I'm Michael Sussman, and I became interested in the railroad industry in 1994 when I was asked to coordinate financing for Massachusetts Central Railroad. Finding no rail industry lender that funded smaller transactions for used equipment, I presented the situation to a finance company with whom I worked in other industries. I researched the equipment's salvage and market values and was intrigued to discover that these used boxcars made better collateral for financing than most other non-rail equipment.

After this successful financing, I asked Bob Bentley, the President of Mass Central, if there were other businesses like his. Bob gave us our first overview of short line railroads. Another turning point occurred while meeting Dick Robey, President of North Shore Railroads in Pennsylvania. Standing in front of a locomotive, I asked how it could pull so much weight with not many more horsepower than the muscle cars of my youth. Dick explained the efficiency of a steel wheel rolling on a hardened steel rail. I realized then that creating new sources of capital for this energy-efficient transport mode would be both profitable to the industry and a contribution to the country.

During numerous conversations with railroad owners, suppliers, and lenders, I heard about an industry with a severe shortage of funding options. I began an extensive study of the history of North American railroads, with a particular eye on 19th-century railroad finance. I wanted to know how the industry that was the primary reason European capital flowed into North America, could arrive at the end of the 20th-century misunderstood, undervalued, and under-funded.

The lending community, in its evolution toward consolidation and standardization, has shifted its business sights away from much of rail finance. Due to the many unique elements and the relatively small number of rail-related entities, lenders that do get involved only focus on the largest transactions. Where this development has been most costly is in the mistaken conclusion that there is an inherent weakness in railroading. As a consequence, lenders, railroads and their advisors have settled for unnecessarily low asset valuations and loan-to-value ratios. Understanding the real value of railroad assets allows us to create breakthroughs for our clients. We have developed Strategic Rail Finance to share this knowledge for the betterment of the railroad industry as a whole.

Prior to the passage of the Staggers Act in 1980, there were 220 Class II regional and Class III shortline railroads. As of 2005, that number has expanded to 585. Over the same period, financial institutions have been merging, consolidating, and standardizing. Banks have grown larger and hence less able to understand the operational and financial facets of individual local and regional railroads.

Characterized by small-to-medium size transactions, distinct financial statement features, and undervalued assets, these railroads are hard-pressed to attract the lending community's attention to their unique market position. While some of these owners can borrow substantially, exceeding their bank's appetite is the norm. Rarely are they constrained by their own business acumen or ability. Neither are they constrained by their market – they often have a backlog of shipping projects waiting for funding support.

What constrains them is the limited ability of lenders to accurately value their assets. With little or no experience with railroads, most lenders are less likely to understand the historical and national background so vital to appreciating individual railroads. Significant anecdotal evidence points to the financial stability and creditworthiness of these business entities. Class II and III financial statements, however, continue to reflect the unique financial and accounting traditions of the railroad industry. Without the deeper understanding that Strategic Rail Finance provides, railroads' strengths and assets fade into the line items on their financial statements. Class II and III railroads, despite their significant growth since the Staggers Act, are mostly undervalued and undercapitalized.

The most fundamental analyses of Class II and III railroad financial statements confound an accurate comparison to other industries. For instance, most Class II and III railroads have current assets to current liabilities ratio of less than 1:1. This fact is by no means an actual indicator of instability. It can only be assessed accurately in light of the unique aspects of railroad cash flow and accounting. The assessment tools that lenders rely on for industry analysis such as Standard and Poor's, Moody's, and Robert Morris Associates, only include the seven Class I railroads and several public railroad holding companies. Bankers, as well as railroad management, are often unaware of the inherent conflict presented by their financial statements.

Over the last 25 years, Class II and III railroads have increased their importance in the overall freight transportation system. To realize their fullest potential, individual railroads must be freed from the limitations of their current capital structure. Bridging this gap requires a reinterpretation of railroads' financial statements to more accurately tell each railroad's story.

Misperceptions notwithstanding, Class II and III railroads have become stable, growing business entities with an outstanding record of repayment to banks, suppliers, and government loan programs. For example, the U.S. Small Business Administration experienced zero defaults and zero losses from any of their 15 loans to railroads, totaling $6.4 million between 1988 and 1997. Strategic Rail Finance has gathered other positive loan data from state departments of transportation. The State of Minnesota rail loan program, for example, administered $74 million in financing to freight rail projects over 20 years. They experienced zero defaults and at the time of our research there was no delinquency.

There is also a misconception of small railroad closures. Close investigation of Class II and III operations over the last fifteen years reveals the low incidence of small railroad bankruptcies. Almost all of the closures, with only a few bad-faith situations as the exception, transpire as what can be considered "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 worst-case scenario, they still do not leave creditors in the lurch, providing another fact in the case for Class II and III railroads as a secure lending marketplace.

Given the contribution of freight railroads to transportation efficiency, public policy that supports rail development is good public policy. However, current statutes, regulations, and programs have not been designed to stimulate private sector financing and public–private funding partnerships. 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.

From Strategic Rail Finance's vantage point as financiers of freight rail transportation projects, we understand that freight rail assets are more valuable as collateral than is generally recognized. Bridging this gap in understanding has led to our successful financing of freight rail projects and is a cornerstone of our message to the industry, Congress, the Executive Branch, state and local governments, and the lending community.

By enhancing programs such as the Railroad Rehabilitation & Improvement Financing program through a comprehensive understanding of rail assets, railroad finance, and the capital marketplace, we can "seed" private sector lending to fully accomplish what the public sector can only partially satisfy. After all, the Land Grant programs of the 19th–century were effective because the government contributed land, a publicly owned asset, that railroads then leveraged into substantial private–sector capital.

Strategic Rail Finance has successfully coordinated private– and public–sector financing to fund individual projects. We are committed to contributing this expertise toward policy initiatives that encourage overall financing of railroad growth.

One of the things that struck me as I researched the great early railroad leaders, James J. Hill, Edward P. Harriman, William Ripley, J.P. Morgan and others was their preoccupation with finance. Major business transactions waited while they negotiated and structured funding mechanisms that supported long-term growth. J.J. Hill worked strenuously for 3½ years to consummate his first major railroad deal, the acquisition of the St. Paul and Pacific Railroad. He patiently negotiated with the Dutch owners of the railroad in receivership until the agreed terms set the financial foundation for what became one of the great rail empires.

Over time this financial vision has been lost as short-term results have been stressed. Railroads, however, are most appealing for their long-term return on investment. They are strengthened through thoughtfully engineered capital planning. Victor Morawetz, Chairman of the Executive Committee of the Santa Fe System, and architect of one of the most admired railroad turnarounds in history, wrote in 1915:

Strategic Rail Finance is committed to providing new sources of capital to fund a dynamic expansion of our continent's utilization of freight rail transportation. Railroads and rail-related businesses represent a stable, long-term opportunity for both public– and private–sector investment. The continent will benefit enormously by a relatively small investment from national transportation budgets. If we coordinate this public investment with important policy improvements we can provide the capital environment for the railroad industry to substantially increase its contribution to North America's economic vitality. Capital provision must be one element of an overall strategy for upgrading an already efficient rail transportation system to support our ever-increasing continental growth. New capital must go hand-in-hand with comprehensive plans and action for the reinvigoration of railroads as a growth industry.