A bank credit committee considers a railroad loan - excerpted from testimony to the Senate Judiciary Committee - transcript

Railway Age, Nov, 1989

A bank Credit Committee considers a railroad loan

On Oct. 6, I testified before the U.S. Senate Judiciary Committee in Washington in opposition to S. 1631. The following is excerpted from my testimony:

S. 1631 is a bill which will require bankruptcy courts to expand their consideration of the public interest in connection with railroad reorganizations under the Bankruptcy Code of 1978. It is this writer's opinion, based upon more than five years of financing experience exclusively in the railroad and railroad equipment markets, that any material expansion of the requirement to consider the public interest in connection with a railroad reorganization will have a chilling effect on the future extension of bank credit to railroads, particularly regional railroads and short lines.

I would like to take this opportunity to present an overview of just what a lending officer has to go through to get a loan to a new railroad approved.

Let's assume Lending Officer X is presenting a proposal to lend $10,000,000 to the Mid-Valley Railroad for a term of eight years. Here is a likely exchange that might occur at a credit committee meeting:

Chairman: Well, X, it seems that you've brought us another one of your railroad deals. Why should we approve this one? X.: Sir, as you can see from the package that I've prepared and submitted in advance of this meeting, Mid-Valley is to be a 375-mile spin-off of some of the lighter density track of the selling Class 1 carrier. As things stand now, traffic has been on the decline for several years. The seller has redirected its reduced marketing staff and has reduced service due, in part, to its crewing costs and a worsening of the physical condition of the track which has resulted from a reduction in capital spending. For these reasons a sale to a lower cost operator is a good choice for both the seller and the shippers on the line.

Chairman: You know we're not lending money to assist sellers and shippers. We're in business to make good loans and earn a profit from our shareholders. X.: I'm aware of that, sir, and Mid-Valley will be a good loan. We've analyzed the company's prospects six ways from Sunday and under all reasonable economic and interest rate scenarios they can make it with some margin to spare. We've met the management and they know their business, and although we've only considered existing revenues in evaluating this loan's repayment potential, we have high hopes that a new local management can build the business and increase services to the shippers which will build the business further. Finally, the buyers haven't committed the sin of paying too much for the property. As a result, they aren't borrowing more than they can repay.

Chairman: Okay, so it's a great opportunity to lend money. What are the principal risks to repayment? X.: Well, sir, as you can see from our credit package, more than 60% of Mid-Valley's revenue comes from local grain shippers. If there's a drought, or even if there's a good harvest and the grain stays in the country elevators instead of moving to market, Mid-Valley can have a material blip in its revenues. Because of this, we've structured the loan to pay interest only for the first year until the company gets on its feet and can tolerate revenue shortfalls.

Chairman: What else? X.: The insulation plant which makes up 18% of the outbound and inbound freight is organized, and its management is currently negotiating a new three year labor agreement. The last time labor struck the plant was 14 years ago, but it could happen. Finally, the public utility generating station that gets two 100-car unit trains a week could experience operating difficulties or be shut down for maintenance. None is scheduled at this time.

Chairman: What about environmental issues? X.: I'm glad you asked. The seller has agreed to divide equally the cost of cleaning up fuel spills at two fueling stations. We estimate that will cost Mid-Valley $475,000. That's the extent of the known environmental problems.

Chairman: Known? X.: Known.

Chairman: Anything else? X.: Well, there is the new Railroad Reorganization Public Interest Protection Act.

Chairman: The what? X.: RRPIP, sir. It's a new law that's been passed by Congress that requires bankruptcy courts to consider the public interest in connection with railroad reorganizations. It was passed in the aftermath of the Chicago, Missouri & Western bankruptcy to give the bankruptcy court the ability to allow "priming" liens ahead of secured lenders as an incentive to make new loans to the bankrupt company.

Chairman: But we get adequate protection under the Bankruptcy Code in this case, don't we? X.: Unfortunately, under this law - we don't.

Chairman: But how will we ever be able to overcome the obvious public interest in keeping a railroad operating and serving shippers? If I understand it, the Trustee would be allowed the potential of unlimited borrowing secured by our collateral and be ahead of us in priority to keep a losing railroad afloat. X.: Yes, sir, in theory it could come to that, and I'm afraid I don't have an answer except to say that the law's new and hasn't been interpreted by a court yet. Anyway, it's highly unlikely that Mid-Valley would ever be in a situation where such a crisis would exist.