Equipment Leasing Guide

IS A VIRTUE PATIENCE

Welcome to the 2020 Railway Age Guide to Equipment Leasing. It would not be an exaggeration to say that heading into midyear 2020, the railroad industry and railcar owners and operators are dealing with times and circumstances heretofore never seen in the rail industry and to the lives of those working in it.

The relentless, exhaustive and ever increasing shadow of the COVID19 pandemic has impacted domestic and global business in ways that were unimaginable four months ago. This is acutely felt throughout the North American rail business. The statistics are generally awful right now. YOY railcar loadings are down 11.8%, while intermodal loadings are down 10.9% (through April 30, 2020 vs. 2019). Loadings levels have dropped below the level seen during the Great Recession in 2009. Perhaps worse still, freight was already feeling downward pressure heading into 2020. For rail freight, the pandemic is more than from the frying pan into fire. It is the frying pan into a lava pit.

The projections for the remainder of 2020 are dire. New railcar deliveries are projected to be close to or even below 20,000 units (from a February 2020 projection of 35,000 units). This is impacting the value of existing cars. Together, the lack of demand for new and used cars is having the same impact on the lease market for cars. In other words, pretty much everything is in a down cycle. It is widely expected for 400,000 stored cars to increase by at least 25%.

Chemicals and farm products (except grain) have been the most resilient loadingswise to date, while autos and auto parts have been an expected and notable underperformer. An outsized decrease in coal loadings has surprised to the downside. Coal’s BY DAVID NAHASS, FINANCIAL EDITOR

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battering from all sides continues. The volatile cocktail of cheap oil and natural gas, pandemic-related decreases in power consumption and power prices, decreasing costs for renewables and their increasing market share continue to provide downward stress on even the most pessimistic projections for coal demand. The Wall St. Journal reported on May 1 that coal-fired generation is expected to decline another 20% in 2020 (hazily sourced from the Energy Information Administration), while additionally reporting that, by some measures, renewably sourced power out-generated coal in 1Q2020 The net result is that coal loadings are down 22.6% YTD. Big ouch.

There is not one area of the rail transportation supply chain free from the impact of the pandemic. Railroads, railcar owners, railcar operators, railcar manufacturers, shippers across all market segments, intermodal import levels—nothing is immune to the impacts. Its ubiquitousness causes the greatest level of concern. What life looks like on the other side of the pandemic remains the great unknown. Broad scoping questions exist, such as the nationwide

commencement of the recovery from the pandemic and the length of the recovery to return back to already-depressed 2020 pre-pandemic levels, never mind getting to a period of economic and rail marketplace expansion (remember the first 75 days of 2020 were a period of freight loadings contraction). Perhaps the most important question of all: How will an economy struggling to put people to work and to return everyday life affect the pace of the recovery in freight markets?

While it may feel like years since the world began sheltering in place, at this writing, the U.S. is two (plus) months into sheltering in place and extensive social distancing. As a result, the full impact of the pandemic is really unmeasured at this time. Certain financial market impacts were felt quickly. Liquidity in certain areas of the equipment finance market dried up early, and some railcar investors have moved to the sidelines to see what the future holds. New car prices have dropped, and in certain market segments, secondary market pricing is also dropping. There have been some rumors of railcar sales, but nothing confirmed of a material nature. Scrap prices bottomed out below $200/ton (Chicago Heavy Melt #1) before moving up in May. Some lessors have been able to keep some cars on lease at expiration, but it is generally expected that many cars across all segments will be coming home from their existing leases at expiration. Inevitably, lease rentals will be impacted (see “Around the Market”). The locomotive market is reeling as well (see “No Freight to Pull”).

To get a gauge on the impact of the pandemic on the railcar market, its longevity and lasting impacts, Financial Edge invited the senior officers of four railcar operating lessors to answer the same five questions on the current state and future of the railcar lease market. Their full responses will be available on www.railwayage.com/ finance. Edited versions of their answers are below. The participants are (in alphabetical order) Paul Deasy President, Chicago Freight Car Leasing, a Sasser Family Company; Jeff Edelman, President, Infinity Transportation; Jeff Lytle, President, Rail, CIT; and Greg Schmid, Managing Director, Rail, RESIDCO.

Question One: How deep is the current downturn in the operating lease market?

Deasy: The impacts of lower industrial production and segment-specific challenges were being felt prior to the manifestation of COVID-19. Over the past month, aggregate carload(s) decline(d) near 30% (higher than the “Great Recession”). This impacts the demand for railcars. Shipper response is mixed. Some are returning railcars to lessors to manage their particular situation. Others are holding on to railcars in order to be positioned to supply product as demand improves.

Edelman: It’s extremely hard to project or measure the depth of this downturn. Aside from a second wave of COVID-19, we think the market will recover steadily into early 2021. The market was in a bit of flux prior to COVID-19 and this situation has led to further challenges. We are concerned about the varied approach to reopening by individual states [and] the current low-level volume of international trade. This issue will create continued uncertainty in the market and may lead to choke points in the supply chain.

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Lytle: We’re seeing different levels of resilience and pressure across the markets. Food-related and petrochemical markets are relatively sturdy. In times like these, our balanced expiration profile and strong and diverse customer base will serve us well.

Schmid: I don’t know if it feels the same as 2009, where the whole world stopped, but the downturn is as bad or worse. Redeployment of assets is a rarity, but renewals for certain car types are still occurring. This is about as dramatic a falloff in demand that there can be, but demand will pick up more quickly than the last crash.

Question Two: Will there be fundamental changes in the lease market related to the mix of softening demand, PSR and modal change that will have a permanent impact on railcar demand?

Deasy: We should expect continued investment in technology to improve scheduled railroading. I would expect shippers to utilize their historic modes of transportation to service their customers. We need to see growth in domestic and export rail demand.

Edelman: Despite lower treasury rates, softening demand, PSR and modal changes, we believe yield requirements will rise for investors. Certain investors were willing to accept lower yields to play in the space. There has been a little taste of reality, and the inherent risks in railcar leasing is front and center again.

Lytle: The railroads have had the benefit of a low-demand environment to implement their operational changes, and I’m hopeful that this will allow them to add capacity and grow their market share over time. I don’t favor “de-marketing” certain lines of business. If you do, it’s hard to bring that business back.

Schmid: The market appears to be in a demand pause, rather than demand destruction like 2009. There will be some long-term softening. PSR is going to have a longer-term impact on the leasing business until the railroads look at revenue growth. Old and sub-optimal assets are at risk before redeployment.

Question Three: For how long can we expect the market disruption to occur?

Deasy: I think it will be up to two years before we see more significant industrial production improvement and corresponding railcar demand.

Edelman: Depending on portfolio mix, specifically with energy-related car types, the disruption could remain for some time.

Lytle: We’re focused on what we can control. Our leadership team has seen this before, and we’ve never felt more prepared as we lean into this one.

Schmid: Outside of PSR, I am seeing signs of a hockey stick return sometime in Q4 this year and Q1 next year. Reduced regulations, liquidity being pumped into the economy and inventories that need to be re-stocked should all help.

Question Four: What, if anything,

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scares you about the future of railcar leasing?

Deasy: We have a vast and productive rail network in North America. We need to see a resurgence/commitment to leverage this network as a growth mode of transportation.

Edelman: What scares us is that many investors seem to forget they are investing in 40- to 50-year assets. The past couple of years, we have seen that the inherent risk of railcar leasing isn’t priced into the transaction. These aren’t long-term bonds; they are depreciating assets [with] utilization and renewal risk. These fundamentals are lost with certain transactions, and the effect shows itself in the pricing. We’re hopeful that we’ve all just received a reminder of the risks in the leasing market.

Lytle: I’ve been around too long to be scared. We focus on keeping our employees safe and productive, working with customers to develop and deliver railcar leasing solutions and drive the lowest total cost of ownership. We are well-positioned with a young, diverse fleet and strong customer service.

Schmid: The railroads have had the breathing room to perfect their own versions of PSR. Shippers are being squeezed to keep private railcar fleets to the bare minimum. They are being discouraged from incremental business. Railroads purchasing their own core fleets may mean a long-term contraction of demand for certain railcar types.

Question Five: Railcar leasing has always been a relationship-centric business. Do you see any changes in the way companies address their future railcar needs?

Deasy: The complexity of the leasing business leads to the need for strong communication and collaboration. This will not change. Virtual/technology-supported processes are and will change to do more things that were done face to face.

Edelman: Relationships matter regardless of the economic(s). We aren’t suggesting price doesn’t matter, but without strong relationships, it’s difficult to stay in this business. We are strong believers in relationships with our customers and working in partnership.

Lytle: There are efforts to market railrelated services, including leasing, on line, and the internet will remain a distribution channel. Relationships matter, and they are tested in difficult environments. We value strong customer relationships and work hard to build them during these challenging times.

Schmid: The operating lease business will always involve intangibles like relationships, customer service and quality that will help companies differentiate themselves. Bank lessors have regulatory constraints keeping them from being as customerfriendly as they would like. The operating lessor that can maximize flexibility still has an advantage.

AROUND THE MARKET Lease rates are, to be kind, scuffling a bit in the current market. Here is a summary of current rates. Fair warning: This is written

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in May 2020; these are the rates from the current moment.

Coal: Standard and Poor’s notes the following, “As of April 17, generators had 9,038 MW worth of capacity slated for retirement in 2020 and another 23,010 MW of coal capacity set to retire between 2021 and the end of 2025.” Need one say more? Coal was under stress and still found room to be worse than before. Net rates are low- to sub-$100 per car per month for net leases, and not much higher for full-service deals. Term notwithstanding. Rapids are a little less prevalent, but not enough for it to really matter price-wise. Car owners should prepare for more suffering ahead.

Small-Cube Covered Hoppers: Forget negative WTI. At $30/barrel, long-term frac drilling is unsustainable. Already under pressure from shorter-haul local brown sand, technology and severe overbuilding, this fleet is likely 40,000 cars long. Lease rates are sub-$100 (net) and likely to stay there for the foreseeable future.

Tanks for Crude and Ethanol: Here, WTI pricing is an impactful factor in bringing CBR to its knees. Equally impactful is the further whipsaw of fewer cars on the road, fewer planes in the air and fewer ships in the water. All these factors combined have body slammed refined fuel consumption. While there will be recovery here, some projections have WTI staying below $50 barrel until 2024. Some tank railcars are being used as storage on private tracks, but it’s not enough to hold up prices or demand. Storing crude is highly regulated and almost impossible on the tracks of a Class I railroad. Lease rates for 117R cars are sub-$500 (full-service) while some 117J cars have being quoted below $700 (in some cases with new cars). DOT 111s are commanding less.

Covered Hoppers for Grain: The supply of covered hoppers for grain remains in excess of demand. The decrease in grain loadings (down 6.1% through April) will be further exacerbated by increases in railcar velocity due to impacts of PSR and the overall drop off in total railcar loadings. Low scrap disincentivizes car owners to take older cars to scrap. This will hold these prices down. 4,750cf cars are leasing for around $200 full-service; 5,200cf cars are leasing for around $300 full-service. DDG hoppers (an ethanol byproduct) have become excess as ethanol demand has dropped. Those cars are down into the low $300s, full-service.

Covered Hoppers for Plastics: Project delays, some market saturation and consumption-related decreases in product demand have tilted the scales to being more unfavorable for car owners. This is another market that will rebound, but for the time being, lease rates on newer cars are sub-$500 full-service (sub-$450 net). Smaller cars with some age are going to scuffle as demand for those cars will show more weakness. Those cars are leasing at $300 and might never recover to higher ground.

Pressure Tanks: This market is slightly more resilient, but under pressure right now. Lease rates (which were tracking above $750 full-service for used and close to $1,000 for new (pre-pandemic)) have come down, and the opportunity to build cars in the short term is keeping prices checked. Lease rates for newer cars are in the $700 range.

Mill Gondola Cars: The steel market remains weak as auto and other industrial production and construction levels drop significantly. As noted earlier, scrap continues to wallow around $200 per ton. Car demand remains weak and values follow with it. Older mill gons (263K GRL) are in the low- to mid-$200s per car per month, full-service, while newer cars (286K GRL) are in the mid-$300s.

NO FREIGHT TO PULL With loadings down, it is no surprise that the locomotive market has drifted downward in tandem. The lease market to railroads is virtually non-existent right now, and the few bright spots (rebuilding existing locos) that were hopeful areas heading into 2020 have been marginalized indefinitely. As a result of contracting freight demand and PSR, heading into 2020, only CN and BNSF were not storing locomotives. Now, CN and Canadian Pacific have the fewest number of locomotives stored, while the U.S. Class I’s have larger numbers stored but have been more reticent to release those numbers. As Union Pacific COO Jim Vena noted in the 1Q2020 earnings call, “We’ve got so many locomotives parked. I’m just about embarrassed to say how many.” Rumors suggest both BNSF and UP could have half or more of their loco fleets stored. (Oftentimes, locomotives are stored serviceable in order to begin operations as soon as there is demand. UP has suggested many units are stored in this condition.) Many railroads are selling more-modern owned units such as SD60s and SD70s. With the order book for new builds decimated and rebuilds sidelined, it is not a good time for this market overall. What needs to happen? One word: Loadings. More loadings.

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The 2020 Guide to Equipment Leasing (pages 10 through 16) is supported by companies that provide equipment leasing and financial services and products to the rail industry. All of these firms have advertisements elsewhere in this section or have used paid profile space to present their background and capabilities.

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SHARPER ANGLES, DEEPER DIVES

Railroads don’t struggle with track geometry, or have difficulty detecting rail flaws, due to advancements in technology.

Geometry—for many, one of the least-favorite school subjects (“When are we ever going to actually use this stuff?!”)—is imperative to the rail industry. Finding faults, on the other hand, is a preoccupation for some people. But for railroads, it’s also critical. Safety depends upon both. TRACK GEOMETRY Track geometry is an important data stream that provides information on track condition, as well as its performance over time or deterioration rate. And much like teaching methods over the years, track geometry has evolved, says Russ Newberg, Director of Operations – RMSS, Holland. “It started with doing basic geometry testing for a few different data channels,” he says. “Collecting surface and alignment impacts were added. Now, it also includes defects that have evolved over time.”

Holland performs GRMS (Gage Restraint Measurement System) testing. “That takes looking at the rail from a static measurement and how it’s laying to what it would look like dynamically,” Newberg says. “We incorporate that with rail profile, taking the rail measurement and looking at it from a cross section. We can conduct rail and tie wear analysis and perform predictive maintenance for tie replacement planning, rail grinding and related maintenance work.”

Jim Hyslip, Ph.D., P.E., HyGround/Loram, concurs with Newberg, adding that track geometry has evolved from “old mechanical systems” prior to the 1960s to “inertial-based systems” that enable higher measurement speeds and other such benefits. Technology has accelerated this evolution.

“One of the big things was recognizing that there’s more information in the geometry data than just the position of the tracks,” Hyslip says. “You can start using it to obtain further information. A big reason we’re able to use geometry data more effectively now for things other than just looking at track roughness is computers, obviously, but also good positioning systems—the computing power that allows us to manage and analyze Big Data sets.

“The location determination systems developed during the past decade or so, with higher-accuracy GPS and better hardware, make data management a lot more efficient. We can overlay subsequent data runs. Aligning the geometry well—and it’s a lot easier to do that now because there’s more accurate location assigned to it—allows trending of geometry condition over time and seeing things like how roughness is developing over time, what the deterioration rate is.

“When we take things like geometry data, which is a routine measurement, and obtain other information about it, like what might be causing roughness and how it could be deteriorating over time, we can start integrating information I refer to as top-of-rail performance, from the geometry car to other information, whether it’s rail wear or other BY ANDREW CORSELLI, MANAGING EDITOR

track conditions. And we can start seeing the relationship between other types of condition information, like ballast fouling, and how that relates to track deterioration rate. Now, we can monitor that rate with good geometry data.”

Hyslip adds that the most recent geometry development has been the use of autonomous measurement systems that do not require a manned geometry inspection car. The more prevalent use of these autonomous systems, he says, is “the wave of the future.”

Many companies such as Loram use track geometry data collected by their railroad customers. “We don’t collect track geometry data within Loram,” Hyslip says. “We obtain it to look at overall condition and deterioration rates. We’re not looking at it from a safety standpoint. The main reason for checking geometry, historically, has been to determine what class of speeds can be run. It’s a safety measure. The tolerances that the FRA applies to geometry are all based on safety. We use it for another data stream that gives us information on track condition, as well as from subsequent runs, its performance over time, or deterioration rate.”

Track geometry tools have become extremely sophisticated. Protran Technology’s Callisto system, for example, “was developed to make gathering track geometry data less complicated,” parent company Harsco Rail says. “This is accomplished by using either a traditional Hy-Rail vehicle equipped with Protran’s hardware on the rear hitch, or on a ProTamp-equipped tamper. Callisto collects and displays all geometry parameters required by the FRA, as well as maintenance and safety thresholds, according to the userselected track class, in real time. We offer

high-quality rail consulting services, cuttingedge technological solutions and individual analysis plans that give railroads the ability to inspect, analyze and predict maintenance. Protran Technology track inspection products deliver detailed insight to railroads on track condition, analyzing current track conditions and planning for future maintenance demands. These inspection products ultimately help railroads understand their track and how to best maintain it, decreasing maintenance costs.”

Hyslip says Loram services “all of the major Class I railroads,” as well as Amtrak, which “by far has the most advanced and the longest history of using track geometry data.”

“Amtrak has been a huge customer of ours, collecting track geometry on the high-speed Northeast Corridor every two weeks,” he says. “That’s 24 runs over the course of the year, and by aligning them precisely, we can see roughness, how it’s changing over time, and the maintenance needed to correct it.”

Holland’s Newberg adds that the difference between transit and freight is significant for track geometry. “Geometry testing frequency depends on gross metric tonnage; for each railroad it will be different,” he says. “It also depends on whether it’s freight or passenger. Typical customers will have a minimum of one year, but the frequency could be as often as every 60 days, depending on what type of traffic is running.”

“We are seeing a market shift toward autonomous track geometry measurement technology,” says ENSCO, which has delivered 18 Autonomous Track Geometry Measurement Systems (ATGMS) since 2017. “We believe this shift is due to customer acceptance of, and confidence in, ATGMS technology. As autonomous technology and systems have matured, so has their performance and repeatability. Today, ATGMS provides the same or greater level of performance and repeatability as manned track geometry systems with the added advantage of being installed onboard a revenue vehicle, eliminating the need for a host vehicle and onboard operators.”

ATGMS measures track geometry and continuously streams the data to a cloudbased server. Railroad personnel are notified instantly of any exceptions via email.

ENSCO’s Autonomous Vehicle/Track Interaction Monitors (VTIs) are another autonomous inspection product “that continues to grow in popularity.” VTIs, installed on board revenue vehicles to measure ride quality, wheel/rail impacts and track geometry surface conditions, “have been credited with helping identify high-risk track conditions and avoid broken rails and derailments.”

The use of autonomous inspection technologies reduces lifecycle cost of inspection operations and allows for high-frequency track inspections where tracks can be surveyed weekly or even daily. “The rise of Big Data has also helped drive interest in autonomous systems, as ATGMS and VTI systems typically provide greater inspection frequency,” ENSCO notes.

Plasser American offers no fewer than eight Track Recording and Measuring Systems. “Our wide spectrum of machines and our customer-oriented development philosophy has led to the fact that a great number of different programmable logic controllers (PLC) and visualization systems are available today,” the company says. “For enhanced user-friendliness, the decision was made to focus development on a system that would meet all special requirements.” For example, Plasser’s T2000, equipped with ENSCO’s Track Geometry Measuring System, offers gauge measurement, cross-level, curvature, profile, alignment, automatic location detection, paint spray, ride quality measurement, Differential GPS and video.

RAIL FLAW DETECTION Track geometry’s cousin, rail flaw detection (RFD), is equally important to safety. Hidden internal defects can lead to derailments and catastrophic wrecks. RFD aims to nip such problems in the bud.

Herzog “combines conventional ultrasonics

with more advanced testing methods such as phased array, geometry testing and joint bar inspection,” the company says. “We can offer clients bigger data sets complete with more frequent, accurate results to help them address their particular rail testing goals.”

Herzog offers three vehicle platforms fitted with multi-channel ultrasonic testing hardware “to efficiently traverse different classes of track.” The Hyrail Freightliner, for main line track inspections; the Hyrail Pickup for mountainous regions and urban settings; and the Hyrail UTV, for use in sidings, yards and areas with tight clearance envelopes. Transducers are mounted to the vehicle’s testing carriage at standard industry probe angles to find different types of defects in the rail. Once on the track and ready to test, Herzog employs a different rail testing process according to the specific requirements of each railroad.

In Start/Stop Verification, after a defect is identified, the operator stops the detector car, steps out of the vehicle and manually confirms if the defect is indeed present using a portable ultrasonic device.

In Continuous Testing (CT), the rail is scanned in bulk mode and test data is transferred in real time to an off-site location for analysis by a qualified technician. Any indications that are suspect are then sent back to a field operator for subsequent on-site verification within a specified time frame.

“Most Class I’s have FRA waivers to perform CT,” Herzog says. “CT reduces track time needed for testing and allows more miles to be tested with increased frequency.”

Sperry Rail uses three technologies to inspect rail, says Sperry Rail Vice President, Technology Simon Broomhead. “We use ultrasonic, which is the most common technique around the world, to inspect the head and web of the rail. In North America, we typically use 15 different ultrasonic channels per rail. We also use induction, an electromagnetic technique. It’s proprietary and unique to Sperry. That was the original method of testing rails developed by Elmer Sperry back in 1928. It’s complementary to the ultrasonic tests. Occasionally, we can get transfer defects of the rail head. The newest of the methods is eddy current, which is relatively new to North America. This is used to inspect the rail surface. It penetrates about a fifth of an inch, five millimeters, down, so it’s very useful for finding rolling contact fatigue. We use all three in combination, along with integration into our vision system.”

Sperry uses these technologies in two different processes. “The original process in North America is what we call ‘stop and verify,’” Broomhead says. “That’s when the rail flaw detection process is completed in a single vehicle pass, typically at low speed. Basically, the rail flaw detection car progresses on the track, the inspection system collects data, processes it from the ultrasonics, and presents that to an operator in pseudo real time, in the form of a picture. The operator has to be a trained NDT (non-destructive testing) technician who is able to analyze those scans in real time. If there is a suspect indication, the operator stops the vehicle, exits it, and performs a hand test to size it and confirm it. The track is then marked, and a repair team will cut it out and replace the rail. That

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PREDICT FUTURE TRACK MAINTENANCE WITH LORAM TECHNOLOGY

Manual track inspections only see what’s at the surface. Loram offers multiple machine vision technologies for the most comprehensive picture of track conditions imaginable. With that actionable intelligence, you can forecast future needs and plan out maintenance programs like never before.

was the only method that used to be allowed under the regulations in the U.S.

“Sperry pioneered what we call Non-Stop Testing, introduced in the 1990s. It divides the rail flaw detection process into two stages. Test data collected at speeds up to 50 mph is uploaded to an analysis center and reviewed by experts who determine the locations requiring manual verification. Ultrasonic experts then perform manual verification. That’s now becoming dominant in North America.”

Nordco uses ultrasonic exclusively. “We’ve got a 32-channel system consisting of 16 transducers per side set up at different angles in the rail head and web,” Rick Wall, Nordco’s Director of RFD Operations, says. “There are forward-looking and reverse-looking transducers. Sound waves are produced with a ‘spider web effect’ to make sure we get every angle covered, giving us a B-Scan image in real time. We pinpoint it, back up, then move ahead and hand test it to pinpoint exactly where the location of the flaw is.”

Wall says RFD eliminates about 95% to 99% of rail flaw-caused derailments, but it

HyGround/Loram track geometry vehicle.

can’t account for things like broken axles or broken wheels. Anomalies for switching are not caught by RFD, he says. He adds that, much like track geometry work, RFD maintenance depends upon traffic volume.

“If you have a busy railroad, testing could occur up to every 30 days,” he says. “It’s dependent on actual tonnage. FRA sets a minimum standard on how many MGTs can cross the rail before it has to be checked. As

long as we test the rail more frequently than the FRA demands, the railroad is OK.”

Sperry’s Broomhead says the future of RFD is based in technology: “One of our key developments is the use of AI (artificial intelligence) to analyze the B-Scan, which is like a CT scan in the medical profession. We spent a lot of time developing AI to recognize downloads. It’s revolutionizing the way we handle and process data.”

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Leading the Way

Plasser American is known for highly productive and innovative track maintenance machines. Besides its outstanding technological achievements, Plasser American has always endeavored to fi nd solutions specifi cally for the American Transit and Commuter Railroad Industry, and to be a reliable, long-term partner with our customers. Decades of experience, up-to-date know-how, excellent track quality and favorable return on investment are refl ected in thousands of machines nationwide.