Re: Comments on Proposed Self-Bonding Rule Changes, Docket ID: OSM-2016-0006

Dear Director Pizarchik:

Taxpayers for Common Sense (“TCS”) would like to thank the Office of Surface Mining Reclamation and Enforcement (“OSMRE”) for your consideration of amendments to existing self-bonding regulations pursuant to the Surface Mining Control and Reclamation Act (“SMCRA”), to ensure that companies with a history of financial insolvency, and their subsidiaries, are not allowed to self-bond[1] coal mining operations.

The U.S. economy has a robust market for pricing and insuring against risk, including future liabilities associated with land reclamation from coal mining. Coal companies should acquire third party reclamation insurance as a cost of doing business. The self-bonding provisions allowing the U.S. government and American taxpayers to assume the risks of default are effectively a government subsidy to (what should be) healthy companies. TCS believes OSMRE should scale back the use of self-bonds significantly if not repeal self-bonding outright.

In the meantime, however, OSMRE has the responsibility under SMCRA to immediately respond to obvious violations of the intent of existing self-bonding regulations, namely that only financially healthy companies can qualify, by issuing guidance that at a minimum:

1. Requires any company currently in bankruptcy proceedings to substitute all self-bonds with surety bonds and letters of credit;
2. Requires that any assets used to signify the health of a subsidiary for self-bonding purposes must be “free and clear,” and not already pledged as collateral for other forms of corporate debt;
3. Defines financially healthy companies able to self-bond as those with an investment-grade bond rating.

Background

SMCRA's coal industry bonding requirements were designed to protect taxpayers from paying for reclamation after Congress recognized how costly it would be to clean up historically abandoned coal mines. Before a company can receive a surface mining permit, SMCRA requires that permittee must post a reclamation bond. SMCRA also authorized a third option – a self-bond or legally binding corporate promise (to do what it must do in any event under the law) that is not secured by a separate surety or by collateral. In recent years, coal companies have qualified for self-bonding in ways that were not contemplated by the original self-bonding rules promulgated by OSMRE in 1983. Specifically, large coal companies have used the financial statements of their subsidiaries to prove they have the assets available to cover reclamation costs. Because this practice is technically allowed,[2] the rules contain a loophole that allows subsidiary companies to qualify for self-bonds even when the subsidiary is effectively insolvent because of the insolvency of its parent corporation.

SMCRA’s self-bonding option has proven inadequate to protect taxpayers for three reasons:

1. When a reclamation liability is bonded – whether by surety, collateral bond or self-bon–, Generally Accepted Accounting Principles allow the related liability to be carried “off balance sheet.”  This means the reclamation liability is not shown on the balance sheet so it does not increase total liabilities and the debt-to-equity ratio of the company.  As a result, the company appears financially stronger than it would be if these reclamation liabilities were carried on the balance sheet.Off-balance sheet accounting is not a great concern when either an independent surety company has analyzed the permittee’s ability to pay and put its own assets at risk on that assessment or the permittee has pledged specific, identifiable assets to secure its performance. In both cases, the liability to the regulator can be satisfied even if other assets carried on the balance sheet become unavailable.  When a self-bond is used, the permittee avoids recording a balance sheet liability simply by making a self-serving promise and nothing more.  In effect, the permittee distorts the reporting of its financial position by eliminating a liability without affecting the asset side of its balance sheet or shifting potential liability to an unrelated third party.
    
2. The value on which regulators rely when companies self-bond is always subject to the volatility of the coal market. The circumstances most likely to lead to an inability on the part of the permittee to pay reclamation cost – a drop in the value of mining properties and assets and a drop in profitability – are exactly the same circumstances that will tend to render a self-bond inadequate. In addition, current regulatory requirements depend on financial statements to assess the financial health of companies. The assets in these statements are not market-to-market, which means that the balance sheet may reflect value that does not exist under prevailing market conditions. 
    
3. Regulators, in theory, can require surety or collateral when a company’s financial performance deteriorates. But that remedy often is not achievable in practical ways because the company’s ability to secure third-party surety bonds or letters of credit evaporates rapidly. Similarly, liquid assets that might be pledged as collateral can be exhausted as the company experiences negative cash flow.  Moreover, the value of illiquid mining assets (the mineral properties and mining equipment) also declines.  In effect, in a coal market collapse, regulators depending on self-bonding will be unable to force a substitution of third-party guarantees or rely on company-owned assets to meet the liability.  Taxpayers are left exposed to the reclamation liabilities of the company.

Finally, there is no requirement that a company’s promise to pay for such costs in the form of a self-bond will get any higher priority than the claims of other creditors in event of bankruptcy. Frequently, the same assets that are used to signify the health of a subsidiary for self-bonding purposes are also used as collateral to take on debt by its parent company. They are, in a sense, “double-pledged.” The difference between the pledges, however, is that the parent company’s creditors have claim to the assets in a bankruptcy whereas the regulatory agency does not.

Peabody Bankruptcy

When the largest U.S. coal producer, Peabody Energy, finally filed for Chapter 11 bankruptcy on April 13 after years of losses ($2 billion in 2015 alone), the company held a total of $2 billion in outstanding mine clean-up or reclamation liabilities, including $1.4 billion in unsecured “self-bonds”. Between 2009 and 2015, Peabody’s off-balance-sheet reclamation liabilities increased from $1.6 billion to $2 billion.  At the same time, the portion of these liabilities secured by third parties decreased from $807 million to $592 million. Peabody’s self-bonded promises increased by more than $500 million.  As a result, Peabody went from self-bonding half of its reclamation liabilities to self-bonding two-thirds of them. Meanwhile, while these off balance sheet liabilities were rising, every indicator suggested that Peabody was a poor credit risk:

• Peabody’s already poor bond rating was further downgraded by both Moody’s and S&P in August 2013.
• Peabody’s stock price dropped from $687 at the end of 2009 to $8 at the end of 2015.[3]
• Long-term debt increased and shareholder equity declined. Peabody’s financial statement debt-to-equity ratio, which ignores the off-balance sheet liabilities for reclamation, rose from 165 percent in 2009 to 1100 percent at the end of 2015. 
• If self-bonded reclamation liabilities were taken into account, then Peabody’s debt to equity ratio for 2009 would have been 187 percent and for 2015 a staggering 1256 percent.

Peabody’s ability to increase its reliance on self-bonding as its financial health deteriorated represents a colossal regulatory failure. Peabody’s bankruptcy comes after a string of other high-profile bankruptcy filings by companies such as Arch Coal and Alpha Natural Resources. In Arch’s bankruptcy proceedings, only $75 million of its $485 million in self-bonded reclamation liabilities were secured. Alpha Natural Resources was similarly approved to guarantee only $61 million of its $411 million in self-bonding obligations in bankruptcy proceedings. Both companies’ remaining unsecured self-bonding liabilities, combined with Peabody’s $1.4 billion in unsecured self-bonds, add up to a whopping total of more than $2 billion that taxpayers could be forced to pay.

None of these bankruptcies was a surprise, and it is obvious that these companies should not have qualified to self-bond their reclamation costs in the first place. With Peabody now bankrupt, there is no doubt that self-bonding practices need to be reformed to protect taxpayers from covering these costs. For the last decade, Peabody Energy’s bond ratings have been “non-investment grade.”  Even as rating agencies were cautioning would-be bondholders that Peabody’s long-term ability to meet its obligations was “speculative,” the company avoiding setting aside assets for its reclamation liabilities by relying on its self-professed creditworthiness.

Next Steps

Regardless of the decision to grant or deny the petition requesting that OSMRE amend its self-bonding regulations, OSMRE is responsible under SMCRA for ensuring that taxpayers do not become responsible for covering reclamation costs of coal companies. OSMRE should:

• Not allow companies to self-bond unless they have an investment grade bond rating (e.g. BBB- or higher by Standard & Poor's or Baa3 or higher by Moody's) for the previous three years. OSMRE should require companies whose bond rating falls below investment grade to substitute all self-bonds with surety bonds or letters of credit. Taxpayers are relying on the promises inherent in a self-bond, and they should not be asked to accept risks that the market believes are significant.

• Cap the overall percentage of reclamation liabilities that can be self-bonded. This would prevent companies, which cannot find willing guarantors at reasonable costs because they are a poor risk, from shifting to greater use of self-bonding, as Peabody Energy has done (discussed above).

• Depend on assessments made by experienced private rating agencies rather than OSMRE employees and state regulators to assess the creditworthiness of permittees.

Thank you for reviewing our comments as you consider changes to the rules governing self-bonding requirements. The recent bankruptcies in the coal industry demonstrate the importance of enforcing self-bonding requirements to protect taxpayers.

Sincerely,

Ryan Alexander

President