Why banks are backing away from private detention deals

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Construction of a $362 million state prison in Lansing, Kansas, remains on track amid criticism of the financial arrangement the state used as an alternative to municipal bond financing.

Financial backer JPMorgan Chase, which accepted private placement of $159.5 million of taxable, 20-year senior unsecured notes for the project on June 1, 2018, announced on March 5 that it would “no longer bank the private prison industry.”

"We intend to exit the space," said JPMorgan spokesman Andrew Gray.

That decision affects CoreCivic, builder of the Lansing prison, and another large private detention developer Geo Group. Both firms, classified as real estate investment trusts, rely on private credit rather than publicly issued municipal bonds for projects.

Under its deal with the Kansas Department of Corrections, CoreCivic will own and maintain the prison and rent it back to the state, in exchange for an estimated $362 million in lease, maintenance, and insurance payments over 20 years. At the end of the lease, the state will own the prison.

Moody’s Investors Service called JPMorgan’s decision a “credit negative for the private prison real estate investment trusts” that “signals future uncertainty regarding access to capital within the private prison industry.

“Furthermore, and as has occurred in the past, the public pressure inherent in the industry could lead additional lenders and/or banks to follow JPMorgan’s lead, ultimately limiting their exposure to the private prison sector,” analysts added.

Wells Fargo Bank joined JPMorgan in announcing its withdrawal from the industry after the banks were harshly criticized in a congressional hearing about the treatment of immigrant children in detention centers operated under contract with the federal government.

“We made a decision two years ago to exit the two relationships that we had with two private prison firms,” Wells Fargo's then-chief executive, Tim Sloan, told the House Financial Services Committee on March 12.

U.S. Bank has also backed away from the industry.

"Our credit exposure to private prison companies has decreased to an immaterial amount in recent years and we continue to reduce our exposure given the risk characteristics of this industry," said U.S. Bank spokesperson Cheryl Leamon.

A Bank of America spokesman said the bank has made no policy announcements and declined further comment.

Despite the loss of the banks, CoreCivic said it still has ready access to capital and that no projects will be affected. JPMorgan has a $140 million commitment to CoreCivic’s $1 billion credit facility through April 2023, according to CoreCivic spokeswoman Amanda Gilchrist.

“Wells Fargo's decision was also focused on participating in CoreCivic's credit facility when we amended and restated the facility in April 2018,” Gilchrist told The Bond Buyer. “Other financial institutions chose to join our credit facility at that time, replacing previous commitments from Wells Fargo. As a result, there is no impact to the company as we continue to have unrestricted access to capital.”

CoreCivic said in a prepared statement that JPMorgan’s decision was “based on false information spread by politically motivated special interests, who completely mischaracterize our company and the meaningful role we play in solving some of our country's biggest challenges.

“JPMorgan was also one of the banks we worked with to construct new capacity which helped the State of California better care for its inmate population when a judge ruled that its system was unconstitutional due to significantly overcrowded conditions,” the statement said. “It is disappointing JPMorgan will no longer have a role in helping to provide similar solutions for our government partners.”

Advocacy group In The Public Interest identified Bank of America, JPMorgan Chase, BNP Paribas, SunTrust, U.S. Bancorp and Wells Fargo in a 2016 report as major financiers of private prison corporations. U.S. Bank has said this year it is also distancing itself from the industry.

Kansas Department of Corrections spokeswoman Cheryl Cadue said the state is not involved in any of the financial details between JPMorgan and CoreCivic. No cost overruns have been reported, and the prison is scheduled to open to minimum security prisoners in October, Cadue said.

The Lansing project, which will replace a 19th-century prison, also in Lansing, is unusual in that the state will staff and manage the prison while CoreCivic is responsible for maintenance. In most private detention centers, a for-profit operator staffs and manages the facility built with low investment-grade or junk-rated municipal bonds from a conduit issuer created by a local government.

The Kansas financing model, promoted by then Gov. Sam Brownback, a Republican, was deemed “insane” by Laura Kelly, now the state’s Democratic governor, when she was a state senator. After taking office as governor, Kelly said the previous administration was "hoodwinked" by overly optimistic projections that the new prison could be operated with less staff.

Kelly "still has concerns" about how the Lansing contract was awarded but will not alter plans for the facility, a spokeswoman said.

A 2017 state audit found that “bond financing with contracted maintenance appears to be less expensive than leasing through a long-term lease-purchase agreement,” though the audit found benefits and disadvantages to either model. With the lease-purchase, Kansas defers risk and has lower up-front costs.

Amid complaints about low pay, KDOC has reported more than 300 prison positions open for an entire year, equal to $17.2 million in vacant posts. Overtime costs of $4.9 million in 2017 shot up 67% in 2018 to $8.2 million.

Long-term, Kansas expects to spend less on staffing the new building because of modern design and technology that solves problems inherent in the Civil War-era prison it will replace.

“The project is unique in that it's our industry's first development of a privately owned, build-to-suit correctional facility to be operated by a government agency through a long-term lease agreement,” Gilchrist said. “Our solution allows the state of Kansas to have access to a modern, efficient correctional facility that is safer for inmates and employees, while allowing the state to avoid using their limited bonding capacity for the construction of a new correctional facility.”

Century-old prisons like the one in Lansing are far from unusual, Gilchrist said. “With more than 100,000 beds in operation today at correctional facilities over 100 years old, many states and the federal government are facing a similar challenge,” she said.

Nearly 2.3 million people are held in the detention system in the U.S. in 2019, according to the Prison Policy Initiative. The inmates are housed in 1,719 state prisons, 109 federal prisons, 1,772 juvenile correctional facilities, 3,163 local jails, and 80 Indian Country jails as well as in military prisons, immigration detention facilities, civil commitment centers, state psychiatric hospitals, and prisons in the U.S. territories.

A CoreCivic contract to house Indianapolis inmates will end after the consolidated government of Indianapolis and Marion County opens a new, municipal-bond financed detention center.

The city issued $623 million of municipal bonds on March 21 to build a 3,000-bed jail and criminal court complex. JPMorgan was co-manager on the Indianapolis bond sale led by senior manager Bank of America.

The new Indianapolis justice complex, designed to reduce incarceration and provide better responses to mental illness, will be leased for 40 years from the Indianapolis and Marion County Building Authority.

"We respect government leaders' processes for determining the best solutions for their constituents, and we also stand ready to accommodate the changing needs of our partners," Gilchrist said of the new Indianapolis jail plan.

Nashville-based CoreCivic, formerly Corrections Corp. of America, says it won 11 contracts with federal, state, and local governments in less than two years and that in the last five years it has retained more than 92% of existing contracts at facilities it owns and manages.

The debate over private detention centers has been magnified by the Trump administration's provocative approach to immigration. Private operators for many years over several administrations have operated immigration detention centers.

CoreCivic emphasizes that it has no role in policy decisions and has not participated in the seperation of immigrant and refugee children from their parents.

“CoreCivic plays a valued but limited role in America's immigration system, which we have done for every administration — Democrat and Republican — for more than 30 years,” the company said. “While we know this is a highly charged, emotional issue for many people, much of the information about our company being shared by special interest groups is wrong and politically motivated, resulting in some investors reaching misguided conclusions about what we do.”

Some public pension funds have divested from private prison stocks. A bill in the California Legislature would prohibit state pension funds from investing in detention corporations.

The Geo Group called the divestment efforts "politically motivated and based on a deliberate mischaracterization of our role as a long-standing service provider to the government."

"Our company has never managed facilities that house unaccompanied minors, including those who may have been separated from their parents," a company statement said. "They also willfully ignore the fact that our company plays absolutely no role in passing, setting, or advocating for or against criminal justice or immigration laws and policies. We welcome the opportunity to have an open dialogue with all financial institutions to address the common mischaracterizations of our company’s role and record as a government services provider."

On April 8, S&P Global Ratings affirmed its ratings of BB-minus for the Geo Group and BB for CoreCivic after the banks' decision to retreat from the industry. JPM shares in a $900 million credit facility for GEO.

“Reputation risk and public pressure to reduce the use of private prisons are constant themes,” analyst Tatiana Kleiman wrote. “That said, the overall trend in private prison use has been favorable and their use is up 125% since 2000. We believe that private prisons are critical to the U.S. infrastructure and could not be easily phased out despite wavering political views.”

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Public-private partnership Infrastructure Laura Kelly State of Kansas JPMorgan Chase Kansas