Risky business: train fleets in a state of flux

The following article is featured in RailReview - the new must-read business journal, website and monthly digest for the rail industry https://www.railreview.com 


A confluence of unique things. Each is small, but they’re seismic together.

That’s Malcolm Brown’s view of rolling stock leasing. His view matters because he’s chief executive of Angel Trains, one of the big three rolling stock leasing companies created at privatisation 20 years ago to take over British Rail’s fleet.

He’s also the owner of the trains that have triggered such an intense interest in this area - the Class 707 electric multiple units being delivered to South West Trains. They’re being delivered but they have no future there, because new operator First MTR, which takes over this summer, has promised a new fleet to replace them.

Brand new trains with no apparent future. A money earner shunted into sidings. Why?

Two reasons. Trains are cheaper today than they were even a couple of years ago. Today an EMU vehicle is around £1.2 million. They used to be £1.5m. Money is as cheap today as it’s been for many years. Put together, it’s cheaper for train operators to lease a brand new train than even one ordered a couple of years ago.

Brown ordered 150 Class 707 vehicles in 2014-15. “They cost significantly more than they would cost today,” he tells RailReview. When First MTR and Stagecoach were bidding for South West last year he reduced the lease price, but it wasn’t enough to secure his new investment a home.

Other factors were at play. The Class 707s are now one of five fleets on SWT’s Windsor routes - the others are Classes 450, 455, 456, 458. All will be replaced by a single type that should be cheaper to run and maintain - not least because they will all be the same, which drives efficiencies in spares holdings and in training for crew and maintenance staff.

The ‘450s’ are protected by government usage guarantees, and will be switched to other routes on which they already run. The other three types have recently been part of an investment project to run ten-car trains.

That project featured extensive and expensive work on the ‘458s’ to increase them from four-car units to five-cars, using Class 460 coaches made redundant from Gatwick Express. Meanwhile, the ‘455s’ had new traction equipment fitted and their DC motors replaced by modern, more efficient AC ones.

Porterbrook paid for this work on the expectation that the units would have continued use with SWT (based in Derby, Porterbrook is another of the three ROSCOs - the third is Eversholt Rail). But the decision by First and MTR to introduce a brand new, uniform fleet of trains (they have not yet revealed the builder or financier) gives Porterbrook Commercial Director Olivier Andre a problem: “We took a view that they would stay on lease until the 2030s, and that was the basis for pricing them. They will be displaced in 2020 and there is no certain home for them.”

Andre and Brown face the same challenge… what to do with their displaced fleets? They’re all third-rail fleets, only suitable at the moment for lines south of London - SWT, Southern and Southeastern. The latter franchise is soon to go to competition to find a new operator. How do they set their price? They need it to be high enough to pay back their investment, but low enough for their stock to be competitive against other owners.

Even then, the bidders might find cheaper funding from someone else, and submit bids that include a large new fleet ordered to replace some or all of today’s Southeastern trains. 


That’s the situation at Greater Anglia. Abellio’s winning bid will bring 1,043 new vehicles to replace every train now running on the franchise… every single one! The bulk of today’s GA fleet consists of overhead line AC EMUs. Brown’s ‘707s’ are DC EMUs, but could be fitted with pantographs to make them able to work under AC overhead lines. However, he would be putting them into a crowded market that faces a glut of stock. Andre reckons that in theory he could do the same with his  ‘458s’, but they’re an older design and it might not be easy (or cheap).

For his ‘455s’, Andre is toying with equipping them with diesel engines to make them a diesel electric multiple unit. This could be a canny move. It builds on the research and design work that’s gone into adding diesel engines to his Class 319 dual-voltage EMU fleet, and takes advantage of a shortage of diesel multiple units (of which more later).

In bringing new trains to Greater Anglia, Abellio is ditching EMUs that date from the 1980s (to no one’s great sorrow), but also trains dating from the 2000s and from this decade. One financier, speaking to RailReview anonymously, described that 2010s fleet (Class 379s) as the canary in the mine that alerted his community to the looming problem with rolling stock leasing. He added that if the ‘379s’ had been the canary, the ‘707s’ were the mine explosion.

Money was the trigger. It’s very hard to find a decent return, as any saver looking at paltry interest rates knows. Bigger investors, such as pension funds, need to find somewhere to earn more money - not least because we’re all living longer and needing pensions for longer. They have often invested in infrastructure because it gives long-term, consistent returns.

In short, there’s a lot of money looking for an investment home. This money turned its attention to rolling stock. It saw decent returns - the ROSCOs make good money (see panel, page 68) - and a railway that was growing. But, according to the anonymous financier, it overlooked a key point - rolling stock can be discarded in a way that infrastructure usually isn’t.

He explains: “When you buy a fleet, you don’t buy it for 100%, you buy it for 100% plus your interest that’s accrued for two or three years, because you don’t have any income coming in. You have fees with the operator involved in managing the manufacture, or there’s a separate team. There may be separate fees from the operator if it’s involved with getting licences. 

“So you get this profile of: here you make a 40% payment and another 40% payment and a 20% payment, and on top of that you have interest accruing, and so you get to about 107% of your asset just as you start coming into service. And then your lease may be three years, it may be four years. Now, at that four-year point you may not have got that 7% down to 100, so you amortise it - and in the early days, people were amortising over 30 years. And then you’d say that at seven years, the fleet’s going to come back and then it’s going to go out again for another seven years, and you look at it over that point of time.”

He continues: “So I just think in operating lease terms. You have a high residual value at year three, year five and year seven. You’re not even going into your 90s yet, so you have to think about the risks involved over the full life to do that.

“Infrastructure is very different. HS1 - that’s infrastructure, that’s going to be there for God knows how many years. It’s long-term, there’s no sort of changes happening to it unless people suddenly decide they’re not going to take the train anymore. It’s a piece of infrastructure that provides them with an annuity over the 30-year period. That’s how they look at it. With operating leases, the asset can come back. What you’re seeing today is your asset coming back.

“You’ve had an infrastructure mindset that never came into our industry at the beginning. We were just a sort of backwater, weirdos in the bank, a bunch of rail guys who are a bit strange but seem to do alright. Where you’ve seen that flip now is where you have advisors, consultants and (most probably) money burning a hole in a pocket because of liquidity and QE , you’ve seen infrastructure funds suddenly going ‘let’s have a look at this market place’. They’ve seen high utilisation over a period of time and gone  ‘well, this is just a 30-year asset which is going to be there for 30 years and that’s fine’.”

In essence, he’s arguing that investors have come into the rolling stock market with an infrastructure attitude, and that the return of new ‘707s’ and almost-new ‘379s’ has been a sharp reminder that rolling stock is a much more uncertain market.

Andre comments: “I think things like the ‘707’ making its way into the mainstream media, like the BBC, it will probably make investors think twice about the risks attached to trains. Some people financing new trains have a very slick pitch saying that it’s a risk-free asset because the railway is growing all the time and will need more stock - what’s not to like? It will be great forever. But it’s not exactly that.”

ROSCOs have been talking about ‘residual risk’ ever since privatisation, but no one really believed them because there was no stock sitting in sidings, off-lease. Stock was replaced but the older trains headed for scrap, not store. Many were former BR trains that were long past their sell-by date. Others were displaced by government deciding to ban slam-door Mk 1 trains on safety grounds. This led to a massive fleet replacement programme taking place on SWT, Southern and Southeastern.

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