New Year's resolutions we'd like to suggest - railroad finance

Railway Age, Jan, 1996 by Anthony Kruglinski

Welcome to 1996 Since this column regularly attempts to predict the future in the rail finance arena, we're denied the usual opportunity that many take to use the first communication of the new year to prognosticate. If we've done our job you already know much of what's likely to happen in new and used equipment values, interest rates, and what's going on within the financial community that serves our industry.

Instead, we'd like to use the first Financial Edge column of 1996 to suggest some New Year's resolutions that might make sense for some or all of our readers-and ourselves Resolution #1: We resolve to stop speculating on who is likely to purchase the rail equipment operating leasing business of USL Capital Rail Services. Late in 1995, Rail Services' owner, Ford Motor Credit, confirmed to Services' employees that it was considering a sale. Speculation on when and if Rail Services would be sold had been rampant during most of 1995. Potential buyers in various minds included First Union Rail, CIT, and just about everyone else in the rail equipment leasing universe, as well as some outsiders. After some reflection, we've determined that as far as the overall marketplace is concerned, it really doesn't matter much who (if anyone) buys these rail equipment assets. How so?

Assuming that General Electric Railcar Services doesn't alter its strategic posture and attempt to go after USL, an acquisition by anyone else will not likely result in any significant concentration of control of equipment. USL's fleet investments are reasonably broad as to car type and any party (or parties) that acquires them will simply become a larger munchkin when measured against GE.

Resolution #2: We resolve to look to Canada and Mexico for the greatest opportunities for gain in 1996. Yes, there will also be significant risks, but a perceived absence of risk is the greatest factor limiting opportunities for profit in the U.S. railcar and locomotive marketplace. The risks and rewards north and south of the border are, of course, different.

In Canada the railroad or equipment investor is faced with a rapidly changing regulatory environment. It will be easier for Canada's railroads tO spin off or abandon light density lines in the near term. That means more opportunities for investors to hit the mother lode or to screw up! In the equipment arena, the rapid withdrawal of the Canadian government from the rail sector is on everyone's lips. CN has been sold, and direct grain subsidies are history.-Opportunities to provide railcars and locomotives to new railroad operators and railcars to shippers would seem to be excellent. And depending on supply and demand, pricing may be better than in the U.S.

In Mexico, on the other hand, social and political unrest still hangs heavy in the minds of many funders. Lately, however, we've seen more people willing to consider Mexico "a work in progress" rather than an open pit of risk. As a result, we expect to see more and more interest on the part of U.S. investors in putting a toe into the Mexican marketplace in 1996. And--perhaps--a foot, in 1997 and beyond Resolution #3: We will cease to be surprised when we hear of high prices for used railcars or low prices for financing them. Recently, we heard of a regional railroad that acquired a large fleet of new railcars under a long term finance lease. While we understand that the pricing for this finance lease was seen by the lessee as excellent, the real kicker seems to be the fact that the railroad pulled this off despite that the value of the new fleet significantly exceeded the net worth of the lessee How did they get this done? Apparently, the several lessors that participated felt the opportunity to obtain a position in new railcars of the variety being leased, at 1995 prices, outweighed the risk of putting them in the hands of a relatively small credit. Most interestingly, we understand that these deprescribed cars are operating under a car-hire agreement with the regional's trunk line carrier that lasts less than one third of the finance lease term. Put another way, if the market value for rent for this equipment should change materially after the initial car hire agreement, the lessee's economics for the cars could change dramatically--better or worse We've also heard of prices for used railcars exceeding I00% of their original equipment prices when first built--sometimes 20 years earlier! (Lessors, try to get your approval committee to let you use a 100% residual some time!) Wow Resolution #4: We resolve during 1996 to continue to expect a higher level of ethical behavior in the railroad financial marketplace. Without wanting to sound like a broken record, we will continue to expect participants in rail equipment transactions to take the "high road" when dealing with others. All too often, rail equipment professionals find that someone in their deal--buyer, seller, funding source--is out to make a personal killing. It might be the funder changing its deal just prior to closing. It might be the purchaser agreeing to a price in the belief that it can renege and achieve a lower price closer to closing. Or it might be a seller wasting everyone's time with an offer to sell when in reality, it was just testing the marketplace. In any case, the word continues to go out from this writer and others on who not to do business with. Let's hope for better in '96.