MTA Economics

When the MTA announced its move to purchase catastrophe bonds as a hedge against future storm surges, it raised a few eyebrows among both the reinsurance world and transit advocates. The catastrophe bond market is a highly specialized one, and the MTA had become the first major public entity to wade into it. Now, as details emerge the bond issuance appears to offer investments a big payoff and provides the MTA protection against unlikely events. It is, essentially, a private insurance.

In the first in-depth piece to examine the catastrophe bond sale, Tessa Stuart of The Village Voice looks at the big bet and the big payoff. As she frames it, after Sandy when the MTA had to turn to insurance to cover billions of dollars of damage, it was clear that the agency’s premiums would be unaffordable moving forward. And so to test the market, the MTA turned to catastrophe bonds. She writes:

That’s how the fate of the subway system ended up in the hands of just 20 investors. If a hurricane were to descend on New York tomorrow, repairs to the subway system would be paid for with money put up by those investors, who bought shares of a so-called catastrophe bond the MTA sold this past summer. It’s not philanthropy; it’s an investment. The same 20 bankrollers stand to make millions, provided another Sandy doesn’t hit tomorrow or anytime in the next three years.

Before Sandy, the MTA owned an insurance policy worth $1 billion. After the storm, says the agency’s director of risk and insurance management, Laureen Coyne, “It was impossible to get that kind of coverage.” Even half a billion dollars’ worth would have cost twice as much. The MTA was particularly concerned about its protection in the event of another flood…

Without a lot of options, the MTA dove headfirst into the small, strange catastrophe bond market, where an estimated 100 investors worldwide do $16 billion worth of deals…In order to sell the bond, the MTA’s in-house insurer, First Mutual Transportation, enlisted a law firm to create an offshore entity dubbed MetroCat Re, located—for “various legal and tax reasons,” Coyne says—in Bermuda. All the money involved in the bond arrangement goes through MetroCat Re.

Essentially, the bond is a simple high-stakes bet: If a catastrophic hurricane causes a Sandy-magnitude storm surge on or before August 5, 2016, investors lose every cent they ponied up. No hurricane, and they get all of their money back, plus a return that will top 13.5 percent.

The MTA put the bond up for sale in July, expecting to sell $125 million in shares, but the interest was overwhelming. The agency ultimately sold more than $200 million to just 20 investors. (Ostrovskaya describes the buyers not as individuals, but “pretty much specific catastrophe bond funds that specialize in this type of investment.”)

The surge protection supplements the $500 million in insurance the MTA has purchased to cover perils such as wind and fire. That policy costs the MTA $46 million a year.

It’s easy to see why the catastrophe bond was popular—it’s an incredibly lucrative proposition. A $10 million share could pay off more than $1.35 million in just three years. The money comes straight from the MTA, which makes quarterly payments into a trust, in much the same way that it would pay an insurance premium. At the end of three years, if disaster hasn’t struck, the investors cash out.

Stuart’s piece goes on to explain how a storm surge high enough to trigger the bond conditions is rather unlikely, but I think that’s besides the point. The only way the MTA could insure against future losses was through these bonds. All told, the various investors could make a combined $27 million — a total similar to what the MTA is paying for insurance — and the agency gets more coverage than it can from insurance companies right now. It’s an intriguing situation, and it’s the one time we’re hoping the MTA has to shell out the money in the end rather than suffer through another catastrophic storm.

The MTA’s debt problem, in handy chart form.

The MTA is sitting on top of a substantial debt bomb. By 2017, the amounts owed by the agency to its creditors will reach $39 billion, and while much of this debt comes from capital expenditures, debt service payments — which are expected to reach $3 billion annually by 2018 — burden the operating budget instead. These figures do not account for the MTA’s next capital plan of around $28 billion, a significant portion of which will be funded through the issuance of more debt.

Agency officials are well aware of the debt problem. They know that the MTA’s lending capabilities may soon be maxed out, but a perfect storm of conditions have left the agency with few other choices. With drastically reduced direct contributions from the city and state, the MTA has to bond out maintenance projects that keep the system running or else risk a slide back into the conditions of the malign neglect of the 1970s. These problems aren’t new or a secret.

Debt, though, is boring. It’s complicated and abstract, and few people from riders to consumers of the news truly care about the abstract debt on the books of a state bureaucracy. What they care about instead are the fares and the service. In a utopian world, customers pay less for more service; in the real world, customers are paying more for incremental service upgrades. Sometimes, they pay more just to maintain the current service levels. Fare hikes rile up the angry masses and provoke outrage, some warranted and some not, from politicians. Fare hikes, of course, are tied to debt, but that’s a level of complexity that most people don’t need or want to care about.

Still, certain government bodies should rise above the populist calls against fare hikes. Whenever the MTA’s budgetary conditions improve, as they recently have, anyone with a megaphone yells for fare hike reductions. It may make for happier customers and, perhaps, more riders, but it does not make for sound fiscal policy. Today, from New York State Comptroller Thomas DiNapoli, we have one of those calls.

In a generally positive report issued today [pdf], DiNapoli found that, after years of troubles, the MTA budget looks pretty good. A combination of unexpected financial contributions and aggressive belt-tightening has led the MTA to realize nearly $2 billion in resources. Over the past seven months, the MTA has reduced out-year gaps to a total of $240 million (down from $638 million) and did so through higher tax revenues, lower pension contributions, lower energy costs, lower debt service and lower health insurance costs. Internal restructuring and cuts as well as an attempt to lower paratransit expenditures has contributed as well.

Yet, even while acknowledging the MTA’s debt problems, DiNapoli chose to focus on how fare increases have outpaced inflation over the past decade and how avoiding planned fare hikes in 2015 and 2017 should be a priority. It is a truly populist stance from someone who is supposed to be responsible for maintaining the fiscal integrity of state agencies. “The MTA’s financial outlook is much improved,” DiNapoli said in a statement. “While funding the next capital program and improving services are critically important, reducing the size of planned fare and toll hikes must also be considered. There is plenty of time before the next scheduled fare increase for the MTA to refocus its efforts on reducing waste, which could go a long way toward easing the financial burden on commuters.”

The MTA’s problems stem from a history DiNapoli is in danger of repeating. For decades, politicians kept the subway fares artificially low at five and later ten cents. Only through recent aggressive fare hikes have the historical inflation trends matched the five-cent fare in 1904 to the current fare in 2013. Fares over the last seven years have risen 47 percent with no corresponding inflationary jump.

But the agency finds itself between that proverbial rock and a hard place. The best and most reliable way for the MTA to generate more revenue is through fare increases, and without a more stable funding stream, fare increases will continue. It’s also disingenuous for the state comptroller to complain on one page about skyrocketing debt and on the other call for a moratorium on fare increases.

So straphangers and the MTA are stuck. We’re stuck with fare hikes that won’t step and debt obligations that won’t simply disappear. It would be nice to keep fares at current levels for longer than 24 months, but it wouldn’t be a prudent fiscal decision on behalf of the agency tasked with overseeing our transit system to do so.

As part of the MTA’s plan to spend $40 million in unexpected state revenue on its customers, Transit will expand weekend service on the M to Manhattan and will increase G train service during the afternoon rush, as outlined in its line review. Gov. Andrew Cuomo announced these enhancements as well as some added bus service that will total $7.8 million, and the MTA plans to invest another $5.9 million in the customer experience and station environment as well.

“For the second year in a row, the state has invested in significant enhancements and expansions to our state’s transit system that will improve the experience of the eight million commuters who use the MTA,” Governor Cuomo, who continued his streak of taking credit for the MTA’s good news, said in a statement. “In the last two and a half years, our administration has made real improvements to the nation’s largest public transit system, implementing reforms that have improved services and made the MTA more efficient by reducing costs, cutting waste and putting the needs of straphangers and commuters first.”

According to the release, these service improvements will benefit nearly 90,000 passengers daily. G trains will operate every eight minutes from 3 p.m. to 9 p.m. on weekdays, cutting headways down from 10 minutes. On weekends, M trains will run from Middle Village, Queens to Essex/Delancey, providing riders with a direct connection to the F. Currently, M riders must make two transfers — from the M to the J and the J to the F — for service into midtown and points north. The M will not operate north of Essex/Delancey or along the Queens Boulevard line.

The other half of the investment picture involves nearly $6 million for other improvements. Transit will hire more cleaners for tracks and stations and will begin to adjust turnstile and Metrocard Vending Machine layouts as well. I hope to have more on these efforts later in the week.

Additionally, Transit will restore some bus routes lost to the 2010 cuts and beef up service on other lines. The newly restored routes include the B37 and B70 in Brooklyn, weekend M8 and Q31 service, Sunday Q77 buses, and additional hours of operation for the S93. The MTA also plans to add a yet-to-be-determined Select Bus Service route and will study bus service in Co-Op City to identify routing gaps and potential solutions. I question the wisdom of restoring service along bus routes that didn’t have the ridership to support it, but perhaps the attention devoted to these lines over the past two years will drive up ridership.

Outside of the city, the LIRR will invest $2.6 million in added service as well. Trains will run every 30 minutes on the weekends to and from Ronkonkoma and Port Washington. Weekend service to Greenport will be extended, and five peak-hour weekday trains will be added on crowded routes. Metro-North has a more modest ask as the railroad will get an additional $1.7 million to “add real-time customer information displays at all of its stations in New York State by 2020.”

For the MTA’s customers, this news is good. After years of service cuts, expanded service is welcome even if the subway enhancements are limited to two lines with relatively low ridership. The fundamental problems of comprehensive access and more frequent service on lines at or near capacity are side-stepped in this plan, but on the other hand, the MTA had only limited resources for expanded service. Officials acknowledged too that the long-term financial picture remains unsettled, at best.

“We have listened to our customers, and we are responding with more bus, subway and commuter rail service as well as enhancements to make that service more reliable and more enjoyable,” MTA Chairman and CEO Thomas F. Prendergast said in a statement. “We are committed to aggressively reducing our costs, and to strengthening service whenever we have sustainable resources to do so. But our Financial Plan remains fragile, and our financial challenges – both short and long term – are numerous. The revised Financial Plan puts our customer needs first while also allocating resources to longer-term challenges like reducing pension liabilities, lowering retiree health care costs and providing initial funding for our next Capital Program.”

Forest City Ratner pays $200,000 a year to append the Barclays Center name to the Atlantic Ave. subway stop. (Photo by Benjamin Kabak)

The MTA is set to unveil a series of budget documents this week that will set the stage for the next few years’ worth of conversations. They’re unveiling revised estimates for the current capital plan based on the need to spend money to repair the system and mitigate the impact of future storms and surges, and they’re keeping in an eye on the next twenty years of system growth as well. I’ll be taking a closer look at these documents this week, but one theme is a constant: Where will the MTA get the money to do whatever it is it wants to do?

One way the MTA won’t get money is through station naming rights deals. The agency needs billions of dollars, and even the most lucrative naming rights deal in the U.S. is worth only around $1 million annually. The MTA’s one current naming rights deal for a subway station is netting the agency a whopping $200,000 a year. But that’s not stopping the MTA from putting itself out there. This week, as part of the July board meetings, the MTA is formalizing its station naming strategy, and I think it gets everything right. Whether it can make money from the effort remains to be seen.

The new guidelines will be voted on this week, and they are available as a pdf on the MTA’s website. The MTA is consolidating the naming rights process and procedures so that Jeffrey Rosen, the head of the agency’s real estate department, and the new policy will not apply to directional signage, changes to the street grid or advertising campaigns that have no impact on a station name. It will apply to any other situation where an advertiser wants change “the official designation” of any MTA facility. This can include signage, maps and on-board announcements similar to the way Barclays Center has replaced Pacific St. at the Atlantic Ave. subway complex.

By putting forward this proposal, the MTA says it wants to receive “fair value” for the rights to name its stations. At the same time, the agency wants to “respect the historic nature” of its stations — which is less of a concern than the third factor: ensuring that customers can “safely and efficiently navigate the MTA system.” The third qualification I’ve stressed repeatedly, and it’s why SEPTA’s naming rights deal fails. AT&T Station — the replacement name for the Pattison station — tells a rider nothing about the station; it could be anywhere. But for its flaws, Atlantic Ave./Barclays Center carries a major destination in the sponsored station name.

With these policy goals in mind, the MTA set forth its standards. It will require “a compelling nexus between the Facility and the Sponsor” for any naming rights deals. “Requests for renaming,” the policy says, “will only be accepted from Sponsors with a unique or iconic geographic, historic or other connection to such [station] that would be readily apparent to typical MTA customers.” In other words, advertisings just looking to slap their names on a station won’t be able to do so. The Tropicana Station at Bryant Park won’t become a reality, but if Macy’s, for instance, wanted to buy out the Herald Square station, the MTA may listen. This limitation could eliminate many potential advertisers before the MTA even has the chance to discuss money.

If any naming rights venture gets this far then, the next issue concerns value. Considering how naming rights deals are tough to come by, it’s hard to say what “fair value” means in any context, but in addition to pure dollars, the MTA will also consider promised capital upgrades made by the sponsor or capita upgrades taken on by the sponsor in exchange for the naming rights. In essence, the MTA is creating something of an Adopt-a-Station program. How this works in practice rather than theory again remains to be seen.

Matt Flegenheimer of The Times reported on this plan over the weekend, and he had the chance to gain more insight into the process. MTA advisers recognize that transit agencies across the nation are hoping to draw money from naming rights, and one of MTA CEO and Chairman Tom Prendergast’s right-hand men claimed that “from time to time,” advertisers have expressed an interest in making a deal.

The policy, the MTA says, is to protect its customers too. “We don’t want to be confusing people,” Allen Cappelli, an MTA Board member, said. “There are neighborhoods where I would be very hesitant because of the geographic significance.” The MTA also won’t rename stations for people, living or dead. (Sorry, Ed Koch.)

This all sounds well and good. Yet, I can’t help but think it’s all for nothing. I’ve followed this issue for years, and nothing much has come of it. Madrid recently renamed an entire line for just €1 million a year while Boston has unsuccessfully put its station names up for sale. Austin, Toronto, New Jersey, D.C. and Chicago all want someone to pay for their stations, but very few people are biting. It’s too hard to overcome the stigma of being associated with something most people love to hate for these deals to be worthwhile. Maybe the MTA can realize some dollars, and they have a solid policy in place. But it’s a policy more like than not to go untested over the years.

Here’s an interesting bit of news regarding MTA finances and a new bond issue: In what amounts to an essential hedge against future storm surges, the MTA has issued a $125 million “catastrophe” bond through its reinsurance broker that could cover some costs from a rainstorm or hurricane. Both Reuters and The Wall Street Journal have reported on the bond issue, and S&P assigned the bonds a BB- rating.

The bonds are unique in that they are a form of parametric insurance tied only to storm surge levels, and it is, according to S&P, a first-in-the-nation issuance. Essentially, the MTA would recoup the outstanding principal from the bonds in the event a named storm generates a storm surge of at least 8.5 feet in the Battery, Sandy Hook and the Rockaway Inlet or a 15.5-foot surge in the tidal gauge in the East Creek and at Kings Point.

The Journal notes that these bonds are “structured securities that allow insurers to transfer their own risks to capital-markets investors, instead of buying protection from more traditional insurance providers,” and Reuters notes that these are high-interest bonds that could carry significant risk for investors. The issuance details are available via Artemis, and the insurance news site offers up more analysis:

In this cat bond, MetroCat Re Ltd. will issue a single tranche of Series 2013-1 notes, which will be sold to collateralized a reinsurance agreement between itself and First Mutual Transportation Assurance Co. (FMTAC). FMTAC will receive from the cat bond a three-year source of per-occurrence reinsurance protection against storm surge measured during named storm events on a parametric trigger basis.

The single tranche of notes has a preliminary size of $125m we understand, although we’re told that the MTA could upsize this if pricing proves more attractive than other sources of reinsurance it utilises. The MTA’s motivation for issuing this cat bond is to expand and diversify its sources of reinsurance protection and also to obtain some coverage on a parametric basis which should payout more quickly than indemnity coverage.

The transaction features a parametric trigger based on actual recorded storm surge heights from a number of zones around New York city. A loss payment would be due based upon a parametric event index meeting or exceeding a trigger level for an applicable area, meaning that it may not necessarily directly correlate with the losses of the sponsor.

According to risk models, only Hurricane Donna in 1960 and Superstorm Sandy in 2012 would have triggered the principal payments and reinsurance provisions from these bonds. Market observers are intrigued by this new form of reinsurance, and analysts expect the MTA to ramp up use of such bonds if market response is positive and market conditions are favorable. In a sense, the MTA, which has not yet commented on these bonds, seems to feel that New York’s vulnerability to such surges from named storms will only continue to increase as the next three years elapse, and recovery money may be easier to access via these catastrophe bonds.

When the MTA releases its 2014 budget in a few weeks, transit advocates and budget wonks alike will be rubbing their hands with glee, rather than dread. While the budget will likely contain some bad news and dismaying long-term projections, the big question of the month will finally be answered: Just what does the MTA plan to do with that extra $40 million?

For the better part of 2013, we’ve heard a lot about Gov. Andrew Cuomo’s transit largesse. As part of an increase in available state money, Cuomo upped his executive contribution to the MTA by around $40 million, and the MTA suddenly has an unexpected windfall to spend. A few months ago, the tug-of-war began with politicians calling for increased service and labor leaders calling for increased salaries. Only a few have urged the MTA to use this drop in the bucket to pay down its crushing debt load, and one way or another, it seems, the public will benefit in the short-term from the $40 million while the MTA’s long-term needs are ignored.

Lately, the battle has been heating up, and two competing editorials argued for the money this weekend. In the Daily News, John Raskin of Riders Alliance — of which I am a board member — and Gene Russianoff called for better transit service. The two write:

The need for expanded service is more pressing than ever. Ridership is at its highest level since 1950. The subways and buses are packed. Ongoing repairs from Sandy are causing additional hardships for R and G train riders, with future repairs likely to cause trouble on many other trains as well.

Riders are paying more money for less service. Fares have gone up four times in six years, at a pace that the state controller found to be more than double the rate of inflation. The base fare jumped from $2 in 2008 to $2.50 in 2013 — and the 30-day card increased from $81 to $112 during the same period. Meanwhile, the MTA still has not restored most of the service that was eliminated in 2010, putting back less than one-third of the $93 million that was chopped from the budget in the depth of the recession.

Restoring subway and bus service is not only possible because of a recovering economy; it is also necessary for New York to truly maximize its economic potential in the years to come. Our transit system is the lifeblood of the region’s economy, moving more than 7 million people every day to work, school, shopping and other appointments, and making a much-needed dent in productivity-killing traffic congestion. Improving service is an investment in jobs, economic growth and future tax revenue.

Specifically, they call for increased off-peak service for subways, restored bus lines, and more LIRR and Metro-North trains as well. I’m still hesitant to embrace the call for reactivating lost bus routes as those routes never had the ridership to justify service in the first place, but perhaps I’m falling for my own chicken-egg problem. If we add buses and encourage regular and predictable (or observable) service, maybe ridership will increase. If the MTA is investing in its service offerings, the other requests are no-brainers.

Meanwhile, on Long Island, the chair of the LIRR Commuter Council has issued his own wishlist in the form of a Newsday Op-Ed. He too requests an increase in off-peak LIRR service; more security measures for some of the system’s lesser-used stations; increased spending on cleaning, maintenance and waiting room hours; more wheelchair access; and fare reduction. His requests are reasonable, but it’s not clear if Mark Epstein understands how little $40 million is. If the MTA devoted the entire surplus to its fares, it would reduce any looming fare hike by less than one percentage point. It hardly seems worth contributing even a token amount of this money toward alleviating a fare hike because it won’t achieve much at all.

Ultimately, though, I’m still left with the uncomfortable feeling that everyone is arguing over something that will soon disappear. The MTA has a little extra money to spend for one year, but there’s no guarantee that money will remain in place in subsequent years. If the funding stream dries up, the agency will be left with a larger operating deficit, and we haven’t even accounted for the fact that the MTA’s budget rests on a shaky foundation of a net-zero wage increase. If net-zero is unobtainable, the $40 million will evaporate before a single extra train can roll down the tracks.

The politically expedient move is to spend the money on customers. The token gesture would placate politicians and irate straphangers. The economically expedient move is to spend the money reducing future debt loads even by just a little bit. I have a sneaking suspicion though the former will win out.