Monday, November 16, 2009

Financial Edge: Inspect it, or regret it

Written by 
By Anthony Kruglinski

anthony-kruglinski-web.jpgI had a conversation last month with Pat Mazzanti, president of Railroad Appraisal Associates (formerly Norman Seip & Associates), the oldest rail equipment appraisal organization in North America. I had called to check up on the amount of work his firm might or might not be doing on new equipment deals in this down market.

Pat confirmed that there is (compared to prior years) a dearth of significant numbers of new equipment deals that would otherwise require his services. He is doing some portfolio analysis as well as lease/buy analysis for several clients. He is also doing appraisal work for several new equipment financings and used equipment transactions, but not in the numbers seen in previous years.

Pat made a point of remarking that many equipment owners, lessees, and secured parties are not taking advantage of this “down time” in the equipment market to take preventative actions that are possible today. Asked what he meant by “preventative actions,” he provided the following summary:

• Shopping Equipment For Needed Mechanical Work. According to Pat, some car owners are recovering equipment from lessees and putting the cars and locomotives directly into storage. While avoiding potential expenses associated with repairs might make sense to a cash-strapped lessor, that lessor is taking a risk that its equipment will not be ready to return to service when the market turns. Pat’s point: Private shops are looking for work today, and getting needed mechanical work today might result in a lower cost than may be possible during a market upturn.

• Inspections At End-Of-Lease. There are many reasons to inspect rolling stock at lease end: 1) Net lessees that have been responsible for maintaining rolling stock may not have been doing so according to the mechanical requirements of the lease. 2) Excessive wear and tear on the equipment that might result in a lessor claim against the lessee may depend on identifying defects at the return. Even if there are no claims to be made, the wear and tear may be such that the lessor needs to shop the equipment to assure it is ready for similar or different services when the market rebounds.

• Identifying Impaired Assets. Pat points out that a significant number of railcars and locomotives may never return to service.
What does he mean? Pat has been hired to give his opinion on the short- and long-term viability of certain equipment types, given the current economic situation and likely future market highs and lows. For instance, the cost of rehabilitating certain locomotives or cars might be prohibitive given the likely market for this equipment in the future. Put another way, they may be “functionally obsolete.”

For instance, a worn-out SD40-2 may be worth more as scrap and recoverable parts than the cost of rebuilding it for any service that is likely in the next five years. Similarly, while some presently parked 20-year-old centerbeam flatcars will go back into service, it is not likely that all will do so. Pat’s customers have been briefed on their options and are therefore able to make decisions on scrapping equipment when scrap prices hit attractive levels. They are also aware of what they have to do relative to alternative uses for cars that are not “beloved” by the market today.

What other factors are coming into play as equipment owners strive to cope? Storage fees. According to Pat, owners of equipment out of service are having to face escalating costs for storing their cars and locomotives. For instance, two years ago the costs of storing a car was between $1 and $2 per day per car. Today, those costs are hitting $5-plus. If the current trend continues, it will force older cars (1970s built) that in past markets would have seen a second life to be scrapped during this cycle.

Asked for an example, Pat pointed to late-1970s-built C113 grain cars. In prior cycles, these cars would have been stored and reemployed when the market rebounded. If the present market downturn continues much longer, Pat feels, the increased storage costs for railcars may force the premature scrapping of an otherwise useful asset.

We asked Pat what else kept him awake at night. Here are two of his most pressing concerns:

• Potential Market Irrationality. Up to this point in time, the market has acted rationally with no significant “fire sales” of railcars and locomotives, despite the financial conditions of many owners. What happens if these owners find themselves, all at once, under the gun to sell?

• Manufacturing Capacity. Pat hopes that North American railcar manufacturers will ramp-up capacity less aggressively than in prior market rebounds. The alternative to this is the potential for further market dislocations in the future.

If our readers would like to challenge Pat Mazzanti on any of his views expressed herein or, even better, hire him to put them in the know relative to their equipment and its role in today’s and future markets. You can reach Pat at pat@railroadappraisals.com.
William Vantuono

With Railway Age since 1992, Bill Vantuono has broadened and deepened the magazine's coverage of the technological revolution that is so swiftly changing the industry. He has also strengthened Railway Age's leadership position in industry affairs with the conferences he conducts on operating passenger trains on freight railroads and communications-based train control.