«Brunswick Rail» - Expert opinion on leasing of freight rolling stock

LeasingInfo portal, August 14, 2006

Konstantin Stepanov, head of Marketing and Research Department of «Brunswick Rail»

LI: Lease contracts are quite well developed in railway transportation industry. What advantages does leasing provide for transport operators, who lease rolling stock?

K.Stepanov:Indeed, leasing is quite efficient for transport operators who demand rolling stock. There’s no need to invest simultaneously sufficient amount of money in capital-intensive equipment. By signing lease contract lessee receives opportunity not only to allocate lease payments to the production (services) prime cost as a result of which tax on income decreases, but also to «relieve» balance sheet structure. As is known, gaining a credit influences balance sheet structure in a negative way. At the same time implementing lease contract helps to avoid negative effects. Besides, lessee receives opportunity to pay off leasing payments from the income obtained while operating object of leasing thus earning equipment funds while using it. It is also significant that leasing payments are carried out evenly and amounts are fixed preliminarily that helps to forecast expenses budget throughout leasing period.

LI: There’s financial leasing and operating leasing of rolling stock. Whatfactorsinfluencechoiceoftheleasingscheme?

K.Stepanov:It all depends on client’s field of activity and targets. So-called operating leasing in a commonly accepted interpretation differs from financial lease. Firstly, under terms of operating leasing lease contract period is generally shorter than lease object depreciation period. Secondly, lease object is not passed to the ownership of lessee after the lease contract period, but stays in ownership of lessor. Under terms of operating leasing an asset does not normally stays on lessee’s balance sheet which helps to retain debt/equity ratio with the use of IFRS. That allows addition loan attraction for financing core and more profitable projects and contributes to further current assets increase. Operating lease is more attractive for industrial enterprises who tend to forward their freights autonomously, but are not interested in increaseу of non-core assets. It is worth to mention that rolling stock leasing rates offered by BRL in several components are lower than renting rates offered by transport companies including RZD. Financial leasing is popular among those companies who purchase rolling stock by signing lease contract. Under terms of financial leasing lease object is being bought out by lessee at the end of the leasing period for depreciation value.

LI: Is there an additional bid security on lessee, considering rolling stock operating risks?

K.Stepanov:Generally there is a need for bid security under terms of financial leasing. BRL insures all major risks on it’s own expense. There has been no practice of bid security from lessee as a way of securing obligations.

LI: How big is demand for international leasing of rolling stock? Howaretheseordersprocessed?What is more profitable for lessor— resident or non-resident leasing companies?

K.Stepanov:This particular question is out of BRL business interest. Unfortunately we do not have enough data to make assumptions.

LI: There both ruble and foreign currency offers for rolling stock leasing due to the presence of Western leasing companies on Russian market. What currency is preferable for leasing deals for forwarding companies? What factors influence their choice?

K.Stepanov:Companies have their own currency choice criteria. Of course there are a lot of factors such as currency exchange rate and company’s internal policy. For example RZD being one of the major leasing deals counterparty works solely with rubles. Shift to ruble deals occurred during last 1.5 years when with ruble strengthening companies had offered ruble deals. BRL offers fixed leasing rates nominated in US Dollars although we are willing to discuss leasing deal contracts nominated in rubles if that meets ours and our potential clients’ needs and expectations.

LI: According to the Russian Legislation, effective operation period of railway rolling stock and depreciation and property tax calculations is in range between 15 and 25 years. What is the average period if rolling stock leasing contract?

K.Stepanov:Contract period depends on such factors as type of leasing, lessee’s area of activity, type of leased railcars, lessee’s financing opportunities, etc. Together with that average period of leasing contract is specified depending on kind of deal in terms of it’s duration: short-term, mid-term or long-term. The average lease contract period is from 5 to 7 years on Russian market today. But this insignificant period is more typical for financial leasing. BRL offers long-term leasing contracts with average period of 10 years which is a quite unique proposal among other leasing companies on the Russian market. We also should consider that there are no reasonable opportunities for obtaining long-term debt financing in Russia.

LI: How have Russian rolling stock market structure changed? What type of rail cars is in the demand? Arenewtransportcompaniesbeingestablished?

K.Stepanov:Rolling stock market is rapidly developing today thus it’s structure can’t remain the same. It is caused by growth of freight forming industries so that the demand for rolling stock is growing, and with restructuring of railway sector in general. Little by little independent player’s market share is growing, their freight fleet grows as a result, and also new private operators join the market, forwarding companies as well as subsidiary enterprises of major industrial companies. I want to draw the attention to the trend that could be observed over the last 2 years. Companies enlargement takes place by consolidation of it’s assets. Market share of major companies grows year to year that proves market «maturity». Freight companies on RZD base are also being created, this is an important process for market in general. Speaking of rolling stock rail car types, at this stage platforms and gondola cars are in demand. Growth of demand for box cars is expected among private fleet owners.

LI: Far-abroad countries (China, USA, Czech Republic) show growing interest to Russian rail cars manufacturing market. What product will they introduce to our market? Do they have leasing programs that will be more profitable and competitive?

K.Stepanov:Rolling stock produced in other countries is not widely used in Russia. For instance far-abroad countries (China, USA, Czech Republic) do not produce any freight cars for Russia, and a very insignificant share is occupied by rail cars produced in Finland and Poland. Firstly it is caused by production licensing from RZD. Secondly, there’s significant price difference between rail cars produced in Russia and international manufacturers that makes Russian customer choice obvious. We assume that far-abroad countries, China in particular, might produce rail cars for Russian market, but only under the circumstances of receiving all necessary licensing documentation and suggesting new competitive price offer for Russian clients. So far we can call «foreign-produced» only the rail cars operating in Russia that were built in former USSR republics.

Speaking of leasing programs, I would like to mention major interest of Western transport companies in entering Russian leasing services market.

LI: What is the amount of initial down payment for leased rolling stock? A lot of companies claim that under the certain periods of lease contract it is possible to decrease average for market down payment.

K.Stepanov:Most of the companies who offer financial leasing initial down payment is 20-30% of the contract amount. On some cases down payment is decreased to 10%. Amount of down payment depends on several factors such as financial health of lessee, cost of the contract and contract period. Under terms of operating leasing BRL doesn’t require initial down payment. Our client simply needs to decide on the type and amount of rail cars.

LI: A lot of leasing companies buy out rolling stock from clients with further possible operating leasing to the same client, in other words offer lease back. Can it be considered as an indicator or railway leasing services development?

K.Stepanov:This type of leasing is relevant for companies that don’t have significant financial resources. It is convenient for these companies to sell their assets to leasing company, sign leasing contract and continue operating the equipment. A company can invest obtained financial resources in core business and thus receive higher profit rather than from using non-core assets in its business. Leaseback gives major companies and holdings or their subsidiary enterprises that plan to attract international capital an opportunity for innovative and profitable financing models that will increase companies’ market value without disadvantages for balance structure.

Leaseback is more complicated investment operation in comparing to simple operating leasing. Thus it’s expansion in Russia is an important step for development of leasing as a type of investment relations. BRL expects growth if interest towards leaseback from major holdings in the nearest future. Although in general it is too early to speak about well-developed railway leasing market: it is growing rapidly, showing high growth rates.

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