VitalRail Capitalization
VitalRail Finance Innovation: Three Decades of Revitalizing America's Railroad Infrastructure
by Michael Sussman, CAPSI Founder
Professional Experience and Philosophy
I have specialized in rail-related business solutions, with an emphasis on financing, since 1994. In those 30 years, I have overseen the financial turnaround of rail operations by bridging gaps in understanding between rail companies, banks, and government funding agencies. By orchestrating collaborative private and public-sector funding structures, I have expanded access to growth capital for several rail companies, including the Dakota, Missouri Valley and Western, Iowa Interstate, Progressive Rail, Iowa Pacific, Laurinburg & Southern, and Iowa Northern.
For each case, I identify that railroad's unique characteristics and service, underscoring how that specific section of the rail network contributes to local, state, and regional vitality. I then create unique financial presentations that educate private and public funding entities about the underlying sources of stability and growth on which they can base expanded capitalization. I have also overseen the growth capitalization of rail suppliers, contractors, and service providers. As part of these efforts, I have advised the U.S. Congress, the Executive Branch, and state and local governments on rail finance.
Under contract with the Nevada DOT, I wrote the 2021 Nevada State Rail Plan, which underscored the value of single rail lines to an the industrial systems and economy of an entire state. The template for this innovative, statewide, rail-enabled economic development action plan can now be applied to the entire North American continent through VitalRail.
Personal Journey and Industry Introduction
In 1995, I remember standing alongside a General Motors electro-motive diesel switcher locomotive with a client, who told me that the locomotive's engine generated 1000 horsepower. I asked how an engine only 2.5 times the horsepower of the Oldsmobile 442 "muscle car" of my youth was able to pull 20 fully loaded railcars. He explained that steel wheels gliding on steel rails create very little friction, enabling the engine's horsepower 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 experience prompted me to conduct an extensive study of the North American rail industry. By 1916, the U.S. rail network reached a peak of 254,000 miles, which was one of the main reasons why capital had flowed into North America from around the world during the preceding century. By 2020, the active network hd steadily declined to less than 140,000 miles, so that today, trucks are the primary mode of surface freight transportation for nearly 80% of the nation.
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 revive freight rail service in North America.
Railroads continue to serve the nation much more than most people realize. As an economically 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, which were primarily earmarked for equipment rather than projects. At the same time, the Staggers Act of 1980 significantly deregulated the U.S. rail industry, which led to the expansion of regional and shortline railroads—from 190 in 1980 to 600 in 2000.
By 1995, 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 1990s 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 the use or maintenance of these long-lived, income producing assets.
As the industry has evolved during the 45 years since the enactment of the Staggers Act, the remaining rail lenders have not adapted to the needs of the Shortline railroad entities, which are 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, though smaller railroads and rail shipper projects are often short on funding options, they have a long record of financial reliability and creditworthiness. In 2016, my research revealed that state DOT revolving loan programs and the Small Business Administration approved 692 rail project loans, totaling $419,448,052, over the prior 20 years. Of these, only three resulted in a default of their obligation.
Shortline railroads handle 50% of all rail shipments but account for only 10% of all rail revenue. 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 to increase the capacity of our freight rail system. We can gain a significant return by placing 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 to find a means of saving a close-to-expiring $10.5 million 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 began by studying everything about their financials and history. The key financial statement item that caught my attention was a $3.5 million loan Iowa Interstate had received from the state of Iowa that had been retained on the railroad's financial statements as a long-term liability. In studying the loan documentation, I read that the loan was 100% forgivable once a Maytag manufacturing plant, for which a rail line was funded and constructed. By 1996, the plant had been in operation for 10 years. Therefore, we were able to shift this $3.5 million from a long-term liability to a contingent liability, significantly improving the company's financial position.
I then discovered 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 as a result Class I railroad mergers in the mid-1990s, ADM was concerned that they could be left with only Union Pacific service. Therefore, they wanted the ability to gain a controlling interest in Iowa Interstate, their only other remaining service provider. This discovery was a eureka moment. 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 closer to having a New York bank approve a $10.5 million sale-leaseback of Iowa Interstate's 550 miles of track and right-of-way. Track upgrade was able to proceed, and this innovative solution saved the net loss carryforward.
Approach to VitalRail Capitalization
Rail finance requires that each railroad or project has to be understood in its own light. It defies cookie-cutter approaches. The lack of 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 be able to 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.
