The Conrail Saga

Norfolk Southern freight, pulled by two Conrail locomotives, passes slowly through Doraville, Ga. (Picture by Todd DeFeo, (c) 2002

Conrail, as a railroad company, began operations in April 1976, although its lineage can be traced to the earliest days of railroads in North America.

The oldest of the roads that would one day fold into Conrail was the Granite Railway Co., built in 1826 to carry granite blocks for the Bunker Hill Monument in West Quincy, Mass. Nearly 150 years later, scores of Northeastern and Midwestern railroads had been acquired by or merged into six different lines: Central Railroad of New Jersey, Erie Lackawanna, Lehigh & Hudson River, Lehigh Valley, Penn Central and Reading.

By the early 1970s, however, these six railroads one by one entered into bankruptcy, citing competition from trucks, subsidized by the federally built Interstate highway system, and an archaic system of economic regulation, preventing railroads from responding to the needs of the market, as the chief reasons for freight decline.

The federal government, recognizing the national economic importance of the six railroads, responded by creating Conrail and appropriating the funds needed to rebuild tracks, locomotives and freight cars. And with the passage of the Staggers Act in 1980, many of these constraints were loosened, giving railroads more freedom to compete with trucks. Other legislation transferred the burden of operating money-losing commuter rail service from Conrail to state agencies.

By 1981, Conrail began its financial turnaround. And after June 1981, Conrail no longer required federal investment and finished the year with the first profit in its history. With that, the federal government sold its ownership interest in Conrail through what at the time was the largest initial public stock offering in the nation’s history.

A March 26, 1987, transaction, with added cash payments from Conrail to the U.S. Treasury, produced about $1.9 billion for the taxpayers and returned the Northeast-Midwest rail freight system to the private sector as a for-profit corporation, as Congress had envisioned when it created Conrail as Consolidated Rail Corporation.

Through the initial public stock offering in 1987, Conrail shares were brought to market at a split- adjusted equivalent of $13 per share. When Conrail was sold to CSX and Norfolk Southern in 1997, the price was $115 per share.

Under the operating plan approved by the U.S. Surface Transportation Board in July 1998, CSX and Norfolk Southern began operating most Conrail lines and facilities on June 1, 1999. In much of New Jersey and portions of the Philadelphia and Detroit metropolitan areas, however, some lines and facilities remain under Conrail’s control to manage and operate.

On June 4, 2003, CSX and Norfolk Southern filed a joint petition with the Surface Transportation Board (STB) seeks to establish direct ownership and control of two Conrail subsidiaries – the New York Central (NYC) and the Pennsylvania Railroad (PRR) lines.

CSX and Norfolk Southern are currently managing and operating NYC and PRR, under operating agreements approved by the STB in 1998. CSX and NS jointly acquired Conrail in 1997.

The proposed transaction would replace the existing operating agreements and allow CSX and NS to operate NYC and PRR via direct ownership. If approved, the petition would make the financial, operational and administrative management of Conrail, NYC and PRR more efficient in an increasingly competitive transportation environment and facilitate CSX and NS capital investment in those properties, the railroads contend.

The proposed transaction, however, would not affect rail operations, service or competition, and would have no adverse effect on customers or the employees of CSX and NS. And once complete, CSX and NS, as direct owners of NYC and PRR, would no longer be dependent upon the consent of the other for many decisions relating to their management of the underlying assets of the assumed lines.

The proposed transaction does not involve those assets of Conrail referred to in the petition as the Shared Assets Areas – separately designated as North Jersey, South Jersey/Philadelphia, and Detroit – and would have no effect on the competitive rail service provided in those Shared Assets Areas. Conrail would continue to own, manage and operate the Shared Assets Areas as previously approved by the STB.

Additionally, the proposed transaction would offer a number of important benefits and eliminate financial complexities that have increased due to changing conditions since June 1, 1999, when CSX and NS began operating the NYC and PRR assets. In addition, the proposition would permit CSX and NS to achieve increased independence over the management of the assets of NYC and PRR as a result of direct ownership.

The proposed transaction is subject to a number of conditions, including STB approval and an Internal Revenue Service ruling qualifying it as a non-taxable disposition.

If these and other conditions are satisfied, Conrail intends to undertake a restructuring of its existing unsecured and secured public indebtedness.

There are currently two series of unsecured public debentures with an outstanding principal amount of $800 million and 13 series of secured debt with an outstanding principal amount of approximately $400 million. It is currently contemplated that guaranteed debt securities of two newly formed corporate subsidiaries of CSXT and NSR would be offered in a 42 percent/58 percent ratio in exchange for Conrail’s unsecured debentures. The debt securities to be issued by CSX’s new subsidiary would be fully and unconditionally guaranteed by CSXT and the debt securities to be issued by NS’s new subsidiary would be fully and unconditionally guaranteed by NS. Upon completion of the proposed transaction, the new debt securities would become direct unsecured obligations of CSX and NS, respectively, and would rank equally with all existing and future senior unsecured debt obligations, if any, of CSX and NS.

The new debt securities that will become direct unsecured obligations of CSXT and NSR will have maturity dates, interest rates and principal and interest payment dates identical to those of the respective series of Conrail’s unsecured debentures. In addition, these new debt securities will have covenant packages substantially similar to those of the publicly traded debt securities of CSX and NS, respectively.

Conrail’s secured debt and lease obligations will remain obligations of Conrail and are expected to be supported by new leases and subleases which, upon completion of the proposed transaction, would be the direct lease and sublease obligations of CSXT or NSR.

Conrail anticipates that after the proposed transaction, the existing ratings of its secured debt would be affirmed, and that the debt ratings of the proposed new unsecured debt securities issued by the newly formed subsidiaries of CSXT and NSR would be at least equal to that of the present corresponding Conrail unsecured debentures.

The NYC lines operated by CSXT include those running from New York/New Jersey through Albany, New York, and Buffalo, New York to East St. Louis, Illinois, and from Albany to Boston. The NYC assets also include former Conrail rolling stock.

The PRR lines operated by NSR include those running from New York/New Jersey and Philadelphia, Pennsylvania through Pittsburgh, Pennsylvania and Cleveland, Ohio to Chicago, Illinois. The PRR assets also include former Conrail rolling stock.

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