Strategic Rail Finance
FUNDING THE GROWTH OF RAILROADS, SUPPLIERS
& CONTRACTORS
248 S. 23rd
Street, Philadelphia, PA 19103 Tel (215) 545-0157 Fax (215) 545-0156 msussman@strategicrail.com
May
13, 2003
Secretary
Norman Mineta
United
States Department of Transportation
400
7th Street, SW
Washington,
DC 20590
Dear
Secretary Mineta,
As
Congress and the Executive Branch confronts the breakdown in implementation of
the Railroad Rehabilitation and Improvement Financing program (RRIF), the
background conversations for expanding freight rail service intensify. Generating and implementing public sector
initiatives that successfully contribute to this important private sector
industry has serious implications for the well being of our nation.
We
are writing to make our successful financing of Class II and III railroad
projects known to you and the department and to suggest that we meet with the
purpose of co-creating the best utilization of our innovative solutions. This letter focuses on several of our
recommendations for improving the RRIF program.
For seven years, Strategic Rail Finance has advanced a new conversation
in Congress and the Executive Branch for the value and opportunity of
supporting Class II and III railroads as a much-needed solution to
transportation congestion. From our
vantage point as coordinators of private sector financing of Class II and III
transportation projects, we have discovered that contrary to prevailing myths,
freight rail assets are much more stable and valuable as collateral than is
generally recognized by industry representatives and public policy
administrators. Bridging this gap in
understanding the potential value of rail assets has led to our successful
financing of Class II and III freight rail projects and is a cornerstone of our
message to Congress and the Executive Branch.
If
Class II and III railroads and rail-related projects continue to be interpreted
as irreversibly isolated from mainstream funding sources, the federal
government will continue to be viewed by many as the only possible “bailout”
solution. We can look to history for
the cause of this debilitating mindset—there is no inherent aspect of freight
railroads as an enterprise that renders it a fiscal orphan. As a matter of fact, freight railroads exist
today as possibly our civilization’s most efficient utilization of energy,
space, and capital. For the industry’s
sake and indeed for our nation’s sake, it is critical that we empower a new
interpretation.
The freight rail industry needs government assistance beyond the
ready-at-hand approach of government loans, grants, and guarantees. Government financing programs can at best
help to maintain railroads, at a time when rail service growth can only
be financed through private–sector capitalization. By enhancing programs such as RRIF and H.R. 1020 (Railroad Track
Modernization Act of 2001) through a deeper understanding of rail assets,
collateral characteristics, and the unique elements of Class II and III
finances, we can “seed” private sector lending to fully accomplish what the
public sector can only partially satisfy.
For instance, we can dramatically augment the value of RRIF, without
increasing risk to the federal treasury, by matching the collateralization
requirements of loan approvals to the portion of assets that are actually being
financed and improved.
Strategic Rail Finance has identified a comprehensive set of efficient
federal government solutions for remedying the capital access limitations of
Class II and III freight railroads.
Currently, if a private sector banker or lender is approached by a Class
II or III railroad, they have none of the usual resources lenders use for evaluating
the financial statements of commercial applicants. Standard & Poors, Moody’s, Dun & Bradstreet, and Robert
Morris & Assoc. all regularly publish financial valuation data on Class I
railroads and publicly held railroad holding companies, but have no data
available on Class II and III railroads.
There are hundreds of less vital industries in America that are more
easily evaluated by commercial loan officers.
In
1999, Strategic Rail Finance designed a Class II and III Railroad Credit and
Financial Analysis Tools Project in conjunction with the University of
Pennsylvania’s Wharton School of Business.
This project received broad-based support in congressional offices from
all regions, as well as the USDOT and USDA.
Funding of $495,000 was endorsed for inclusion in FY2000, by Rep. Frank
Wolf, then Chairman of the House Appropriations Committee’s subcommittee on
Transportation. We suggest that
activating this project now will go a long way toward solving Class II and III
railroad funding needs.
The most fundamental financial statement analysis of Class II
and III railroad financial statements confound analysts experienced in other
industries. For instance, most Class II
and III railroads have a current ratio of less than 1:00. Reflective of the unique aspects of railroad
cash flow and accounting only, this fact is by no means an indicator of
instability.
Class II and III railroad owners across the country often
struggle with the realization that their assets are more valuable if sold off
than if they continue serving their communities. Public and private sector policies that value track material
and real estate higher when abandoned for salvage than as collateral for growth
capital should and can be remedied. We
recommend that this become the foremost goal of improvements to federal
financing initiatives such as RRIF.
The Federal Railroad Administration utilized Ernst & Young
accounting firm to provide the evaluation work in establishing the Credit Risk
Premium rates as well as the loan application requirements for RRIF. In performing this work, Ernst & Young
compared the financial performance of 1000 businesses. A tiny percentage of these 1000 businesses
were Class II and III freight railroads.
Not surprisingly, the RRIF program elements were based on gaps and myths
about smaller railroad financial performance.
Credit Risk Premium rates and loan application requirements that are
currently planned are far from reflective of Class II and III
creditworthiness.
Over the last ten
years, misperceptions notwithstanding, Class II and III railroads have been
stable, growing business entities with an outstanding record of repayment to
banks, suppliers, and government loan programs. For example, the SBA has experienced zero defaults and zero
losses from any of their 15 loans to railroads, totaling $6.4 million between
fiscal year 1988 and fiscal year 1997.
State programs have submitted similar positive loan analyses. The State of Minnesota rail loan program,
for example, has administered $74 million in financing to freight rail projects
over the past twenty years. They have
experienced zero defaults and at the time of our research in 1999 there was no
delinquency.
There is also a widely held misunderstanding of the circumstances around
small railroad failures. Closer
investigation of the financial history of Class II and III operations over the
last ten years reveals the low incidence of small railroad bankruptcies. In the relatively few closures that have occurred
they transpire as what we call “organized closures”. In other words, they go out of operation in stages, paying down
creditor balances, as demand for rail service on their line declines. In this rare worst-case scenario, they still
do not leave creditors in the lurch.
There remains an important part of this story to
highlight. Across the country, Class II
and III railroads are achieving one successful service expansion project after
another. While many of these operations
are substantial, the system includes as many that are small and therefore
easily overlooked in their importance to the national transportation
system. However, in the communities and
regions they serve they are fundamental to the social and economic life of our
fellow citizens.
Class II and III railroads, individually and as a system,
represent a stable, long-term opportunity for both public and private sector
investment. The country will benefit
enormously by a relatively small investment from the national transportation
budget in concert with several policy improvements. The resulting innovation will provide the capital environment for
railroads to substantially increase their contribution to America’s economic
vitality.
Secretary Mineta, we appreciate the
opportunity to work with you and your staff in growing these possibilities for
improving our national transportation system.
We look forward to your thoughts and input.
Sincerely,
Michael
Sussman
President
cc:
Michael Jackson