Anyone who buys one of the three Roscos will gain a solid
foothold in continental Europe – as well as in the UK – where the
rail-finance market has started to blossom
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Raising £2.5bn of bank debt to leverage an acquisition of a
company would be extremely challenging, if not virtually
impossible, in any other industry but the rail sector in Europe,
given today’s credit markets. But a bank club has committed this
amount of finance to back the Babcock & Brown and Deutsche Bank
acquisition of UK Rosco Angel Trains from Royal Bank of Scotland,
which is likely to net the UK banking group in the region of
£4bn.
If any asset class appeals to long-term lenders when bank
liquidity is obviously such an issue, the UK’s rail industry has
become a prime example. The Angel Trains deal precedes large-scale
rolling stock procurement processes in the UK – notably and
imminently the Intercity Express Programme (IEP) and Thameslink –
that have been opened up to manufacturers, banks and lessors by the
Government, which will require well in excess of £3.5 billion worth
of long-term funding.
The banks backing the Angel Trains acquisition – comprising a
number of asset finance and infrastructure finance banks featuring
a healthy contingent of German and Japanese banks – have long been
keen to get a piece of the action in the UK rail industry, leasing
into which has been dominated by the three Roscos that were formed
as part of the privatisation of British Rail in the mid-1990s.The
Roscos account for a whopping 96 per cent of rolling stock leasing
in the UK.
UK Rosco finance market opening up
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By GlobalDataHowever, with the long-life asset regime set to finish in 2010,
bringing to an end the 20 per cent write down rules, it is not only
banks that are looking at the industry. The growing number of
infrastructure funds and sovereign funds are said to be eyeing the
UK rail industry with considerable interest to provide long-term
funding that would be comparable with 35-year capital markets
funding.
“The UK market is complicated because you have to understand the
regulatory environment, but you know what to expect because the
regulatory framework is clear,” says Christian Forster, head of
rail for Europe at HSH Nordbank in London.
Also, implications of Basel II capital issues are pushing many
financial institutions in the direction of good-quality assets, the
value of which are not only clearly understandable – unlike the
wide-ranging Collateralised Debt Obligation (CDO) asset class that
is at the epicentre of the US sub-prime woes – but offer residual
value risk-reward appeal to financial institutions.
“More and more financial institutions are happy to take
ownership of the asset, including rail assets,” says Forster.
Intercity Express Programme
UK rail is heavily regulated and essentially controlled by the
UK transport department (DfT), and how the Government handles
upcoming rolling stock procurement programmes like IEP could be the
making or even the breaking of the future of rail leasing in the
country.
Almost all of the current UK passenger rolling stock is financed
via operating leases. However, the risk and reward structure for
IEP, and potentially Thameslink and Crossrail (with potentially 600
rail vehicles by 2017), may be different, the DfT has
indicated.
According to the DfT’s Rolling Stock Plan, published in late
January, it is appropriate that the Government takes the initial
lead on complex projects, setting a framework for them to be
financed and delivered by the private sector. “To facilitate
delivery of these projects and to ensure value for money, it is
sometimes appropriate for DfT to specify rolling stock in
franchises. Whole-life costs and value for money considerations
will continue to lead the DfT to the most appropriate
specification, financing and procurement solutions,” the report
stated.
The IEP programme is written to include a number of funding
risks (how to ensure such long-term capital is available) and
certain operational risks.
“The way it is structured is not as a helland- high-water
lease,” says Keith Howard, commercial director at Porterbrook
Leasing in Derby, England.
“Looking in from outside of the process, the IEP scheme may well
end up being a very expensive approach,” he says.
In fact, the choppy relationship between rail and Government in
the UK could be in for choppier times ahead. Observers say the
Government’s approach to IEP could increase the costs by 15 per
cent and that it too is prescriptive.
IEP is going to be a test case for the Government and, if it
works, the same financial strategy is likely to be applied to the
£1.5 billion Thameslink project.
Roscos’ place in the market
Porterbrook is the one Rosco that focuses solely on the UK
market, with rolling stock assets on its books totalling £2.25
billion.The leasing company focuses its strategy on Electric
Multiple Unit and Diesel Multiple Unit assets. “We’ve not seen an
intercity product that we like,” says Howard.
HSBC Rail, although earmarked for sale or fleet securitisation
options (the latter option also having been on the cards for Angel
Trains in recent years), is said to sit “comfortably” within parent
HSBC Holdings. While HSBC Rail books leasing business in the UK and
in China, the leasing company is said to be “very involved”,
according to industry financiers, in the IEP process.
Porterbrook cited 2007 as its “third largest investment year” to
date, says Howard. The company raised £315 million from parent
Abbey and, ultimately, Santander.
“I have to ask, going forward, whether we will have access to
similar levels of capital,” he says.
“We have not needed to go for any funding yet this year. In the
past, we have always funded internally from our parent. If our
parent doesn’t want to fund our acquisitions, we will have to go to
the market,” he says. “I think the banks have appetite, but at what
price it is not clear.”
Third-party funding
The UK Roscos are pragmatic about the opening of the rail-lease
market, which will eventually mean more competition, partly nudged
on by the ongoing – not very radical – investigation by the UK
Competition Commission into rail leasing. Also, bankers are adamant
the Roscos would not be able to fund the IEP and Thameslink
programmes without third party financing support.
“I think new players will have to come into the market – and
they will,” says Howard.
According to informed sources, Porterbrook’s parent, Spanish
banking group Santander, was about to ink a sale of the business,
but then the impact of the credit crisis took its toll.“A financial
institution that lost about 75 per cent of its market value was
going to buy Porterbrook last summer,” a banker says.
Albeit on a relatively small scale at present, Sovereign Train,
a rolling stock lessor that started business in 2007, has signed
leasing contracts with Train Operating Company (TOC) Grand Central
to lease brand new Polaris DEMU trains from China from 2010,
replacing its existing fleet of 1970s-80s vintage rolling
stock.
The acquisition of Angel Trains will not only be a fresh boost
to the Rosco’s role in the UK market, it will also allow Babcock
& Brown, through its CB Rail joint venture with Bank of
Scotland Corporate, to gain further market share in Europe’s
operating lease market because Angel Trains has a significant
portfolio managed out of Germany and the Netherlands.This may lead
to scrutiny from the European Commission’s Competition
Directorate.
“There is an existing European market that has been opened up by
deregulation and is becoming increasingly attractive to outside
investors, and given how the UK market has developed over the past
10-15 years, there are certainly skills within the UK rail market
that can be exported to the European market. Companies such as
Arriva have been active in the European rail market, for example,”
says Tom Johnson, partner in the Rail Group at Norton Rose.
“Generally, the European market has evolved into an
operating lease product for the end-users (passenger operators
generally look for short- to -mid-term operating leases; freight
typically look for short-term operating leases), so there has not
been much scope for developing sophisticated structured leasing
solutions,” says Johnson.
Growth of rail
Rail transport accounts for about 15 per cent of all forms of
transport in Europe’s 25 member states and this is forecast to
increase to 30 per cent by 2015, according to Ulrich Suedhoff, who
works in the European strategic marketing department of GE Rail in
Frankfurt.
“Leasing accounts for approximately 30 per cent of all rail
finance in Europe,” says Suedhoff.“We see there are more and more
incumbents that are looking at leasing as they enter new markets,
for example, because it is less risky to lease. The state-run rail
companies are also using leasing more and more because they are
hedging their approach.”
However, the financial might of rail operators like Deutsche
Bahn of Germany and SNCF of France, with their AAA-credit ratings,
means they will probably continue to tap the long-term capital
markets to fund rolling stock.
“I believe operating leasing will grow in importance in the
context of the overall market, but I do not think the big guys,
like Deutsche Bahn and SNCF will lease in on a large-scale basis,”
says Martin Metz, head of global industry in the European land
transport division of DVB Bank, also based in Frankfurt.
Off-balance-sheet funding
That said, when Deutsche Bahn finally pulls off its IPO, the
associated quarterly financial reporting requirements will
inevitably place more pressure on the company to be accountable for
its financial expenditure. Some industry financiers think this will
be the catalyst for Deutsche Bahn using more offbalance- sheet
financing.
“Continental Europe offers better risk returns than in the UK,
where margins are generally thin,” says Forster.
Bank deals tend to be arranged up to the value of €100m where
banks, including many of the German banks like DVB Bank, partner
with leasing companies and hold rolling stock fleets in special
purpose companies. However, there is market talk that European
banks will launch dedicated leasing arms to service the rail
industry, as they have done for the airline industry.
“The financial community has become more comfortable with the
rail asset class. I don’t think the wheel can be turned back and
rail freight is leading the way,” says Forster.
“There is an age-of-asset issue for locomotives in the UK, but
not so much as there is in Europe. Markets where there is most
activity are Germany and Benelux,” says Ian Lawrence, senior
manager of rail and infrastructure at Alliance & Leicester in
London.
Train replacement
Ageing locomotive stock is also subject to increasingly tighter
regulation on emissions, which will lead to an anticipated increase
in ordering over the next few years as operators look to replace
30-year-old-plus engines.
Overall, strategic players in Europe, like AAE of Switzerland,
Mitsui in Amsterdam and rail container leasing company VTG, based
in Hamburg, are among the larger operators in the rail freight car
leasing business, but are dwarfed by the size of players like GE
Rail in Europe. They all work with local and international banks to
fund their portfolios.
The outlook for rail freight is likely to become more
competitive – Europe’s incumbents are unlikely to let freight
liberalisation develop without taking a large role.
When TUI sold its stake in VTG in 2005 for as much as €800m,
members of Germany’s rail community were outraged that buyout firm
IPE-Ross had brokered the deal on behalf of SNCF. Although IPE-Ross
denied the allegations at the time, breaking down the barriers in
Europe’s crossborder rail markets is going to be a highly charged
process that still has some way to go.
Not quite at full capacity
Leasing volumes differ considerably between continental European
countries. However, that all might be about to change
Although some UK freight operators and intercity train operators
have tapped the UK lease market in recent years, there are just two
tax-based leasing jurisdictions in Europe that offer European rail
companies attractive deal economics. The French tax lease market
for rail is thought to be as deep as €2bn worth of deals a year.
Sweden’s comparative product is much smaller because levels of tax
capacity are limited compared with the tax capacity of France’s
banks.
Mark Howard, deputy head in continental Europe for asset based
finance at Société Sérenle Commercial Investment Bank, based in
Paris, says: “The French lease market is an active, expanding
market and the outlook for the product is strong. Four more French
municipalities and regional governments are coming to market with
TER and tram tenders this year. There will always be interest in
the rail industry from French lease arrangers.”
“Even with a competing Swedish lease product, the French lease
product, at this moment in time, is the most attractive to rail
operators in Europe,” says Howard.
“You need the tax capacity in Sweden and the market is less
broad than it is in France,” says Christian Forster, European head
of rail at HSH Nordbank.
In Germany, the KG finance structure has been used very often
for shipping and increasingly for aircraft, most notably financing
Singapore Airlines’ first three A380 aircraft. But for rail, the
jury is out.
“It may be the case that KGs think they can’t build up the
volume quickly enough and that other assets are easier to build up
in volume,” says Ian Lawrence, senior manager of rail and
infrastructure at Alliance & Leicester.
“KG deals would only be done on a returndriven basis because
they may add a basis point here or there. I’m not aware of any KG
deal in the past five years, but there was one about six years
ago,” comments another banker.
Japanese Operating Leases (JOLs) are one of the preferred
long-term financing structures for aircraft finance, increasingly
for shipping (mainly for Japanese shipping lines) and also for
container lease finance. Nonetheless, rail does not fit the bill –
at least at present.
“Japanese Operating Leases are almost impossible for rail and
the lease structure only works well for assets with a shorter
useful life,” says Forster.
Europe’s big competitors
The European Investment Bank (EIB) in Luxembourg is a very large
lender of cheap funds to rail operators in Europe. Some of this
lending is motivated by its Trans European Networks (TENS) policy
strategy and other lending is designed to boost transport links in
Europe’s regional cities.
In addition to the €181m loan to the QW Rail Leasing joint
venture to fund London Overground trains, the EIB has signed loans
totaling €940m to metro and rail operators so far in 2008 –
and all of them are in Spain.
The EIB’s lending comprises:€200 million for AVE Madrid
Valladolid and €500 million for AVE Madrid Valladolid 2, in the
highspeed rail sector;€50 million for Metro de Madrid and €190
million to national rail operator Renfe to fund rolling stock
acquisition.
Basel-based Eurofima – the European rolling stock financing
organisation that is AAA-rated – financed CHF3.2bn (£1.59bn) worth
of rolling stock for rail operators across the region, up by more
than 39 per cent on its total activity in 2006.
Eurofima issues AAA-rated bonds in various capital markets
around the world and on-lends to its shareholder rail companies
that stretch from Sweden, to France, to Bulgaria and Greece.The UK
rail operators have never been a member of Eurofima.
Russia: the land of leasing opportunity
“Russia’s rail industry accounts for about 80 per cent of all
transport in the country. The industry mainly uses the finance
lease market and, the more competitive it becomes, the industry
will focus more on operating leasing,” says Ulrich Suedhoff,
European strategic marketing head of GE Rail.
Russian Railways came to the finance market recently, launching
its US$1bn term loan to general syndication through mandated lead
arrangers BBVA, Bank of Tokyo-Mitsubishi UFJ, Barclays, BNP
Paribas, ING, UniCredit and WestLB. The facility is equally split
between a three-year piece paying 55bp over Libor and a five-year
tranche at 75bp.
UralSib Leasing Company recently secured a five-year US$20m
syndicated loan, provided as part of a club deal, arranged by VTB
Bank (Austria) AG. UralSib will use the loan to provide funding to
one of Russia’s largest private rail operators.
Interest in financing Russia’s rail-leasing industry is gaining
greater momentum.
Late last year, the European Bank for Reconstruction and
Development (EBRD) announced a US$141.5m loan to Russia’s
Inpromleasing to help achieve one of the key goals of the country’s
on-going railways reform: encouraging private sector investment in
new rolling stock needed to meet growing demand for a booming
market.
The EBRD’s funding will enable Inpromleasing, an independent
leasing company founded in 2000, to finance the purchase of freight
wagons to be made in Russia.The wagons purchased with the EBRD loan
are to be leased to three Russian private rail operators. The bank
will remain the lender of record for the full amount, but is
syndicating US$84.9m to commercial banks under an EBRD A/B loan
structure.
The EBRD is keeping US$56.6m on its own books as the A portion
of the loan, which has a seven-year maturity.
“We evaluate each project proposal on the basis of its merits –
hence, if we receive a request to finance a leasing company that
meets the EBRD investment criteria, we would certainly be
interested to finance it; through the A/B loan structures, we
always try to broaden the lending base for our clients, not only in
Russia, but in any other country of our operations,” Agnieszka
Lukasik, a senior banker in the transport sector, at EBRD in
London, tells Leasing Life.
Giving in to potential
Authorities in London and Madrid have warmed to the idea of
train leasing. But are longer leases as these are – the way
forward?
London and Madrid have espoused the relative merits of long-term
operating leasing for train acquisition programmes, reflecting a
complete change in financing strategy for both Transport for London
(TfL) and Metro de Madrid.
Metro de Madrid is talking to a selection of four metro train
manufacturers, bankers and lawyers for its €720m structured lease
deal to finance new stock on the capital city’s network.The metro
operator had not done any off-balance-sheet financing until 2006 –
everything before was on a public procurement basis.
A selection of Spanish, French and German banks are said to be
submitting bids, according to banking sources in Madrid. The
deadline for this new tender was March 31.
It includes the delivery of three sets of new trains, both
narrow – and wide-gauge, for an amount up to €720m, with a
structure that envisages an operating lease for up to 19 years. A
formal decision will be taken by Metro de Madrid on April 11,
sources say.
Last December, Metro de Madrid closed a €400m fully-structured
facility – which the transport company treated as a15-year off
balance sheet lease – that refinanced a number of train sets
previously purchased by the transport body. Metro de Madrid has a
purchase option at the end of the lease.
Dexia SA subsidiary, Dexia S§abadell, Société Générale, Caja
Madrid and Instituto de Crédito (ICO) raised the funds via a
special-purpose vehicle company for that deal, in which the banks
will each take a share.
Transport for London
Long-term structured financing offerings to municipal transport
operators in Europe are becoming increasingly popular as evidenced
by a recently closed deal for London Overground, an operating
division of TfL.
SMBC Leasing and Finance, the leasing arm of SMBC, and NAB
Capital, the institutional banking and capital markets business of
National Australia Bank, acting through their UK operations, have
entered into a joint venture, called QW Rail Leasing Limited, to
provide a £262 million operating lease to TfL for a fleet of 54 new
four-car Bombardier Class 378 Electric Multiple Units (EMUs).
The European Investment Bank joined SMBC and NAB to lend
approximately €181m into the deal.
“We would only have done something different if it didn’t affect
operational flexibility and value for money,” says Mike Binnington,
principal of corporate finance at TfL in London. “Almost by
definition, finance leasing would not have given us the
flexibility.”
Unlike the Train Operating Companies (TOCs) in the UK, London
Overground is not limited to taking operating leases on five to
seven-year terms. The TOCs have rarely been granted Section 54
approval from the UK’s DfT to sign longer leases.
The trains will be used to operate services on the new London
Overground railway and are expected to enter into service on the
North London Railway and the East London Railway from October 2008.
The leases on the trains run until 2027.
While the lease structure gives London Overground a walk-away
option in 2027, it is likely the rolling stock will be operated
over a 35-year useful life term, says Binnington.
Olympics and London Underground
TFL is investing more than £1bn in infrastructure upgrades on
the lines, together with the rolling stock, which will form a key
part of the transport strategy for London for the Olympics in 2012
and beyond.
QW Rail Leasing said it beat a number of bidders in the
competition to provide the financing for the new trains, including
UK Roscos and other major European rail operating lessors.
Binnington confirms that TfL invited six bidders for the
facility and received five bids, including bids from the UK
Roscos.
The financing approach was designed to provide TfL with the
optimum solution in terms of value for money and flexibility, while
ensuring the timely delivery of the new fleet, SMBC and NAB said in
a statement.
London Overground is expected to make a decision about whether
to add a further 28 vehicles (seven train sets) to the 188 vehicles
financed by QW Rail Leasing. If the option is taken, the rolling
stock is likely to be added to the QW Rail Leasing package through
an “add-on” agreement, says Binnington.
Long-term operating leases are not everyone’s approach,
however.
“They are the sort of deals where you are hedging your bets that
the asset will not be returned,” says Ian Lawrence, senior manager
for rail and infrastructure at Alliance & Leicester.
Another banker comments: “It’s more of a bet on sovereign risk,
which is something we wouldn’t do because betting on sovereign risk
can be dangerous. Why should I take the risk for an asset that is
built for purpose?
