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February 2013

Rail Industry Trends Article
Rail finance and leasing outlook: What are the key issues in 2013?

Rail Industry Trends
Compiled by Pat Foran, Editor

During the information-gathering process for our 13th annual Finance & Leasing Guide, we usually ask industry executives a question or two in an attempt to piece together a U.S. rail finance and leasing outlook. One of the questions we asked more than 60 execs last month: What is the key issue facing the rail finance/leasing sector in 2013?

Some are concerned about the freight-car demand imbalance (shale-related tank cars are in great demand, other car types aren't), the near-term traffic trend lines for coal and grain, and the corresponding impact on car utilization and lease rates. Others expect lingering uncertainty — economic, regulatory, supply/demand dynamics — to continue to add unwelcome variety to their lives.

Judging by this year's responses — and the conversations we had with a couple dozen of the respondents along information-gathering way — rail finance and leasing officials are less optimistic 2013's prospects than they were about 2012's. But pessimism doesn't appear to rule, either. See below for a sampling of their unedited (except for typos) responses, which we received during the last three weeks of January.

What is the key issue facing the rail finance/leasing sector in 2013?

"The disconnect between tank car demand (extremely high) and most other car types (modest to poor), and how this affects the fleet and new car deliveries."

"Money is still tight. Sinking revenue from the decline in coal traffic will have an impact on rail earnings and stock prices. Class Is should still be able to raise money very cheaply, short lines and smaller lessors may find it more difficult."

"There are a couple of potential issues that face railcar lessors in 2013. (1) First, the cost of new railcars compared to the lease rates that can be obtained in the market place. This should bode well for older cars that become available for purchase or lease in the North American fleet. (2) The drought that has negatively affected grain shipments and the utilization of covered hopper railcars. This could [have] a negative impact on lease rates and car values in the near term. (3) Finally the drop in the demand for coal and the declining coal shipments and utilization of coal gons as a result, railcar lease rates and the value of coal gons could decline even further."

"As rail markets shift commodity mix, and geographic mix, the rail car fleet will be deployed into new markets with radically different lengths of haul, customer processing times, product densities, and on routes with different levels of fluidity. Traditional forecasting models of rail car supply and demand will no longer adequately explain changes in the demand for various rail car types. Railcar fleet managers need tools that link the underlying production function of the rail system to the demand for rail cars, by car type."

"Two key issues: (1) Will the current administration succeed in killing the coal industry, and (2) will traffic volumes start to show signs of sustained growth in other sectors other than intermodal and petroleum. Most leasing companies and other financial institutions have big investments in general service rail equipment (including coal cars, grain cars, boxcars, etc., as well as in locomotives). Demand for those types of equipment was soft through most of 2012."

"During the past several years there have been an array of government stimulus programs offering private and public railroads free or nearly free money such as the Stimulus Act (ARRA) grants, the TIGER grants and assistance to rails through the tax code in the form of 45G tax credits for track expenditures. Because of budget pressures and slow but positive economic recovery this extraordinary ARRA and TIGER assistance is to be reduced or withdrawn altogether. Moreover, there may be a much more challenging interest rate and credit environment later in 2013-14 when interest rates turn up and the government must 'crowd out' private lenders from the debt markets to finance its continuing deficits. A similar tendency will affect Europe as phased Basel III capital requirements for European banks are reducing the amount of reserves available for commercial lending versus purchase of Tier 1 reserve assets. The challenge will be to ensure that high quality collateralized debt retains the lowest possible discounting status for reserves calculations. But, all these credit tendencies could lead to the need to 'dust off' more traditional thinking and structural options from the past."

"Rail leasing issues for 2013 will be similar to 2012 and can be defined as: (1) A deficit of multi-use rail equipment available for numerous industries (i.e., mill gondolas for rock, sand, MOW and scrap metal; steel open top hoppers for the rock, coal and single car loadings; and straight deck flatcars for finished products and raw materials); (2) A dramatic deprivation of rail equipment available to supply the robust and growing parts of the economy (oil, natural gas, intermodal) and (3) An abundance of single-use equipment (aluminum coal cars, frac sand covered hoppers) to serve industries bogged down with uncertainty due to the political climate and an imbalance between the high capital costs of new equipment and low to moderate lease rates which the market will tolerate."

"Uncertainties caused by the Federal Gov't."

"Maintaining the right 'mix' of railcar types in a fast-changing market — securing valued lease rates."

"The inherent risk of railcar ownership has increased without a corresponding improvement in lease rates or ROI. The rate of change in car specs, the regulatory environment and maintenance requirements mandated by the carriers has caused a major shift in asset lifecycles and historical pricing models making it more risky for leasing companies to own freight cars, especially if offered on full service leases. With significant inflation looming on the horizon as a result of irresponsible fiscal policy, longer lease terms without the ability [to] adjust for inflation will represent a huge exposure to equipment lessors."

"Biggest challenge of 2013 is whether the economy will continue to grow or sputter."

"Difficult finance regulations."

"Re-regulation. Railroads have been able to develop market based pricing that when combined with some of the most impressive productivity and efficiency improvements of any railroads in the world financial improvements have been significant. Now the few shippers that pay higher prices in the differential pricing curve want to cap the up end of the rate distribution. Regardless of how this is done, artificially constraining market based pricing will have substantial unintended consequences."

"A slowing economy which might affect the values of cars coming off leases."

"The nature and scope of proposed regulatory changes is a key issue across the rail, rail equipment and industrial sectors of the U.S. economy. Dependent on outcomes, regulations will shape the nature of equipment designs, their construction and maintenance, and the character of demand for equipment in the future."

"The key issue facing the industry is the significant lead times for tank cars and the potential for the industry to repeat prior mistakes by overbuilding certain equipment types. Other issues include regulatory changes, particularly with the increasing traffic in crude oil, and the shifting of maintenance burdens to car owners."


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