Toby Kolstad: Inauspicious Beginnings, Uncertain Endings & the Prospects for a New Lease on Lease Life

Last year began inauspiciously for rail-car lessors. There were surplus quantities of most car types, market lease rates were well below the levels required to finance new cars with borrowed money, and rail traffic was down compared with the previous year.

Most lessors would have preferred not to add many new cars to their fleets and wait for demand to catch up to supply. This was the tactic they had employed in similar circumstances in 2002, the year they prompted rail-car production to fall to 18,000 cars.

	Toby Kolstad
	Conditions will improve, and lease rates and car values eventually will increase enough to justify the past investments in these assets; it’s just not likely to happen anytime soon.

Rail-car builders bore most of the suffering for the late-1990s oversupply of cars and the 2002 recession; all builders suffered huge losses and struggled to stay in business.

This time around, some builders decided not to be the whipping boy for the rail-car industry, and tried to “build through the downturn,” in the words of one leasing company executive.

Reeling in Real Demand

Either through multi-year orders or aggressive leasing tactics to keep any kind of demand alive, some builders were very successful in keeping their lines running at or near the production rates of 2007. They even got a little help from Congress, which put an accelerated depreciation provision in the Economic Stimulus Act of 2008. The legislation caused some buyers to bring forward their 2009 orders into 2008, which is why new-car production was greater in the second half of the year than it was in the first.

It was never clear how the basic strategy of pumping up orders would work over the long haul since lease rates would never recover while surplus cars existed, and real demand would not rise until they did. Even where traffic gains had eliminated most, if not all, of the surplus of coal cars, lease rates never really recovered to normal investment levels.

The fall 2008 financial catastrophe ended all attempts to keep the market for new rail cars alive by artificial means. Credit became too expensive and speculation too risky to keep building cars as traffic levels fell with no end in sight for the decline in business.

So, in spite of their best efforts, car builders were forced to accept the inevitable collapse in production.

Which brings us to first-quarter 2009. Lease rates for most car types are down, but not as much as they were before the recession of 2002. Nor are the rail-car surpluses as bad as they were before the start of the last recession. For some car types — such as coal and grain cars — the surplus is not very large and if shipments don’t fall too much this year, lease rates may hold steady and perhaps even increase later in the year if real demand begins to develop. For covered hoppers designed for cement and plastic pellet traffic, mill and coil gondola cars used for metal shipments, tank cars, and maybe even box cars, a recovery of the lease market may depend on whether the still-evolving (as of press time) economic stimulus package of 2009 actually restarts economic growth or just worsens the current financial problems. Regarding the latter: The success of governmental meddling in the economy has been spotty, at best.

These, Too, Shall Pass

Lease rates should recover as soon as the economy starts to revive — presuming there isn’t any overbuilding. No amount of stimulus, however, will put any life into the market for centerbeam flat cars. This fleet was built to handle enough lumber to build 2 million homes per year, and it is difficult to imagine when that level of production will return.

So, 2009 begins as inauspiciously as 2008, with few signs of immediate relief for battered lease rates and used car values, and with even more serious maladies affecting the national economy. However, just as the industry survived the catastrophe of the early 1980s and the overbuilding of the late 1990s, these problems, too, soon shall pass.

And one thing is almost certain: Conditions will improve, and lease rates and car values eventually will increase enough to justify the past investments in these assets; it’s just not likely to happen anytime soon.

Toby Kolstad has been in the railroad industry for more than 30 years, with stints at Illinois Central Gulf Railroad, Denver & Rio Grande Western Railroad, a car builder and lessor. Currently a consultant on rail-car matters and president of Rail Theory Forecasts L.L.C.