Timber bonds

Contents

CHAPTERS.

PREFACE 7

2. Floating Debts 12-14

Preface

This book treats the Timber Bond from a purely practical basis. No attempt is made to advance theories. When given careful consideration, the criticism of the present sinking fund practice and title examinations will be acknowledged sound by all concerned. No effort has been spared to make the chapters short and the language used simple and clear. The circulars and mortgages quoted are given in full that they may be safely followed for guides and comparisons.

I wish to express my thanks to Mr. Edward E. Barthell of Nashville, Tennessee, for the mortgages, to Mr. Calvin Fentress of Lyon, Gary & Company, Chicago, for ideas and criticims, to Mr. H. S. Sackett, U. S. Forest Service, for information and data, and to the Bond Houses for circulars and suggestions.

T. S. McGkath.

Chicago, July 5, 1911.

CHAPTER L

TIMBER BONDS.

The underlying strength of the security behind the Timber Bond is steadily forcing it into great favor with bankers, institutions and individuals. When the exact nature of the investment is fully understood by people with money the market for timber bonds will become very broad and the six per cent bond will pass out of existence. Even now, timber bonds are being sold on a 5%% basis. These bonds are issues which have been created with the greatest care. The cruises of the timber and examinations of the physical properties have been made, or checked, by the private experts of the issuing bond house. The titles have been examined at the county seats and abstracts verified by the original records. All the legal procedure from the incorporation of the company down to the delivery of the bonds has been certified by eminent attorneys. The books and accounts have been audited by experts who are celebrated for the thoroughness of their investigations and their insight into affairs. The work of floating these issues has been superintended from its inception, either by experts of the negotiating bond house, or the underwriters referred to in chapter three of this book.

Forest fires, and the loss of timber thus caused, is the chief argument used against timber bonds. The public gets its ideas of these fires from what has occurred in the upper Mississippi Valley. The situation of the commercial timber at present practically removes this fire risk. The chapter on forest fires will clearly show this danger to be greatly magnified.

There are some speculative timber bond operators now doing business and some issues at present outstanding that will default. Less than half of one per cent of the dealers can be classed as speculators, or with a tendency toward rapid riches. Amongst no other class of bond dealers is the percentage of legitimate, conservative and careful operators so large as in the Timber bond field.

The serial is the only safe timber bond and the last maturity must fall due while there is ample stumpage standing to protect the property until the trust deed is fully satisfied and the Trustee released. The sinking fund clauses should cover this point clearly and thoroughly. A careful reading of the chapter on sinking fund will enable the student or banker to form safe conclusions.

Successful practice and the daily operations of sound and active traders is the best guide for those contemplating the timber bond field either from the outlook of borrower, banker, dealer or investor. The bond circulars given in this book have been selected with care and will furnish material for a complete survey of the issues of timber securities now outstanding. The circular form used by the same house for different issues is nearly always after a set style, but the values of stumpage, percentage loaned, sinking funds and other vital points differ in each circular.

The legal opinions and legal procedure in general must be closely watched when dealing in timber securities. The forms of mortgage given in this book are the best in existence today and should be carefully studied. No investor should purchase a timber bond before reading a copy of the legal opinion on the issue and noting if the titles have been checked at the county seats and the original records examined.

Holders of timber bonds or those wishing to invest in such securities can have the bonds they own or want to purchase examined, appraised and passed on by independent experts. Capitalists can now take advantage of the high returns on timber investments, and under skilled guidance buy those that are sound and safe.

CHAPTER H.

FLOATING DEBTS.

In the present generation when the stumpage owner, logger and millman are nearly always the same individual, it takes much more capital to operate the lumber business than it did in the old days. The timber holdings must be very large to warrant the construction of the modern mill, and supply it with cutting material for a sufficient number of years. The logging equipment comprises steam railways, locomotives and cars in addition to the woods tackle. All this gear costs heavily for every mile of road built and every thousand feet of timber taken out. The logging and milling crews are larger, the commissary more extensive, the pay rolls heavier, the liabilities of every nature more pressing. The cost of stumpage is tied up for a long term of years and can be collected only in small portions as the land is logged off. The money spent in the cutting of trails, building of railroads and construction of mills is a permanent investment that practically can never be reclaimed. The operator is forced to extend credit to the people who buy lumber from him and he carries them for any length of time from ten days up to six months. He must pay freights in cash,

FLOATING DEBTS 13

taxes are exorbitant and inexorable, and pay rolls can never be postponed.

In time the floating debts and quick assets get ont of all proportion and must be adjusted. An investigation is instituted to study each part and phase of the business in order to learn how to relieve the situation. This study commences with the timber holdings in the hope that some of them may be so situated as to permit being sold and turned into cash without hurting the logging layout or hampering the future operations. Instead of being in a position to sell stumpage, it is usually found that the mill is sawing up timber a little faster than was originally expected and not only is selling stumpage out of the question, but to be entirely easy over the big investment in the mill, logging road and equipment, more timber should be purchased. The investigation then moves on to the railroad, railway equipment and logging equipment in order to see if some of the locomotives can be spared, lighter rails laid, fewer cars used or if a saving can be effected in donkey engines, cable or other gear. It is found here that the timber is being logged faster than was at first planned, that locomotives and cars are working up to capacity, that donkey engines are crowded and that a heavier rail could be used much more economically than the light one at first put down and now doing service. The maintenance of road has not been kept up to standard and the equipment has been so busy that maintenance of equipment has not been attempted. It is only a short time until the rolling stock must commence going to the shop for extensive repairs. No curtailment can be effected here. Instead an expenditure must be made for reserve rolling stock, more rails, donkey engines and tackle. The roadbed ought to have considerable money spent on it and altogether quite an outlay should be made in this end of the business. The examination then moves to the mill to see if any economies or savings can be effected there. The mill is of the most modern construction, under thoroughly efficient management and operated with full care and frugality. It cannot be improved on. The books are then audited and a general review of the business is made to learn the best plan of action. The final result of all these searching investigations is to convince the operator that a business where the capital is chiefly in the form of what might be called " funded assets' ' cannot be conducted on the basis of a business having its capital in the form of floating assets.

CHAPTEE III.

FUNDED DEBTS.

Owing to the nature of the business, logging enterprises and sawmills are often located in places where the banking facilities are very limited. Small banks cannot extend accommodations of much value to a large undertaking like the modern logging and milling projects. The operators are forced to seek elsewhere for money credit. Short time loans from nearby banks are not satisfactory, as they are liable to be called at the most inopportune moment. The banks in times of need must first care for their local customers.

Commercial paper has not proved suitable to the mill man. The floating of such paper, and meeting the interest on and retirements of short time notes, forces him to operate in dull seasons and on losing prices. He must care for his floating debts no matter how large the immediate loss on the transactions. The logging camps and mills cannot be shut down on account of the urgent current money requirements. A bond loan prevents the necessity of operating at a loss. It provides all the necessary capital required to do business in the safest manner. It eliminates all floating debts and short time paper. The operator knows exactly what he must figure on in the way of interes t charges and retirements. After arranging to meet these every six months he can run the business to suit himself.

The logging and milling business is often the life of the community in which it exists and all the other enterprises in the neighborhood are dependent on it for success. These others are too small to go out of the immediate vicinity for loan accommodations. To do business they must be carried by the local bank. The timber company has land to sell, by-products and fuel to dispose of. It is deeply interested in building up the town, and should not, for these reasons, use the resources of the local bank. A bond loan allows it to avoid borrowing from the local bank.

Having a large stock of lumber in the yard ready for immediate shipment enables a company very often to get a premium over the market price for quick delivery. It takes money to carry such a stock. A bond loan furnishes it and permits the operator to make bigger profits.

In the discounting of bills and accounts much money can be saved by a large business. Ample working capital places the operator in a position to take advantage of lower cash prices and cash discounts. A bond loan furnishes the necessary funds and the saving thus effected goes a long way toward paying the interest on the bond issue.

The company that is fully equipped with working capital is in a very powerful position

FUNDED DEBTS 17

when it comes to getting and holding trade. It makes little difference about the size of its timber holdings and milling capacity when it is competing for orders. If it is cramped for funds it cannot hold its own with the company that has smaller assets but more ready money. A bond loan secured by its land and timber furnishes all necessary cash requirements.

It would be possible to recite many more sound reasons showing the advantage of funded debts over floating liabilities, but those enumerated are sufficient to prove to the banker and bond dealer the wisdom of the timber operator who mortgages his property for the necessary funds to furnish the cash to handle his business with economy and safety.

The lumberman has gone over the situation, reviewed his business thoroughly and realizes he must have more money. Instead of being able to take advantage of the numerous ways of making and saving, of protecting his holdings, of extending his business, and caring for his customers, he is constantly crowded by his due bills, and his affairs are at a point where something must be done. He decides to fund his debts.

The operator carrying a large investment in plants and stumpage, loaded with floating debts and facing the necessity of further heavy cash expenditure for improvements, extensions and purchase of timber, out of which he can draw no immediate return, has decided to fund his present liabilities, and borrow the money necessary for his needs in the form of a bond issue, maturing over a period of years, and secured by a first mortgage and prior lien, on all his holdings now owned or to be acquired.

In order to negotiate this loan and get a fair price for his bonds, the enterprise must be well founded and sound. The property must be favorably located, the shipping facilities ample, the market for the product not restricted, the plants modern and economical producers, the timber of good quality, the cost of logging and milling not excessive, the selling department well organized and effective. Every branch of the business must be able to stand the closest scrutiny of the experts that the bond underwriter or the banker will send on the property to make investigations.

CHAPTEE IV.

THE UNDERWBITEB.

The difference between timber bonds and industrial bonds has not always been realized by those issuing timber securities. Again timber bonds have been brought out by some houses in the same manner in which they would issue real estate or land bonds. The errors have resulted in some defaults. Such houses are responsible for the prevailing notion that only the bond dealer who specializes in timber securities can handle them with perfect safety.

This idea hurt timber bonds and narrowed their market. It founded the feeling amongst many bankers and bond dealers that timber bonds were good things to avoid. These men did not have the time to study timber and allied industries and they invested their funds in paper they understood or could easily learn all about from a reliable source.

The prejudice thus created also hurt the timber owner and forced him to put up security out of proportion to the money loaned him. It caused him to pay heavy sinking funds and high interest rates, and to sell his bonds at a big discount. The inherent value of the timber bond alone saved it from being driven out of existence by the ignorance and greed of " Timber Experts ' ' and other interested parties. The timber cruising firms knew nothing about bonds and they were very jealous of their knowledge of timber. The bond dealers and bankers found it next to impossible to get the real facts and give themselves and the timberman a fair deal. The result was that the timberman usually suffered through the unwillingness of the timber expert to advise the banker fully on the technical questions regarding stumpage.

The first timber bond was written about ten years ago and the situation explained above continued for several years. Then the most reliable timber bond dealers commenced organizing their own force of experts and some wealthy lumber operators also entered the timber bond business. This partially relieved the situation, which was further helped by the rise of a few very expert cruising firms who adopted the broad policy of fully advising the bond buyers on every phase of stumpage values and logging. These cruisers, however, are not familiar with commercial life, as they are professional woodsmen. Neither do they understand the creation of a bond issue. Thus, the average bond house and banker was unable to get satisfactory advice on timber bonds until some two years ago. About that time a couple of men who thoroughly understand stumpage, timber values and the lumber business, and who are experts in industrial bonds, entered the field as underwriters. Their policy is to analyze and report on issues through every phase of their creation,

THE UNDERWRITER 21

for any person who wants the information. Their business is underwriting whole issues for timbermen and placing them with banks and bond dealers. These men supply the long felt want. That buyers appreciate their services is attested by the fact that millions of dollars worth of bonds have passed through their hands in the short time they have been operating.

"When the timberman decides to float a bond issue on his holdings, he goes to these underwriters or some bond house or banker to negotiate his loan. If he places it in the hands of the underwriters their first move will be to make a close survey of the entire project before calling for the investigations of auditors, cruisers and attorneys.

CHAPTER V.

BEVIEW OF BUSINESS.

All the expenses incident to a bond issue must be borne by the timberman. These expenses consist of an audit of the books, a cruise of the timber, the legal charges for examining titles, drawing the trust deed, drafting the text of the bond, the charges of the trustee, the cost of certifying the bonds, the cost of printing the mortgage, lithographing the bonds and incidental expenditures. Should the bond issue fail through some fault or mistake of the timberman, it would be very costly to him.

Every precaution should be taken to eliminate the risk of failure before incurring the outlay for expensive investigations. The business should be reviewed to ascertain if the loan is feasible on the basis of the statements and data furnished by the timberman. This review should cover the financial, industrial and stumpage operations. The prospective borrower can furnish a statement of assets and liabilities as taken from his books. A statement showing the volume of operations with the disbursements and receipts incident thereto. Each department should be shown in detail. A cruise of the timber, giving its kind and quality and if long leaf pine, stating whether it is round or bled, a description of the various equipment

2$

REVIEW OF BUSINESS 23

and plants. An examination of these statements will enable the analyst to judge with fair accuracy if the loan can be negotiated. If so, he should get on the ground and examine the property to see the kind of timber, and the nature of equipment used in getting it out, to judge the efficiency and value of the mills, to note the manner of accounting, and to see the method of handling sales. In this way he takes a mental photograph of the entire business and can tell almost exactly what the timberman can borrow if the information is approximately verified by the expert investigations to follow.

Standing and living timber is the life of a timber bond. The heft of the security for the loan must be green and growing stumpage. A small proportion of over mature trees may be allowed. No loan should be made on timber consisting mainly of over-ripe trees. Down timber should not be considered unless it is easily accessible. Dead timber still standing should be cruised. Fire killed timber should be cruised. The timber should be on land owned in fee simple. Twenty five per cent of stumpage contracts may be allowed if the life of the contracts or the time granted for removal of timber is longer than the life of the bonds. Bonds should not be written when secured by timber standing in a county where taxes on timber land are excessive.

The ground should be fairly good for logging. If very hilly or rough the breakage in falling is liable to be excessive. It should be a good logging chance. The breakage must be deducted from the stumpage yield and the loan value figured on the estimated feetage less the estimated breakage for the entire tract. In redwood and other very large timber, the breakage is heavy.

In the South, where long leaf pine is bled for turpentine, either by boxing or cupping, care must be exercised in making valuations. Round timber is the tree before being boxed or cupped for working. Boxed timber is the tree that is now or has been boxed or cupped for working. The cup system is easier on the tree and more modern than the box. Round timber is worth more than boxed or bled timber and in bled timber the tree that is cupped is more valuable than the tree that is boxed. The value of bled timber depends entirely on the condition of the particular tract as shown by the detailed cruise.

The logging equipment must be modern, in good condition, ample to get out timber fast enough to protect interest and retirements on the loan. The cost of logging should not be too far above the average for its particular locality. If the cost of logging is under the local average, it speaks highly for the enterprise.

The logging railway should be well built, fully equipped to handle the output and operated with economy. The kind of locomotives used will depend on the grades. Where geared

REVIEW OF BUSINESS 25

engines are necessary the rolling stock should be equipped with air brakes. In fact all rolling stock, whether operated with geared or direct engines, should be fitted with air. One runaway would more than pay the cost of such equipment.

The mill should be in good repair. Whether band or circular it must be economical of its kind. Bonds should not be written on mills that butcher timber. Such sawing shows indifferent and improvident management and eats into the security. Timber slaughtering mills are quickly killed off when competing plants go after their trade. The capacity of the mill should be sufficient to cut enough lumber to care for the interest and retirements on the loan. There should be ample water supply at the mill and sufficient hydrants and hose to handle any fire. The pumps should be good, the hose sound and easily accessible. If possible a sprinkler system should be used. The refuse burner should be covered with spark arrestor and placed as far from the mill as possible.

The Sales department must be well organized. The market is vital to the income and the books must show a clean record on this point. Also the Accounting and Collecting departments must be effective, and the business in good credit. The shipping facilities must be good. The plant must be on a railroad that enables the lumber to reach a ready market. Plants loeated on more than one road are very desirable. Plants located so they can ship by rail and water are the choicest risks. Plants located on a line that suffers from chronic car shortage should be avoided. Plants located on a line that is short on motive power should be avoided. Each lumbering enterprise has its individual points that must be scrutinized and these features will be brought out in the expert reports of auditors, cruisers and attorneys.

CHAPTER VI.

AUDIT OF BOOKS.

Many people confuse the auditor with a bookkeeper or office accountant. This is a great mistake. The expert auditor or certified public accountant is one of the most higlily trained and technical professional men of the present day. He is in the same rank with the consulting civil engineer and the expert investment analyst. He is educated deeply in his special work and taught to go to the very heart of conditions in the most direct and thorough manner. Nothing escapes his trained and vigilant scrutiny. The cruiser estimates the timber supply and future possibilities. The auditor writes the history of the business. The auditor does not care particularly for glowing prospects ; he wants accomplished facts. The auditor brings together every branch of the business in a clear and concise form. He shows receipts and disbursements, earnings and outlays, profits and losses, assets and liabilities as they actually exist.

Up to the present time investment buyers of timber bonds are furnished only with the balance sheet appearing in the circulars of the house selling the securities. These buyers should be provided with an annual statement of the affairs of the company whose bonds they own. This statement should be made tip by responsible Public Accountants who are familiar with lumber operations and accustomed to audit for bond issues.

The mortgage protects the banker and bond dealer by permitting them to enter on the property and make investigations and audits at any time. This is in the nature of insurance. Ii^ prevents the property from being skinned and forbids fraudulent operations by dishonest people. The timber industry is composed of exceedingly high class men and these investigations are not often made. Comprehensive reports, made by independent experts, and furnished regularly, would increase the desire for timber bonds, by giving the public who now hesitate to buy on account of lack of knowledge of timber operations, confidence in them. These reports would tend to put timber bonds in a very desirable class and greatly broaden their market.

Eecently I had occasion to ask a bond dealer for the latest balance sheet of a lumber company for whom he had sold an issue of bonds. The bonds were disposed of more than two years ago and he has not since had their affairs inspected. The only information he could give was from the original audit. This attitude is wrong and dangerous. The day will soon be here when buyers of timber bonds will insist on annual reports. They are entitled to them

AUDIT OF BOOKS 29

and bond dealers should see that they are furnished without request.

The particular audit on the books and accounts of an operation for the purpose of learning if the operator is entitled to a bond loan is made to determine the assets, the liabilities and the profits. This examination will show the purchase price of timber land, equipment and mills. It will show the figure they are being carried for on the books at present. The audit will exhibit every detail of manufacturing cost, taxes, interest, insurance and overhead charges. Many operators think they are making a profit when in reality they are running at a loss. These men omit charging up the cost of stumpage, the interest on the investment, the taxes or the money they loan the business from time to time. When operating without a bond issue it may be well enough to overlook interest, but with a bond issue it is the most insistent and imperative item to handle.

The audit will show the collections and weed out the bad accounts. The audit will prove the exact cost of lumber on cars, the volume of sales, the actual selling price and the percentage to be written off for bad debts. With this data before him the analyst can figure with a good degree of accuracy how large a loan it is safe to make on the enterprise. The auditor should go back over the books and get the operations for five years and compare each year. If the books are not so old he should go back as far as possible. The comparative figures for a number of years will show if the business has been progressing or retrograding. The audit should be made by accountants who understand what is wanted for a bond loan investigation.

CHAPTER VII.

EXAMINATION OP PKOPERTY.

The timber is estimated either by public cruisers or the private cruisers of the bond buyers or the underwriters. The following description of examining a timber property for the purpose of a bond issue is taken from the booklet issued by Messrs. Clark L. Poole & Company, Chicago. This house has sold around $40,000,000.00 worth of timber bonds. They have never had a default of interest or principal :

1 ' When a lumber company desires to make a bond issue based on its timber lands and sawmill plant as security, we require of it a general statement showing the valuation of the property, the number of acres of timber land, varieties of timber, the estimated amount of lumber it will produce and other information of a general nature, including the amount and purpose of the bond issue desired. If the security seems ample to make such bond issue safe and investigation into the credit and standing of the company is satisfactory, we agree to accept the bond issue if our own independent preliminary investigation results in bearing out the statement furnished by the company that has made application for the bond issue.

"At this point the real work of making the bond issue begins. We have in constant employ W. E. Straight, of Chicago, formerly of Michigan, who is a timber cruiser of high reputation, and over 30 years' active experience in estimating all varieties of timber. A timber cruiser's business is to go into the woods and make an estimate of the amount of lumber the trees will cut, which is given to the owner in written reports. As the owner manufactures the trees into lumber, he compares the actual amount of lumber that is manufactured with the estimate of the cruiser. If the reality conforms with the estimate, the cruiser has demonstrated his ability for accuracy, as Mr. Straight has done for many years for several of the largest lumber interests of Michigan and elsewhere. "Some morning a modest appearing man calls on the lumber company which has negotiated for a bond issue. He asks for the complete plats of the timber holdings. Mr. Straight has begun his investigation, and is preparing to make his preliminary survey. After getting in his mind a picture of the extent of the timber holdings as to acreage and boundaries, he is ready to make a start into the woods. Accompanied by the logging superintendent or someone who is familiar with the holdings, he travels the woods until he has seen every part of them. He goes from one end to the other and crisscross, his work being what is known as a cruiser's running estimate. He discovers the general run of the poorest and best timber, the character of the land and its adaptability for agricultural uses after the timber is cut, whether there are many lakes, streams and marshes ; whether it is an easy or a difficult lumbering proposition; character of the logging railroads, whether it would be expensive to construct them, or whether it could be done at a comparatively reasonable cost; whether the timber is scattered or is well bunched ; whether the streams are practical for floating the logs; whether the mill is so located that it can be supplied with logs at a small cost ; as well as many other items of information that are practical in connection with the economical operation of a lumber manufacturing plant.