Technical Analysis of Non-Recourse Tax-Increment Bonds in Reference to Lot 1 Bond // Eliot Singer

[I know most people, including city officials without CPA qualifications, find finance difficult. Please try to take the time to read through the details, including looking at the linked bond prospectuses. Understanding finance is not only crucial for holding governments accountable for how money is spent—this should be a bipartisan concern—but in your personal financial management. How many of you keep a budget? Do you do your own taxes? Do you manage your own investments and savings?]
Non-recourse Versus Full Faith and Credit Tax Increment Revenue Bonds

The reason city officials are not expressing concern over the commitment to redeem the tax increment revenue bonds for the Lot 1 parking structure and related infrastructure, or over unforeseen consequences from failing to do so, seems to be they do not expect refunding in June 2020 to be a problem. The Bond Indenture and Bond Purchase agreements are very clear about this refunding intent (a new 30-year bond with same funding sources and no recourse) and that the refunding would need to be sufficient to pay off the principal and accumulated interest (due June 1, 2020). There would be a taxable and tax-exempt bond series (likely mostly taxable, as with other city bond issues for parking structures).

Those familiar with the municipal bond market are less convinced 5% (mostly) taxable interest on a $25,265,000 bond offering is sufficient to attract investors for a non-recourse bond backed only by tax increment (TIF) and DDA millage revenue on the Center City project.

Most bonds that use tax increment as security for debt service (interest and principal repayment) are also backed by full faith and credit of the municipality. This means any shortage in tax increment revenue, whether for a single payment or over the life of the bond, is covered by money from the municipality’s general financial resources.

For example, the Projected Tax Increment Revenue and Debt Service Coverage spreadsheet (p. 14) for the $3,545,000 25-year bond series for City Center I (condos and commercial at MAC/Grand River corner, plus former Jacobson’s), issued in 2000, filled in shortage in tax increment from 2005-2008 with money from the general fund, with the projection of surplus tax increment from 2009-2025 to more than reimburse the general fund.

Investors prefer tax increment bonds to be backed by full faith and credit, because that greatly reduces their investment risk, and therefore, municipalities can issue bonds at lower interest. However, the municipality not the investor then takes on risk of insufficient tax increment revenue to pay for debt service. In fact, tax increment revenue has consistently fallen short of projection in TIF plans, at great cost to municipalities, including East Lansing. (Even the conservative TIF plan for City Center I has fallen short because of the Great Recession and the closure of Barnes & Noble, The Gap, and other businesses that factored into taxable value.)

Choosing not to back the ~$25 million tax increment revenue bond issue for Center City (Lot 1) with full faith and credit is a response to this legacy of insufficient revenue to pay for debt service. The hope is to put the risk on the investor, yet still issue bonds at low enough interest to fit the TIF plan.


Grandville DDA

Because non-recourse bonds allocating tax increment for debt service are so unusual, it is important to analyze examples from other communities to better understand how they work. An extensive search of the EMMA web site, which lists most municipal bonds and provides investors with access to the bond statements (prospectuses), located two relatively recent non-recourse tax increment revenue bonds (plus one from 2002 for Pontiac TIFA), among numerous tax increment revenue bonds backed by full faith and credit of municipalities.

In 2012 the Downtown Development Authority of the City of Grandville (near Grand Rapids) issued $1,785,000 in non-resource tax increment revenue bonds for a streetscape project.

The average interest rate on this 20-year tax-exempt bond series is around 5.6%. (Tax-exempt bonds typically pay lower interest, as do shorter maturity bonds.) The bond statement warns investors on the front page: THE BONDS ARE NOT A GENERAL OBLIGATION OF THE CITY OF GRANDVILLE…. NO OWNER OF ANY BOND SHALL HAVE THE RIGHT TO COMPEL THE EXERCIZE OF ANY TAXING POWER OF THE CITY FOR PAYMENT OF PRINCIPAL THEREOF OR INTEREST…THEREON. Then: The bonds involve a high degree of risk, and prospective purchasers should read the section herein captioned “BONDHOLDERS RISKS.” Among the risks discussed in that section (pp. 16-17) are: possible reduction on taxable value “caused by economic factors beyond the [DDA’s] control” and reduction in millage rates. (Reduction in projected taxable value due to national or local economic distress has been the main reason so many TIF plans have experienced shortages. An example of reducing millage rates would be substituting income for property taxes.)

However, while it is important to recognize the risks due to future uncertainties, the Projected Tax Increment Revenue and Debt Service Coverage spreadsheet (p. 15) for the Grandville non-recourse bond shows tax increment revenue on the average 1.85 times what is needed to pay annual debt service, despite assuming no growth in taxable value over 20 years. This is because the tax increment is from DDA tax capture across the DDA district, which in 2012, despite the downturn, was substantially more than enough for the size of the bond. (The 2002 Pontiac TIFA bond also used total district tax capture revenue with even higher coverage ratios.)

Lansing Township DDA

The second example is 2013 Lansing Township DDA Tax Increment Bonds for The Heights in Lansing Township. These were in addition to the ~$22 million 2010 bond offering, which was backed by full faith and credit of the township, in case commercial leasing and related (non-tax increment) net project revenue (after payment of ground lease) proved insufficient to cover debt service.

The 2013 tax increment revenue bonds are for $7.5 million in two bond series maturing in 2037 and 2042 respectively. The tax-exempt bonds have a 5.95% interest rate, the taxable bonds 8%. The taxable bonds are scheduled to have their principal paid down sooner. The combined annual debt service on the two tax increment bond series comes to about $600,000 per year for thirty years.

The bond statement warns “the bonds are speculative, involve a high degree of risk, and are suitable only for purchase by sophisticated investors able to withstand potential loss of their investment. Accordingly, the Bonds are being offered only to…purchasers who are both a ‘qualified institutional buyer’ …and an ‘accredited investor.’” Among the risks listed (pp. 10-14), in addition to those like in the Grandville prospectus, are that “the financial viability of the commercial businesses and luxury residential apartments…could be adversely affected as a result of changes in the real estate market” and “risks related to lack of operating history, reliance on projections.”

The securities (financing sources) offered investors are multiple, and at parity with use of the same securities for debt service on 2007 DDA bonds (mostly refunded in 2012), which are backed by full faith and credit. Parity means the sources of revenue are equally shared, so if there were a shortfall, the non-recourse bonds would receive the same proportion as the full faith and credit bonds.

These securities include DDA tax increment in general (not limited to new taxable value from The Heights) and the BWL franchise fee, which was pledged by Lansing Township to its DDA in 2012. Additional security could come from the DDA millage, though this was not yet implemented at the time the 2013 bonds were issued. The DDA pledged to institute this “ad valorem” millage should the tax increment and franchise fee revenue prove less than 150% combined debt service on the 2007/2012 and 2013 bonds.

Debt service on the 2007/2012 bonds ranges from about $620,000 to $645,000 through 2031. The maximum of the combined debt service is about $1,241,000. The spreadsheet (A-12) shows in 2012, before any added taxable value from The Heights: $1,109,609 in tax increment and $425,000 in franchise fee, for a total of $1,444,609, considerably more (if not 150%) than the combined debt service after payment started on the 2013 bonds.

The spreadsheet assumes 3% growth in taxable value and 2% growth in franchise fee, and there will be a considerable reduction in tax increment in 2023, after the DDA will no longer be allowed to divert Ingham County taxes. The hotel and apartments at The Heights were expected to add $14 million to 2014 tax rolls; in fact, they added about $10 million in 2016. Nonetheless, the coverage ratio, even without the DDA millage, using more conservative growth assumptions, would still be more than 100% every year through 2042.

So, despite limiting the 2013 $7.5 million non-recourse tax increment bond offering to “accredited investors” due to its high risk, the spreadsheet shows ample revenue for debt service coverage, barring major economic detriments.

East Lansing Lot 1 Bonds

For the Lot 1 bonds as issued in December 2017 and purchased by Scottsdale Capital: “The Purchaser understands that no official statement, prospectus, offering circular, or other comprehensive offering statement is being provided with respect to the Bonds. The Purchaser has made its own inquiry and analysis….” The bonds can be resold, in lots of at least $100,000 only to accredited investors (Bond Purchase Agreement C1-C2).

It is clearly stated that the bonds are not backed by full faith and credit of the city and that interest and principal are “PAYABLE SOLELY FROM THE FUNDS AND SECURITY PLEDGED TO THE PAYMENT THEREOF BY THE INDENTURE” (tax increment on Center City and DDA millage on Center City). However, none of the specific risks outlined in the official statements for the Grandville and Lansing Township non-recourse bonds are mentioned.

To refund the bonds, there will need to be an Official Statement detailing risks and a Projected Tax Increment Revenue and Debt Service Coverage spreadsheet. Both the $1,785,000 2012 Grandville and the $7,500,000 2013 Lansing Township DDA non-recourse tax increment revenue bonds have higher interest rates and addition securities (though not full faith and credit) compared to the East Lansing BRA ~$25 million non-recourse bond, funded solely by project specific tax increment and DDA millage, with a back-loaded plan.

Exhibit A of the Bond Indenture as approved by the BRA left blanks for how much principal would be due on dates from 2020-2047. If we obtain an updated Bond Indenture with the numbers filled in, we will undertake analysis of tax increment revenue and debt service coverage. One key question is whether interest starts accumulating from December 2017 or only in 2020 (the bond indenture is unclear on this point). Another important question, that might be unanswerable through the public record (even with FOIA), is where Scottsdale Capital obtained $25 million to purchase the bonds, since a balloon payment on a loan in 2020 (when redemption is scheduled) would have major implications.

For now, in lieu of having an actual debt service schedule, or at least the full bond series, we can project from the amount of the bond issue just closed on, $25,265,000, using the assumption refunding will be at the same amount and interest, though both would likely be higher. Using the same ratio of eligible expenses to interest (1.0576) as in the brownfield plan (calculated at 5%), the total debt service would be $51,986,019. Amortized in equal payments over 30 years, this comes to $1,732,867 per year.

The first year the TIF Plan exceeds this amount is year 14: 2033. The DDA millage comes to about $37,000 (growing at 1.5%), which would make 2031 the first year of excess revenue. Until then there would be shortage in allocated revenues for debt service. (The TIF plan is based on a higher eligible expenses amount or the transition point between shortage and excess would be even later.) Over the first four years, the shortage would be about $1 million.

The $31 million in bonds authorized by the BRA, of which so far only ~$25 million has been issued, could not come close to debt coverage by tax increment revenue plus DDA millage under the brownfield plan (maximum of ~$56 million). $31 million principal plus interest would be $63,785,600, and brownfield plan tax increment revenue plus DDA mils over 30 years would only come to ~$57 million.


Eliot Singer

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