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Bonds Used to Finance Private Prisons, Jails Turn into Junk

by Christopher Zoukis

The promise of safe, humane and less costly prisons has been used for decades by the private prison industry to sell its products. As prison populations skyrocketed, local, state and federal governments became convinced that financing and building more and more correctional facilities was the way to go. So did investors, who picked up municipal bonds used to finance private prison construction in droves.

But lately the bottom is falling out of the prison and jail bond market.

Almost immediately after the U.S. Department of Justice announced plans to discontinue the use of privately-operated Bureau of Prisons facilities in August 2016, S&P Global Ratings downgraded bonds for several private prisons to below junk status. That meant the ratings giant believed they were essentially worthless, as the debt was likely to go into default.

The now junk-status bonds include those used to finance prisons in Garza, Reeves and Willacy counties in Texas. The Willacy facility, which has over $60 million in bond debt, is currently vacant after a February 2015 riot left it uninhabitable. [See: PLN, Dec. 2016, p.20].

Referring to Willacy County in particular, S&P Global Ratings credit analyst Kate Boatright stated, “the downgrade reflects our view that the current shortfall of pledged revenues on these bonds could lead to a potential default by December 2017. We expect a default on these bonds to be a virtual certainty based on lack of revenues that will be available for payment on these bonds even under the most optimistic performance scenario over an extended period of time.”

According to Bloomberg News, about $300 million in tax-exempt bond debt issued for almost two dozen private facilities has already defaulted – including many facilities in Texas, where speculative jail building was common during the 2000s. Local government bonds are typically repaid with revenue from leasing the facilities to private prison operators (known as revenue bonds). In some cases, the bonds have not been used for their intended purpose and the IRS has revoked their tax-exempt status and imposed penalties. [See: PLN, Sept. 2015, p.18].

In Mississippi, the Department of Corrections recently closed the privately-run Walnut Grove prison as a result of budget constraints, fewer prisoners and a U.S. Department of Justice review that found widespread staff misconduct and deliberate indifference to the welfare of the juvenile offenders who had been housed at the facility. [See: PLN, Nov. 2013, p.30].

While Walnut Grove now sits empty, the state still owes $121 million on the bonds issued to build it. “Despite the closure of the Walnut Grove facility, the department is obligated under the loan agreement, the note and the Walnut Grove lease to make payments sufficient to pay debt service on the Walnut Grove bonds,” the bond holder said in a statement.

Local alderman Chip Jones suggested that the empty prison be used for another purpose. “Anything’s better than nothing,” he said. “The taxpayers are paying for that building, and it’s just sitting there.”

So who benefits when bonds issued to finance prisons and jails go into default? Typically the companies that underwrote the bonds, which received substantial fees when the bonds were issued whether or not they default in the future. For example, when Bergen Capital underwrote bonds totaling $69.8 million for the Irwin County Detention Center in Georgia in 2004 and 2007, it made over $2.5 million in fees. The agency that owned the jail later went into bankruptcy, putting bondholders at risk – but Bergen had already been paid upfront. 

 

Sources: www.chicagotribune.com, www.clarionledger.com, www.bondbuyer.com, Bloomberg News, www.debtwire.com


 

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