The recent failure of the UK’s East Coast rail franchise has no immediate credit implications for major rolling-stock leasing companies (ROSCOs), including Eversholt Investment Limited (BBB+/Stable), Fitch Ratings says.
We expect their revenue to hold up as the service and use of the rolling stock will be continued by the government’s decision to act as the operator of last resort.
The early termination of the East Coast franchise was the result of underperformance relative to the operator’s assumptions (particularly traffic volume) at the time of the tender in 2015. When train operating companies (TOCs) fail, the government steps in as operator of last resort. It guarantees a minimum level of service until a new franchise is contracted.
The government is likely to continue with the same fleet given the potential service disruption from deploying a new fleet and the limited availability of excess rolling stock. This will protect the ROSCO’s revenue.
The main risk for ROSCOs is non-renewal of rolling stock leases when franchises are re-let, coupled with the inability to secure another franchise to lease the stock to. TOCs usually deploy the same fleet when a franchise is re-let, but may switch to another fleet from a different lessor.
The large ROSCOs mitigate this risk by diversification across numerous franchises, meaning that they can offer their fleet to other franchises. Lessors covering only a few franchises (sometimes referred to as “mini ROSCOs”) have less scope to do this and could be pushed into default if they lose a franchise.
ROSCOs rely on stable and predictable cash generation. They fund assets with long-term market borrowings or syndicated facilities and could suffer weakened earnings if fleet utilisation falls. The UK rolling-stock leasing segment is dominated by three large ROSCOs, which control 87% of the total fleet: Eversholt, Porterbrook Leasing and Angel Trains.
These are successors to part of British Rail, which was split up and privatised in the mid-1990s. They provide long-term operational leasing to TOCs, usually based on the length of the franchise. ROSCOs are not directly exposed to volume risk as contracts typically have a fixed price.
Market dynamics for large ROSCOs are therefore stable. A significant increase in government participation in the rolling-stock market, as supported by the Labour Party, or the emergence of a large public TOC could influence the rolling-stock trends, but this is not a central scenario underlying our ratings.