Friday, May 14, 2010

Financial Edge: Recovery: Jump in or hang tough?

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Financial Edge: Recovery: Jump in or hang tough?
By Anthony Kruglinski

anthony-kruglinski-web.jpgRailroad Financial Corp. (my firm) recently wrapped up its 24th Annual Rail Equipment Finance Conference in Palm Springs, Calif. This year nearly 250 people attended (two dozen more than last year). They were railroaders, manufacturers and suppliers, shippers, lessors, investment bankers, bankers, and just about every variety of individual interested in rail equipment. Despite the fact that we hold the Conference at a golf resort, every business session was packed with people trying to glean some sense of where the market for railcars and locomotives is headed.

For instance, they learned that while 2009-2010 had seen nearly a third of the railcars in North America parked out of service, those totals were coming down—for some car types, briskly. They learned that some locomotive lessors were prepping elements of their parked fleets for service in the third and fourth quarter of 2010. They learned that declines in rail traffic and rail employment seemed to have bottomed out and reversed themselves. Most important, they packed the evening social functions seeking to network themselves into whatever business activity was threatening to poke its head above the top of the trenches in which we all have been living for two years or so.

Put another way, there are a lot of people seeking to jump on this recovery if, in fact, the leased-car market is in a recovery. Is it? Good question.

If you take a look at railcar rental rates, you will still see amazing deals in the marketplace. While rental rates may be firming, we are still getting reports of lessors agreeing to current depressed market rents for terms of up to five years! This is occurring when logic suggests that if the market is turning they should be keeping their terms short so as to be able to take advantage of any surge in rental rates. What’s behind this willingness to commit to cheap rents for so many years? Fear—abject fear that cars currently on lease will be returned and be parked in the weeds. That does not spell recovery.

But other lessors smell recovery and are willing to risk cars coming back rather than be manipulated into locking in today’s low rates for years to come.

What’s likely to happen? The lessors willing to fall on their swords will do so and that element of the market (which we believe to be limited) will be sucked up into certain deals, leaving the rest of the market to take advantage of the old adage, “a rising tide lifts all boats.”

As rail traffic picks up, as it seems to be doing, not only will it require cars that are currently in storage to be put back into service, it will have an effect of some kind on the velocity at which rail traffic has been moving during this business downturn. Clearly, no one wants to return to the bad old days of gridlock in certain rail corridors, but just as velocity increased when traffic went down, there should be a reduction in velocity when traffic rebounds. That will cause more cars and locomotives to be reactivated to service.

Let’s talk about locomotives. Scuttlebutt suggests that during the business downturn, the Class I’s may have stored locomotives taken out of service for mechanical reasons rather than repair them (which suggests that if you are a locomotive lessor who has a requirements in your leases that your leased locomotives remain in running condition, it’s time for some inspections). In any case, it may be more efficient for one or more of these Class I’s to tap the pool of thousands of leasable high horsepower locomotives, which may be already parked on their property by lessors, rather than sink cash from tight capital budgets into fixing their own broken units.

While we are on locomotives, I should note that both GE and EMD spent significant amounts of time reporting to the Rail Equipment Finance attendees on their efforts to prepare for the next tier of EPA rules and regulations due in 2015. Make no mistake about it: Class I’s are watching this situation to learn what their 2015 locomotive options are likely to be, especially if significant mechanical adaptations will need to be put in place to comply with the 2010 rules.

Whatever the OEMs develop for 2015, it will have an impact on what the Class I’s do with their existing fleets. Do they invest money in repowering existing locomotives? Do they rebuild existing units in kind for service beyond 2015 to take advantage of presumed grandfathering for existing units or do they scrap everything they can and buy new, when they understand what “new” is likely be and to cost?

Of course, what the Class I’s do with their fleets will impact the future for the thousands of leased locomotives that remain on the books of operating lessors!

What is this writer’s advice at this point in time?

• If you are a lessee: Jump into this market now and get the best lease terms possible for as long as possible.

• If you are a lessor: Hang tough. Better days are around the corner and perhaps only months away.

Everyone else should stay tuned to this space!

William C. Vantuono, Editor-in-Chief

With Railway Age since 1992, William C. 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, among them Next-Generation Train Control, Light Rail, and Rail Insights. He is the author or co-author or editor of several books, among them All About Railroading; John Armstrong’s The Railroad: What It Is, What It Does; Railway Age’s Comprehensive Railroad Dictionary; and Planning, Engineering, and Operating Light Rail, With Applications in New Jersey.

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