In the recent election, issues like national security, illegal immigration and “American resurgence” in the world were a few of the many issues that took center stage and possibly enabled Trump’s victory.
In recent months, President Trump and his administration have allocated significant resources to combating illegal immigration, expanding detention facilities along the Mexico border and, potentially, deporting millions of undocumented immigrants. Furthermore, he has signed several executive orders to reverse former President Obama’s plan to phase out private prison operations.
What does this mean for prison muni bonds and their investors? In this article, we will discuss the new private-prison directives under the new U.S. administration, and how these changes will impact investors’ potential portfolio holdings.
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The American Prison Scene: How It Used to Be
In the pre–Obama presidency era, the American justice system relied heavily on the private prison system to support the operations of state and federal prisons, in everything from building more correctional facilities for inmates to maintaining the day-to-day operations of the prison. The U.S. Department of Justice awarded some very lucrative contracts to private firms for maintaining prisons and the prison population. The operation of these private prison facilities was often funded through bond issuances. These were backed by revenue streams coming from the federal government leasing these private prison facilities or from tax measures passed by the municipality or state.
Under the Obama administration issues like mass criminalization took center stage and warranted serious prison reforms. Amid all that, in August 2016 the Department of Justice acknowledged federal reliance on private-prison contracts and introduced directives to phase out these contracts with private-prison firms.
It is interesting to note that the state prison population peaked in 2009 at approximately 1.6 million inmates and started declining from 2010 onward. According to statistics from the U.S. Bureau of Justice, within the next four years the inmate population dropped by almost 3%. With declining populations, many of these prisons were consolidated and some smaller prisons were shut down for good. However, this jeopardized the repayment of bonds backing such prison facilities.
During this time, rating agencies like S&P and Fitch were actively looking at the revenue streams of private prison debt and downgraded several issues to junk debt. These downgrades were widespread throughout the U.S., with prominent ones being the Garza County Public Facility Corporation in Texas (CUSIP 367080AU2), and La Paz County Industrial Development Authority in Arizona (CUSIP 50375EAL5). By October 2016, two dozen prisons that had issued tax-exempt debt had defaulted on their obligations, which totalled more than $300 million.
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What Could Change Under the Trump Administration?
Trump’s strong rhetoric against illegal immigration, his claims to reverse any prison reforms already in the works and his willingness to promote the expansion of detention centers and private prison structures are likely to make private-prison debt investors very happy.
Given that private-prison contractors were a few of the biggest contributors to Trump’s presidential campaign, their stock prices soared to new heights after November 2016. For instance, the GEO Group (GEO) is one of the biggest private-prison contractors in the U.S., and its stock price has almost tripled since the election.
A policy reversal in favor of private prisons under the Trump administration gains importance when you consider recent findings by the Homeland Security Advisory Council that state that almost 65% of the immigrants detained by the Immigration and Customs Enforcement Agency are housed in facilities operated by private contractors.
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Potential Opportunities for Investors
President Trump’s prison reform is a clear indicator for the following opportunities:
- Reinstatement of private leases: Demand for private-prison bonds, which were selling at deep discounts and junk ratings, is being resuscitated. This includes private-prison infrastructure, which had previously projected an end to their federal leases and were being phased out but can now be a lucrative opportunity. Under the Trump administration, these leases can be reinstated, in turn providing much-needed revenue streams to their bonds.
- Mexican border facilities likely to witness growth: Investors can keep a close eye on debts issued by detention facilities near the Mexican border; these facilities are already seeing a huge surge in numbers of inmates, which is grounds for more federal government funding to facilitate the deportation process. This includes the U.S. states on the Mexican border—like Texas, which alone accounts for over 10% of the total private prison debt issued in the U.S. These states are likely to see a surge in inmate population and government contracts to back debt financings.
- Overall rise in prison population: Trump administration has hinted on introducing new laws to combat both criminal and “less criminal” activities, which will in turn increase the prison population.
Keep our glossary of municipal bond terminologies handy to familiarize with different concepts commonly used by municipal investors.
The Bottom Line
Private prisons and companies providing for their operations emerge as a clear winner under the Trump administration. The private prison industry accounts for over $1.1 billion dollars in bond issuances in the U.S., and the majority of these issuances are seeing a light at the end of the tunnel, with potential renewals to their federal contracts, an increase in inmate populations and revived revenue streams.
As all that happens, investors must keep a close eye on potential changes in bond ratings, which may present investment opportunities. Furthermore, investors must always keep in mind that the maturity of a bond issuance will likely outlive any presidency and its policies—while private-prison debt may present a lucrative opportunity, it could be short-lived.
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