then made specific attacks on road capital expenditures including expenditures for yard improvements. He stated:

There are certain other items that cannot definitely be identified specifically as yard expenditures, but it seems likely that during the balance of the year capital expenditures for yards alone total about $10 million. On the basis of the sketchy income budget recently submitted for 1969 it would appear that there is going to be very little cash available except for commitments already made. It seems highly improbable that amounts such as $26 million for Columbus yard are going to be available for some time to come. It therefore raises the question as to whether or not future expenditures of this type during the remainder of 1968 are justified.

I strongly recommend that the yard program be reviewed at once and that the balance of the unexpended money for this year also be reviewed in an effort to bring our cash in line at least up to January 2. From that point on it is quite inevitable that we are going to have extremely serious problems and that every effort must be made to establish a positive cash flow quickly as possible.

Despite the addition of the Eurodollar loans, the cash situation did not sufficiently improve. The Treasurer's report on November 26, 1968, indicates that the projected cash loss for 1968 would be $273 million which would be met by $253 million in borrowings, including $103 million in bank loans, $100 million in commercial paper and $50 million from the Eurodollar borrowing. The gap remaining was $20 million to which was added the need for $24 million additional cash in bank balances leaving additional cash required at $44 million for 1968.

(3) THE CRISIS GROWS (END 1968-FALL 1969)

The following year did not promise any relief from the continuing cash demands. A cash forecast dated January 23, 1969, to Bevan from Schaffer indicated that the cash figures for 1969 would go from a $46 million positive balance on December 31, 1968, to a deficit of $104 million in December of 1969. Schaffer concluded his presentation of figures with the statement that "Although this forecast is very tentative at this time, I believe it to be a good indication of the cash problems facing us in 1969."

By February of 1969 it was clear that major increases in financing would be necessary simply to keep the company afloat. A memorandum from Schaffer to Bevan on February 25, 1969, indicated that the company was in a cramped financial position and that there were heavy needs ahead. The memorandum indicated that the source and application of funds statement showed an anticipated source deficit of $157 million for 1969.

By the latter part of 1968 and early 1969 it had become unmistakenly apparent to management that the financial problems were extremely critical. It had been hoped that the merger would lessen the cash drains which had been experienced on the PRR. Yet, in this postmerger period, cash was actually flowing out at a much greater rate and there appeared to be no prospect of a reversal. Financing means were limited. The market for long-term railroad debt was bleak and for Penn Central it was nonexistent. Short-term debt was limited by the likelihood that lenders would discover the cash drain. There were not many salable assets, or at least not many assets that could be sold without alarming lenders or shareholders. In addition, many of the assets were covered by pledges, mortgages or other restrictions.

A particular problem at that time was the limit on bank borrowings and the problems of the additional restrictions that such borrowings would impose. Gerstnecker was aware that borrowing limits were being reached:

Question. Were you involved in discussions to increase the revolving credit to $300 million?

Answer. Yes.

Question. Did you believe at that time it would be possible to borrow any additional amounts [from] banks of the revolving [credit group] above the $300 million?

Answer. I think the reverse. When I told Mr. Saunders of my reason for leaving, I [told him] I would not take part in borrowing any more money than that. I thought we had reached the limit of our credit.

Gerstnecker's concerns were shared by Bevan. Bevan consulted George Woods, formerly chairman of First Boston Corp. and, at that time, a recently retired President of the International Bank for Reconstruction and Development. From the testimony of Gerstnecker:

Question. Did Mr. Bevan fully perceive the increased bind the company was getting into in terms of its borrowings; that is, you were coming to a finite limit, and also the restrictions and burden of interest were becoming more and more complicated?

Answer. Yes.

Question. Did he express fears [to] you in discussion with you?

Answer. Yes.

Question. Was this [in] any particular context? For instance did you ever have a session where you sat down and discussed this?

Answer. Yes; I had a session with George Woods, who is Chairman of the World Bank, I guess, or Monetary Fund or something, and who had previously been the head of First Boston. And Mr. Bevan took me with him, after saying he had gotten Mr. Saunders' approval to go talk with George Woods, and he told George Woods of his concerns and wondered if he had any suggestions as to why it might be -as to what might be done, and my understanding is, and my recollection is, although I'm not positive of it, that as a result of that discussion George Woods talked to Mr. Saunders and indicated to Mr. Saunders that the $300 million was the limit and should be the last borrowing that the company could make unless the cash flow or the operations could be turned around.140 Knowledge of the financing problems at that time was not limited to top management. From Gerstnecker's testimony:

Question. Was this a common open concern among people in the finance department what the limit would be?

Answer. Yes.

Question. Was that ever discussed at the budget committee meetings, [attended by operating officers as well as finance officers] particularly in the context "We're coming to some limit and we're getting blocked in by restrictions," and things of that sort? Answer. I don't recall there was. There were discussions at the budget committee where we would have before us one of Mr. Shaffer's forecasts of cash loss in which it would say "Here is another $40 million loss, and we can't put up with this, we just can't lose a million dollars a day as we are doing," but there never was a sophisticated type of discussion that I recall.

On February 10, 1969, Bevan and Gerstnecker met with Patrick Bowditch 141 and another officer of First National City Bank to discuss increasing the revolving credit from $100 million to $300 million. The reasons given for the request for the additional loan were that the merger of the railroad was taking longer than anticipated and that estimates indicated a cash loss during 1969 with earnings not expected until late 1969 at the earliest. Another reason was the difficulties in issuing the new blanket mortgage. Bowditch suggested that a meeting of all banks be held in which Penn Central would indicate detailed lists of debt maturities by year for the years 1969 through

140 Bevan first spoke with Woods on Jan. 7, 1969. Woods advised Bevan on efforts to increase the revolving credit to $300 million. In May, Bevan sent Woods an unsolicited payment of $25,000. Woods continued in an informal advisory capacity until the bankruptcy.

141 A First National vice-president and the officer servicing the Penn Central commercial account.

1975 along with other information. The information was never supplied.

On February 28, 1969, William Mapel, Bowditch's superior, wrote a memorandum describing his understanding with Bevan and Gerstnecker on the increase in the revolving credit to $300 million. Mapel felt that the loan was on sound footing. He noted in his memo.

With respect to the credit itself it has been upgraded through a tighter amortization schedule, a negative pledge on railroad properties which presently have a debt capacity of about $200 [mm] and a negative pledge with the right to secure at our option outstandings through a pledge of Pennsylvania Company's stock. The latter was volunteered to me by Bevan without the knowledge of Gerstnecker, who told me to suggest this to Gerstnecker with the full knowledge that he would approve it. It is very important, however, that the nature of this deal with Bevan at no time be discussed with anyone else in the company. *** I feel that we have negotiated a very satisfactory deal with the company, and I have every confidence that it will live up to its commitment on balances. Furthermore, it is their firm intention to sell the blanket bond issue as soon as possible, and at that time they expect to use the proceeds to repay the banks.142

During this same period Bevan was negotiating for the issuance of additional commercial paper. On March 19, 1969, the ICC authorized the issuance of an additional $50 million of commercial paper, bringing the total to $150 million. This paper was quickly marketed. The Pennsylvania Co. was also being used during this time as a financing vehicle. In July 1969, $35 million of Pennsylvania Co. debentures were privately placed and an additional $40 million of Pennsylvania Co. preferred stock was to have been issued. The latter financing was, however, never effected.

A report prepared by the treasurer's office, dated, May 20, 1969, showed an anticipated year-end cash deficit of $130 million which, when measured against a cash balance of $46 million at the yearend 1968, indicated a cash deficit of $167 million for 1969. The treasurer's report also indicated the uses of the first $100 million to be drawn down under the $200-million increase in the revolving credit. This included $35 million for compensating balances, $25 million for vouchers released and $30 million to pay off temporary loans from banks, leaving a balance of working cash of $10 million. This, plus the $35 million to be received from the Pennsylvania Co. would provide sufficient cash to the end of June. Additional cash would be needed to meet debts occurring on the first day of July. The $100 million of revolving credit was drawn down on May 27, 1969.

The cash situation contined to deteriorate. As of June 10, 1969, the treasurer estimated that yearend cash balances would be only $37 million even after inclusion of the additional $100 million drawdown under the revolving credit, the additional $50 million commercial paper, and the additional $35 million through Pennsylvania Co. preferred stock. The railroad was reaching a final crisis in its financings. In a memorandum of June 20, 1969, to Gerstnecker, Schaffer indicated that even drawing down an additional $50 million under the revolving credit in August (bringing the total drawdowns to $250 million) and raising $75 million through Pennco borrowings, the company would still end the year with a balance of only $37 million. Because of required bank balances, this meant that an additional $63 million of

142 It should be noted that our investigation has uncovered no indication of any activity with relation to the blanket mortgage after some initial activity in the early fall of 1968. The market for such an issue was poor, formidable legal and mechanical problems existed, and investors would not purchase such bonds from a company with the negative cash flow being experienced by Penn Central.

borrowings would be needed by the end of the year. This program allowed for a strict road capital program not exceeding $50 million for

1969.

By this time it had become apparent that the additional financings themselves were producing serious cash burdens on the railroad. In addition to the need to keep extensive compensating balances against the bank loans as required by banking practice, the interest payments were becoming large. With $250 million of revolving credit and $150 million of commercial paper and with the Pennsylvania Co. borrowings, the interest costs were approaching a rate of $50 million a year. In September of 1969 Bevan met with First National City Bank officials to obtain their approval of an increase in commercial paper by $50 million to a total of $200 million. Under the terms of the revolving credit agreement, the debt of the railroad outside of the revolving credit could not exceed $150 million which was the existing amount of commercial paper. The railroad had drawn down an additional $25 million on the revolving credit on August 18, 1969, and was drawing down an additional $25 million on September 3, 1969, bringing the total to $250 million. Bevan pointed out that he could draw down the last $50 million of the revolving credit and leave the commercial paper at $150 million, but that he would prefer to obtain the last $50 million by commercial paper. He agreed not to draw down the last $50 million of revolving credit until commercial paper had been paid off in an amount equal to the final revolving credit drawdown. First National City Bank obtained the approval of other banks for this change in the agreement. The effect was to decrease the backup lines for the commercial paper while allowing Penn Central to increase its borrowings. Prior to this time the $150 million of commercial paper had been backed by a $50 million bank line and the last $50 million of the revolving credit, providing a 66% percent coverage. With the commercial paper increased to $200 million the backup was reduced to only 50 percent. Prior to an attempt to get additional security in early 1970, it appears that the banks, through their agent First National City Bank, never seriously doubted the financial ability of Penn Central to pay off its loans. They continued to rely on the issuance of a blanket mortgage bond and on the earnings of the real estate subsidiaries in addition to a hoped-for turnabout in the performance of the railroad.

On September 8, 1969, Saunders wrote to Bevan asking for a program to meet capital needs for the next year and for the 2 years thereafter. Bevan responded with a memorandum to Saunders on September 10, 1969, in which he pointed out the continuing financing strains from the operations of the railroad. In light of the cash situation, Bevan observed:

Therefore, in my judgment, extraordinary efforts must be made to preserve every dollar possible. We will be coming up with additional suggestions in this regard shortly, but I think an immediate stop must be put on capital expenditures.143

In view of the current cash situation, it seems to me that every project should be stopped immediately until each one can be analyzed individually to see whether or not it is absolutely necessary that it be progressed at this time or done at all this year.

*

143 It should be noted that capital expenditures were not greatly larger than they had been in the premerger period. See the descriptions in the earlier portions of this section. Bevan's request reflected the degree of the cash shortage and not unreasonably large capital expenditures.

I realize that there are problems incident to labor and overhead involved in stopping these projects but I think that a very complete analysis should be made immediately so that every possible cent of cash will be saved and I am particularly interested in what can be saved in the next 30 days. Where we have outside contractors obviously holding up the work or postponement of the work is easier than where we are doing it with our own labor.

I requested an intensive program to reduce accounts receivables but because of the nature of the program I am not optimistic of a material gain this year, although it could bear some near-term results. I do think, however, that a very drastic cut in inventories should be instituted immediately even to the extent of selling in the open market any excess items we may have on hand.

Saunders responded on September 12, 1969, in a letter to Bevan in which Saunders described efforts he had made to convey Bevan's requests:

With regard to your letter of September 10, I enclose a copy of [a] letter which I have written to Mr. Perlman today with copy to Mr. Flannery. I have also talked with them personally about this and impressed upon them the necessity of immediate action.

I have also talked with Malcolm Richards with regard to curtailing at every possible point and making no further purchases, except where absolutely necessary, until our situation improves.

At the budget meeting this morning, asked Mr. O'Herron and Mr. Hill to work with Peat, Marwick on a study of our billing and accounts receivable situation to the end that recommendations can be brought forward for improvement.

On October 29, 1969 the Penn Central received ICC authority to issue an additional $50 million of commercial paper, bringing the total to $200 million. At this point the company had effectively exhausted all loans and all commercial paper possibilities. Most banks were at or near their legal or practical lending limits and were looking towards a paydown of these loans rahter than increases. Goldman, Sachs, Penn Central's commercial paper dealer, was already indicating to management that it was difficult to keep out the $200 million and that any adverse information might cause a run on the commerical paper.

It was also in October of 1969 that Penn Central learned that it would not be possible to market Great Southwest stock (which would have included a Pennsylvania Co. secondary offering). This offering would have produced approximately $45 million for the Penn Central complex. As indicated elsewhere in this report the idea of the Great Southwest offering apparently originated with the Penn Central management. The cash needs of Great Southwest, however, were enormous and pressing and Pennsylvania Co. was no longer capable of supplying it with cash. The desperate financial activities in late 1969 and early 1970 by Great Southwest are detailed elsewhere in this report, including a last minute effort in 1969 to have the three principal officers of Great Southwest purchase $40 million worth of Great Southwest stock as a substitute for sales to the public or to private investors.

(4) THE LAST EFFORTS (FALL 1969-JUNE 1970)

By October 1969 the prospects for improvement were bleak. A cash estimate from the financial department on a receipts and disbursements basis dated October 9, 1969, indicated a cash deficit of $338 million for 1970. In November of 1969 Penn Central's commercial paper dealer began becoming more concerned about the condition of Penn Central.144 The desperate condition of the railroad would first

144 For a detailed treatment of commercial paper sales and the role of Goldman, Sachs, see section III-A.