Wednesday, May 30, 2012

What’s lowering railcar rents?

Written by  Tony Kruglinski

A perfect storm of interest rate, tax, and market factors is driving down the rents for many of today’s railcar users to historic lows. Low interest rates are contributing to long term operating lease interest costs of 3% or less per year depending on the credit quality of the borrower. U.S. bonus tax depreciation (50% in 2012) is playing a big role in cheaper rents. A variety of factors are pushing the 2012-2013 North American railcar build rate to near historic highs.

Today’s tsunami of railcar building and leasing has a diverse and incredibly strong economic underpinning. It used to be that a spike in carbuilding usually meant one thing: operating lessors speculating on a hot rental market. All kinds of long term bets were placed on short term requirements and everyone shared in the roasting that the market served up for them when it turned. In this market, new carbuilding is being driven by a variety of economic factors—some super-heated to be sure—as well as the appetite of our veteran operating lessors.

Small cube covered hoppers and general purpose 30,000 gallon tank cars are being built to serve the fracking industry that is pulling hydrocarbons from shale deposits in the American west and in central and eastern regions. Industrials have decided that this is a good time to reequip and have placed and are placing orders in line with this strategy. Virtually all market sectors (with the specific exceptions of coal cars and center beam flatcars), are participating in this aggressive building of new cars.

Not only is it a great time to be a railcar builder. It turns out that it is a great time to finance these cars on medium term leases with the nation’s banks.

What’s going on?

Tax leasing—the purchase by a taxpayer of capital equipment for lease to others—is one of the few ways left for a bank to manage its tax bill. The bank buys the equipment and uses the depreciation it receives as the equipment owner to subsidize lower rental rates. If you can find manufacturing capacity, U.S. 50% bonus depreciation makes 2012 a particularly good year to do this.

Low interest rates also push down the rental costs of bank-provided operating leases. But there’s more. Financial debacles in the mortgage industry coupled with international efforts to bolster bank capital have combined to make long term leases (15 to 20-plus years) unattractive to banks.

Instead, the banks that have had a positive experience with railcar residual values on longer leases have taken the view that medium term operating leases of 7 to 12 years are just their cup of tea.

The result?

Railcar buyers, particularly those with decent credit, are finding that they have very affordable financing alternatives to the 1 to 5 year operating leases traditionally offered by North America’s operating lessors. If railcar buyers can stretch their commitments to meet the banks’ sought after 7-8 year minimums, they can do a sale/leaseback and save 20% to 25% on the rents that the operating leasing companies need to make their deals make sense. Even better, the bank deals come with purchase options. (Existing car owners are getting in on the action with their own sale/leasebacks.)

Make no mistake about it. Operating lessors are open and eager for business and are writing new leases at rates that finally make financial sense for them. But these deals are primarily in the operating lessors’ “sweet spot” of 1 to 5 years. When operating lessors try to compete for the deals the banks have targeted, the bank numbers are blowing them away.

Tony Kruglinski is President of Railroad Financial Corporation, which for more than 20 years has provided financial advice to railroads, lessors, manufacturers, and industrial companies. Contact him at tkruglinski@railfin.com.