Some Shortline Railroad Finance Basics

1. AAR Annual Meeting of the Railroad Treasury/Finance Division Naples, Florida 11/6/2007 Roy Blanchard, The Railroad Week in Review Some Shortline Railroad Finance Basics www.rblanchard.com

2. “There is a need to work more closely with short lines in the light of growing regulatory and legislative pressures now facing the industry.” -- Mark Schmidt, BNSF, 3Q07 Short Line Newsletter www.rblanchard.com

3. Short Lines and Class Is (FY 2006) www.rblanchard.com

4. The Shortline Railroad Universe: • More than 500 shortline (regional and local) names, 43,000 route miles, 12 mm cars per year (cpy)* • 32 S&Ts (BRC et al), steel roads (EJ&E) have 2600 route miles, 5.2 mm cpy • NS has most (253), CP fewest (61) • Top 20 SL ops companies (ex steel, S&T) - 174 roads, 27,000 miles, > 4 mm cpy • Top 5 Commodities 2007 thru Q3: 16% forest products (lumber, panels, paper and related), 14% chemicals, 11% grain, 12% coal, 9% metals and related *More accurately, revenue units (I’ll explain) www.rblanchard.com

5. Leading North American Short Line Operators www.rblanchard.com

6. How Short Lines Earn Their Money • Revenue per carload, mostly from Class I divisions, allowances or fees; some ancillary fees (demurrage et al), property leases, short-haul intra-line moves. • Class I pays short lines out of revenue per EITF99-19; can discourage short line participation if market manager performance is measured on total revenue. • Common short line compensation schemes: ISS, handling fee, Jct Settlement, switch fees; the folly of car-hire reclaim. • How fuel surcharge revenue is shared varies widely. www.rblanchard.com

7. Shortline Economics • Class I average FY 2006 revenue per merchandise load was US$1996. • Shortline pro forma allowance still US$250-$300 per revenue load, does not go up with Class I RPU increases • Double-digit Class I volume YTD 2007 decreases in low-rated commodities (forest products, aggregates, waste) hit allowance-based short lines the hardest • Proposed regulatory and legislative limits to rate increases will hurt ISS short lines the most www.rblanchard.com

8. Short Line 3Q07 YTD Commodity Trends www.rblanchard.com

9. Class I vs. Short Line Expense Comparisons www.rblanchard.com

10. Measuring Short Line Results • Rules of thumb: Rule of 100, $5,000 per mile per year for track maintenance to meet FRA Class 2 specs, fuel burn 8-10 gallons per revenue unit per year • Resources consumed per revenue unit (Watco): man-hours, car hire, fuel burn, switching hours, etc. • EBITDA vs. Operating ratio: No tax advantage to capitalizing major expenditures, below-the-line items have little meaning for core values; puts focus on cash-generating capabilities of property. • EBITDA margin 40% - 50% for well-run short line; CP estimates DM&E will be at 40% for CY 2007 www.rblanchard.com

11. Shortline Growth • Most roads started as Class I branch lines • Staggers Act encouraged spin-offs; effects of new STB ruling? • Lines transferred at low cost on assumption that short line would continue to feed Class I core exclusively • Some short lines “bought their freedom” (A&M/BNI) • Recent short line transactions have been leases (BNI), Joint Ventures (NSC) • Until recently SL pct volume growth > Class Is; Masking Class I losses? • A bright spot: BNI short line units up 8% through 3q07 www.rblanchard.com

12. Short Line Realities • Better than Class Is for gathering and distribution, small-customer service, local infrastructure funding • Free up scarce Class I resources (locos esp) for core ops • 60% of short lines may not meet minimum economic thresholds; exceptions are single-purpose lines w hi vols • The most successful understand and complement Class I financial, commercial and operating goals www.rblanchard.com

13. Shortline Consolidation • Bethlehem Steel roads to Lehigh Valley Rail Mgt., Georgia Pacific to GWR, Alcoa to RailAmerica • Consolidation among shortlines: RailNet to OmniTrax, Savage; Rail Management Group, Maryland Midland to GWR • Second-tier moves – Caney Fork & Western to Cundiff Group • Class Is wary of buyers over-paying www.rblanchard.com

14. The Capacity Question • AASHTO: Predicts 70% growth in freight volume by 2020. • National Freight Infrastructure Capacity and Investment Study: Rails need to invest $135 bn in capacity over the next 30 years to meet demand. • The AAR: HR 2116, S 1125: the Rail Freight Infrastructure Act of 2007, provides for 25% tax credit for new railroad capacity in both infrastructure and locomotives. See also www.aar.org/itc/itc.asp . • Public-Private Partnerships www.rblanchard.com

15. Short Line Capacity • ASLRRA: Current federal tax credit program offsets up to 50% of the amount invested in new or rebuilt track. • Railroad Rehabilitation and Improvement Financing (RRIF) Loans – Administered by FRA. Direct loans or loan guarantees for the acquisition, development, improvement or rehabilitation of existing or new intermodal or rail equipment facilities.  • State and local rail infrastructure funding varies by state, some more generous than others. • Save Our Service (SOS) rail customer coalition lobbying for the tax credit extension www.rblanchard.com

16. Closing thoughts: Possible Implications for Short Lines in a Re-regulated Railroad Environment • Cost of Capital: Rate ceilings, low-rated commodities most, shortline concentration. • Small Rate Cases: Risks of customer filing to remove commodity from exempt list. • HR 2125: “Railroad competition and Improvement” Act does none of the above; nobody calls it “re-regulation.” • Paper Barriers: Class Is holding off; “buying your freedom.” • Competitive Access: A bad deal all around. A fable. www.rblanchard.com

17. Thanks For your kind attention. Now for the fun part… It’s Q&A time! www.rblanchard.com