Air and Rail networks have lost substantial revenues. First Rail freight traffic due to trade disagreements, tariffs, and the downturn in coal, and then both Air and Rail due to the impact of the Covid-19 shutdowns. Economics remains challenging. The landscape that has emerged was unexpected. Air Carriers are zero base budgeting equipment needs, personnel (payroll support ends in September), and optimizing networks. Flying point-to-point with few passengers onboard is not economically viable. Legacy carriers are rediscovering the virtues of ‘hub-and-spoke’ systems which work to maximize load factors. Operators are retiring older equipment from their fleets, preferring newer more fuel-efficient equipment and technology.  

An example is the jumbo jets which are too big for current passenger demand.  The International Air Transport Association updated its projection of when it expects passenger air travel to return to pre-Covid-19 levels – 2024. This year, when Boeing finishes the last fifteen 747 freighters on order, 747 production will be discontinued.  The last passenger 747 was delivered in 2017. Older 747-400s are not expected to fly again. There are only 35 of the newer 747-8 variant flying. These four-engine aircraft are not as fuel-efficient as newer design dual-engine aircraft. The pandemic has grounded almost all of Airbus’ superjumbo A380s and Airbus will close A380 production delivering the last unit in 2021. The A380 was designed with little cargo space compared to the twin-engined A350 which has twice as much cargo capacity as the four-engine A380. With 500 seats on average, the A380 is just too much aircraft and too expensive to operate when most seats are empty.  Engine issues have delayed Boeing’s 777X which when certified will compete directly with the A350.  

As fleets are repositioned trends are becoming apparent.  The pandemic has accelerated the adoption of video conferencing. Many see this resulting in a long-term reduction in higher-margin business travel. We’ll have to wait to see if Robert Crandall, former chief of American Airlines, will be right when he said, “You are never going to see the volume of business travel that you’ve seen in the past.”  Lower margin leisure travel is expected to return once a vaccine is available.  But even after a vaccine has been developed and tested it will take time for acceptance and coverage.  Then countries will have to standardize entry and documentation requirements for international travel to return.  Class One Railroads, using Hunter Harrison’s Precision Scheduled Railroading (“PSR”) strategy, are removing railcar capacity, locomotives, and employees.  Their focus is on reducing ‘operating ratios’ and improving short-term profitability.  

The unexpected demand environment is forcing Bank Lenders, Operating Lessors, Private Capital, and those who service and support aviation and rail equipment investment to reconsider their investment strategies. Success rarely comes from projecting trends.  Rather it comes come from insights that define future demand. Even with no additional Washington stimulus, another 1.4 million jobs were created in August, unemployment declined to 8.4%, and labor force participation increased to 61.7% (only 1.7% below its February level).  

The best investment strategy in a low demand environment?  Maintain liquidity, competitive market position, and key talent.  Be responsive to opportunities that deliver long-term value.  Call RESIDCO.

Global freight traffic flows are recovering. U.S. and German manufacturers surveyed in late August reported a ‘jump’ in export orders, “Container traffic is approaching the level reached before the corona crisis”. In the U.S. seasonally adjusted imports (inbound TEU’s) are up significantly on the West Coast, and Domestic North American Intermodal container volumes have fully recovered to pre-pandemic volumes*.  The purchasing manager’s index rose to 54.2 in July from 52.6 in the previous month (which was above expectations of 53.6, and its highest reading since March 2019).  Economically sensitive Rail carload freight (excluding Ag/Petro/Coal) has improved but is expected to be down for the balance of 2020.  

First it was tariffs and trade tensions that impacted freight traffic.  Then the coronavirus lockdowns disrupted domestic and international supply chains.  During the second quarter of 2020, the World’s largest economies experienced the deepest contraction in six decades (record keeping began in 1960).  The previous largest drop in a single quarter had been -2.9% in the first quarter of 2009.  The pandemic exposed the strategic vulnerabilities of reliance on China as a sole source, low cost supplier.  Unnoticed until now China managed to capitalize on our appetite for access to their markets.  It has been a one-way street as China is now ‘adjusting’ their export of pharmaceuticals, laser technology, cryptography, and artificial intelligence, given the ‘rapid development’ of China’s ‘industrial competitiveness’.  National security concerns will impact future trade volumes as the world’s two largest economies drift apart.

Hope for a rapid vaccine deployment is keeping the Dow Jones Transportation Average near a record.  But weakening passenger demand in the US domestic aviation market and continued restrictions on international travel weigh heavily on airline recovery efforts.  The proportion of the global passenger jet fleet in storage has remained at approximately 33% with fewer than 30% of narrow bodies inactive versus more than 40% of widebodies.  This reflects the proportionally higher passenger demand for domestic and intra-regional travel compared with international long haul.  The most popular aircraft in the U.S. fleet remains the Boeing 737-800 and Airbus’ A320/321 (the MAX is now expected to return to service in early 2021). 

The Conference Board’s July economic indicators, both leading and coincident, are pointing to a recovery.  Economists expect a strong rebound in the Third Quarter.  But as long as the pandemic lingers, the economic shock across the aviation and rail equipment leasing sectors will continue.  As the recovery unfolds the big picture question will be how will existing aviation and rail equipment capacity (and supply chains) be efficiently managed while we wait for demand to fully recover?  Despite low interest rates and fiscal stimulus, low utilization of existing fleet assets is likely to continue through 2021.  Demand remains uneven.  A third of the railcar fleet is in storage, railcar lessors are reporting pricing pressure on lease rates, aircraft manufacturers face order deferrals, and aviation lessors are faced with widespread restructuring challenges.  We are better than before,but not yet back to pre-pandemic levels.  The present requires the ability to identify investment opportunities that perform in this uncertain environment.  It’s time to prepare for the rebound.  Call RESIDCO.

Making Sense of What the Economy and Freight Markets are Telling Us, August 27, 2020, FTR + Midwest Association of Rail Shippers.

As the U.S. economy began to reopen, investors looked past the pandemic and optimism drove financial markets to within 4.5% of their all-time high.  Lockdowns eased and a stronger than expected jobs report (2.5 million new jobs added in May) indicated the U.S. economy was impatient to reopen. American and Delta reported progress in summer demand, shoppers are returning to stores, and Europe and Asia have restarted portions of their economies. After the Fed announced plans to keep interest rates near zero for an extended period (at least through 2022 indicating they are expecting an extended recovery) the markets retreated. 

The virus remains a reality and there are concerns over a possible recurrence of COVID restrictions. But a vaccine is expected to be available within a year (perhaps as early as this fall) and a June Wall Street Journal survey reports 69% of economists expect a recovery in the third quarter. The uncertainty that is driving daily volatility is dictating a ‘bumpy’ recovery.  

The nature of the passenger aviation industry is such that flight operations will have to deal with a slower recovery than the wider economy. S&P Global Ratings expects global air passenger numbers to drop 50% to 55% in 2020 compared with 2019, and travel demand to remain below 2019 levels until 2023. Idle U.S. passenger aircraft peaked in mid-May.   United is reinstating flights at over 150 of its U.S. and Canadian destinations in July to 30% capacity. American announced it will increase domestic flights in July, to 55% of its July 2019 schedule. Recovery of global passenger travel will take additional time and require the implementation of agreed international safety procedures and removal of quarantine restrictions.  

The lack of passenger revenues is driving temporary conversions of passenger aircraft to freighters and increasing sale-leaseback financing activity (since March 1st  lessors have closed multiple transactions with Delta, Southwest, American, and United). Virgin Atlantic increased its cargo-only flights by more than one-third to nearly 600 in June, breaking its record for freight carried in May. British Airways began operating two 777-200s as cargo-only flights with cargo on seats. China Eastern Airlines is using 13 reconfigured A330-200s in temporary cargo service. Emirates has converted 85 of its Boeing 777-300ERs as stand-in freighters (in addition to their 11 777Fs). Some carriers are considering repurposing 737NGs as freighters and then arranging to replace them with MAX sale-leaseback financing.  Older A380s can be moved to second lives as freighters.  A ‘shared space’ 747-400M, in service with KLM since 1989 continues to fly.  It has capacity for 268 passengers with a locked bulkhead on the main deck separating the cargo area from the forward passenger cabin. 

Rail volumes remain stressed. U.S. rail freight carloads fell 27.7% in May from the same period in 2019.  That is the largest year over year decline for any month on record.  May was also the worst month for U.S. coal carloads in history. Cars in storage increased to 520,729 units. But consumer confidence rose, and both the Purchasing Managers and Non-Manufacturing Indexes rose. ‘All indications are that we’re starting to bottom out”.  

To update your evaluation of the duration and volatility of factors influencing aviation and rail asset values, call RESIDCO. It’s key to setting the stage for tomorrow’s portfolio growth.

Domestic economies are beginning to reopen as evidenced by the number of TSA airport security screening checks.  They totaled 87,534 April 14th and by May 25th had tripled to 257,451.  “We’re past the trough in terms of peak damage”.  Much of the pickup reflects the states’ decisions to open parts of their economies.  While global supply chains remain fragile the mechanics of transportation decision making remain unchanged.  What is the payoff from the trip? Is it high value/time-sensitive? Where is traffic currently being allowed, and what mode is most cost-efficient?  

Globalization fostered the ever-increasing specialization of labor across countries.  The Covid-19 crisis has demonstrated the weakness of over-reliance on extended supply chains, whether for manufacturing automobiles, aircraft, or pharmaceuticals. ‘Just in time’ easily can become ‘just too late’. An example: the U.S. relies heavily on Mexico for parts and vehicle production.  Thirty-nine percent of auto parts ($60.8 billion) were imported from Mexico in 2019. Without Mexico, the Detroit auto industry will be unable to effectively restart production. Going forward the private sector must re-examine supply links, border restrictions, risks, and define solutions.  

Increased taxes financed the spending that helped the U.S. get out of the Great Depression in the 1930s.  From 1929 to 1939 the corporate tax rate rose from 11% to 19%, capital gains tax rates went up from 12.5% to 22.5%, and personal income tax rates jumped from 24% to 62% (the top marginal rate was 91% in 1960).  With the current level of deficit spending and lost tax revenues due to lockdowns, it’s not hard to imagine higher taxes. But borrowing now amounts to a transfer of economic activity from the future to the present.  

With air travel demand picking up, how full will planes be? Single-aisle airframes generally have 3+3 seating. Leaving all middle seats vacant implies a maximum load factor of 67%.  On a fleet-wide basis, the International Air Transport Association has said “social distancing would mean a maximum load factor of 62%.”  That would require a different business model than the airlines have been using.  Break-even loads vary with changing cost and airfare fluctuations (in 2019, the systemwide beak even load factor was 73.8% while the actual load factor was 84.6%).  

Class One Railroad operations remain strong with freight car velocity, terminal dwell, and car trip compliance improving. The Roads are running fewer and longer trains on tight schedules (Precision Scheduled Railroading). As traffic has declined, crews, locomotives, and freight car resources are being ‘balanced’ to meet the lower current volumes and improve operating ratios. New equipment deliveries are down and an equipment surplus hangs over the industry.     

The Global economy: the European Union’s borders remain closed to non-nationals until mid-June, and China has suspended entry of foreign nationals. U.S. tensions with China are escalating over trade, technology theft, the coronavirus, and Hong Kong’s independence. Managing a transportation portfolio in this turbulent ‘New Normal’ requires an ability to identify and seize opportunities the markets are currently offering. As demand recovers, focus on improving your odds of success. Call RESIDCO.

With economies ‘locked down’ and travel restricted, the pandemic has disrupted U.S. industrial production and impacted derived domestic rail freight traffic negatively.  The Federal Reserve reported manufacturing output fell by 13.7% in April, its largest monthly decline dating back to 1919.  Record declines in spending and employment are creating State budget disasters.  Furloughs caused by the lockdowns are creating current economic disasters for furloughed workers and their families.  The American Association of Railroad’s (“AAR”) April reports U.S. rail traffic falling 25.2% and intermodal falling 17.2%.  April’s originated carloads averaged 196,107 per week, the lowest weekly average for any month in more than three decades.  

All major car loading commodity groups fell including coal, autos, steel, lumber, chemicals, scrap, petroleum products, sand, and food products.  Autos and auto parts traffic disappeared in April because the auto industry shut down for the month.  Petroleum products and frac sand fell due to the price collapse in the crude oil markets.  

Earlier this year, China pledged to increase purchases of American farm, energy, and manufactured goods by at least $200 billion over two years ($12.5 billion over a 2017 base of $24 billion in 2020, and $19.5 billion above that base in 2021).  China’s farm imports from the U.S. of $5.05 billion in the first quarter were up 110% from last year (up 72% in January, down 27% in February, and up 37% in March).  Soybeans were up 210% from last year, pork up 640% from last year, and cotton up 43.5%. 

To hit trade-deal targets U.S. farm exports to China will need to double this year.  But China’s First Quarter GDP contracted 6.8%, its first drop in the twenty-eight years since Beijing began reporting quarterly gross domestic product in 1992, and a further contraction is expected in Q2.  China’s follow through on the trade deal may be challenged by a U.S./China strategic confrontation resulting from Beijing’s lack of transparency in its handling of the outbreak of the coronavirus. 

Regardless, China is the largest manufacturer in the world and the largest commodity consumer; 1.1 Billion more people live in China than in the U.S., and China’s working-age population is 900 million (geographically China is 98% the size of the U.S.).  The Eurozone economies (as a whole) contracted 14.2% in the first quarter (the U.S. 4.8%).  To match the U.S. population of 328 million requires combining the populations of Germany, France, the United Kingdom, Italy, Netherlands, Belgium, the Czech Republic, Austria, and Switzerland.  The world’s globally integrated manufacturing networks remain in disarray.  Most expect Q2 to be worse than Q1.  This is not a normal contraction

But with 25% of the 1.672 million North American Rail fleet in storage, the disruption creates the opportunity to deploy capital as the economy reopens.  Americans will return to work and rail transportation will remain economically compelling.  For careful, conservative, common sense, and competent solutions, call RESIDCO.

The past aviation super cycle was driven by growing demand from Asia’s emerging middle class (China) as well as the expansion of no-frills carriers.  With much of the world now subject to air travel restrictions more than two-thirds of the world’s passenger aircraft are parked.  The reality is that most of these aircraft will be parked for the remainder of 2020.  

Boeing expects air traffic may not return to 2019 levels for two or three years (David Calhoun at a recent investor presentation announced, “we will be a smaller company for a while.”)  Airbus, the European plane maker, is cutting jetliner production initially by a third, and embarking on a plan to ‘right-size’ its business.  In a ‘Best Case’ scenario traffic will return to ‘normal’ mid-2021.  While both are optimistic air traffic will eventually revert to its long-term growth path, the reality is they just do not know when.

‘Lockdowns’ are causing businesses to lay off workers where face-to-face interaction is unavoidable.  Over the past six weeks, the Labor Department’s initial jobless claims have totaled over 30 Million (unemployment is forecast at 20%, the highest since it reached 25% during the Great Depression).  With the U.S. economy shrinking at a seasonally adjusted annual rate of 4.8% in the First Quarter and a further decline expected in the Second Quarter, we are entering a recession.  

Conservative ‘Worst Case’ estimates expect a ‘U’ shaped recovery – two to three years for air traffic to return to trend line growth;  Domestic narrow body smaller aircraft traffic first, International traffic later.  Airline executives are now leaning toward smaller aircraft that can be more easily filled in a time of depressed demand. Delta is keeping all 31 of its fleet of A220s flying, despite grounding more than half of its fleet (it has firm orders for an additional 64). Boeing terminated discussions with Embraer SA (which produces a rival to the A220) and will now rely on returning its 737MAX to service.  Will cabins be configured to allow social distancing while we wait for herd immunity, require everyone to wear a face mask, take temperatures at the gate, or a vaccine appears? Ultimately, how quickly global traffic recovers will depend on how well the current outbreak is contained and how the global community chooses to work together to limit future outbreaks.

The trend toward younger fleets started after 9/11.  Markets were surprised when many U.S. carriers decided not to bring back the 737 Classic.  Similarly, the COVID crisis is creating a dynamic that is forcing Carriers to ‘right-size’ existing fleets, retaining newer models, taking delivery of aircraft in the current production inventory (e.g. Boeing’s 737MAX — with financing supplied by the added liquidity the Fed is providing), and retiring older units[1].  Air travel is not going away.  Look closely, the pandemic is likely to create asset investment opportunities.  But, be prepared for a ‘choppy sluggish’ recovery even after the virus is contained.  To navigate to tomorrow’s fleet environment, call RESIDCO.

[1] With oil’s collapse, economics (and load factors) will ultimately decide whether existing equipment remains attractive.

Air cargo represents less than one percent of global trade by tonnage but amounts to $6 trillion worth of goods moved every year – more than 36 percent of global trade by value.  Globally, half of that airfreight cargo has been carried on passenger jets rather than dedicated freighters. The rapid shutdown of passenger flights has eliminated passenger jet freight capacity, and air freight rates have responded, increasing significantly. 

With the cascading passenger flight cancellations (and flight restrictions), air carriers are moving idle passenger planes to freight in high-demand routes, taking advantage of the very high air cargo market rates at a time when fuel prices have plummeted (American Airlines Group Inc. is flying its first scheduled cargo service since 1984 between Dallas and Frankfurt).  As Asian manufacturing capacity comes back online, moving goods to the U.S. will further increase demand for airfreight. Equipment maker, John Deere & Co., is budgeting an extra $40 million in expedited freight cost for the second quarter to help ensure parts from Chinese suppliers can reach its facilities in Moline, Illinois.

Markets are telegraphing their uncertainty over how long the coronavirus will impact the domestic consumer activity which has driven our recent eleven-year bull market run.  The sell-off that’s occurring is being amplified by a constant media blitz of event cancellations, corporate travel bans, ‘shelter in place,’ school closings, and election-year ‘coronavirus politics’.  To stop the pandemic, we are forcing a recession.  Near-term, the impact will reduce second-quarter economic growth.  However, the politics of the fall election (and a $2 Trillion Stimulus package) will lead to a rebound in the second half.   

While commercial passenger air travel has been turned on its head, U.S. rail freight continues to move the essential goods we need to survive.  The slowing of the global and U.S. economies will delay domestic rail traffic improvement.  

But, as the summer appears, and the virus abates, domestic manufacturers and retailers will need to play inventory catch-up.  Companies will face such a need to restock there will be the potential for a significant freight traffic recovery in the second half of this year.  Longer-term, rail equipment demand uncertainty has been created due to the industry’s adoption of precision scheduled railroading (“PSR”). PSR (and trade) are driving the market dynamics, impacting rail equipment values and lease rates.  

Rail traffic (excluding coal and grain) is down year over year (still up from January lows).  First-quarter container volumes through the Port of Los Angeles, the largest U.S. gateway for inbound seaborne container shipments from China, are expected to be down 15% year-over-year.  Spring flooding will impact traffic along the Mississippi.  Oil’s slide will negatively impact the demand for crude oil tank cars and the frac sand cars that serve the shale oil industry.  

Air and Rail equipment values and lease rates are stressed.  But consider what the markets allow. Volatility creates opportunities. Now is the time to look for those gaps, weaknesses, and areas of growth; ask “Where are the most productive assets available?

We have some answers.  Call RESIDCO.

The coronavirus was the turning point. Schools and universities are being closed. Public activities are being canceled. Air travel and supply chains are being disrupted. Companies are telling employees to stay put. The virus constitutes a force majeure event.  

Even before the U.S. ban on travel from Europe, Air Carriers were reacting by trimming capacity, reducing both domestic and international flights. Southwest Airlines Gary Kelly has said, “The velocity and the severity of the decline is breathtaking, there is no question this is a severe recession for our industry and for us, it’s a financial crisis” (Southwest had previously said reduced bookings could result in as much as $300 million in lost revenue in March alone).   

China, in an attempt to contain the outbreak from spreading imposed travel restrictions. Many Chinese factories halted production in February. Worldwide, these shutdowns will impact industries from auto parts to pharmaceuticals. 

A key trade flow indicator economists examine is the volume of the Trans-Pacific trade. This trade lane accounts for 40% of the world’s gross domestic product.  Despite the recent Phase-One trade deal, the volume of U.S. products moving to China remains depressed. As the virus spreads, political leaders throughout the world are imposing broad travel restrictions. The result is less passenger and freight traffic to move.  

Trading relations often come with unseen risks. China’s entry into global markets resulted in a global over-dependence on low-cost Chinese production. The virus has exposed this weakness, and its effects are rippling through the interconnected world economy. “This coronavirus is a wake-up call.  We are much more vulnerable than we thought.”  Business leaders are scrambling for solutions as they face supply chain disruptions and current market uncertainties. Finding alternative suppliers isn’t easy. Future patterns of trade among nations will change in order to create more supply chain redundancy.   

Economic contractions are not a ‘bug’ of free-market systems, but rather a feature. Short term incentives act to create unsustainable swings in everything from product designs to supplier and labor relations. Competition over the delivery of fuel-efficient planes drove the Airbus 320neo and Boeing’s 737MAX (over the past 10 years Boeing and Airbus orders totaled more than 20,000 jetliners). Then, air carriers were more concerned about the cost of jet fuel, their single highest expense after labor.  

Surprisingly, when Russia refused last week to join OPEC in its call for crude oil production cuts, the Saudi response was to make the biggest price cut to their crude in more than 30 years  Lower oil will help the U.S. consumer, hurt U.S. shale producers, but have little impact on current Air Carrier operations. 

The impact of the virus on travel is so large it has resulted in the International Air Transport Association increasing the potential demand shock to the global airline industry upward from its February estimate of $29 billion to a loss of $113 billion in revenues in 2020.  

Public market liquidity is a convenience, to be taken advantage of, or to be ignored.  We are at a turning point. For actionable insights, call RESIDCO.

Air and Rail Investments

Investor interest continues to demonstrate market confidence in Air and Rail transportation equipment. Increasing interest in these ‘alternative investment’ categories has created a challenging environment. Rail transportation is a high-volume low-value freight business while air is a high-value passenger and freight business. Even with interest rate cuts (three in the last year by the Fed), falling global traffic levels across both modes have created caution flags for near-term investment activity. Whether the cause is tariffs, or the coronavirus outbreak (COVID-19), equipment demand, lease rates, and equipment values are being impacted. 

COVID-19 and Travel

China’s rise as the world’s second-busiest market has been a strong source of growth for the world’s major economies and airlines. The virus’ impact on supply chains and passenger traffic is complicated. Air travel is suffering as thousands of flights are being canceled. The International Air Transport Association has published an initial assessment that estimated global lost airline revenue is as high as $29 Billion (airlines in China would be the most impacted). 

U.S. carriers completely halted flights to China in January. The US Department of State has issued a level-4 travel advisory, meaning the public is advised not to travel to China. In February, the CDC issued a Level 3 warning, recommending avoiding all nonessential travel to China. In China, Cathay Pacific Airways asked all staff to take three weeks unpaid leave, Hong Kong Airlines Ltd., terminated 400 workers and Asiana Airlines Inc. (South Korea) asked thousands of staff to take unpaid leave. The number of infections worldwide is approaching 80,000 (China’s official count of 74,576 infected, and 2,118 dead is being updated daily1). China is bearing the immediate brunt, but the virus clearly presents a risk to the global economy.  

With the delay in returning the 737MAX to service (which is now impacting suppliers, e.g. GE LEAP engines), election-year politics, and the spread of the coronavirus beyond China, it’s difficult to assess the magnitude of impact. 

Favorable U.S. Developments?

The leading economic index indicates continued growth, US consumer confidence remains high, labor markets are tight, and existing home sales (supported by lower mortgage rates) are at a two-year peak. The possibility of slower economic activity requires thorough analysis, a sound underlying investment strategy, and downside protection. 

Minimize Risk

Risk is inseparable from the opportunity for profit, and whenever there is change, there is opportunity. Transportation equipment investment is no different. In every investment, risk is an exchange: the buyer holds the primary risk, while the seller has given up the chance that equipment values will go up. The biggest economic risk is buying at the wrong price, at the wrong time. 

Market intelligence, equipment configuration, and equipment condition are all critical. Equipment ownership and long-term contracts that ensure predictable cash flows and equipment values in difficult markets are needed. Often existing, well-maintained equipment is a better choice than new. Investors should be financially (and psychologically) prepared for volatility. It’s time to review your portfolio and ensure it’s properly positioned to weather the storm that might lie ahead. In times of uncertainty, think long-term and strive to minimize risk.

Prepare Now

We believe the current supply chain disruptions and turbulent global markets will lead to buy-side investment opportunities. Get ahead of today’s challenges. Call RESIDCO.

1 Wall Street Journal, “Coronavirus Wreaks Havoc on Airlines”, February 21, 2020.

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.