What are the key issues facing the rail finance/leasing sector in 2011?

By Pat Foran, Editor

What are the key issues facing the rail finance/leasing sector in 2011?

It's a question we posed to more than 60 rail finance and leasing industry execs during the information gathering for our Annual Finance & Leasing Guide, which was published in our February 2011 issue.

Colored by the lingering uncertainty that continues to color pretty much everything, post-recession, their answers reflect concerns about the near-term economy, funding/financing availability, rolling-stock surpluses and the industry's collective response to same, along with a range of regulatory matters.

How slow is slow when it comes to economic growth, and how will said "slowness' manifest itself in the rail finance/leasing sector? For the time being, an unsatisfying "We'll see" will have to do.

As for rail-car orders, lingering equipment surpluses and the impact of same: We'll see there, as well. Orders for cars (from railroads, even — witness Norfolk Southern Railway's 2011 baseline budget inclusion of $155 million for freight cars, including the purchase of 1,500 coal cars) and locomotives (for example) are picking up. Class Is also continue to pull cars and power out of storage. For example, NS had 5,400 cars and 0 (zero) locomotives stored as of Dec. 31, 2010, compared with 20,000 cars and 200 locomotives stored at year-end 2009. Meanwhile, Union Pacific Railroad still had 35,000 cars and 1,050 locomotives mothballed as of Dec. 31, 2010, compared with 44,000 and 1,600, respectively, as of Jan. 16, 2010.

Finance and leasing-sector folks also are concerned about a range of legislative and regulatory issues. In particular, lessors and lessees alike cite the uncertainty surrounding the Financial Accounting Standards Board's (FASB) proposed and potentially significant changes to how leases are reported. For the past couple years, FASB and the International Accounting Standards Board have been working to develop a common standard for lease accounting. Under the proposal, operating lease accounting would be eliminated.

"What they're trying to do with an operating or full-service lease is to put that liability on the books — financially, it has been a sub note, so to speak," says Paul Deasy, director of sales and business development for Chicago Freight Car Leasing Co.

The standard originally was slated to be implemented sometime this year, but FASB has yet to set an official implementation date. Even so, asset owners already may be factoring the potential rule changes into their rail-car or locomotive purchase/lease decisions, Deasy says.

Factoring "Xs" into the decision-making process always has been SOP for the lender, lessor and rail-consulting crowd. Here are some of the Xs they told us they're working with this year:


Rail & The Economy

"The most critical challenge in 2011 will be maintaining the freight recovery that began in 2010. Freight volumes are the primary driver of equipment demand and equipment values. As traffic levels continue to rise, fleet performance will improve and the high surpluses will decline further, resulting in higher lease rates and increased new car demand. But it all begins with freight."

"[One of the key issues is] the uncertainty of a sustained economic recovery."

"We believe the economic recovery will continue in 2011. Risk factors to the outlook are unforeseen financial shocks and the steady rise in fuel prices. Railroads should benefit from the disarray in trucking caused by CSA [Comprehensive Safety Analysis] and HOS [Hours of Service] regulations. We expect more truck traffic to convert to intermodal, but we also worry that supplies of domestic containers and chassis may be inadequate to meet demand. Disconcerting are the ongoing attempts to roll back the clock and re-regulate the railroads."

"Gaining confidence in the economy to sustain growth and creating demand for goods and service to be transported by rail."

"Slow growth of the economy, whether companies will continue to spend. However, this may be an advantage to leasing companies as they may not want to spend their capital and lease more."

"The economy, and meeting financial institutions' current lending requirements to enable this industry to grow."

"To survive and make money if the North American freight rail recovery is only, as expected, ‘slow and steady’ (from 14,000 new cars last year to about 25,000 in 2011 — still way down from the average of 60-65,000 cars in recent years)."

Lending & Finance

"Financing will be more difficult to find in the next few years. In the U.S., the risks involve not only the environmental rules related to locomotives, but also the uncertainties associated with state and local budgets and with expected cut-backs in federal spending. New transactions will require a sound business case and well-defined long-term risks."
 
"[One key issue is the] availability of funding to finance constant freight transportation improvement. Very capital intensive and typically carries a relatively low rate of return on and requires much longer period to cover the investment."

"I am concerned about the debt appetite in the bank and bond markets. Several large fleets require refinancing in 2011, several key rail lenders have exited the market and whether the bond markets can and will absorb the balance remains unclear. Deal terms, advance rates, margins and amortizations will likely need to be improved for the banks which may negatively affect economics to the borrowers/lessors. However, the relatively low real interest rates will mitigate the aforementioned term tightening to a certain degree for the lessor community."

"In general, the banks are eager to lend in 2011 to replace loan volume lost in 2009-10, but banks and, to a lesser extent, credit markets remain somewhat fragile."

"[One of the key issues is] to compete effectively for a slice of rail financing in faster growing economies like the BRIC countries [Brazil, Russia, India and China] and overcome cultural attitudes about leasing (“renting”) equipment in those markets."

"Financial cutbacks by the state and federal government could mean the end to rail funding programs as we know them — including those directly impacting Amtrak. Emphasis may need to be placed on non-deficit producing programs, such as the RRIF [Railroad Rehabilitation and Improvement Financing] program."


Equipment Supply — Orders, Leasing & Purchasing

"We see that as the economy works to recover, stabilize and hopefully grow in 2011, the challenge will be to supply shippers with the rail equipment they require at a price that assists the economy's further recovery. We see that some markets will experience a quick shortage of equipment, creating a distorted price set for the car type, while other markets will continue to see an abundance of available equipment."

"The uncertainties resulting from the financial crisis we have recently weathered and a series of pending regulatory changes (to banks and financial institutions) are key issues. Banks and financial institutions have been big players in the rail leasing sector. To what extent the pending regulatory changes could impact the rail leasing market remains to be seen."

"New car production: The industry is known for overbuilding, which creates a surplus. Have we learned a lesson? Probably not."

"[A key issue is] the excess stored freight cars and locomotives."

"I believe the key issue facing the rail finance/leasing sector in 2011 is still car surpluses.  The surplus for most car types has certainly declined but rental rates have not increased proportionately and many are below compensatory levels. It appears a number of Class I railroads are considering acquiring significant numbers of new cars of various car types in 2011 which would be part of their core fleet. This would likely increase the existing car surplus and keep rental rates at depressed levels for an extended period of time."

"Ample supplies of relatively new, high-capacity equipment to meet expanding demand for a variety of rail cars over the next two years. Also, long-term planning geared to investing in replacing older equipment as well as growing demand for capacity additions in a number of car types."

"Too many rail cars chasing too little demand in some cases – like coal. High steel costs making new cars too expensive to justify investment. Unknown impact of new accounting changes."

"Oversupply of some types of used rail cars in the marketplace. Large numbers of certain car type remain in storage or underutilized causing depressed rental rates. High cost of new cars make it difficult to justify medium to long-term commitments from the lessee community for the corresponding lease rates for those car types in demand."

"Demand for rail equipment remains weak, which continues to depress values in the secondary market and virtually eliminates the need for new equipment — except in certain markets and locomotive technologies."

"Cars in storage: What is the condition of a lot of these cars? Will they end up being scrapped and create a legitimate demand for new cars?"

"[One concern is] high car costs and increased maintenance costs (railroad), resulting in a requirement for better returns by way of higher lease rates."

"Continued rail-car operating cost increases, particularly maintenance/running repairs, surpassing increases in market rental rates."

"Used asset values ... Lease rate liquidity."

"Pending changes to Lease Accounting rules that would have a significant impact on both lessor and lessee business policies and practices."

"The change to international accounting standards. This is a concern because it changes how operating leases are accounted for."

"The pending changes in lease accounting will play a crucial role in the structuring of future rail transactions."

"GE and CIT: Will they remain in rail-car leasing? Both fleets are available at the right price."

"To deal with ‘crowding out’ in the North American transit sector of transit car replacements by higher priority infrastructure needs, operating losses and reduced capital budgets."