Railroad Reorganization

by Stuart Daggett

This plan differed from its abandoned predecessors in four important particulars, each of which was in its favor:

(1) It employed bonds and stock instead of bonds alone;

(2) It lowered instead of increased fixed charges;

(3) It procured cash from stockholders instead of from second consolidated mortgage bondholders; and

(4) It absorbed the New York, Pennsylvania & Ohio into the Erie system instead of continuing the lease thereof.

In the employment of bonds and stock instead of a simple issue of bonds, the Erie managers adopted what experience has shown to be the best method of dealing with the complicated situation arising from a great railroad default. The use of securities on which return was optional side by side with those on which return was obligatory tended both to protect the railroad company when earnings were low, and to benefit the recipients of the new securities when earnings were high. As worked out, it gave to the second consols and funded coupons a less return in the one case, and an equal or greater return in the other, than did the plan of 1894, and to the income bonds, though it offered no chance of equal gain, it at least promised a minimum below which payments should not fall. It further made a far nicer recognition of the relative priorities of different classes of old bonds possible, and whereas the previous plan had made the same demands on, and had given the same return to the second consols, the funded coupon bonds of 1885, and the income bonds, the new plan gave, as has been pointed out, to the first 75 percent in general lien bonds and 55 per cent in first preferred stock; to the second, 100 per cent in general lien bonds, 10 per cent in first preferred, and 10 per cent in second preferred; and to the third, 40 per cent in general liens and 60 per cent in first preferred stock. Income, coupon, and consolidated bonds benefited alike from the assessment upon the stock, which laid the burden of raising cash upon the owners of the road, where it most properly fell. No species of security was given for the assessment, not even common stock, with which the managers might well have been generous; although it must be remembered that the sale of $15,000,000 prior lien bonds for cash was part of the reorganization plan. It may be remarked that since, on July 2, 1895, the common stock was being offered at 10⅝, with no sales, and the preferred at 22½, and since the chance for dividends which the new stock was to enjoy was most remote, it was perhaps well that the syndicate guarantee of the payment of assessments had been obtained. Fixed charges by the new plan were lower, as a result of the liberal use of stock in the exchanges and the cancellation of floating debt as above; while the terms under which the outstanding New York, Pennsylvania & Ohio bonds were retired were the most drastic part of the scheme. In all, the total mortgage indebtedness of the Erie Company and its leased or controlled lines of $234,680,180 for January, 1896, was reduced to $137,704,100 by June 30 of that year.[149]

A weak point in the plan was, nevertheless, the small reduction in bonded indebtedness which it occasioned. Although, to repeat, the bonded indebtedness of the system was reduced from $234,680,180 to $137,704,100, the shrinkage was more apparent than real, since it consisted chiefly in the exchange of stock for New York, Pennsylvania & Ohio mortgage bonds, on which interest had not been paid by the Erie, and but seldom by the New York, Pennsylvania, & Ohio itself. These securities were slashed in most drastic fashion, particularly such of them as were inferior to the first mortgage. The amount of the reduction in the volume outstanding is indicated by the fact that for $5000 first mortgage New York, Pennsylvania & Ohio bonds were given $1000 Erie prior lien bonds, $500 Erie first preferred, $100 Erie second preferred, and $750 Erie common stock; and for $500 second mortgage, or for $1000 third mortgage, were given $100 Erie common stock. If, now, we exclude the New York, Pennsylvania & Ohio bonds from our consideration of the funded debt, we find the indebtedness of the Erie system on January 1, 1896, excluding the non-assumed New York, Pennsylvania & Ohio bonds to have been $121,399,431; and on June 30, excluding the new prior lien bonds used to exchange for these securities, to have been $123,304,100; or an increase through the reorganization of $1,904,669.[150] Further, there was an accompanying increase in the capital stock of the combined companies, which did not, of course, involve an increase in fixed charges, but which increased the volume of securities outstanding.[151] What the reduction in the capital of the New York, Pennsylvania & Ohio, joined with its amalgamation with the Erie system, did do was to lessen the burdens of that line to the parent company. For many years the Erie had engaged to operate the branch for 68 per cent and had paid 32 per cent of its gross earnings to the New York, Pennsylvania & Ohio, to be applied to payment or partial payment of interest on the excessive issues which were now retired. It was probably to be long before an operating ratio of 68 per cent could be successfully maintained; but the Erie after reorganization was obliged to turn over, not 32 per cent of gross earnings, but 4 per cent on the $14,400,000 prior lien bonds which had been given for New York, Pennsylvania & Ohio securities, or an amount of $576,000; which amounted to a reduction of the minimum rental of more than one-half, and of the sums actually paid of almost three-quarters.[152]

Turning again to fixed charges, we find them estimated, after the first two years, at $7,850,000. The average net earnings for the period 1887–94 had been $9,331,250. These earnings will not serve strictly as a basis for calculation, for from 1887 to 1892 they include an average of perhaps $750,000 derived from Lehigh Valley trackage payments and other sums now discontinued. With the deduction, therefore, of this amount from the net earnings of the period named, the average is reduced to $8,768,750; or $918,750 more than it was thought fixed charges would be. When it is considered that this $918,750 represented the sum available for dividends on $146,000,000 of outstanding Erie stock, it is plain that the over-capitalization of the company in 1895 was still very great.

With these comments it is necessary to leave the plan. It was far the best that had ever been applied to the rehabilitation of Erie’s affairs; it was discriminating in its nature, and, thanks to the increasing prosperity of the last eleven years, it has been fortunate in its results. In August, 1895, a decree of foreclosure was signed in the city of New York, and the following November the property was sold under the second consolidated mortgage, and purchased by the reorganization committee for $20,000,000.[153]

Since 1895 the Erie has shared in the prosperity of the country. Its ton mileage has increased from 3,939,679,175 in 1897 to 6,275,629,877 in 1907; its gross earnings have grown from $31,497,031 to $53,914,827; and its net earnings, which had hovered for so many years near or below the level of fixed charges, have now soared away above. Under these circumstances it is but natural that large sums should have been applied to improvements. Between December 1, 1895, and June 30, 1907, $12,732,486 were spent in the purchase of land, in yards, stations, and buildings, in reducing grades, relocating tracks, and in other ways, and charged to capital; $36,511,046 were spent for new equipment, and charged to capital; and $8,625,307 were taken from income for equipment and improvements of various sorts. These expenditures have had a most gratifying result. The average train load has grown from 224.74 tons in 1895 to 471.67 in 1907, although coal now constitutes a smaller proportion of the freight; and the average revenue per train mile has more than doubled, in face of a revenue per ton mile which has only slightly increased. In 1907 the Erie’s ton mileage was 59 per cent greater than in 1897, and its passenger mileage was 73 per cent greater, but the expense of conducting transportation had increased but 27 per cent. Instead of freight cars with an average capacity of 22½ tons the company now uses cars which average 34 tons. Instead of locomotives which on the average could exert a tractive force of only 24,500 pounds as late as 1901, it has now engines which average 31,000. Freight train mileage is 2,600,000 less than it was in 1896, and passenger train mileage has only slightly increased.