Period prior to 1893
Period of 1893–8.
Comparing the total interest with the total bond issue, we find the average rate to have decreased from 5.5 per cent to 4.9 per cent by the reorganizations prior to 1893, and from 5.1 per cent to 4.3 per cent by the reorganizations of 1893–8. Of some significance is a comparison of the rates prior to the reorganizations before 1893 with those subsequent to the reorganizations of 1893–8. The total interest payable on the issues at the later date was $38,291,319. If the same proportions of bonds had been issued at the same rates of interest as before the reorganizations prior to 1893, this interest would have amounted to $48,552,688. The total interest payable on the issues before the reorganizations prior to 1893 was $35,658,192. If the same proportions of bonds had been then outstanding at the same rates as after the reorganizations of 1893–8 the interest charge would have been $27,941,807. Thus in the first case there would have been a saving of $10,261,369 annually, and in the second case one of $8,279,775. This computation is inexact because it fails to take account of the normal reduction of interest rates due to improved credit and to increased prosperity from causes other than reorganization; but it is included here because, in the first place, a large part of the reduction was due to actual reorganization; and in the second place, because much of the improved credit is attributable indirectly to reductions of charges and other reorganization features.
It should be noticed that the new bond issues not only bore lower rates of interest, but were of greater volume and of longer term than the issues which they replaced. The greater volume is reflected in the considerable reduction in the number of issues at the same time that the total amount of bonds outstanding decreased slightly or increased. Thus the reorganizations before 1893 increased the amount of bond issues from $645,605,522 to $788,629,515, and decreased their number from 128 to 98; while the reorganizations of 1893–8 decreased the amount of bonds from $919,836,832 to $881,574,002, and decreased the number of issues from 189 to 90, or in far greater proportion.[714] The matter may be viewed in another way. Just before the beginning of the later reorganizations the predominant rate of interest for the roads concerned was 6 per cent. The number of issues at 6 per cent outstanding was 85 and the average amount per issue was $3,540,302. The predominant rate just after those reorganizations was 4 per cent. The number of issues at 4 per cent outstanding was 16, and the average amount per issue was $32,544,319. In other words, the process was to replace numerous small issues which bore high rates of interest, by a few comprehensive issues at lower rates; thus simplifying the financial situation, as well as lightening the burdens which the roads had to bear.
The lengthening of the terms for which the various mortgages were to run is equally apparent. Before its reorganization in 1897 the Union Pacific had no mortgage issued for more than 40 years. The first mortgage of 1897 ran for 50 years. The Reading in 1895 had four mortgages, all issued during the reorganization of 1888, with terms of 70 years. All its other mortgages were for shorter periods. In 1897 it put forth a grand divisional mortgage with a term of 100 years. The Erie in 1894 had two mortgages of 91 years each and one of 84 years, issued during the financial scandals of 1869, but no other of over $1,000,000 which ran for more than 43 years. Both its prior lien and its general mortgage bonds now outstanding are to mature 101 years from date of issue. The Atchison in 1889 could boast of only one mortgage with a term of 51 years. Its reorganization at that time gave it two of 100 years. The Northern Pacific issued one 100-year mortgage in the course of its troubles in 1889, and two mortgages for 101 and 150 years respectively in its reorganization of 1896. The reason for long terms has been the wish to make new mortgages attractive. Reorganization mortgages, as has just been said, tend to be large mortgages, at a lessened rate of interest. They are also blanket mortgages with an inferior lien. Some inducement besides the compulsion of necessity is useful in securing the assent of old bondholders to the proposed exchanges of these bonds for outstanding securities. The long-term bond protects the holder against the probable steady fall in the rate of interest on capital. It promises him advantage in the future in return for surrender in the present.
The reduction in charges by the substitution, for mortgage bonds with fixed interest, of securities upon which payment of interest is optional, has been as important as the reduction in the rates of interest just described. Such securities may be either income bonds or stock. The income bond has a lien upon railroad property similar in kind to the lien of an ordinary mortgage. Upon default in the payment of its principal it can exercise foreclosure rights. But it has no claim on earnings except in a right to receive dividends out of net earnings before any dividend shall be paid upon the stock. Stock certificates control the company by their right to vote,[715] but are entitled to its profits only after expenses of every kind have been met. When divided into preferred and common shares the former receive preference in dividends and sometimes in voting power. Among the reorganizations described in the text three made use of income bonds before 1893 and one after 1893. The amounts of the issues and the percentages of incomes to total capitalization before and after the reorganizations were as follows:
Income Bonds
| Per cent | |||||
|---|---|---|---|---|---|
| Before | After | Before | After | ||
| Atchison, ’95 | $51,728,000 | 31.8 | |||
| Atchison, ’89 | 80,000,000 | 35.4 | |||
| Reading, ’83 | $22,347,227 | 56,389,466 | 21.7 | 39.3 | |
| Reading, ’80 | 11,678,500 | 18,737,709 | 15.0 | 19.3 | |
The East Tennessee reorganization of 1886 did away with income bonds, as did that of the Atchison in 1892. It will be noted that these bonds were more used before 1893, owing probably to the fact that the name of bond was considered to increase the salability of a security on the market. Securityholders hesitated to accept stock, but received bonds without too great a protest. The extent to which railroads catered to this preference is seen in the case of the Reading deferred income bonds, on which payment of interest was deferred to a 6 per cent dividend upon the common stock. From certain points of view, however, the income bond is inferior to preferred stock. For instance, preferred stock almost always has voting power, while income bonds usually have none. And although the income bondholder is sometimes protected from the insertion of new claims upon earnings between his bond and the underlying property, provisions in preferred stock certificates may afford an equal guarantee. In consequence, the use of income bonds has declined as a more accurate knowledge of their limitations has become widespread, and the Atchison adjustment 4s represent the sole use of this security in our reorganizations from 1893–8.
The exchange of preferred stock, with or without new bonds, for old bonds which have borne a fixed interest rate represents the best current practice. Six of the seven principal railways reorganized from 1893–8 retired old bonds with fixed interest by new bonds and preferred stock or by preferred stock alone. Take for illustration the case of the Erie, which exchanged new general lien bonds and preferred stock for old second consolidated bonds; of the Northern Pacific, which exchanged new prior or general lien bonds and preferred stock for its second and third mortgages; of the Union Pacific, which gave 4 per cent bonds and preferred stock for its old first mortgage 6s; exchanges which are but typical of a widely extended use. Even the Reading, which alone refused so to lighten the claims upon its earnings, employed preferred stock in retirement of old first, second, and third income bonds.