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North American Rail Car Market

North American
Freight Car Market

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Progressive Railroading Magazine http://www.progressiverailroading.com/

Progressive Railroading Magazine, June 2009

"The risk of not properly managing risk when recession rules "

There is a proverb in my home state which says “when you’re up to your ass in alligators, it’s hard to remember that your prime objective is to drain the swamp.” The Chief Financial Officers at railcar leasing companies must think that they are in much the same predicament today as the hapless fellow in the swamp, with cash flow problems caused by terminating leases diverting attention from the need to properly manage risk.

In good times, risk management is often seen as a deal killer by leasing reps, with the wishes of their customers for low rates and flexible terms often at odds to the needs of their company for high rates and long term contracts with fixed terms. Leasing companies that have managed to balance these conflicting interests in the past will see less damage to their income statements during the present downturn than those that haven’t. And in the future, it is more than likely that leasing companies will pay more attention to this area and that lease contracts will be less “customer friendly” than in the past.

Risk management is not something that can be ignored during economic downturns however, especially when it appears that the wishes of the lessees coincide with needs of the company. For example, competition and a huge surplus of railcars is putting pressure on leasing companies to lower their rates; at the same time, the economic uncertainties are forcing railroads and shippers to limit the commitments they are willing to make in lease contracts. For lessors who think the recession will be over shortly, low rates for a short term appear to be a perfect solution to today’s problems, but if the recession lasts a long time, those short term contracts will only compound the problems for the leases that are scheduled to terminate down the road. Instead of just a fraction of the leases in the portfolio coming up for renewal, a majority of the leases may have to be addressed all at once.

Risk management involves more than just the timing of lease renewals. Customer credit, asset diversification, and corporate debt loads are other considerations that also top the list in normal times. Poor credit ratings are sometimes overlooked when there are large numbers of surplus cars incurring high storage costs, but bankrupt or cash starved lessees can tie up equipment and/or raise maintenance costs by not properly repairing the cars or by using them improperly. Sometimes the costs of leases with companies with poor credit costs more than the lost revenue and storage costs of not doing the deal in the first place.

Leasing companies with diversified portfolios of many types and ages of railcars usually fare better during economic slumps than those with only a few types of cars and age profiles, and this is true even in the current recession. Although there are surplus quantities of every car type, some are more abundant than others and lease rates for these car types have fallen faster and will take longer to recover than the rates for cars that have only recently become surplus. Leasing companies with manageable or low debt loads may find many opportunities to address any problems they may perceive in the composition of their equipment portfolio, especially if the recession drags on for a long time.

Highly leveraged leasing companies may have to reduce their debts by selling some or all of their equipment. This type of industry realignment has happened before; creative destruction is one of the constants of the railcar leasing industry. During the last severe downturn in the early 1980s, most of the newcomers to the industry failed and many of today’s leasing companies either arose to take their place or added their assets to their own fleets.

Just as fighting alligators has separated the strong from the weak in the Bayou State, so too will this recession change the lineup of railcar leasing companies. In a few years the industry may look entirely different than it does today, with new entrants to the industry, old companies that have greatly increased their share of the market, and some tombstones for companies that have left the field. The industry will survive and prosper once again, and those companies that manage their risks well will earn the returns that justify investing in railcar assets.

Rail Theory Forecasts is a consulting company specializing in North American rail freight traffic and freight car demand forecasting. Publisher of the annual North American Freight Car Market

Rail Theory Forecasts (RFT) was founded in 2001 to advance the art and science of predicting future developments and trends in the railroad industry, especially with regard to the demand and supply of railcars. The basic premise which has guided the company’s efforts is that current developments can only be understood and evaluated within an historical context, and that forecasts and projections of future developments must be soundly based on the interplay of the factors that have most influenced past events