VitalRail Capitalization
VitalRail Finance Innovation: Three Decades of Revitalizing America's Railroad Infrastructure
Professional Experience and Philosophy, by Michael Sussman, CAPSI Founder
I have specialized exclusively in rail-related business solutions, particularly financing, since 1994. In the 30 years since, I have overseen the financial turnaround of rail operations by bridging gaps in understanding between rail companies, banks, and government funding agencies. Orchestrating collaborative private and public-sector funding structures, we expanded access to growth capital for the Dakota, Missouri Valley and Western, Iowa Interstate, Progressive Rail, Iowa Pacific, Laurinburg & Southern, Iowa Northern, and other rail companies.
In each case, we identify a railroad's unique characteristics and service, underscoring how that section of the rail network contributes to local, state, and regional vitality. We then engineer unique financial presentations that educate private and public funding entities on the underlying sources of stability and growth on which to base expanded capitalization. Along the way, I have also overseen the growth capitalization of rail suppliers, contractors, and service providers. I have advised the U.S. Congress, the Executive Branch, and state and local governments on rail finance.
Under contract with the Nevada DOT, we wrote the 2021 Nevada State Rail Plan, extending our insights into the value of single rail lines to an entire state's industrial systems and economy. The Nevada State Rail Plan, a statewide rail-enabled economic development action plan can now be applied to the entire North American continent through VitalRail.
Personal Journey and Industry Introduction
I remember standing alongside a General Motors EMD switcher locomotive in 1995. I asked my client, "What horsepower is this?" He responded, "1000 Horsepower." I asked how a unit only 2.5 times the horsepower of a "muscle car" from my youth could pull twenty loaded railcars. I knew three Oldsmobile 442s lined up on the track could not budge those cars. He patiently explained how the low friction of steel wheels on steel rails allowed the 1000H.P. to be efficiently transferred into the train's pulling power. I was immediately struck by the realization that railroads, with such energy efficiency at the core of their business model, were significantly undercapitalized and underappreciated by lenders, investors, citizens, shippers, and elected leaders.
Historical Context and Industry Challenge
This prompted me to conduct an extensive study of why this industry, which was the reason capital flowed into North America from around the world in the 19th century, arrived at the end of the 20th century with its U.S. network reduced from 240,000 route miles to now less than 140,000. Understanding why and how our society has evolved to drive capital toward highways and trucks, a dramatically less efficient mode of land freight transportation, tells us everything we need to know to steward the re-growth of freight rail service.
Railroads continue to serve the nation much more than most people realize. As an economical and environmentally preferable solution to transporting massive amounts of raw materials and finished goods, our rail industry has withstood the test of time. It is an essential element in North America's economic and social well-being. Railroads will continue to operate for decades. To contribute to growth and lasting improvement, we must address a critical unmet need: financing new rail infrastructure, loading facilities, and equipment.
Lenders have misunderstood and underserved the North American railroad industry as a lending marketplace for decades. In the aftermath of U.S. bank deregulation in the 1980s, many local banks moved commercial lending to their regional or national offices. Very few of these banks employed lending officers with rail expertise. The few banks still interested in rail finance refocused on the largest transactions, and primarily for equipment rather than projects. At the same time, railroad deregulation led to the expansion of Regional and Shortline railroads—from 190 in 1980 to 600 in 2000.
By 1995, the minimum loan thresholds had increased to $5 million, and most local lenders had lost touch with railroads' contribution to their marketplace. This produced a profoundly unhelpful situation for railroads and society. It is vastly easier for a young person to borrow money to buy a backhoe than for a seasoned rail operator to finance a locomotive, even though a locomotive’s longer useful life and more stable market value make it far more secure as collateral.
The banking community during the 1990's shifted almost entirely away from lending for rolling stock purchases. Operating leases, where lenders and leasing companies retain asset ownership became an embedded feature of the rail industry. Local rail operators no longer benefited financially from their use and maintenance of these long-lived, income producing assets.
As the industry has evolved during the 44 years since the enactment of the Staggers Act, the remaining rail lenders did not adapt to the needs of the Shortline railroad entities, characterized by smaller transactions, unique financial statement elements, and used equipment. And with limited capital availability for customers’ rail loading facilities and equipment, the path to increased rail service includes a significant funding challenge.
Options were further limited by the 1997 termination of the highly successful USDOT Local Rail Freight Assistance program for small loans. The subsequently instituted Railroad Rehabilitation and Improvement Financing program (RRIF) lacked a simplified application process for smaller loans.
Interestingly, while often short on funding options, smaller railroads and rail shipper projects have a long record of financial reliability and creditworthiness. As we learned through research in 2016, 692 rail project loans approved over the prior 20 years by State DOT revolving loan programs and by the SBA, totaling $419,448,052, resulted in only three defaults.
Shortline railroads account for 10% of all rail revenue while handling 50% of rail freight shipments. This statistic underscores the productivity of Class II Regional and Class III Shortline railroads. Railroad owners are brilliant at working with limited capital. Still, many owners have had to preserve their limited capital by leasing their rail lines, rolling stock, and property. As a result of the limited ownership and equity gain from asset appreciation, many operators have lacked access to the significant growth capital required for new facilities, property, equipment, personnel, and market development.
This gap presents a significant opportunity for increasing our freight rail system's capacity. We can gain a significant return by putting more equipment and development funding into the hands of local rail management, transload operators, and shippers. Doing so will produce economic value. Focusing first on the remaining independent Shortlines, which private equity groups do not own, will allow them to own rather than rent their equipment via operating leases. They invest too much of their resources in maintaining these units not to reap the benefits.
Case Study: Iowa Interstate Railroad Financial Innovation
In 1996, the owners of Iowa Interstate Railroad asked me for a solution to save a close-to-expiring $10.5MM Net Operating Loss Carryforward. They also needed more capital to upgrade track. Even experienced railroad leaders require outside-the-box thinking to fund their growth plans. I started by studying everything about their financials and history.
The key financial statement item I zeroed in on was a $3.5MM loan they had received from the state of Iowa that their accountants had retained on their financial statements as a Long-Term Liability. In studying the loan documentation, I read that it was 100% forgivable once a Maytag manufacturing plant, for which a rail line was funded and constructed, had operated for 10 years. We were, therefore, able to shift this $3.5MM to a Contingent Liability, significantly improving the company's financial position.
I was then struck by the fact that Archer-Daniels-Midland, Iowa Interstate's largest customer, had acquired a 3% option alongside its recent purchase of 48% of Iowa Interstate stock. Upon further investigation, I learned that due to mid-90s Class I railroad mergers, ADM was concerned that they could be left with only Union Pacific service and wanted the ability to gain a controlling interest in the Iowa Interstate, their only other remaining service provider. Eureka! I directed my client to ask ADM to guarantee the new financing because, with such a significant commitment already, they would undoubtedly want to maintain track and service quality by guaranteeing the new funding. With ADM's guarantee in hand, I knew we were heading toward a New York bank approving a $10.5MM sale-leaseback of Iowa Interstate's 550 miles of track and right-of-way. Track upgrade could proceed, and this innovative solution saved the Net Loss Carryforward.
The VitalRail Capitalization Approach
Rail finance requires understanding each railroad or project in its own light. It defies cookie-cutter approaches. Lacking this focus is a key reason why railroads and rail projects, particularly the smaller ones, have been undercapitalized. As a networked system, the entire rail network will grow from capitalization of local branch lines as well as higher-volume trunk lines. That is why VitalRail illuminates the value and potential of every mile and foot of track, whether active or inactive.
