The UK’s recent West Midlands rolling stock deal marks another slice of the sector taken from the traditional rolling stock operating companies (ROSCOs Angel Trains, Porterbrook, and Eversholt) by challenger lessors.

In this case it was Infracapital and Deutsche Asset Management, via their jointly-owned rolling stock lessor Corelink Rail Infrastructure, that reached financial close on a £700-million ($940 million) deal with debt from:

• Credit Agricole
• MUFG
• SMBC
• BAML
• BNP Paribas
• RBS
• Lloyds
• Societe Generale
• SEB
• ICBC
• Sun Life
• Legal & General Investment Management

For Infracapital, the deal was the first transport asset in the recently-raised greenfield fund, and for Deutsche Asset Management the investment came from PEIF II.

This transaction follows others which saw relative newcomer Rock Rail make inroads into a sector previously dominated by the ROSCOs.

Unlike the ROSCOs, who operate under an asset financing model, owning a large fleet of trains and leasing them out, the challenger lessors have favoured a single asset financing model which enables a more hands-on approach to providing services to passengers as opposed to the ROSCOs' focus on preserving the residual value of the asset.

In July 2017, Rock Rail – together with SL Capital and GLIL – reached financial close on the financing of trains for the South Western train franchise.

In October 2016, it also emerged that Rock Rail – along with ROSCO Angel Trains – would procure rolling stock for the East Anglia rail franchise. Rock Rail also signed the deal to provide trains for the Moorgate rolling stock order, its first deal in the sector, back in March 2016.

The reason fleets are being replaced is that franchises have contained a requirement for new rolling stock because of performance upgrades that the operator has to deliver. And leasing costs for existing fleets are often well above those of new fleets, says Tammy Samuel, rail partner at Stephenson Harwood.

New entrants to the rolling stock funding sector are able to lease trains to operators at lower prices because of falling manufacturing prices and current low financing costs. The result is that the cost to train operators of new rolling stock has fallen 30% over three years, according to a report by Graeme McLellan, partner at Stephenson Harwood.

Meanwhile, older fleets reflect the higher financing costs available a few years ago in their leasing prices. Which means the ROSCOs are now struggling to bring their leasing prices down to levels that enable them to compete with Rock Rail and other challenger lessors.

Some will have to take a hit on their equity return if they want to stay competitive, noted one source, indicating Porterbrook as the most likely to face this problem.

At the same time, other developments show that the recent rolling stock transactions by Rock and others are making the ROSCOs pay attention, in some cases even moving their business models closer to what their competitors are doing.

One example is ROSCO Angel Trains’ recent fleet-specific deal for the East Anglia franchise. This deal was shared with Rock Rail, which will provide some of the vehicles for the franchise. Angel Trains recently (6 December 2017) refinanced its debt for the procurement of trains for East Anglia, with £835 million of new funding from a group of banks and institutional investors:

• MUFG
• SMBC
• Export Development Canada
• CIBC
• Legal & General Investment Management
• BlackRock
• Barings
• MetLife

New trains coming off lease

And the replacement of older fleets with newer trains has not been without casualties.

On the East Anglia franchise, Rock Rail’s and SL Capital’s 378 multiple-unit Stadler cars are displacing the relatively new seven-year-old trains on the Stansted Express, which will be kicked off the franchise at 10 years of age.

And with a long, 13-year franchise, it’s not viable for the displaced fleet to be kept in storage that long.

Meanwhile, Angel Trains’ class 707 electric multiple units being delivered to South West Trains won’t be used because the new franchise operator First MTR, will replace them with the new fleet provided by Rock Rail.

However, the fleets that came off lease were small, had relatively high manufacturing costs and were financed when interest rates were much higher, noted MUFG’s Stephen Williams. Meanwhile, the new trains being provided by challenger lessors recently have the exact opposite characteristics.

This means new fleets don’t face the same level of re-leasing risk.

“It’s inconvenient to replace a fleet of trains that has been established on a particular line. There has to be a clear, compelling economic case to do so. And it makes it harder to have a compelling case if there is a large homogeneous fleet on a given franchise,” Williams said.

And it’s very hard to imagine that with interest rates likely to rise, the rolling stock financed now with low interest rates, could be replaced by new fleets financed at higher debt pricing levels, notes the Stephenson Harwood report.

Meanwhile, most new lessors are providing Bombardier’s Aventra trains, the latest model of electric commuter and semi-long distance trains, which will be used for Crossrail, Angel Trains’ portion of rolling stock for the East Anglia franchise, and the majority of the West Midlands franchise. This makes re-leasing less of a risk because the trains will be relatively liquid assets used extensively across the south east of England, and therefore at least to some extent interchangeable.

And levels of rolling stock supply are not expected to continue to increase after new trains are supplied for the South Eastern rail franchise, for which the ITT has just come out, one source argued. As a result, with rail passenger numbers still growing, that should mean that all trains on the network should ultimately find a home, he said.

Rail infrastructure

And with a slowdown in the excitement for rolling stock, the next frontier will be rail infrastructure, including depots, platform extensions, and infrastructure upgrades.

Around £50 billion is expected to be spent on this to 2024, and it will be partly privately financed, with financeable projects coming to the market soon, and lenders and investors already starting to gnash their teeth.