The Unorganized Bondholder
JOHN E. LANGDON
Hundreds of thousands of dollars are lost annually In Canada through careless investment. Fraudulent and worthless securities are being constantly poured on to the market to trap the unwary. A general observance of this simple maxim will assist in the reduction and elimination of this economic waste— “BEFORE YOU INVEST—INVESTIGATE“
WELL IN EXCESS of $50.000.000 of corporation mortgage bonds have gone into default over the past four years. These financial upsets have brought heavy losses in their wake and weakened confidence in this type of investment. In other days a mortgage was a mortgage in the true sense of the word, but now it appears that a bond is only a first charge upon income, while the security is seldom enforced when the borrower is in default.
Except for one or two isolated cases, the security back of these bonds has not been realized upon. Rather, there have been reorganizations, readjustments or “sawoffs,” leaving the bondholder with a weaker security and, as has been too often the case, without even a mortgage on the property in which he originally placed his money.
The fault for this unhealthy situation cannot be attributed wholly to any one cause. Much of the blame, however, can be laid at the door of the trustee—“a person appointed to hold property, to take care of and apply the same to the benefit of those entitled to it.”
Before the development of the present type of mortgage bond, a corporation desiring to raise money would mortgage its assets to an individual lender. When such loans ran into millions of dollars it was not always possible to find a lender. Hence the growth of a type of financing whereby a single mortgage is created and bonds in varying amounts issued thereon.
In this way, it is possible for a corporation to borrow large sums of money from hundreds or even thousands of investors without the necessity of creating more than one mortgage. Naturally this has greatly facilitated the raising of capital for legitimate purposes.
When capital is raised by a corporation through the medium of a bond, the borrower lists the assets to be mortgaged in a trust deed. This deed also sets forth in detail various things which the borrower obligates himself to do in return for the loan of the capital. It is not the intention here to deal in detail with the format of a trust deed; suffice to say that a mortgage for $100,000 does not differ in essentials from one for $10,000.000.
Obviously the borrowing corporation cannot hold itself directly responsible to thousands of bondholders. There must be a central agency to look after the interests of the bondholder, to see that the borrower is living up to the terms of his contractual obligations, protect the security and, in the case of a default, enforce the security.
This important function is performed by a trustee, who may be an individual or a corporate entity. He is invariably selected by the borrower or the investment house undertaking to raise the needed capital. For many reasons it is not practicable to have the bondholders select the trustee.
The bondholder looks to the trustee to preserve his interests. He exercises due precautions in investing money in corporation mortgage bonds. The investment once made, however, the bondholder expects the
trustee to watch and protect his interests. The trust deed covering the mortgage securing the bonds, moreover, provides the necessary powers to assure adequate protection for the investor. For this work the trustee, in his capacity as guardian for the bondholders, receives a fee commensurate with the size of the bond issue.
A casual examination of the regular trust deed would leave one with the impression that the trustee assumes many obligations justifying the payment of this fee. Closer examination, however, shows that in return for this fee the trustee accepts no responsibility. One of the concluding paragraphs in practically all corporation trust deeds drawn up in recent years is to the effect that, notwithstanding all that has gone before, the trustee assumes no responsibility.
Though he may be aware of certain conditions contravening a trust deed, the trustee is not obligated to take steps to protect the bondholders’ interests. That he does not is explained by the fact that he is not obliged to do so under the terms of the mortgage trust deed. It is only when officially requested in writing by the holders of at least twenty-five per cent—in some cases as low as ten per cent—of the face value of the bonds that he takes steps to protect their property.
The difficulties in securing such a large percentage of the bondholders to take collective action are only too apparent. Many months may elapse before they unite to protect their property, and the security meanwhile may be seriously impaired.
This state of affairs is not exaggerated. Numerous cases have come up in the last four years to cast doubt upon the value of a trustee who will take a fee but not accept the responsibility of looking after the bondholders’ interests.
It may be of interest to quote one or two actual Canadian cases to show the manner in which a trustee performs his duties as steward for the bondholders. Real names are omitted.
A Remedy is Needed
~THE “JOHN DOE COMPANY” issued I bonds under a trust deed which permitted it to borrow money under certain conditions. The borrowing power was grossly exceeded and the security impaired. A bondholder brought the matter to the attention of the trustee. No action was taken to rectify the situation. The default was clearly apparent, but without going to considerable expense it was out of the question for the informant.......a small bond-
holder to secure sufficient bonds to force the trustee to take action.
Another instance of somewhat similar circumstances was where the “X.Y.Z. Company” agreed to maintain a specified security back of its bonds. This was not done, owing to circumstances over which the borrower had no control. The trustee was aware of the default for many months. Nothing was done until he was notified by the requisite number of bondholders, who learned of the default through other chan-
neis. By this time the impairment of security had reached serious proportions.
Other cases could be cited to show that a trustee, aware of a situation detrimental to the bondholders’ welfare, has not taken action to protect or enforce the security on behalf of those for whom he is paid to act.
Another feature of the unsatisfactory situation in the Canadian trustee field has to do with enforcement of security. Where a borrower has admittedly defaulted on his obligation, the trustee almost never commences action to realize on the security for the benefit of the bondholder. He would seem to be afraid of doing anything calling for the assumption of responsibility. Reasons may be advanced for this lack of aggressiveness. The trustee may not have been requested by the required number of bondholders. Even though requested, he must be guaranteed expenses. And with bondholders scattered all over the country, it is practically impossible to secure collective action.
What, then, does the trustee do in return for the fee which he has accepted in payment for looking after the interests of the bondholder? He may wait for the borrower in default to come forward with a compromise plan. Or a bondholders’ committee may be formed (it should not be called protective) to investigate affairs of the borrower. The outcome of the workings of the majority of these bondholders’ committees has been unsatisfactory. They have performed their duties in good faith, but invariably the net result has been to leave the bondholder wondering whether he bought a mortgage bond or a scrap of paper.
These committees seldom enforce the security back of the mortgage bonds, as is their legal right. More often they come forward with a compromise plan of reorganization. And just as frequently the borrower presents his own plan, as if he were the creditor rather than the debtor.
Where does the trustee come in? When a plan is formulated he calls a meetingassured that all out-of-pocket expenses will be repaid—and asks the bondilolders to approve or disapprove. The leadership which might be expected from one acting for hundreds or thousands of bondholders, as the case may be, is studiously avoided.
If the corporation mortgage bond has received a “black eye” in the past four years, it can be attributed to the lack of protection afforded to the unorganized bondholder. I-'or this state of affairs he trustee has no small share of the responsibility. True, he cannot foresee the borrower defaulting on his obligation, nor can he exercise more than a “watching brief” in the borrower’s affairs. But the trustee can take a more positive stand, and give leadership in the preservation or realization of the mortgage bondholder’s interests. If willing to accept a fee, then he should be prepared to accept the responsibility implied by a trusteeship. He should not accept the one without the other.
Until this condition is rectified, the investment rating of the corporation mortgage bond will never rank as high as it should. This type of financing is fundamentally sound. Its principal weakness is the form of protection provided where a default occurs. Investors themselves can do much to guard their own position by informing themselves, through reliable agencies, of all that pertains to the welfare of the company in which they have invested their money. It is not enough to investigate before investing. The investor must keep on investigating if his savings are to be kept intact.
Question—I have an account with the Huron and Erie Mortgage Corporation. I have heen told that mortgage companies are having a hard time at present, and would like your opinion cm the financial standing of this company.—G. P., Wadhope, Man.
Answer—Huron and Erie Mortgage Corporation was incorporated in 1864 and has paid dividends regularly to shareholders since 1891. The company, therefore, has a
strong background of experience which has carried it not only through good times but through previous depressions.
It is true that the company holds a substantial amount of Western mortgages on which it has undoubtedly suffered some losses. This has resulted in some decrease in net earnings, which were reported at $525,890 for the year ended December 31, 1932, as compared with the peak earnings of 1930, which were $593,495. The provincial authorities in Ontario do not appear to be disturbed as to the condition of the company, and we have no reason to believe that your account with it is not as safe as it would be with any other of the larger and older loan companies in Canada operating under Ontario or Dominion jurisdiction.
Question—Will you outline the position and prospects of Imperial Oil and International Petroleum stock? I hold some of both, and am somewhat inclined to sell all my Imperial Oil and invest mostly in International Petroleum. Doesn’t the present trend favor International Petroleum?—I. 0., Petrolia, Ont.
Answer-Imperial Oil is the leading company in the oil industry in Canada. It has a very strong financial position, and although its earnings for the last four years have been declining steadily with relation to the common stock, this has been because sixty per cent of the dividend on that stock is paid from earnings outside of Canada.
International Petroleum earnings in Peru and Colombia have been affected by the declining price for crude petroleum. In the last few weeks of the summer, prices of crude petroleum in all parts of the United States started rising, and that is of great interest to International Petroleum as its price is based on the mid-continent price in the United States.
This gives some hope of increasing earnings from outside Canada for Imperial Oil, although it may not make much difference in 1933, as from now on the tendency is to declining consumption in winter months. However, this company, being the leader in its line and financially so strong, has excellent opportunities as general business gets better in the world and there is greater demand for oil products.
International Petroleum’s financial position is not known, as it does not publish financial statements. Earnings only appear as they are incorporated in that of its parent company. Imperial Oil. Obviously, the wells in operation during its whole career have earned a great deal of money.
Since the oil code was written in the United States, gasoline prices there have gone up. There is a tendency throughout the United States to be optimistic as to the effect of operations under the N. R. A. and its success in limiting production of crude petroleum. Much will depend, of course, on renewal of the business revival which had quite a good beginning in the United States. There are many critics of the administration’s programme, and many other stimulating measures will have to be taken in order to make it successful, but before these are taken no one can express an opinion about them or their probable success. Certainly the oil business in Canada will reflect very closely any changes in the price of crude oil and the trend in purchasing power in the Dominion.
Question Please advise if you think Corporate Investors Limited is a well-managed investment trust that is likely to succeed. I am \ thinking of investing some money with them | but want to be sure that the people behind the ; company are all of good report.B. C., I Belleville, Ont.
Answer—The directors of Corporate Investors Limited are all business or profesj sional men of established reputation, and j we believe the trust to be well conceived and to have a sound management. The proof of good management, however, is in the results of operations, and this trust has not been operated long enough to offer full proof. Initial offering of the shares was made less j than a year ago, and as yet the trust has a | fairly limited capital. I