Taking Risks

I have heard twice in the last week or so that the fact that our convention center will need a general fund pledge and/or that we cannot attract private financing for a convention center hotel does not impeach the feasibility of the project. The first time was in a conversation with a CVB board member and the other was in today's newspaper.

Fundamental to financing anything - a car, a boat, a house, a hotel and a convention center - is the question of risk. How much is there? Who takes it? What will I get paid for the risk? How can the risk be reduced?

In the case of the convention center, the Goldman Sachs preliminary financing structures clearly articulate how much risk professional investors are willing to take. They seem to think that the hotel and tourism revenues will only support about $200 million in debt. For the rest of the purchase price - about $400 million - risk must be transferred to someone else. In the case of the convention center, the someone else is the Metro general fund.

The hotel "best and final offer" demonstrates a similar amount of risk aversion. The offer from the hotel manager/development combo of Marriott/Phelps Portman indicates that they would put up about $9 million in private money and make some limited guarantees for debt service. In return they get 3% of the gross revenues. In other words, they are reducing their risk to a level they find business-worthy and are not willing to assume full responsibility for the profit and loss of the enterprise. With the hotel manager/developer unwilling to take risk, someone must be found to whom we can transfer it.

Before 2008, there were professional risk takers called bond insurance companies. In fact the current convention center hotel used municipal bonds that were backed solely by the revenues of the hotel. That security was deemed too risky for professional investors so AMBAC insurance provided the necessary guarantee. It was good that they did because, if memory serves me, the hotel went into default and AMBAC had to make good on the debt.

Many professional risk takers have now evaporated. Why? Because they took too much risk. Many bond insurance companies that could be relied on to assume the risk are now not credit-worthy. Those that remain, like Warren Buffett's company are only insuring bonds with limited risk like water and sewer, electricity, general government, etc.

A convention center and a hotel are now for the most part deemed too risky for professional investors. They are unwilling to invest because they see the possibility that they may lose all or some of their money. The reason they would lose all or some of their investment is because the project will not produce the necessary revenues to support operations and debt service without some sort of external support. So, in order to be induced to invest in a convention center and hotel, they will require a transfer of the risk from the investor to someone else. The fact that a project like this cannot support itself makes it, by definition, not feasible.

We do lots of things in government that do not pay for themselves - parks, libraries, police, fire - so feasibility is not the final test of whether or not a project gets done. But let's not pretend that something will make money when professional investors in their corner offices in New York, Boston and Chicago have told us otherwise.