For the retirement of $77,430,000 outstanding first, second, and third mortgage bonds$75,000,000  
For the retirement of the existing $26,000,000 branch bonds26,000,000  
For additional branches at a rate per mile not over $30,00020,000,000  
For enlargement of terminals and stations, additional rolling stock, betterments and renewals, and other expenses not properly chargeable to operating expenses20,000,000  
For premiums on bonds exchanged10,000,000  
For general purposes9,000,000[575] 

Only a portion of these securities was, therefore, to be issued at once. The provision for enlargement of terminals, etc., was likely to call for early issues, as might a portion of that reserved for new branches and for general purposes. It was expected that a certain amount of branch-line bonds could be retired without much delay. On the whole, the bonds immediately put forth were not expected to exceed $15,000,000; though there was nothing in the plan to prevent a greater issue. The interest rate was “not to exceed 5 per cent.” That this wording was deliberately adopted is shown by the terms of the mortgage, which expressly gave to the company the power to issue the new bonds, from time to time, bearing such a rate of interest as the managers might think advisable up to 5 per cent. It was understood that the issue was to be in three classes, one of $57,000,000 to bear 5 per cent, one of $23,000,000 to bear 4½ per cent, and one of $80,000,000 to bear 4 per cent; and on this basis it was thought that fixed charges would be reduced $2,000,000, to which would have to be added interest on bonds issued in excess of those previously outstanding.[576] The reserve of $10,000,000 for premiums shows that in the opinion of the directors the offer of substantially more than par in new bonds was necessary in order to induce exchanges of old bonds for new. To prevent careless use of this reserve it was provided that the $10,000,000 in bonds could be used to pay premiums only upon the affirmative vote of at least nine members (out of thirteen) of the board, and when in the opinion of the trustees, expressed in writing, a saving of interest to the company could be effected.

Not the least important part of the plan was that designed to gain the preferred stockholders’ approval. It will be remembered that by the terms of the reorganization of 1875 the consent of three-quarters of these stockholders was necessary to validate any mortgage after the first mortgage then proposed. The increase in indebtedness now suggested threatened to postpone indefinitely dividends on the preferred, and could not be expected to be welcome. In consequence, the directors offered three distinct inducements: first, a promise of a distribution to the preferred stockholders of sums which had been taken from earnings and spent on the property to date; second, a promise of early and regular dividends in the future; third, a preferential right of subscription to the new bonds. By resolution of August 21, 1889, they therefore definitely declared in favor of the distribution of a sum equal to the earnings which should be found to have been applied in earlier years to the capital requirements of the property. An investigation was made, the amount was officially declared to be $2,844,430, and an equivalent amount of new bonds at 85 was set aside to cover it. For the future Mr. Villard and his associates announced a determination to begin dividends at the rate of 4 per cent, the first to be paid January 1, 1890; and declared that thereafter dividends would be paid out of the current net earnings, or, if these should be insufficient, out of a reserve fund until the net earnings should justify a larger distribution. Finally, it was provided that the common and preferred stockholders should be given the privilege of subscribing to the new bonds at 85 to the extent of 15 per cent of their holdings. That these concessions attracted attention was shown by the action of the preferred stockholders in calling for an actual distribution as soon as possible of the amounts deducted from earnings in past years. On October 17, 1889, they passed a resolution recommending to the incoming board of directors “to take into consideration the distribution of the whole amount due to the Preferred Stock, under the plan of reorganization, as soon as the Company shall be financially in a proper position to do so;”[577] and again the following year they resolved “that the incoming Board of Directors be ... requested to set apart the additional earnings in ... consolidated bonds ... and to (consider) the question of either increasing the ... dividend above 4 per cent or of declaring an extra dividend to the preferred stock.”[578]

All things considered it is improbable that the refunding plan could have been put through without the promise of dividends to the preferred stock, but it remains unfortunate that such promises had to be made. The money which had been put into the road had been of necessity so invested to preserve the solvency of the company. In a sense it had increased earning power, but not all expenditures which affect earnings may be charged to capital. In the first place, if earnings are below fixed charges, or are constantly tending to fall below, sums put into the property merely assist the company to keep its head above water, and are not a sound basis for an increase in indebtedness; and in the second place expenditures which serve to preserve earnings may not be charged to capital account, even when the method of preservation is the construction of branch lines, and still less when the method is the improvement of the existing plant. If, then, as was the case, the earnings claimed by the preferred stockholders had gone to preserve the solvency of the company, and to defend it against competition, the arguments of these stockholders in 1889 did not hold good.

As for the plan itself, it was simply a method for providing new capital, and should be judged as such. Its refunding provisions were mainly misleading. It proposed to secure a reduction in fixed charges by the exchange of bonds bearing 5 per cent or less for bonds bearing 6 per cent, but how the reduction was to be accomplished was not clear. The maturity of the bonds to be retired was remote, and the assured reduction was therefore also remote. The first mortgage had been issued in 1881, and ran for forty years; the second dated from 1882 and was to mature after fifty years; and the third, which had been issued only the year before, was not redeemable until 1937. The Missouri division and Pend d’Oreille mortgages matured somewhat earlier,[579] but had nevertheless a considerable time to run. The mortgage issues would therefore not soon fall in of themselves. Secondly, bondholders would evidently not consent voluntarily to surrender old unexpired bonds without such a premium in new bonds as would make their annual return approximately the same. Something they might concede in view of the more remote maturity of the new issue and the somewhat more inclusive character of its mortgage lien, but not enough to create any considerable saving.[580] The new issues for improvement of the road, moreover, involved an increase in the annual interest payments; which we must not, perhaps, condemn offhand, for the raising of capital was in some measure forced upon the company, but which is important in considering the railroad’s financial condition and prospects. The fact was that the Northern Pacific was not self-supporting; it had been obliged to issue $20,867,000 bonds of its own and to guarantee $20,981,000 besides, between 1884 and 1889, in order to secure an advance of $2,462,288 in annual net income during a period of rapidly increasing prosperity; and it was now obliged to increase this indebtedness in the attempt to maintain its solvency for the future.

Between 1889 and the end of 1892 business increased, and net earnings at first gained more rapidly than did fixed charges. Mr. Villard was again supreme in the management, and actively directed financial operations until his departure for Europe in 1890. The most important operation conducted was the lease of the Wisconsin Central, whereby the eastern terminus of the Northern Pacific system was transferred from St. Paul and Minneapolis to Chicago. The directors who were elected with Mr. Villard in 1887 controlled the Wisconsin Central and the Terminal Company, which had been formed to secure an entrance for that road into the Lake city.[581] Perhaps because of this financial interest, the conviction seems to have crept over them that the Northern Pacific would do well to make connection with the trunk lines at Chicago, instead of stopping further west; and they brought the subject up in 1889, and again in 1890. On July 1, 1889, a traffic contract went into effect, under which the Northern Pacific obtained the use of the Wisconsin Central lines in consideration of the business which it should turn over to them. Certain provisions imposed on both roads a share of the operating expenses whenever the proportion of operating expenses to gross earnings was greater than 65 per cent, and which gave both a profit whenever the proportion fell below this level. The Wisconsin Central retained entire and absolute control of its own property, except that the Northern Pacific was to share in the profits of the subsidiary Terminal Company whenever these profits should be more than $800,000.[582] This was considered unsatisfactory, because the Northern Pacific had no control of the Central’s operation; and on April 1 of the following year a new contract gave to the former a lease of all the lines owned and controlled by the Wisconsin Central Company and the Wisconsin Central Railroad Company between St. Paul and Chicago for 999 years; including terminal facilities at Chicago held by the Chicago & Northern Pacific Railroad Company, a subsidiary corporation.[583] “It was deemed by the Board,” said the annual report, “as of the utmost importance that your road should have access to the city of Chicago by a line in its own ownership and possessed with terminal facilities which it could control and have possession of. The whole subject was most carefully considered by the Board, and the contracts and leases were adopted after deliberate and careful consideration.”[584] The advantage of this lease to the Wisconsin Central lay in the large volume of traffic which the arrangement secured to it; that to the Northern Pacific was more doubtful. Connection with Chicago was desirable, but it was to prove difficult to operate the Wisconsin Central for 65 per cent, and the acquisition was to arouse the hostility of all the other roads between Chicago and St. Paul. We shall see that the lease was presently given up and that the attempt to make Chicago the eastern terminus was for the time abandoned.

The year 1891 was a good one, but during the following twelve months the situation changed for the worse. Most noteworthy was an increase in fixed charges of over $2,000,000, due in part to an increase in the funded indebtedness, but more largely to an increase in rentals paid. This increase brought charges above total net income, and shows how serious the position of the company had become. In fact, the company’s repeated issues of bonds had failed so completely to put it in a stable position that in but three of the nine years from 1884 to 1892 was a surplus greater than $500,000 above fixed payments secured, while the operations of two of these same years resulted in a deficit.

The first admission by directors that the road was in difficulty consisted in the passing of the preferred stock dividend for March 31, 1892. That this action did not deprive the holders of all return was due to the previous conversion of the consols formerly reserved into a trust for ten years on which to draw whenever the road should be unable to pay the usual dividends. The directors therefore added to their declaration of suspension a resolution that the “time, manner, and method of the distribution of so many of the $3,347,000 of consolidated bonds set aside for the benefit of the preferred stockholders as may be necessary to supply the deficiency, if any, in this or any subsequent fiscal year, between the amount of net earnings and 4 per cent on the preferred stock, be submitted to preferred stockholders at the annual meeting in October next.”[585] Not unnaturally stockholders were alarmed. At the annual meeting in October an investigating committee was appointed,[586] and proceeded to a careful examination of the property accompanied by certain officers of the road. The committee was not friendly to the management. Its preliminary report announced that the physical condition of the system was good, but its later criticism of the company’s financial condition was severe. In the words of the London Standard “there has been no such scathing arraignment of Directors since the exposures of the Erie Railway.” The committee stated that the bad condition of the property was due to the reckless financial methods of the directors. It alleged that officers had held dual positions, and had subordinated the interests of the Northern Pacific Company to those of the Wisconsin Central, relieving themselves at the expense of the former road. It commented upon the unprofitable character of certain of the other branches. The floating debt, it maintained, had been financed by Mr. Villard personally at double the current rates of interest, and it recommended litigation in default of some assurance that the policy of the company should be changed.[587] In reply the directors issued a lengthy statement taking up the charges in detail. The policy of building branch lines, said they, was imperatively necessary in order to develop business. Although some of the branches had not earned their fixed charges, yet, if they had been credited with 60 per cent of the gross earnings on business which they had brought to the main line, they would have shown a good profit. The policy of branch-line construction had met with the unanimous approval of successive boards of directors, and had been ratified by the stockholders in 1886; and in this connection the reply defended specifically the acquisition of the Wisconsin Central and other lines. The carrying of the floating debt by officials interested in the property, instead of being subject to criticism and censure, was entitled to the highest commendation.[588]

It is difficult to pass with justice upon the conflicting contentions above outlined. However, writing in 1905, long after his retirement from Northern Pacific affairs, Mr. Villard expressed himself as follows: “In 1891 Mr. Villard ... made ... his last official tour of inspection of the main line and principal branches of the Northern Pacific.... The most alarming impression of all made upon him was the revelation of the weight of the load that had been put upon the company by the purchase and construction of the longer branch lines in Montana and Washington, which he then discovered for the first time. There was the Missoula branch to the Cœur d’Alene mines; the Cœur d’Alene Railway & Navigation, a mixed system of steamboats and rail lines; the Seattle, Lake Shore & Eastern; and the roads built into Westernmost Washington; representing a total investment in cash and bonds of not far from $30,000,000, which together hardly earned operating expenses. The acquisition and building of these disappointing lines had in a few years absorbed the large amount of consolidated bonds set aside for construction purposes, which had been assumed to be sufficient for all needs in that direction for a long time.”[589] No man should have known the real profitableness of these extensions better than Mr. Villard; and the circumstances of his account give it special weight. The admitted fact that in several cases the managers of the Northern Pacific voted as directors of that corporation to buy property from themselves as whole or part owners in other enterprises also excites distrust, and this feeling is strengthened by the unsatisfactory financial condition in 1893 of the Northern Pacific system as a whole.

Even before the report of the investigating committee the directors had been busy with the floating debt. This amounted to $9,918,000 late in 1892, according to the treasurer’s statement. In February, 1893, it was decided to cancel it by the sale of the stock of the St. Paul & Northern Pacific held in the treasury, but this aroused violent opposition. The St. Paul & Northern Pacific ran, it will be remembered, from Brainerd to St. Paul and Minneapolis, and had formed the eastern terminus of the Northern Pacific system until the acquisition of the Wisconsin Central. It was justly considered an extremely important section of the main line, and the possible loss of its control was regarded as disastrous.[590] Dissuaded from their first purpose, the directors considered the issue of a collateral mortgage sufficient in amount to relieve all pressing necessities, and proposed to utilize in this way treasury securities which it would have been unwise to sell. At the same time the stockholders’ committee had much the same idea in mind, and wrote to President Oakes in March, and again in May. “Referring to my letter to you of March 15,” said Brayton Ives, “I beg to say that the financial plan therein referred to contemplates the creation of a collateral trust in which shall be placed $10,000,000 Northern Pacific consolidated 5s, $3,000,000 Chicago & Northern Pacific firsts, and all of the St. Paul & Northern Pacific stock belonging to the Northern Pacific Company, estimated at $7,000,000. Against these securities it is suggested that notes to the extent of $12,000,000 be issued, bearing 6 per cent interest, and payable in five years, or before, at the pleasure of the company, provision being made at the same time for the increase of the amount of the notes to $15,000,000 on the deposit of additional collateral securities satisfactory to the underwriters. I am happy to be able to repeat the belief already expressed, that if the board of directors will allow the underwriters to name seven directors of the company the entire amount of notes will be subscribed for without delay.”[591] This plan was backed by responsible houses, including the Mercantile Trust Company, Kuhn, Loeb & Co., the Equitable Life Assurance Company, and others, who agreed to take $7,000,000 of the new bonds at 95, less 1½ per cent commission. The directors paid no attention to Mr. Ives’s letter, and his offer was subsequently withdrawn.