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New entrants tasting success in financing rolling stock - Global Transport Finance - June 2016
1. New Entrants Tasting
Success In
Financing Rolling Stock
The global financing market has rarely, if ever, been
more competitive. Industry experts are keenly aware
of the need to seek out innovative and untapped
opportunities. Over recent months, this has been
particularly felt in the rolling stock market, where
there has been a sudden significant increase in
financier interest. A number of new entrants have
been enjoying successes.
What Has Been Happening?
Rail has been enjoying a renaissance. Passenger
and freight growth hikes continue to be driven by a
host of factors. These include increasingly crowded
roads, better rail safety, greater awareness of carbon
emissions, wider environmental concerns, and the
increasing pace of technological development.
Whathaschangedmorerecently,however,isthe
emergenceofanincreasedinterest—oftenfromnew
marketentrantsrangingfrombanksandpensionfundsto
privateequityinvestors—infinancingrollingstock.This
hasbeendrivenpartlybymanufacturersofferingnew
trainsatverycompetitiveprices,andtheavailabilityof
cheap,long-termfinancing.Thisattractivecombinationis
creatinginterestinbothincreasingcapacityandreplacing
existingrollingstockwithalternativesthatarecheaper
tooperateandmaintain.Thisishappeningeveninplaces
whereorderingnewrollingstockwas,untilrecently,
considereduneconomic.
Liberalisationofrailmarketshasalsocontinuedtoattract
theprivatesector,includingfinanciers.Thereisadirect
correlationbetweentheliberalisationofrailmarkets
andtheuseofprivatefinanceforrollingstock.Inmany
countries,railfreightisalreadylargelyliberalised,but
liberalisationofthepassengermarkettypicallylags
behindandvariessignificantlydependingonthetype
ofrollingstock.AnalysingWesternEuropeasawhole,
approximatelyhalfofprojectstopurchasefreight
locomotivesandwagonsarefinancedprivately,whereas
bycomparisononlyaroundaquarterofprojectsto
purchasecertaintypesofpassengertrainunits,including
electricmultipleunitsorEMUs,anddieselmultipleunits
orDMUs,arefinancedprivately.Therealsoremainsa
furthersignificantopportunitythatiscurrentlyuntapped:
usingprivatefinanceforhighspeedrollingstockand
trams/urbantransportsystems.
There are also numerous investment opportunities
available where local and national governments
continue to raise funds by refinancing and privatising
existing rolling stock.
These opportunities to obtain a steady return over
the medium to long term have enticed a host of new
entrants to the market.
Graeme McLellan is a London-based
partner in the asset finance team at law firm
Stephenson Harwood, specialising in aircraft
and rolling stock finance.
2. The Good, The Bad … and The Double-Edged
Swords
Many factors relevant to investing in aircraft are
similarly applicable to investing in rolling stock. But for
those familiar with the aircraft financing market, there
are a number of significant differences to consider
when contemplating rolling stock investment. Many
of these can be clearly classified as either benefits or
risks, but a number of factors can create both.
The Double-Edged Swords
Let’s start by looking at two examples of the double-
edged swords.
1. Bespoke Design Requirements:
The physical constraints for train operation are
profoundly different from those for aircraft. Whereas
an Airbus A320 can operate virtually anywhere, trains
ordered for a particular geography must comply with
local legal and regulatory requirements, including in
relation to signalling and on-train equipment, and
the constraints of local infrastructure. These include
the kinematic envelope (the maximum space that
a particular class of train occupies on the track,
including as it travels around curves) and, for EMUs,
the nature and stability of the power supply.
From a financier’s perspective, routes requiring trains
with particular design requirements are unlikely to
be replaced by other rolling stock — such bespoke
trains are potentially a safer financial investment.
Conversely, if such bespoke rolling stock is replaced,
it may be correspondingly difficult to find a new lessee
for that fleet – counterbalancing their perception as a
lower risk investment.
2. Usage Guarantees:
Another double-edged sword is the usage guarantee.
Some governments (both local and national) try to
encourage private investment in rolling stock by
providing such guarantees. Typically they guarantee
that there will be a lessee for a particular fleet of
rolling stock on pre-agreed terms. However, such
guarantees do not always extend to non-payment of
rentals or other lessee non-performance.
From a financier’s perspective, a long-term usage
guarantee for 20 or 30 years may provide certainty of
rental stream and reduce the residual value exposure.
Equally, it may prohibit the increase of rental
payments, thereby restricting financial return on the
investment. Furthermore, some usage guarantees
also facilitate particular types of local financing
(such as German covered bonds) on extremely
competitive terms, effectively barring such financing
opportunities to most new entrants.
The Good
Let’s turn now to factors that financiers in the rolling
stock sector may find particularly helpful:
1. Government Involvement:
More extensive government involvement tends to exist
in the rolling stock sector (particularly for passenger
rolling stock) than in the aircraft sector. If an airline
defaults on an aircraft lease or financing, the general
expectation is that the lessor or financier will terminate
the arrangement and repossess the aircraft — which
it will store, maintain and remarket. Conversely, if a
passenger train operator defaults, financiers often
benefit from both passenger expectations that the
trains will continue operating and pressure on (and
by) politicians to ensure that they do. Similarly, a
lease termination resulting in new and expensive
infrastructure being unused is unlikely to be tolerated
and will prompt government intervention.
2. Reduced Replacement Risk:
Current historically low interest rates may equally
offer a long-term risk-reducing factor to financiers.
Any rolling stock fleet financed now, benefiting from
current long-term interest rates, is less likely to
be displaced by a replacement fleet financed using
higher rates of interest. The key risk to financiers is,
therefore, that long-term interest rates fall below
their present levels – which may be unlikely.
3. Reliability and Operating Costs:
Financiers of new fleets can also be confident
that their rolling stock is unlikely to be replaced
prematurely purely on the basis of reliability and
operating costs. New rolling stock is generally very
reliable and rarely breaks down. Such new trains have
also been designed with an increased focus on their
whole-life costs, including their environmental impact
and weight / power consumption, as well as other
maintenance and operating costs. As such, it is likely
to be some time before new rolling stock designs can
3. offer a combination of further improved reliability and
lower operating costs deemed sufficiently significant
to justify replacing fleets currently being ordered.
4. Passenger Demand:
Passenger demand for rail travel is also increasing,
partly due to falling numbers of young people learning
to drive in Europe, North America and Australia.
Significant increases in passenger numbers are
being seen in a number of countries, with acute
overcrowding necessitating increases in capacity.
Investors are evidently identifying and responding to
the anticipated sustained growth in demand.
The Bad
Turning now to issues of which financiers in the rolling
stock sector should be wary:
1. Less Standardisation:
By comparison to the aircraft sector, there is far greater
diversity in classes (or models) of rolling stock and the
range of local legal and infrastructure requirements.
2. Defective Equipment:
Reliability has increased very significantly but, as with
any manufactured product that cannot benefit from
significant and sustained mass production, there
are risks of defects and faults, particularly with new
or amended designs. There is, however, evidence of
increasing sophistication on the purchasing side to
mitigate such risks for owners and financiers. These
include: put options – enabling a purchaser to return
all rolling stock to a manufacturer until a specified
minimum fleet threshold has been reached; bank
guarantees covering all payments to manufacturers
until the agreed minimum fleet threshold is achieved;
and more considered allocation between the parties of
infrastructure, change of law, force majeure, etc risks.
3. Obsolescence and Other Risks:
In assessing the likely useful economic life of new
rolling stock (and therefore its likely rental-generating
timeframe), there remain a number of risks to
consider: technological innovation may render
particular fleets susceptible to early replacement; a
change of law may require uneconomic modifications
to rolling stock; interoperability improvements
resulting from multi-jurisdictional legal frameworks
may result in increased competition from future
rolling stock operating on a wider geographical
basis; and the current trend towards increased
electrification seems likely to continue, but there will
inevitably remain routes for which this is uneconomic.
4. Bid Documentation:
Newentrantstotherailfinancingmarketshouldalso
bearinmindthatbiddingtofinancenewrollingstock
canbemoreresource-intensivethanequivalent
proceduresforaircraftfinancing.Somerailfinancing
procurementsrequireonlybrieftermsheets,butothers
involvecomprehensivemark-upsofextensiveproposed
contractualdocumentation.Thescoringofsuchbids
can,inturn,resultinfinancierstakingstrategicviewsto
enhancetheirlikelihoodofsuccessandanunderstanding
ofthescoringsystemisakeypreliminaryexercise.
