XIII

THE INVESTMENT-BANKER AND THE PUBLIC-UTILITY COMPANY

BONDS of public-service corporations can frequently be bought to yield 5 to 51⁄2 per cent. to the investor. These high yields inspire caution. They raise a presumption against the issue. Cautious investors discriminate against high-yield bonds. High-interest rates and lower prices are they not indications of lack of demand for these securities? And is not the explanation of this weaker demand a higher percentage of failures in this field than with the railroads? The investment-banker does not waste time in direct answers to these questions. He backs up his offerings of public-service bonds by detailed evidence of their worth, obtained by investigation of every factor influencing their value.

The first step in offering an issue of publicservice company bonds, is to investigate the business basis of the proposition, which is found in the territory served. Only large cities or groups of small cities, united for all business purposes, are considered by the best houses for direct offering. When gas, water, electric light, or transportation

securities, issued by companies serving small towns, are offered, the usual method is to combine them under a collateral trust mortgage, so that a large issue of bonds, each with the same security, may be offered. I have before me a description of an issue of this character, $9,000,000 in amount, secured by twelve issues of bonds, sundry notes, and fourteen issues of stocks. These securities have a market value of about $22,000,000, and return more than three times the interest on the $9,000,000 bonds. Great difficulty would, however, be met in selling them separately, because of the limited market which would be open to each. The holding company, of which this is an illustration, is useful in making a market for securities of small companies, which would otherwise be unsalable at reasonable prices.

The banker prefers, however, direct offerings of bonds secured not by the pledge of these pieces of paper issued by smaller companies, but by the pledge of property. So far as he is governed by this preference, he must confine his operations to the larger cities, for nowhere else can he find the conditions of perfect security and reasonable certainty of appreciation in value which he desires. His offering is made stronger if the security includes a large amount of surrounding territory,

but the foundation must be the dense and growing population of the city. Great importance is placed by the banker upon the growth of the city under examination, not only its past growth in population, but its future as a manufacturing, railroad, and commercial centre. For example, note the following vital facts concerning Seattle, furnished in connection with a recent bond-offering.

In 1880 the population of Seattle was 3,535; in 1890, 42,837; in 1900, 80,671. At present the estimated population is 265,000. From 1903 to 1907 the taxable valuation of the city rose from $56,674,000 to $156,531,724, and bank clearings from $206,913,000 to $488,591,000. During the past six years, the building permits have increased 300 per cent., and the value of real-estate transfers over 600 per cent. The Great Northern and the Northern Pacific Railway systems have terminals in Seattle, and the Canadian Pacific enters the city. The Chicago, Milwaukee and St. Paul is building to Seattle, and the Union Pacific is planning an entrance from the south. The harbor is excellent. The aggregate commerce of the port in 1907 was $140,472,821. The trade with the Orient and with Alaska, already large, is rapidly increasing. Seattle is 600 miles nearer Yokohama than San Francisco, and the natural gateway for Alaskan trade. Numerous industries are established in the city, which has become undoubtedly the most important business and distributing centre on the North Pacific Coast, and, in fact, one of the great cities of the country.

When such statements can be made concerning a city, and if other conditions affecting security can be satisfactorily met, bonds secured by a lien on its public-service corporation property are as safe as the best railroad bonds.

Assuming that the business basis of the company is sound, the next step in the investigation is the engineer's examination. Every banking house of standing has engineering connections, and large sums are often paid for exhaustive reports. The engineer's examination covers the condition of the plant in reference to maintenance and operating efficiency; the quality of the management, especially as to its demonstrated ability to cultivate amicable relations with the public; and the rates charged. If these rates are higher than those generally prevailing in the State, or higher than sufficient to yield a reasonable return upon the investment, they are likely to be reduced; and the bond-issue must be limited accordingly. The engineer also makes a careful appraisal of the cost of replacing the physical property of the company, since this sum represents the figure on which the courts will always allow a reasonable return. The engineer often goes so far as to criticise the policy of the management, to suggest plans for improvement in service, and to point out ways in which the company's business can be expanded. His report is a document often hundreds of pages in length, which gives the banker a complete picture of the property and business which he is asked to finance.

Often, engineering firms, in order to secure constant employment for their organizations, bring propositions to the bankers as promoters, and go so far as to offer their cooperation in financing the undertaking. The tendency is now toward such coöperation between bankers and engineers. A proposition submitted by an engineering concern of standing in its field is sure of respectful and attentive consideration from the banker, who knows that the engineer's primary interest is not to take part in the financing, but to make his regular percentage of engineering profit. The engineer's interest may extend beyond the initial stages of a proposition. He may take charge, for a period, of operating a new concern, breaking in a permanent organization, and insuring economical and efficient management during the trying first years.

Supplementing the engineer's investigation is the audit of the company's books. Banking houses usually employ their own auditors, although they often utilize the services of public accountants. The chief importance of the audit is to make sure that the company's accounts have been properly kept. Many items can be charged to cost of construction which belong in cost of operation. A surplus may be created by placing upon such