Market shifts create opportunities and risks

Seismic market shifts in the oper- ating leasing marketplace for railcars are providing new opportunities for lessors to put cars parked in the grass back into revenue service. For lessees facing lease terminations for equipment they need, the opportunities look more like risks. This month, I’ve interviewed my partner David Nahass, who represents both lessors and lessees in a variety of situations. Here is what he has to say about this evolving operating leasing marketplace.

Kruglinski: The market for the short- term leasing of railcars is evolving. What’s your point of view on the state of this market?

Nahass: The lease market for railcars has tightened up in a number of commodity segments. For example, plastic pellet cars are on the move right now for the first time in years, and almost every set of aluminum rapid discharge coal cars are now on lease. There are significant numbers of new smaller cube covered hoppers for sand and cement being manufactured. In many cases, the lease market for railcars is beginning to shift or has shifted to being more lessor favorable. Few, if any, markets are moving in the opposite direction.

Kruglinski: What are some of the decisions that lessors and lessees need to make to deal with a shifting marketplace?

Nahass: Lessees have to look at their current railcar fleets and make decisions about how a stronger market for railcars might affect them: Should I commit to cars now before lease rates increase further? Should I attempt to extend the lease on lower priced cars that are slated for termination in the next 12-to-24 months? What should be done in anticipation of the future growth needs of my company?

Lessors are trying not to be defined by poor decision-making. Lessors want to keep equipment on lease. However, no one wants to miss a dramatic upswing in the market by putting cars into leases with low lease rates and then having no inventory of car supply when the market has shifted. On the other side, lessors do not want park equipment coming off lease and either find the upswing lease to be delayed more than originally anticipated or, alternatively, to erode profitability because of ancillary costs (storage, transportation, and maintenance) related to returning cars that have been off-lease back into service.

Kruglinski: How does this work out in the marketplace?

Nahass: We see a number of leases that get completed at higher numbers than you might expect relative to the market at the time. A lessee may decide that entering into a renewal for equipment coming off lease provides continuity that is important to the business. After all, returning in-place equipment and leasing replacement equipment may incur double costs or delay product movements. It could increase costs rather than reduce them. We implement “Requests for Proposals” (RFP) for companies to keep this process honest and keep in-place lessors at or near market rates for our clients. The RFP process pays for itself, in most cases, many times over.

But it cuts both ways. On the lessor side, the lessor wants to avoid additional expenses and off lease costs that they will have to bear transitioning equipment from one lessee to another. An incremental increase in lease rate of $15 per car per month generates less than $1,000 in increased revenue costs to a lessor in a five year lease. That revenue is easily exceeded at a railcar shop or in a tariff move from one destination to another.

Kruglinski: What different decisions take place in marketplaces where equipment is at a premium, say for the sand or cement cars that you mention above?

Nahass: For the lessee, those situations are challenging. They have to decide between taking control of the acquisition process for the equipment or taking what the market offers them. If a lessee needs equipment, generally, not having that equipment is costing them money. Committing to equipment to fill that need and having that equipment delivered relieves a pressure valve: the needs of the business have been satisfied. We do not suggest a course of action that has a lessee responding to the market rather than initiating action in that same market. It can be costly. We suggest to our clients that they take some preemptive action when additional car needs are identified in order to avoid being in a position where there are only one or two alternatives/solutions to a lessee’s car needs.

Kruglinski: When do you think the market will completely favor lessors? Is it in 2011?

Nahass: For most car types, 2011 will be a strong year. Rates will rise to levels that are more reasonable in nature. An overly weak market for railcars is not good for lessors. The market needs healthy lessors and healthy lessees. Some car markets will remain soft until 2012. We will have a pretty good handle on those coming out of the 2011 Rail Equipment Finance Conference.