Equipment trust certificates account for a bit less than 5% of the number of collectible bonds recorded so far. Their relatively small number (less than 500 different issues) belies their great importance to railroad successes while their low prices reflect lack of interest by a majority of collectors.
The easiest way to understand equipment trust certificates ("ETCs") is to consider them close ancestors of equipment lease plans in widespread use today.
The basic idea of ETCs, like automobile leases, is that a buyer first arranges a purchase of desired equipment with a seller or manufacturer. One of the parties then arranges a third party to fund the purchase. The funder takes a down payment from the buyer, pays the seller, and sets up a lease with the buyer. The funder also receives the physical or legal title to the equipment and secures the title for an agreed-upon number of years. Until the buyer makes the final payment, the buyer has "equitable title" to the equipment, keeps it in good repair, fully insured, and enjoys all beneficial use of the equipment. At the end of the lease, the buyer makes the final payment and the funder relinquishes the legal title.
In the case of railroads, equipment is usually rolling stock such as locomotives, passenger cars, and freight cars. It can also be highly specialized equipment such as cranes, ballasting machines, work equipment, trucks, snowplows and the like. More broadly, equipment lessors can purchase and then lease practically anything from computers to airplanes. Regardless of the nuances of leases customary for various industries and types of equipment, the lessor puts up money in one lump sum and the lessee makes lease payments and pays insurance, management fees, etc. for a specified period. If anything goes wrong and the lessee is unable to pay, the lessor can repossess the equipment and re-sell it to another buyer.
History of equipment leasing
Equipment leasing is not a new invention. Its origins in North America can be traced to the building and leasing of river barges in eastern Pennsylvania in the 1820s. In its earliest execution, navigation companies purchased equipment by printing five to ten-year bonds and trading them to builders. Builders then received interest payments and principal over time or perhaps sold them to other investors. In essence, this kind of purchase was a "chattel mortgage" or a "conditional sale" and was not always accepted as legal under state laws.
The problem for builders and secondary investors was that chattel mortgages on equipment were junior liens. They were in second of later positions behind existing loans. In the case of default, holders of mortgages on equipment were often left holding worthless paper.
The invention of car trusts
Those problems were eventually overcome in the late 1860s with the invention of "car trusts." By placing legal title to equipment in the hands of trustees, equipment was much easier to repossess in the case of non-payment. Costly court foreclosure was therefore avoided. With the formation of "car trust associations," trusts could issue their own bonds, solidly secured by direct ownership of equipment.
Car trust bonds were usually structured with terms approximately equal to or less than the life span of rolling stock, so roughly eight or ten years, maybe less. Lease payments were generally equal to the total of principal and interest divided by the number of desired payments. Since car trusts were formed to purchase specific equipment for specific railroad companies, car trusts were normally very well secured and quite successful.
A number of companies (Iron Car Equipment Company and others) were formed to purchase and lease equipment, not to specific companies but to any companies that needed equipment. Those types of companies were less successful because railroad companies never intended to buy equipment and therefore never kept equipment particularly well maintained.
Evolution of equipment trusts
Up until the end of the 1800s, railroad companies generally purchased locomotives and leased passenger, freight cars, and cattle cars. With increasing improvements in size and efficiency of locomotives, and the necessity to keep pace with competition, it became clear that leasing was a better alternative. Car trusts would work just as well for heavier equipment as for lighter rolling stock. Somewhere around 1910 to 1915, the term "car trust" morphed into "equipment trust."
Most of the equipment trust certificates that collectors will encounter look like normal bearer coupon and registered bonds with only a few differences in nomenclature and execution. Here are most of the important comparisons:
|Equipment trust certificates
|dividend coupons (or warrants) attached
|interest warrants attached
|terms normally up to 15 years
|terms up to 999 years
|labeled as 'shares'
|labeled as 'bonds' or 'notes'
|issued and managed by independent trusts
|managed by railroad companies
|company non-payment results in repossession
|company non-payment results in bankruptcy or receivership
|investor money guaranteed against loss by physical equipment
|investor money guaranteed by collateral of all types, although not necessarily readily salable
|redeemed serially (part of ETC issuance redeemed every six months)
|entire issuance typically redeemed at one time
Large railroad companies generally preferred (and STILL prefer) leasing their equipment instead of buying outright. First, it allows companies to pay for equipment over time. Second, it gives them more favorable positions relative to taxes. Finally, if companies miss a lease payment, regardless of the reason, the oversight will not automatically trigger bondholders to band together and start foreclosure.
Names on equipment trust certificates
Equipment trusts are generally three-party arrangements between equipment sellers, railroads, and the trusts that will fund and lease equipment. The companies that set up and administered equipment trusts were those that had ready access to adequate supplies of money, primarily accessible by their relationships with large numbers of professional investors. Trust companies, investment banks, and savings and loans have historically set up trusts and named them similar to the railroad companies that needed equipment. Trusts, however, are NOT companies. Consequently, they do NOT use the word "Company" in their names. For instance, the Florida East Coast Railway Company leased equipment from the Florida East Coast Railway Equipment Trust.
Other equipment obligations
The word "Equipment" appears on a number of bond certificates that were not really Equipment Trust Certificates. One hybrid type is labeled "Equipment Trust Note." Those were notes (short term bonds) issued by equipment companies and secured by lease contracts on equipment. Legal titles were held by trust companies.
Another type is labeled "Equipment Note." These were notes issued by railroad companies themselves as opposed to trusts and equipment companies. Equipment notes were direct obligations of railroads. If lenders ever foreclosed, part or all their of operating equipment was subject to seizure. The legal titles to collateral may or may not have been held by trustees.
Five characteristics of equipment trusts
Whereas both bonds and ETCs are now electronic, both kinds of paper certificates that people collect were issued as proof of investment and as methods of collecting dividends and interest. Behind both types were greatly more elaborate contracts, and in the case of ETCs, those contracts spelled out:
- details and descriptions of equipment purchased, even down to specific car and locomotive numbers
- payment amounts and schedules
- marking requirements and maintenance of markers (all equipment was to be marked with signage that recorded title holder names)
- maintenance, insurance, replacement, and inspection requirements
- default stipulations (grace periods and descriptions of what would happen in case of default)
Terms of collectible ETCs
Most equipment trusts had specific terms of fifteen years or shorter and many were offered in several series, each varying in percentage rates and amounts spent on equipment. Many equipment trusts sold serial certificates which allowed trusts to pay off specific equipment and specific numbers of certificates once or twice a year instead of waiting until the end and redeeming all certificates at once. This gave equipment trusts great flexibility in controlling the amount of debt outstanding and the amounts they paid in dividends.