Pensions and discount rates

By Dave Anderson:

The Pittsburgh City Council has voted decisively against the Mayor's plan to lease the entire array of city parking assets to a consortium led by JP Morgan.  The lease was supposed to generate a one time payment of $452 million dollars for the next fifty years of cash flow from current and future parking assets.  The one-time payment was to pay-off Parking Authority debt and push the city's municipal pension fund balances to at least 50% funded before January 1, 2010. If the pensions was 50% funded or better, the state would not take over the plans. 

The pension funds in aggregate are funded at 27.5% as of the last state actuarial report.  That report used data that is over two years old.  I am betting that even if the market value of the pension portfolio grew at the assumed annual rate of 8.5% over the past three years instead of basically treading water with the market , the pension funds will be in worse shape due to a change in assumptions about the future discount rate. 

A dollar today is worth a little more than a dollar next year because that dollar today can be used to buy a good or service now instead of having to wait a year.  The question is how much more valuable is that dollar today instead of next year?  If the economy is strong, that dollar is more valuable now because it could be used to invest and generate more money for the dollar holder. If the economy is either shrinking or effectively moving sideways, next's year dollar loses is only a little weaker.  The discount rate for the future is the measure of how much less valuable a dollar next year.

A simple but methodologically soundl way to calculate a discount rate is to look at a long term US Treasury interest rate and plug it into a fairly simple equation to calculate the net present value.  Currently the US 30 year Treasury is yielding 3.69%.  The October 14, 2008 30 year Treasury was yielding 4.27% while the 20 year bond on the same day yielded 4.57%.  The December 30, 2007 30 year yield was 4.45%. 

The lower the discount rate, the more money one needs in the bank to cover future obligations.  For instance, if I owe someone $1,000 one year from today, using yesterday's 30 year yield as the discount rate, they would be willing to accept $963.10 today.  However if the discount rate was 4.45%, they would be willing to accept $955.50 to cover the $1000 obligation that was due a year from now. 

Over the short term of a year or two, 75 basis point changes in a discount rate don't matter too much.  However over a one hundred year time horizon changing the discount rate from 4.45% to 3.69% means the city would have to basically double its current cash reserves to maintain steady funding status, all else being equal.

I'm speculating now, but I wonder if this is part of the reason why the City Council, led by a councilor, Natalia Rudiak, who I know knows how to do these calcuations, is balking at the mayor's parking plan?  There is a decent chance that even if the Council approved the lease plan, the change in discount rate assumptions would still force a state take-over so the city would still be SOL and without a fairly valuable asset under its control any more.  

 

Casino saturation and failures

By Dave Anderson:

The Pittsburgh River' Casino looks like it is officially on the path to being a boondooggle. 

And it is not just me making that conclusion.

The Pittsburgh Post-Gazette reports that the Rivers Casino ownership structure is facing a credit downgrade from S&P because the slots parlor is making way less money than anticipated. [h/t Chris Briem]

Standard & Poor's downgraded the credit rating for casino affiliate Holdings Gaming Borrower one notch yesterday, from B to B-minus, citing concerns about the Rivers' "weak operating performance" and its ability to meet debt service payments if there's no change in fortunes....

"It's not as if they're just marginally below [expectations]. They're meaningfully below," said Craig Parmelee, who manages Standard & Poor's gaming and lodging team.

Later on in the article, S&P officials say it is typical to see about a third of all casinos go bankrupt in their original ownership configurations. That is the historical rate under normal conditions. However we are not under normal conditions of consumer non-spending. I think it is likely that the Rivers Casino may go bankrupt sometime during the summer of 2010.

I am not a lawyer, but from my understanding of corporate bankruptcies, everything is under reconsideration in bankruptcy. Seniority of obligations provides some protection for some interested parties, but previous contracts and obligations are moot if the bankruptcy judge decides that is the most viable course forward. This is important because the casino has an annual $7.5 million dollar payment to the Sports and Exhibition Authority for the Penguins arena bonds. I have no idea what the seniority status of the SEA; my bet is that they are fairly low on the totem pole. We may find out the value of the implied moral guarantee contained in the Commonwealth Lease afterall.

The other portion of the article I enjoyed were the reasons why the Rivers Casino is having trouble. An amazing and unanticipated confluence of events such as three casinos within fifty miles, including two with table games were unanticipated competitors, the Steelers suddenly decided to play football in a stadium that is right across the parking lot from the casino, and suburbanite fear of urban areas were all unanticipated factors that have contributed to weaker than expected performance at the Rivers. Whocodaknown.

This should not be surprising. Nate Silver in his Esquire gig looks at gambling and makes the reasonable conclusion that the industry is now a mature industry that is not an automatic profit center with solid and guaranteed annual growth irrespective of the broader circumstances. Almost every major metro area is within a few hours of at least a major slots parlor if not a full-service casino now.

But desperate state governments looking to casinos to bail them out of their budget nightmares are likely to be disappointed. The same may be the case with trying to tap other "sins" for revenue. Nationally, sales of alcohol for off-premises consumption were down significantly last year, an unprecedented 9.3 percent in the fourth quarter, according to the Commerce Department.

Alcohol consumption can at least be expected to bounce back a bit � right? � but a lot of the potential customers of the new casinos may be tapped out. The year 2008 was the first time in history that total casino gaming revenues declined throughout the United States (by about 5 percent according to industry estimates).

Just about everyone who wants to gamble in the United States is already a morning's drive away from being able to do so; with the possible exception of isolated Texas, states that open new casinos will mostly be stealing customers from one another...

Whowouldathunkit.... operating a generic product in an area that is approaching saturation with a target audience that is flat broke and has minimal truly discretionary entertainment income to spend would lead to significantly lower than expected revenue. Absurd I tell you, absurd.....

Slots revenue is less than half the projection...

By Dave Anderson:

The Rivers Casino in Pittsburgh was supposed to be an economic engine that could provide plenty of politically low cost revenue to numerous local projects as well as a shot in the arm for the city and county operating budgets.  The revised ownership group projection for average net of pay-out revenue per machine was $361 per day.  At no point has the Pittsburgh Rivers Casino reached that level. 

This should not be too surprising as $361 per machine per day was always optimistic as I noted in 2006:

Mark Belko reported on February 23, 2006:

The daily average for the 81,751 slot machines in play in the northeast was
$256 last year[2005], according to a Northeast Slot Report compiled by Gaming
Industry Observer.

Looking at the more recent data from the Pennslvania Gaming Control Board, last week showed that revenue at the Pittsburgh Rivers Casino was less than half the owner's steady state projection per machine per day.  This is a major oopsie. 

Right now, the trend is steady and strong.  Revenues are plunging at the Pittsburgh Rivers Casino, and there is no discernable change in slope when promotional play or significant media advertising started. 

My 2004 prediction that a need for additional revenue to cover the promises that were required to authorized slots would lead to table gamesstill looks pretty good today:

I see in a couple of years some low level fiscal analyst will run the tax numbers again and see that gambling revenue is coming in below projections and that gambling funded expenditures are significantly above revenue. The solution then is to embark on another round of gambling and casino expansion with all those fun externalities for this time, the projections will be even more optimistic if we just do a little bit more of it. We did not go far enough.... WHOOPS!!!!

At this point, I am hyper curious about the Sports and Exhibition Authority's bond issue as the implied moral guarantee by the Commonwealth is not that valuable right now, and the 80% of the bond payments that are derived from slots revenue in Pittsburgh has to be questioned as to whether or not it will actually be there when payments are due.