railroads. Among the roads of weak credit the St. Louis and San Francisco was overloaded with equipment liens, whereas the Western Pacific and the Boston and Maine, weak roads in opposite parts of the country, had no equipment obligations. Nor can there be any sectional generalizations, although the far-western roads as a class show the least inclination to issue such obligations and the coal roads in eastern trunk line territory perhaps the most. Yet, when all is said, the question is reduced to the specific financial policy of individual roads. The physical equipment itself that is covered by the lien is usually diversified. 31 It covers in the great majority of cases, both locomotives and cars. 32 When issued to cover a single class of equipment this class is usually of the standard form used in large quantities by different railroads. 33 The cost of the equipment is usually 10 per cent in excess of the original issue although the stronger roads such as the Pennsylvania and the subsidiaries of the New York Centrals have issued notes for the full purchase price of the equipment. In very rare cases an equipment trust has been formed to cover rolling stock already used, so as to give the road money to make repairs.36 31 Of the 320 separate equipment issues of American Railroads existing at the beginning of 1915 only 78 or 24 per cent were mortgages on one kind of equipment alone, the remaining 242 issues or 76 per cent covered more than one kind. In making this and some of the later statistical computation the writer has made liberal use of the very valuable publication of the Guaranty Trust Company of New York entitled Railway Equipment Obligations. 32 The following are two typical equipment trusts. They have been selected at random merely by way of illustration. Mobile and Ohio R. R. Co. Equipment trust series "F," 41⁄2 per cent interest. Dated March 1, 1912. Due $23,000 each March 1, and $22,000 each Sept. 1, 1922. Equipment cost $500,615. Obligations issued $450,000. Security: 4 Pacific locomotives, 2 Mikado locomotives, 6 steel passenger cars, 4 steel underframe mail and baggage cars, 1 steel underframe express car, 334 steel gondola cars, 50 steel underframe automobile box cars. Louisville and Nashville R. R. Co. Equipment bonds series "A", 5 per cent interest. Dated June 2, 1913. Due $325,000 to June 1, 1923. Equipment cost $7,226,420. Obligations issued $6,500,000. Security: 20 freight locomotives, 4 Pacific type locomotives, 26 steel underframe passenger cars of three types, 2 steel underframe baggage and mail cars, 8 steel underframe baggage cars, 5 steel postal cars, 3,000 all steel hopper and gondola cars, 39,000 freight and gondola cars of eight types, 80 cabooses. An extreme case of diversification is represented by Chicago, Rock Island and Pacific Railway Company's equipment 5 per cent notes, series "H." Dated July 1, 1913. Due $441,000 semi-annually to July 1, 1923. Equipment cost $5,521,348. Obligations issued $4,410,000. Security: 25 Mikado type locomotives, 30 six-wheel switching locomotives, 30 Pacific type locomotives, 2 mountain type locomotives, 1,500 steel underframe box cars, 500 steel gondola cars, 50 caboose cars, 18 steel chair cars, 20 steel coaches, 5 steel three compartment passenger cars, 7 steel smoking cars, 10 steel baggage cars, 8 steel dining cars, 4 steel horse express cars. It is extremely difficult to form an accurate idea from the outside of the real cost and value of the equipment covered by any issue, unless it is of one standardized pattern. 37 The provision in 33 Steel gondola cars are most frequently used when the issue covers only a single form of equipment. There were in 1916 approximately 21 equipment issues covering these cars alone. 34 Of a total of nine series of equipment issues of the Pennsylvania Railroad outstanding April, 1915, all were originally issued for the full value of the equipment acquired. 35 For example Kanawha and Michigan Railway, Equipment Car Trust of August 15, 1906. 36 The Detroit, Toledo and Ironton Railroad equipment notes of 1914. The issue is explained, of course, by the low credit of the road. This trust was created when $2,000,000 was borrowed to repair 1763 coal cars. It is unusual in bearing 6 per cent interest and maturing in three years. The borrowing was excessive as new cars could have been bought for less money. This railroad and its predecessor have afforded the case célèbre of equipment issues. See note 53. 37 The following table gives a few averages of the cost of standard equipment. The averages are deduced from a random selection of different equipment issued covering a single class of rolling stock; they include practically all of each type outstanding between Nov. 1, 1914, and Feb. 1, 1917. It is difficult to check these figures by the actual contracts. A writer in the Annalist estimates the average net cost of a standard 40 ton steel underframe box car for the eight years from 1908 to 1916 to be $947, with extremes from $844 to $1,200. The average in the above table of $1,112 seems to indicate excessive prices paid or else inflation of the costs. Owing, however, to the extreme variation in demand, there is a remarkable difference of cost of the same equipment according to the time of purchase. This subject is ably discussed with statistics in the Annalist, vol. VII (Jan. 24, 1916), p. 116. the lease agreement that is of most real consequence is that dealing with the rapidity with which the total loan is to be paid. Under all circumstances, railroad equipment wears out rapidly and is growing obsolete constantly.38 Were there no means of fully maintaining the equity behind an equipment lien, therefore, it would be the weakest kind of corporate security. But it is the strongest; for by making it obligatory on the part of the road to pay off the obligations faster than the equipment wears out, the equity to the note-holders is not only maintained but increased. To achieve this result, certain definite presumptions must be made, the most important of which is the true rate of depreciation. 39 For the purpose of valuing the equity behind the equipment obligations it is necessary to base the calculation on the sale value of secondhand equipment. We may assume that the equipment declined about 85 per cent in value during the first 131/2 years, at which time it has a scrap value of about 15 per cent of cost, and that the 38 It is usually contended by railroad engineers that obsolesence is greater with locomotives than with any other form of equipment. While this may be true, it should be remembered that an obsolete locomotive can be used on branch lines and for company work whereas obsolete freight cars are uneconomical however employed. Obsolete passenger cars are even worse because besides being inefficient, they usually tend to create ill feeling in the minds of the patrons of the road. In the opinion of the present writer that class which suffers least in value through use-both physical depreciation and obsolesence is the steel underframe tank car for the transportation of petroleum products. 39 The depreciation of rolling stock has been the subject of many elaborate studies. Unfortunately, these have led to no unanimous conclusion. The Master Car Builders Association estimates for cars as follows: wooden bodies and wooden underframes 6 per cent annually; wooden bodies and steel underframes 511⁄2 per cent; metal bodies, steel underframes and trucks 5 per cent. This basis was taken by the statistician of the Guaranty Trust Company in figuring margin of safety for equipment obligations. See Railway Equpiment Obligations (third edition), p. 9. Chamberlain uses rough estimate of 15 to 20 years as the life of equipment. See Principles of Bond Investment, p. 309. The Pennsylvania road has used 3 per cent for freight cars and 4 per cent for locomotives. Rates have varied. See T. R. Lill, Jour. Account., Jan., 1917, p. 1, giving statistics. Now, while it is perfectly true that the development of steel construction, particularly the steel underframe, has very much increased the serviceability of the car it is not clear from records that the salable life of the car is any longer. The investigations of the Master Car Builders Associations and the various studies that have appeared from time to time in the railroad periodicals have assumed the existence of, and have sought to determine a theoretical period of usable life for railroad rolling stock. Such a computation is not sufficient for the equipment bondholder because, from his point of view, the value of rolling stock is not its theoretical usable value, but its salable value. The two criteria are essentially different. A car may have a theoretical life, based on an arbitrary depreciation constant, long after it ceases to have a secondhand sale value. It may be held in reserve for freight congestions when it cannot be sold-except at the very time of the freight congestion. Moreover, the constants worked out by the manufacturers are based on mere decline in physical value through use, and presume only an arbitrary and slight, if any, constant of obsolescence. Furthermore, the annual cost of repairs increases as the car ages, so that there comes a time when it is cheaper for a road with credit to "scrap" the cars than to meet the constantly increasing cost of repairs. In fact, after a time, the value of the car becomes a kind of constant scrap value, the use and sale value being functions of the repair charges. From these theoretical considerations and such figures as the writer is able to gather from practical railroad men, he is of the opinion that collections of mixed equipment, such as are cited on a previous page, consisting of ordinary locomotives to about a third of the total cost and the other two thirds standard cars readily usable by other roads, has a salable life of about 132 years. At the end of this time it has a scrap value of about 15 per cent of its original cost. This scrap value suffers only slight diminution during the next five to ten years, provided sufficient sums are annually spent in repairs to take care of the obvious decays and breakages. For purposes of computation, we may assume, therefore, that the equipment declines 85 per cent in value during the first 13% years of its life. The decline in salable value appears to be more rapid during the first three years of the equipment's use and less rapid during the last four or five years, than an arithmetically regular decline would imply. The first year, this decline is fully a half more than what the average of the period would be, whereas the decline during the last year is only about a half that of the average. From the fourth to the eighth year, the decline is the average. If these assumptions are approximately correct, we may construct a table showing the percentage of original cost represented by the decline in salable value for each year. It would be something like this: 15th " scrap value 15 per cent of cost It should be remembered that any such computation is inexact and at best a mere guess. It is, however, much more accurate for the purposes of judging the secondhand sale value of equipment, than that of the Master Car Builders Association, which concerns itself merely with usable value based on material depreciation. On the other hand, general economic conditions may entirely upset these estimates. If the equipment is bought just before a general business "boom," it is entirely possible that the subsequent rise in the initial cost prices of equipment and the necessities of the other roads might create a situation such that year-old cars could be sold for more than they cost. It is quite true that a standard steel underframe box car, bought in January, 1915, could be sold in January, 1916, after a year of reasonable use for more than it had cost; it is even probable that this same car could be sold January, 1917, after two years of use, for what is had cost. Of course just the reverse is true if the equipment is bought at the height of a boom period. decline is most rapid at first. Under such circumstances, the rela- Percentage of deprecia-Money value DepreciaBeginning of Volume of tion of origi- of depreciayear immediate- certificates nal cost dur-tion during ly after instal-outstanding ing preced- preceding ment paid ing year year $1,000,000 2 810,000 9.5 $95,000 905,000 $100,000 90 89 Certain inferences may be made from a study of these figures. 40 Similar calculations of the equity behind equipment obligations at varying periods of their life have been made by other writers using slightly different assumptions for the rates of depreciation. Two such calculations have received publicity, in neither of which do the general results differ from the computation here given. The Guaranty Trust Company's calculation is based on the Master Car Builders Association's figures for depreciation cited in a previous note. It shows a larger proportionate equity during the first few years of the equipment trust. Chamberlain explains the same principle (op. cit., p. 309) by means of a diagram but is somewhat vague and unscientific in the use of his depreciation constants, though more exact than the computation here given in the use of semi annual rather than annual instalment payments. His diagram shows at a glance, much better than figures, the principle of increasing equity behind the equipment obligations. |