms collectively generate $400 million in sales.

However, since approximately 61 percent of participating firms' sales

are guaranteed under SBA's Surety Bond Program, roughly $244 million in

additional SBA guaranteed contract surety bonding will be covered, or

about $200 million in additional government commitments (see Table,

below).

Construction firms in $3.5-$50 million range

-------------------------------------------------------- Total value of

Total to receive Total receipts of bonding affected Total government

SBA surety Average receipts firms receiving by the guarantee exposure (e) x

Total guarantees (a) x per firm bonds (b) x (c) (d) x 61% 82%

0.91%

(a) (b).............. (c).............. (d).............. (e).............. (f)

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11,477........... 104 firms........ $3.85 million.... $400.4 million... $244.2 million... $200.3 million.

The adopted standard, however, does not impose a regulatory burden

on these newly eligible firms because it does not regulate or control

behavior.

(2) Description of Potential Benefits of the Rule

The benefit of this rule for the government is that the resulting

additional competition from contracting firms that are newly eligible

to bid on and perform contracts under the adopted size standard should

result in lower costs to the Federal government and to other public and

private contracting bodies for construction and service contracts.

Since 1971, through and including fiscal year 1992, it is estimated

that the Surety Bond Guarantee Program has saved the public sector over

$1.2 billion. The savings is the computation between the lowest bid

coming from the Surety Bond Guaranty Program participant and the next

higher bidder. The premise is that the cost of the procurement has been

reduced because the small contractor (i.e., the lowest bidder), would

not have been awarded the job had the contractor not been a participant

in the Surety Bond Guarantee Program. The savings to the public sector

at the local, city, state and federal levels will also include amounts

these entities would have had to pay for the higher bidder's surety

bond protection if the Surety Bond Guarantee Program were not in

existence. Private sector savings are also believed to be significant,

but not measurable. In addition, the firms that will now be considered

small for purposes of surety bond assistance will benefit through the

receipt of such assistance in further developing their business

objectives.

(3) Description of Potential Costs of the Rule

This change in size standards as it impacts on government should

not add a major element of cost to the government and, in fact, as

described above in (2), may reduce the cost to a procuring Federal or

other public agency as a result of additional competition for

contracts. The competitive effects of size standards revisions differ

from those normally associated with regulations affecting key economic

factors such as the price of goods and services, costs, profits,

growth, innovation, mergers and foreign trade. The change to size

standards is not anticipated to have any appreciable effect on any of

these factors.

(4) Description of the Potential Net Benefits from the Rule

From the above discussion, SBA believes that, because the potential

costs of this rule are minimal, the potential net benefits are clear.

By increasing the size standard to $5.0 million, a number of businesses

in the $3.5 to $5.0 million range that presently have difficulty

obtaining surety bonding will now be eligible for SBA surety bond

guarantee assistance. As a result, competition will be similarly

increased, and hence reduce the overall costs to both public and

private procuring bodies.

(5) Description of Reasons Why This Action is Being Taken and

Objectives of Rule

SBA has provided above in the supplementary information a

description of the reasons why this action is being taken and a

statement of the reasons for and objectives of this rule.

(6) Legal Basis for the Rule

The legal basis for the rule is Sections 3(a), 5(b)(6), and 15(i)

of the Small Business Act, 15 U.S.C. 632(a), 634(b)(6), 637(a) and

644(c).

(7) Federal Rules

There are no Federal rules that duplicate, overlap or conflict with

this rule. SBA has statutorily been given exclusive jurisdiction in

establishing size standards.

(8) Significant Alternatives to Rule

The changes to the current size standard set forth in this rule

attempt to establish the most appropriate definition of small

businesses eligible for SBA's Surety Bond Guarantee Program. The SBA

considered a $6.0 million Surety Bond Guaranty size standard as well as

a $5.0 million Surety Bond Guaranty size standard, but decided that

$5.0 million was the best alternative for the reasons set forth in the

supplementary information.

SBA certifies that the rule will not have federalism implications

warranting the preparation of a Federalism Assessment in accordance

with Executive Order 12612.

The SBA further certifies that this rule will not add any new

reporting or recordkeeping requirements under the Paperwork Reduction

Act of 1980, 44 U.S.C., Chapter 35.

For purposes of Executive Order 12778, SBA certifies that this rule

is drafted, to the extent practicable, in accordance with the standards

set forth in section 2 of that order.

List of Subjects in 13 CFR Part 121

Government procurement, Government property, Grant programs--

business, Loan programs--business, Small Business.

Accordingly, part 121 of 13 CFR is amended as follows:

PART 121--[AMENDED]

1. The authority citation for part 121 continues to read as

follows:

Authority: 15 U.S.C. 632(a), 634(b)(6), 637(a) and 644(c).

2. Section 121.802, is amended by revising paragraph (a)(3) to read

as follows:

Sec. 121.802 Establishment of the size standard.

(a) * * *

(3) For purposes of surety bond guarantee assistance,

(i) Any construction (general or special trade) concern is small if

its annual receipts average for its preceding three completed fiscal

years does not exceed $5.0 million.

(ii) Any concern performing a contract for services (including, but

not limited to services set forth in Division I, Services, of the

Standard Industrial Classification Manual) is small if its annual

receipts average for its preceding three completed fiscal years does

not exceed $5.0 million.

(iii) For other surety bond guarantee assistance, an applicant must

meet the size standard set forth in Sec. 121.601 for the primary

industry (as defined in Sec. 121.802(b)) in which the applicant,

including its affiliates, is engaged.

* * * * *

Dated: May 5, 1994.

Erskine B. Bowles,

Administrator.

[FR Doc. 94-13239 Filed 5-31-94; 8:45 am]

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