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February 2016

Rail News: Rail Industry Trends

Survey says: Rail finance and leasing execs expect rough sledding in 2016

By Pat Foran, editor

How does 2016 look, business wise, for the rail finance and leasing set? Not all that good, if the comments we received last month from industry execs are any indication.

A sampling of North American railroad finance and leasing officials shared their thoughts via responses to survey questions we sent during the information gathering for our annual Finance & Leasing Guide, which was published in our February issue.

There's been a fair amount of fretting within this industry segment for a couple years now, and for good reason. Last year around this time, rail finance and leasing folks told us they were concerned about the sluggish economy and pending new tank-car design standards, which ultimately were issued in May 2015

The rule revelation offered a bit of closure, but it also opened up new avenues of uncertainty. While the near-term market for tank car retrofits appears to be robust, the market for new equipment is anything but. The Association of American Railroads appealed certain portions of the design standard requirements. Even before the appeal was filed, at least one major railroad scrapped plans to order new tank cars, citing customer concerns about uncertainty and demand. Other leasing companies also hesitated (and continue to hesitate) to place orders. Meanwhile, the crude-by-rail market softened considerably, lessening demand for tank cars.

So: This year? Lessors, lenders and other finance/leasing execs told us last month that they think it'll be worse than 2015 because rail traffic volumes (particularly energy-related) volumes continue to lag, and equipment supplies continue to outpace demand. What else are they thinking about? Their unexpurgated responses to our 2016 survey questions, which were submitted via email or shared during telephone conversations, follow.

From a business perspective, will 2016 be better than 2015? Worse? Why?


Worse. The energy industry health directly correlates to the health of the rail industry (and) the energy industry is not healthy. Railroads will attempt to fill in the holes with new business from intermodal and other smaller impact business segments to some success.

Worse. Carloads are shrinking.

Worse — loss of coal, slow down in crude and slow economy.

2016 will be far worse than 2015. Low oil prices and an overbuild of energy-related cars for crude oil and frac sand have put pressure on utilization and lease rates for those cars, and that has spread to other cars as people look to shift orders to other car types. New entrants and “dumb money” have also flooded the market. In short, the industry is building cars that are not needed.

For the railroad finance and leasing business — worse. [But] we do believe the M&A market will remain strong in some industrial sectors.

So far, 2016 looks to be worse than 2015. With carloads off, the Class Is are cutting excess work equipment. They basically can do more with less equipment as work windows open up to perform track maintenance.

Greatly depressed commodity prices, higher rail velocity, increasing idle rail-car inventory (including speculative rail-car orders) are among many reasons 2016 will be a greater struggle than 2015. However, with that said, it appears appetites for investment in leased assets is still strong and we predict demand will continue throughout 2016. 

Same overall: offsetting forces will balance as energy and related businesses and certain raw materials (steel) will be down ... with intermodal, chemicals, ag, and some building and construction materials to be up. Rather than reduce freight rates to attract more/new business, railroads will continue to enjoy freight rate increases even though fuel costs and other efficiencies have made them more profitable.

I think the leasing environment will be very mixed this year as we transition away from crude-focused investment to a broader base. Volumes are flat or down and velocity is up, making the demand equation challenging.

2016 will be challenging due to change in the traffic mix, as well as an increase of capital demands along with increasing customer expectations.

2016 will be flat to modestly down compared to 2015 because of lower overall economic activity.

We expect business to be flat year over year. There will be offsetting improvements in some areas (auto and intermodal and  grain) with continuing decline in coal, minerals, and energy.

For our business (international rail and transport industry consulting), we expect 2016 will be better than 2015. While our work in Russia is likely to be curtailed, we expect to continue to serve customers in other CIS nations including Azerbaijan, Kazakhstan, and even Ukraine. We expect the rail and transport consulting business in Africa to continue to be strong as many nations invest in new rail projects or try to revive older railways. European countries will present a mixed consulting environment with expanded competition in rail passenger services and continued reforms in Eastern Europe. We expect the consulting business in Latin America to be subdued — a recession in Brazil and uncertainty in Argentina and Columbia will dampen new rail investment projects. North American transport consulting environment is a big question — declines in coal and bulk traffic will be somewhat offset by increases in intermodal traffic and improved competitive positioning relative to truck transport. Opening of the expanded Panama Canal will bring additional traffic to eastern ports and benefit the eastern roads. But, the potential for mergers and acquisitions could set the consulting industry ablaze.

Last year was a year of growth and opportunity for Vertex, and we expect 2016 to be the same, if not better. In 2015, Vertex transformed an abandoned manufacturing facility into a state-of-the-art railcar manufacturing operation, entered into a joint partnership with the largest railcar manufacturer in the world, completed one of three production bays at its Wilmington facility, received two critical AAR certifications, hired nearly 200 people, built its first hopper cars and completed a rail spur to move completed cars out of the facility. ... In 2016, Vertex will continue to scale operations and outfit its facility as the company pursues certifications to build additional types of rail cars. In addition, Vertex is expanding product offerings, services and capabilities across its network. Hiring will continue throughout 2016 as the company takes orders and works toward its overall goal of producing 8,000 cars per year.


What is the key issue facing the rail finance/leasing sector in 2016? Why?
UNCERTAINTY. Rising interest rates may cause an overall economic slowdown that postpones new builds. Also, the overall risk associated with rail-car ownership has increased significantly, causing owners/equity to reevaluate the historic risk-reward metrics which supported new builds. Additionally, international tensions, political uncertainty in the United States and elsewhere, economic woes in China, the threat of terrorism, etc., will all contribute to a more cautious approach to committing serious capital to long-lived assets like rail cars.

Volatility in the commodities market is the key issue facing the rail finance/leasing sector in 2016. Fluctuations in commodity prices cause firms to hesitate to make decisions in the face of uncertain market conditions.

General economic levels and (shale) oil glut!

Overbuilds, new players and low energy prices.

Asset valuations, the cost of money and downward lease rate pressure.

Lower fleet utilization leads to fewer new car/locomotive builds. Coal, sand and energy needs are down dramatically. Will backlog in other freight/intermodal carry the day?

The supply of MOW equipment outweighing the demand for it.

Asset value risk for equipment in services with unexpected declines.

Key issues include rail-car fleet sizing and utilization, and optimization of assets. 

The traffic volumes across the board are down double digits. Metals, coal and oil appear to be leading the decline. These lower volumes increase velocity to the point that demand for rail-car leasing is reduced.

The key issue in the finance/leasing sector in 2016 is how best to respond to the drop in demand for tank cars and frac sand covered hoppers. In other words, how will diversified leasing companies cover energy fleet softness? Will it be a year where we see fleet consolidations or will lessors hunker down and cover as much as they can with revenue from fleets with better demand?

There is more capital available to be invested in railroad projects than there are bankable cases being presented to the market. Many project proponents do not know how to quantify and justify their needed investments, and do not structure the deals in a way that is sufficiently attractive to the financial markets.

Internationally, a key factor will be the role of Chinese financing for rail projects in many developing regions. A slowdown in the Chinese economy may spur government financing initiatives in Africa, central Asia, and Latin America. China and Russia are in talks for financing high-speed passenger lines between the two countries  but we expect progress on these types of investments to be slow. In the UK, cross-rail and various high-speed projects will take a lot of available financing capacity. In the U.S., the biggest factor affecting rail financing will be the demand for rail freight transport, and the availability of funding for public projects (e.g., CORE). We think credit will be generally available and not expensive so drivers of the financing sector will be demand side.


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