The valuation process that was used in developing the Association's certification to the Special Court must be augmented substantially. It will now be necessary for the Association to undertake on-site review of the system to verify inventories and develop the documentation required for the litigation process.

Another issue to be decided by the Court and in which the Association will have a continuing role, is the allocation of securities among the transferors. Although extensive segregation studies of each transferor's properties have already been made, the Association's work on the allocation of securities could not be final as of the time of certification on March 12th. In the first place, to the extent that the ultimate outcome in the Special Court is determined not by the FSP projections but by revised projections of ConRail's earnings, new segregation studies may be needed based on the new projections. Second, more detailed information is being developed for individual transferors and this will inevitably have an impact on the securities allocated to some transferors, particularly the smaller ones that were not an important element in the planning process.

In order for USRA to defend the fairness and equity of the compensation offered for transferred property, we will need to be able to defend, revise, and update the earnings projections of Con Rail. This is because Con Rail earnings will essentially determine the value of Con Rail securities. This review of earnings potential will have to take into account any revisions of the operating plan that may be adopted based on actual experience. In addition, the Association must prepare to deal in detail with the dire forecasts others can be expected to make of Con Rail's potential. There can be little doubt that the financial viability of Con Rail will be a critical issue in the coming litigation, and the Association must be prepared to defend every element of the detailed financial projections now being produced for Unified Con Řail.

The new authorization we are requesting is needed essentially so that administrative expense funds can be appropriated for fiscal year 1977. We are estimating that appropriations required for fiscal year 1977 will be 12.1 million. In terms of the program areas I have just been discussing, the $12.1 million breaks down as follows: $0.3 million for completing financial and operational detail for Unified Con Rail; $2.0 million for moitoring Con Rail, including winding up the Section 211(h) loan program; and $9.8 million to prepare for legal defense of the reorganization. I would like to insert in the record at this point a table that lays out the funds for the three major tasks by organizational unit. I would also like to insert in the record our budget justifications for the pending supplemental of $6.7 million and for the fiscal year 1977 appropriation request of $12.1 million.

1 Includes funds in initial budget submission for ConRail monitoring and sec. 211.

MARCH 15, 1976.

UNITED STATES RAILWAY ASSOCIATION BUDGET SUBMISSION FOR ADMINISTRATIVE EXPENSES

GENERAL STATEMENT

I. INTRODUCTION

The United States Railway Association is about to enter a new phase of the reorganization mission assigned to it by the Congress. Following the conveyance of the rail properties of the bankrupt estates on April 1, 1976, the Association will have responsibility for providing funds to Con Rail for working capital and rehabilitztion, for monitoring the use of those funds, and for defending the reorganization process against legal challenges presented to the Special Court.

This budget submission presents the Association's need for additional funds for the current fiscal year and the transition quarter and amends our budget submission for fiscal year 1977. Additional amounts are requested totalling $6.7 million for FY 1976 and the transition quarter, and a revised total of $12.1 million is requested for fiscal year 1977. USRA's authorizing legislation contains a ceiling of $54 million for administrative expenses. These additions would bring our total appropriations for administrative expenses to $64.9 million so that legislative action to increase the authorization will be necessary.

The proposed revisions are occasioned by (1) modification of the Final System Plan required by the withdrawal of the Chessie System and the Southern Railroad from the reorganization process; (2) new or revised tasks assigned in the Railroad Revitalization and Regulatory Reform Act of 1976; and (3) a clearer perception of the support required for proper defense of the fairness and equity of the Final System Plan in the courts.

A. Impact of Chessie and Southern Withdrawal

On February 11, 1976, the negotiations between the Chessie and various railway labor unions reached ad impasse. The Chinese management subsequently announced that they were unable to reach a satisfactory agreement and they would not be able to complete arrangements for purchase of major rail properties of the Reading and Erie Lackawanna. At the same time, the Southern announced that it would not be able to purchase and operate rail properties of the Penn Central on the Del MarVa peninsula.

The Final System Plan incorporated an alternative structure in case these two carriers were unable successfully to negotiate the labor agreements required in order to consummate the purchases contemplated in the Plan. The alternative proposes that Con Rail take over and operate the bulk of the lines that would have been purchased by Chessie and Southern. The Association will now undertake a substantial and complex refinement of operating and financial plans for a Unified Con Rail. A portion of this work must be accomplished prior to conveyance, but we believe the Special Court will permit much of the detail to be presented as late as July. Contractors are being asked to revise certain studies using the new structure and we are programming new data into the operational and financial models used to predict Con Rail activity and profitability. We expect to produce new projections on traffic, expenses, revenues, rehabilitation and capital programs.

B. Impact of new legislation

The President signed the Railroad Revitalization and Regulatory Reform Act of 1976 on February 5th. The Act authorized appropriations of $2.1 billion to USRA for purchase of Con Rail securities over a five year period. The Association's Board of Directors must make determinations each quarter concerning the amount of USRA's investment in Con Rail securities for the quarter year. This will require a quarterly review of Con Rail's compliance with covenants concerning performance, reporting, financial management, and recordkeeping. A review of operating results and an assessment of Con Rail's ability to become financially self-sustaining will also be accomplished each quarter. Con Rail will be required to furnish USRA each year with a business plan covering the following five years. The plan will include detailed operating, marketing, maintenance and rehabilitation, capital, and financial programs; plus a statement of maintenance and rehabilitation goals; and an analysis comparing these goals to the maintenance and rehabilitation program set forth in the Final System Plan. These mechanisms are designed to give USRA adequate controls to assure that the government's investment in Con Rail is utilized for the purposes intended and will, in fact, establish a profitable, private sector railroad.

The new legislation substantially modifies USRA's authority under Section 211 of the original Regional Rail Reorganization Act. This section was originally intended to be used primarily to make loans to provide Con Rail with the funds needed for rehabilitation of plant and equipment. This will now be accomplished under a considerably more complex financing mechanism involving the new Section 216 which authorizes the purchase of Con Rail securities as discussed in the previous paragraph. Section 211 as revised provides $230 million in loan authority which will be used to make loans for the payment of certain obligations of the bankrupt estates so that the conveyance of property to Con Rail and its start-up will not be disrupted. The law established the nature of the liabilities that are eligible for such loans and USRA must make more detailed findings in approving the use of Section 211 loan funds.

The new law provides authority for supplemental transactions to accomplish further restructuring of the railroads in the region. This could entail a substantial workload but we have no way of estimating what is involved at this time. As experience is gained and as new information becomes available, presumably some additional determinations will be desirable to rationalize the rail system of the region. USRA has acquired the basic data base required for such determinations but some refinement and updating would be necessary when a specific proposal is under consideration.

There are a number of additional assignments for USRA in the new legislation, but we do not now expect these to generate a substantial workload. These include assistance to the Department of Transportation in negotiating initial operating and lease agreements (on light density lines) with State, regional or local transportation authorities; and consultation with the Department on the conversion of rail rights-of-way on discontinued lines to other uses.

Finally, the new legislation specifies that USRA must report, annually, to the Congress on Con Rail's performance. This report must include an evaluation of (1) Con Rail's performance in terms of the basic goals of the Regional Rail Reorganization Act; (2) any deviations from the financial projections in the FSP; (3) the amount and uses of Federal funds made available to Con Rail; (4) projected financial needs and sources of funds for Con Rail; (5) the ability of Con Rail to become financially self-sustaining without requiring funds in excess of those authorized.

C. Defense of the Final System Plan

Not until January did our overall assessment of the complex issues involved in defense of the FSP reach a point where it was possible to define the need for supporting information from the various parts of USRA. The Association is the principal party in one of the largest, most complex and important legal controversies involving the government and private industry to come before American courts in decades. The outcome of this controversy is important not only for the government and the private parties directly involved, since the legal theories and results of this case will figure significantly in the broad area of government assistance to financially threatened industries within the private enterprise system generally. An unsuccessful outcome of the litigation could also entail billions in public funds being expended beyond those contemplated in the FSP and the Regional Rail Reorganization Act.

USRA will need to be able to defend, revise, and update the earnings projections of Con Rail, particularly as they relate to the value of Con Rail, particularly as they relate to the value of Con Rail securities. This process will have to take into account any revisions of the operating plan that may be adopted based on actual experience. In addition, the Association must prepare to deal in detail with the dire forecasts others can be expected to make of Con Rail's future.

The Association will require the capacity to "fine tune" the FSP calculations of net liquidation value. For example, new methods of scrapping property and new evidence as to prices may have to be taken into account in the NLV analysis. We should expect the estates to present their own detailed NLV plans and the Association must be able to develop both factual and analytical responses. Moreover the Act now provides for Certificates of Value bearing guaranteed values based on net liquidation value as found by the Special Court. Thus a central focus on such value is inevitable.

The Association will also require the capacity to respond to other basic theories of physical value. For example, to the extent that transferors are held to be entitled to prove that their properties could be sold intact for some particular purpose, the Association will need to respond both on the question of the ability to sell for that purpose and on the question of values.

The Association will have a continuing role in the allocation of securities. Although extensive segregation studies of each transferor's properties have already been made, the Association's work on the allocation of securities will only have begun on the certification date of March 12th. In the first place, to the extent that the ultimate outcome in the Special Court is determined not by the FSP projections but by revised projections of Con Rail's earnings, new segregation studies may be needed based on the new projections. Second, we can anticipate a need for more detailed information about particular segregation units, because a computer run on the basis of general assumptions is inevitably going to have some rough edges that may make a major difference to all but the largest transferors. Third, there may well be a need to conduct some different kinds of studies, at least to respond to the special characteristics of particular segments, and possibly to provide a new basis of analysis.

USRA staff must develop a rebuttal file that takes account of prior statements by concerned parties as well as experts expected to testify on their behalf. This requires a review of various reorganization proceedings, ICC proceedings, Congressional hearings and state regulatory proceedings.

This supplemental estimate for the period through September 30, 1976 and the amendment for fiscal year 1977 are based on events that have occurred since the Association prepared its most recent budget estimates last October. As noted in the Introduction, these events are (1) the withdrawal of the Chessie System and the Southern Railroad of offers to purchase and operate large segments of the bankrupt rail properties; (2) enactment of the Railroad Revitalization and Regulatory Reform Act of 1976; and (3) refinement and clarification of the needs to support our litigation before the Special Court.

Our increased needs amount to $6.7 million for the period through September 30, 1976, and $9.1 million for the fiscal year 1977. These additional amounts bring our total requirement for the period from July 1, 1975 to September 30, 1976 to $23,364,000. We estimate that $18,764,000 of this will be obligated this fiscal year and $4,600,000 during the transition quarter. For FY 1977 our total needs are $12,100,000.

In January the Association transmitted to the Congress a justification for a $3 million FY 1977 administrative expense budget. The January submission was based on preliminary materials prepared during the fall so that the President's FY 1977 budget could include a forecast for USRA administrative expenses. Recent events have made the budget forecast totally inadequate.

At a December hearing with the House Appropriations Committee and a January hearing with the Senate Appropriations Committee we requested supplemental funds of $6.1 million for the period March 1st through September 30,1976.

71-072 O-76-3