What’s in the Box III: Feasibility of the Valiant Proposal (Part D)

In this (ever-expanding) series, we have been examining all the pieces of the proposal by the Valiant partnership for a development on the Library Lot.  The series began by pointing out that the consultant, Roxbury Group, who were retained by the City of Ann Arbor (but paid by the DDA) to examine the feasibility of the Valiant proposal, failed to do that.  Recall that the original proposal by Valiant is on the city’s RFP page and a revised proposal was presented in a table contained in the Roxbury report (summarized in this post).

5. The Bonds

a. Then and Now

The major change between the original Valiant proposal and the revised proposal was the basis of financing the bonds that are to pay for the conference center.  The original proposal called for the city to issue “Full Faith and Credit” municipal bonds.  This puts the city at risk, should the development fail to produce enough revenue to make the bond payments.  In the revision, the developers assert that their own credit standing will be applied to EDC (Economic Development Corporation) bonds.

Here is the text from the original proposal.  Note the candid admission that the conference center will not be self-supporting. It is also clear that the developers consider the conference center to be at heart the city’s responsibility.

The primary proposition of the Developer is that this project will be built around the most important economic development facility for Ann Arbor, the Conference Center. Since Conference Centers rarely generate enough revenue to cover debt, since they are public purpose facilities, these facilities are usually built with public sector funding. It is clear that a Conference Center of this size and quality cannot be paid for from the hotel/retail component. At the same time, we do not want to have any costs imposed on the City for this Center. Our proposal therefore is to utilize a portion of the tax and other revenue streams that would be generated from the private portion of the project, to cover the costs of the Conference Center. That way the community obtains a most valuable asset, but without any out of pocket costs.
The specific proposal is to have the costs of the Conference Center paid for by proceeds of a Full Faith and Credit… bond, issued by the City or other appropriate issuer. The debt service on this bond would be covered from a number of income streams generated for the City by the private portion of the project.

Here is a summary of the bond financing from the original and revised proposals:

Source Original Revised Comment
Bond type Full faith and credit municipal bond Economic Development Corporation bond The developers say that the EDC bond will be issued on the basis of their credit
Bond amount $8 million $6.9 million Square footage of conference center also reduced (32 K to 26K)
Ground Rent about $350,000 $775,000 No explanation for increased amount
Property tax – hotel/retail $250,000 “plus” not included This is also referred to as a PILOT
Property tax – condos $75,000 $60,000 number of condos reduced from 12 to 6
Upfront sum from condo sales $900,000 “plus” no change indicated This amount also to support conference center initial development

b. The Bond Alternatives

If the city had been persuaded to issue full-faith-and-credit bonds,  its treasury would have been open for the debt payments.  The text from the parking structure bond offer makes it clear:

The City shall be obligated to pay the principal of and interest on the bonds as a first budget obligation on its general funds, including the collection of any ad valorem taxes which the city is authorized to levy…

Notice that phrase, “first budget obligation”?  It means “no excuses”.

However, the revised offer calls for Economic Development Corporation bonds.    As the Roxbury report summarizes, “Valiant has offered to guarantee the amount of financing necessary so that any shortfall is covered by the developer, not the City.”  This made the offer much more attractive to members of the DDA, at least.  As quoted by the Ann Arbor Chronicle, “Leah Gunn added that she thought the most exciting line in The Roxbury Group’s report was that ‘Valiant was able to strengthen the development’s potential for revenue generation, eliminating the need for any publicly-guaranteed debt.’ ”

So what is an Economic Development Corporation bond and how does it work?  Municipal Economic Development Corporations are established under the authority of Michigan Act 338 of 1974. Actually, Washtenaw County has two, the Ann Arbor Economic Development Corporation (established in 1978), and the Washtenaw County Economic Development Corporation (established in 2001).

Here is what the preamble to the Ann Arbor EDC information packet says.  It is a sweet evocation of the Ann Arbor we came to love.

Projects approved by the EDC must, by consensus of its board of directors, be in the public interest; they must provide commercial services where a need for them exists; they must offer permanent employment opportunities to city residents; and/or they must be in keeping with the city’s character and the needs of its residents. Preference is given to enterprises which are non-disruptive of the environment and which add diversity to the jobs pool in the city. Demographic changes in Ann Arbor may, therefore, result in some alteration of these guidelines.
It is the intention of the EDC to retain and attract qualified applicants engaged in (1) research and development activity; (2) providing necessary services; and (3) light manufacturing and assembly. The EDC is not a lending agency; rather, it is an issuer of tax-exempt bonds, under Michigan Public Act 338 of 1974, as amended.

According to a 2009 update, the Ann Arbor EDC has issued bonds at over $125 million par value for many Ann Arbor endeavors, including Glacier Hills upgrades,  Weber’s Inn, the new YMCA, and Greenhills School.  Some of these were evidently a long time in the past, like the notation in the list for “Parke, Davis”.  The EDC makes money from fees associated with the loans and sometimes uses it in making grants.
The Washtenaw County EDC signed a memorandum of understanding for service delivery with the Washtenaw Development Council, which has subsequently become SPARK.  According to a story in the Ann Arbor Chronicle,  the WCEDC met earlier this year for only the second time since 2005.

These bodies can issue tax-exempt bonds (municipal bonds) that are not full-faith-and-credit; the city or county is not encumbered by them.  The bonds are restricted to use for projects, obviously, that have economic development potential, and there is the intent that it should be a benefit to the community, as expressed by the AAEDC’s preamble.  The bonds are not a loan from the municipality; independent financing has to be identified before bonds are issued.  The point is simply that by making the bonds tax-exempt, borrowers can expect a lower cost of financing (i.e., interest), since tax impacts are important to some investors.

c. Where does the money come from?

Recently there was a flurry of activity for EDC bonds across the state because of the 2009 Recovery Act.  As the press release about recovery zone bonds issued by SPARK explains, “Recovery Zone Facility Bonds” were available for private borrowers. The Chronicle story says that the entire county was designated a Recovery Zone by the county Board of Commissioners in 2009, and that the county was allocated just over $33 million for such bonds.  (This was evidently the “renovation zone” money that was mentioned fleetingly in the Valiant proposal.)  Both the Ann Arbor EDC and Washtenaw County EDC would have been able to issue bonds based on this money.  But as Stephen Lange Ranzini recently confirmed in an email, none of these dollars were ultimately loaned out.  He says, “Yes, despite a lot of effort to advertise the program and many meetings with interested parties, no one applied. The program ends 12/31/2010.”  (Note that renewal of the Recovery Act was one of the actions that the US Congress failed to do in this session.)  Ranzini, who is the President and CEO of  University Bank in Ann Arbor, is the outgoing President of the Ann Arbor EDC (but remains on its board) and is also a board member of the WCEDC.

Generally, in the absence of such exterior funding (as the Recovery Act money), the money to finance the EDC bonds must come from a bank, via a mortgage or simply a loan. Ranzini confirmed that in such a case an applicant would have to present an irrevocable letter of credit from a bank in order to be considered for bond issuance.

d. What happens if the debt payments are not made?

If a bank is to loan money to the Valiant partnership with bonds as the repayment mechanism, there must be a clear plan for how bond payments will be made.  The picture is more complicated since the idea is to finance a public facility (the conference center).  Here is what Ranzini said about this:

“Private individuals would need to secure credit from a bank (which would issue the letter of credit backing the bonds). The bank would of course use the public facility and other assets (such as corporate and personal guarantees of the sponsors) to secure their loan. These guarantees might be unsecured or secured but that is up to the bank’s credit committee to decide how much risk the bank is willing to take.”

So in other words, either the Valiant partnership would have to be able to persuade a bank to issue a letter of credit (and remember that an irrevocable letter of credit is absolutely binding) based on their own personal credibility and assets, or – as seems possible – the conference center itself might be required to assume some responsibility if the promised revenue does not materialize.

But look at where that revenue is to come from, according to the assurances of the developers: ground rent (which we indicated in the previous post is very shakily premised on some optimistic projections), sales returns from very expensive condominiums (which have not sold well if at all in Ann Arbor lately), and property taxes from those same condominiums.

If you were a bank, would you sign that letter of credit?  If the city of Ann Arbor assumes the responsibility for financing the conference center, you might yet.

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