Monday, June 28, 2010

2010 Guide to Equipment Leasing: Fractures in a frozen river of stifled traffic growth

Written by  Anthony Kruglinski, Financial Editor

These are tough times for prognosticators—especially those of us who have been doing it for decades in the rail industry. In the case of this writer, it has been almost 20 years of regularly making fairly accurate predictions within the covers of Railway Age, followed by a few years of not being able to accurately predict the end of our economic malaise.

Now, as we reported in our last Financial Edge column (RA, May, p. 52), we can hear and see fractures in that frozen river of stifled traffic growth. Increases in rail traffic are starting to get people thinking positively of pulling cars and locomotives out of the weeds where they have been parked for two years or more. Hope is on the horizon.

Welcome to Railway Age’s 2010 Guide To Equipment Leasing. As we do each year in June, we will try to make some predictions as we report on the state of the rail equipment leasing industry and its customers.

This is a market in which my firm, Railroad Financial Corporation, is actively involved, so we will be reporting from a position on the front lines of the battle.

North American rail equipment lessors:

Near-term prospects

As we reported from our Rail Equipment Finance Conference earlier this year, nearly one-third of North America’s nearly 1.6 million railcars and locomotives were reported to be parked, out of service. The statistics for locomotives are less accurate, but the estimate in March was that almost a quarter of the locomotive fleet was similarly idled.

Despite what is stated below, not much is likely to have changed with respect to these numbers in the several months that have passed.

What has changed is the atmosphere surrounding the operating leasing industry that rents ralcars and locomotives. For the first time in several years, it is reporting some optimism that things are soon to change for the better. Rail traffic has been reported up on a year-over-year basis in recent weeks. And as we reported last month, some locomotive lessors are pulling locomotives out of storage and readying them for service in the third and fourth quarters of 2010.

What are the operating lessors reporting relative to cars on rent?

Almost uniformly, they are reporting 85% to 90% of cars on rent. (We’ll note a few exceptions below.) How is this possible if one-third of the railcars are likely parked?

First, many of the parked cars can be seen as railroad marked. It’s more likely that the explanation is that many of the parked cars are actually on lease to lessees who are honoring their lease obligations to the operating lessors, but parking the equipment as unneeded at this point in time.

The exceptions to these general stats may be seen in the only operating lessor whose fleet does seem to be fragmenting as lenders take back cars with the agreement of the lessor. The so-called “Babcock & Brown fleet” is reported (depending on the segment) to have cars deployed at levels below the general numbers of the other operating lessors.

But something else is going on.

As we have reported during the last three years, there is a somewhat bottled-up desire on the part of investors to jump into the operating leasing business at the same time as several of the owners of existing lessors seek to monetize their investments in this equipment. The problem is that as car values have been pushed down during this same period, the investors feel that they deserve a discount on the prices of the cars pre-recession, while the owners feel reasonably confident that the values of their equipment will come roaring back when the economy recovers. What kind of a discount? Between 20% to 25% of the book values of the cars in question.

There had been something of a stalemate between buyers and sellers and, until recently, the only strategic fleet sale had been a small one that closed in December of 2008. Recently, the acquisition of a small (fewer than 5,000 cars) portion of the “Babcocks” fleet segment was announced in the market. Have the days of deep discounts finally arrived?

We think not. Rather, we believe that favorable financing (the seller was a bank) and more-than-drastic discounts in price had more to do with getting that deal done. The other way to look at this is that the buyers have finally decided that the deep discounts they sought were not in the cards.

What about the large strategic sales that have been reported or rumored in the market over the last couple of years but not completed? (We speak here of CIT, GE Railcar, and, by definition, AIG.)

Still not much going on, but we will comment on market rumors in our company-by-company handicapping below. (By the way, we’ll discuss these operating lessors in no particular order.)

First Union Rail

This operating lessor, which has approximately 90,000 railcars, came under the control of Wells Fargo when Wells acquired Wachovia late last year. There have been questions in the marketplace regarding Wells’ intentions with respect to First Union Rail. Did Wells have the capital to regularly reinvest in First Union Rail to allow First Union Rail to continue to serve its customers? Would the huge losses that ended up on the Wells tax books as a result of Wells acquiring Wachovia prevent Wells from taking advantage of the depreciation that is priced into North American rail equipment rental rates? Might Wells consider taking a quick profit and “flipping” First Union Rail to one of the many investors circling the industry?

We had a chance to ask these questions recently when we spoke to an insider and were assured that Wells is interested in keeping and growing its new acquisition and that it has the capital to do so. Wells’ tax position seems not to be an impediment to this strategy. So there you have it. First Union Rail lessees should expect “more of the same” from First’s Union Rail’s veteran management team. And that is good news.

CIT Rail

With more than 100,000 railcars and 500 locomotives, CIT Rail is truly one of the big players in the rail equipment operating leasing industry. It also falls into the category of one of the operating lessors whose parent has more than once considered its sale to monetize inherent value and solve other corporate problems.

All of that may or may not have changed when CIT Rail’s parent corporation went through a bankruptcy proceeding several months ago. Contemporaneous with that bankruptcy process, we are told that CIT repaid long-term lease financings that covered almost one-third of its fleet. (CIT guaranteed these financings and CIT’s bankruptcy would have been a default under the financings.)

Public records indicate that nearly $1.5 billion of “Debtor-In-Possession” funding raised in connection with the bankruptcy was used to repay CIT’s railcar lease financing at stipulated loss schedule numbers! Clearly, the rail equipment in CIT Rail was seen to have value!

Why did CIT do this? Logic indicates that CIT felt it had value in the equipment covered by these financings beyond what was owed and did not want to turn the equipment back to its equipment financiers. We are also told that the “lease-in” financing had been an impediment to proving the value to a potential buyer in at least one prior effort to sell CIT Rail.

Now that that impediment is gone is CIT Rail to be put on the block again?

(While we have no information to confirm that CIT used its bankruptcy to write down the value of its rail assets on its books, that is likely to have already happened.)

The industry is rife with rumors that a CIT “book” is about to be put out to potential investors. That’s something that remains to be seen, given CIT’s new management, which might decide to grow its presence in our industry rather than cut and run.

GATX

GATX owns or manages more than 165,000 railcars and nearly 700 locomotives. It is seen as a stable and enduring “player” in the rail equipment operating leasing market with an appetite for fleet growth for the “right” deals. It is regularly reported to be at the front of the line whenever rolling stock assets are offered—or reported to be offered—for sale. The only negative in its profile for growth might be its costs of funds, which, because it regularly funds itself in the public markets, may be higher than some of its peers owned by banks and others with higher credit ratings.

GE Railcar Services

Fielding approximately 180,000 railcars, GE Railcar Services is (we believe) the largest railcar operating lessor in North America. It is also one of the most difficult to analyze value and predict. To begin with, the majority of its railcar fleet is reported to be “leased-in” from various third parties under long-term agreements that give GE Railcar control of the equipment (presently and at lease end) while giving the lessor the benefit of a long-term, high quality rental stream. These lease-in arrangements make it very hard to predict what, if anything, will happen to GE Railcar in the near and long terms. Other than reports that GE has cut back on new railcar orders it had made in the past, very little concerning this huge railcar lessor has been made public.

Will GE Railcar be put on the market if the market for railcar fleets improves? (Put another way, will GE Railcar be sold once its cars-on-rent statistics improve?) This is difficult to say. We have been told that the absolute complexity of the GE Railcar Services owned/leased-in situation makes it difficult for potential purchasers to prove-up the values that GE feels are inherent in its investment, so who knows?

The one thing that is certain in the situation is that GE Railcar Services is still the 800-pound gorilla in the room and that it and its parent can do pretty much what they want as they go forward.

Union Tank Car Company

Fielding more than 80,000 cars (primarily tank cars and plastic pellet cars), Union Tank Car Co. is one of the largest operating lessors in its segment. The big news during the last few years has been the acquisition of a controlling interest in Marmon Industries, UTC’s parent, by Warren Buffett’s Berkshire Hathaway. While UTC had been well funded for decades, now it is really well funded!

The future? We have been told that UTC is also interested in fleet growth, but not at the expense of over-paying for equipment in a down market. (Sound familiar?) The good news for lessees is that there should be absolutely no dislocation in their relationships with UTC. What Warren buys, he holds.

Helm Financial

Owned by investors in Singapore, Helm Financial, headquartered in San Francisco, has a fleet of more than 15,000 railcars (primarily coal cars) and nearly 850 locomotives. (Its locomotive fleet is primarily high-horsepower “surge” power, much of which has been parked during this economic downturn.)

Known for making smart strategic moves in good and bad markets, Helm’s position in this market is something of a puzzle. Actively deploying its steel coal car fleet in response to market opportunities in the Eastern coal car market has kept this fleet busy on-and-off as this market fluctuates. On the other hand, with the high-horsepower locomotive market in the deep doldrums, many of its older locomotives may never find active employment again.

One thing is reasonably sure. Whatever cards Helm will end up playing as the market recovers, it will play them well and to its advantage.

Macquarie Rail

With approximately 5,000 cars in its fleet, Macquarie Rail owns equipment serving a wide variety of industries. Its management reports that it is presently well funded by its Australian parent and that it looks forward to making additional fleet acquisitions in what it sees as a market that is “slowly improving.”

In the past, this railcar operating lessor has made its acquisitions at the older-aged end of the spectrum, but we believe that a desire for continued growth may propel it to a wider scope of interest, perhaps not by buying new cars, but by broadening its view to include younger equipment.

Mitsui Rail

Mitsui Rail, the oldest of the Japanese-owned North American railcar operating lessors, has a varied fleet of approximately 10,000 railcars. Its management sees the market in which it operates as “recovering” and looks forward to growth when opportunities arise.

Mitsui Rail’s profile in railcar leasing has been one of actively acquiring seasoned equipment on lease and also trading its position regularly to generate gains.

What will work, and when?

That’s a good question and one that we have been asking operating lessors around the country in preparation for this issue of the Guide to Equipment Leasing.

As a general matter, virtually everyone speaks to an increase in customer inquiries. Some of it is industry-specific, such as grain or scrap steel. Other comments just point to an overall change in attitude toward the positive from the negative. We have had reports (not surprisingly) of lessees trying to lock up five-year terms at current (still) low rents

Here is what the market has had to say about specific car types:

Covered hoppers: There has been an increase in calls for 4,750-cubic-foot grain cars as well as 3,000- and 3,200-cubic foot cars (the latter for sand to support the oil and gas industry). Rents for the 4,750s are in the mid $200s for full-service leases. The smaller-cube covered hoppers are renting for $300 to $350—again, full service.

Mill gons: With steel mills ramping up, mill gons are renting in the low $300s for full-service leases. Most sought after are 263/5-foot-sided units.

Aggregate cars: Interest in renting these cars appears to be picking up related to road building activities.

Boxcars: There is some interest in Plate F 50-foot, 100-ton cars with 12-foot doors, but generally speaking the pulp and paper traffic that supports this fleet has not picked up.

Coal cars: While there are still significant numbers of aluminum coal sets parked, owners of steel cars suitable for service in the eastern states to hall metallurgical coal and for the export market have been renting briskly. Rental rates from $300 to $350 per car, full-service, have been reported.

Locomotives: Still a dismal situation, with thousands of high-horsepower locomotives sitting parked out of service. We have been hearing reports of some operating lessor units going to work for short periods of time as Class I railroads evaluate the cost of repairing their own stored out-of-service units and subsequently deciding that leased units are a better bet in the short term.

It is our bet that many of the locomotives currently stored will never go back into service and will be cut up if and when scrap steel rates go up.