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Headwinds & Heads-Up for Bank-Owned Rail Portfolios

Market Competition

When a National Bank invests in personal property, the Code of Federal Regulations, Title 12 Part 23, and the Office of the Comptroller of the Currency provides regulatory investment guidelines.  Prior to the early 1990s, banks entered into personal property leases only when they were the functional equivalent of a loan (meaning leases had to be “net, full-payout leases”). 

As bank regulations relaxed, banks began to enter the operating lease markets by creating operating subsidiaries that met regulatory investment requirements. With their low cost of capital, banks quickly became significant market competitors. Wells Fargo1, CIT, PNC, and Citigroup are examples. They own a significant portion of the national fleet of 1.6 Million units.  But with 400,000 railcars in storage and 2019 lease rates down 10 to 20% from the prior year, it has become a challenge to remarket or sell off-lease “nonearning assets” given current market pricing.    

Other than intermodal and autos, railcars carry grain, coal, crushed stone, sand, gravel, primary metal products, chemicals, iron and steel scrap, petroleum products, lumber, wood and paper products, and other high-volume, low-value commodities. Shippers want to manage their supply chains and inventory investment by controlling transport capacity and linking deliveries directly to production lines, customer factories, distribution centers, and ports of entry/export.  

With several modes of transportation available (truck, rail, air, and river), shippers and railroads are aware of the value of consistent delivery, pricing, and volume; this is what is driving the Class One focus on ‘Precision Scheduled Railroading.’ But by reducing service in insufficiently profitable secondary lanes, the Class 1 railroads are deciding to grow margins and cede market share to alternative modes. The result is the Class One Railroads are using fewer railcars and locomotives.

Rail Traffic as of January 2020

Exacerbating the oversupply of equipment U.S. rail volumes fell (again) in January (their 12th straight decline).  Excluding coal (which was down 13.8%) and grain (down 11.6%), U.S. carloads were down .6% in January. Carload gains included chemicals, grain mill products, and metallic ores (carloads of iron and steel scrap were up 5.2%).  U.S. intermodal originations fell 5.4% and have now fallen for 12 consecutive months.  

Job gains, the Institute for Supply Management’s (“ISM”), Manufacturing Purchasing Managers Index (“PMI”), the Non-Manufacturing Index (“NMI”), housing starts, and consumer spending were bright spots, all higher in January.  

Positive trade developments (the new U.S.-Mexico-Canada Agreement – “USMCA,” and the China “Phase One” deal) are being offset by the unknown economic impact of the Chinese coronavirus outbreak.  In January, coal carloads averaged 69,706 per week, the lowest January average since before 1988. In the first 10 months of 2019, coal accounted for less than 24% of U.S. electricity generation, down from 27% in 2018, and 50% in 20052.  Moreover, weekly average grain carloads in January (19,635) were the lowest for January since 2013.  

Investment Solutions

Railcar leasing can provide stable and predictable cash flows as freight volumes return, and the Class Ones show tangible benefits for shippers, such as consistent delivery and pricing that is market competitive.  As markets adjust, how can investment results best be managed? For restructuring solutions, seek the advice of independent, unbiased, and experienced counsel.  Call RESIDCO.

1Wells Fargo maintains they are the largest railcar lessor in North America, with more than 175,000 railcars.

2Ibid.

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PSR Dampens Freight Car Demand as China Trade Revs Up

Labor and Equipment Demand

Eliminating hump yards and running fewer, longer, ‘scheduled’ trains, the Class One’s are continuing to implement Precision Scheduled Railroading (“PSR”). It’s transforming rail networks, reducing the need for labor and equipment. 

The Union Pacific is planning to reduce its workforce by eliminating 3,000 workers this year (after reducing its staff by 11% in 2019).  As train speeds increase, the need for rail equipment decreases.  It’s estimated that for every one-mile increase in average freight train speed and additional 50,000, additional railcars will be moved to storage. Of a fleet of 1.6 Million railcars, 25% were in storage this January.  And train speeds are increasing due to PSR, lingering trade tensions, and to lower freight volumes caused by our slowing manufacturing economy*.  Going forward with larger capacity and new cars being delivered, fewer cars will be needed.  Added to this, the Rails are losing market share as shippers move product to truck to meet just-in-time inventory requirements. 

The Election Effect

Over the years, car ownership has changed dramatically.  In 1962 the railroads owned 90% of the freight car fleet.  Today, 75% is privately owned. The oversupply of railcars and locomotive power caused by PSR and lower freight volume is acting to reduce market values of existing equipment and lease rates at renewal.  The current low-interest-rate environment is depressing lease rate factors available for new equipment.  Uncertainty over the fall election and direction of international events (both in the Middle East and Asia) are working to hold the business investment flat.  As a result, new railcar deliveries for 2020 are expected to trend down. 

Given the election year, Trump signed a “phase one” trade deal with China this January 15th.  It provides a measure of relief for rail shippers.  China agreed to make purchases of $200 billion worth of U.S. goods over a two-year period, doubling its agricultural purchases to $40 billion.  Whether China will honor this agreement (which includes ending its practice of forcing foreign companies to transfer technology to Chinese companies as a condition for access to the Chinese market) is an open question.  

The agreement won’t fix everything.  There will be a continuing lack of cooperation over technology, national security, military, and political ideologies.  These are significant and continuing issues.  As the U.S. and China pursue their own national and economic interests, the conflict will continue.  A degree of economic decoupling is likely and the future of freight traffic between the two countries remains unanswered.  At stake are a stronger economy and global influence.  

Globalism, which fostered complex supply chains spanning multiple borders, is retreating.  The U.S. has become unilateralist and is rewriting trade rules to prioritize its interests while shunning trade blocs.  Bilateral deals have been completed with Canada, Mexico, now China, and soon with Britain, as it has left the E.U. The economic impact of the coronavirus in China is unknown, but airlines are suspending flights and businesses are shutting down operations there.  

Investment Risk Planning

As fiscal stimulus fades and global growth slows, U.S. GDP growth is expected to remain at 2%.  Even though we’re in the longest bull market in history, overall uncertainty has not been reduced.   Tariffs have led to a decline in business investment. While change is certain, how we react to events, preplan for them, and manage through them is within our control.  

Struggling to price investment risk and looking for answers?  Call RESIDCO. 

*The U.S. manufacturing sector contracted for five straight months through December, the Institute for Supply Management.

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