Budget Woes

Gail Kerr has a good column today on the challenges Metro faces as we put together FY11's budget. Not that any of this is news. To his credit, the Finance Director issued a similar warning to the Council this past spring which I discussed a bit at the end of this post.

Missing from Gail's analysis is the outcome of the convention center debate. If the convention center is approved, it very likely rules out a property tax increase. We can talk til we are blue in the face about how the revenues for the proposed convention center can only be used for a convention center. In addition to turning blue we will also be lying because many of the taxes (2% of HOT and redirected sales taxes which make up the majority of the earmarked revenues) can and/or are being used for something else. In addition to turning blue and lying we would also be misleading because we can and have changed state law to expand the permitted uses of of these taxes. The most recent example of this sort of change is when we created the Convention Center Authority. In the same bill we also expanded the use of the 1% Tourist Related Activities money to include financing a convention center. We tried and failed to expand the use the 2% Direct Promotion of Tourism to also include financing the convention center. That effort was stopped when someone discovered we would be killing the CVB's funding. None of these facts will matter because regardless of the limitations - real or perceived - of state law, the public will believe that the property tax increase was directly related to the construction of the convention center.

The possibilities for a sales tax increase are equally remote for the same reason. Increasing sales taxes will require a public vote and that day at the ballot box could easily turn into a referendum on the convention center.

The convention center demonstrates an "all-our'eggs-in-one-basket" approach that could turn our other obligations to our employees, our city services, our education system into after-thoughts that become victims of political backlash.

Another Convention Center Report

We had a nice little last minute meeting on the convention center yesterday. This was meant to hear from the "independent" analyst, HVS consulting. The meeting was not as productive as it could have been because the power point was presented in hard copy form just before the meeting. So, all questions had to be developed on the fly. Not a great way to serve the interests of the public but I did my best to wing it.

Here are a few fun facts presented.

1. Nashville is wonderful.
2. A new convention center will improve the level of visitation.
3. On an operating basis, the convention center will lose money.
4. A hotel is critical for the success of the funding streams. Without it we would have to review everything.

We already knew Nashville was a great place. We live here and probably know that better than Mr. Hazinski from HVS.

The convention center will improve visitation but not a lot. In 2003, KPMG did an audit of our existing center. At that time, we had about 170,000 convention and trade show visitors. Mr. Hazinski estimates that after spending $1 billion we will raise that number from 170,000 to 209,000 AFTER 5 YEARS. That is right folks. We will spend $25,000 for each new conventioneer. At least we aren't claiming there will be 1,000,000 new visitors.

No one ever expects a convention center to make money so in some ways, this study is a very modest improvement. The Charles Johnson study indicated that we would make money. That was too much of a stretch so they now say there will be a modest loss AFTER 5 YEARS. Well, Mr. Hazinski was quick to point out that without a parking revenue number provided to him from another consultant whose math he did not verify, the loss would be about $5 million a year AFTER 5 YEARS.

Not in his presentation but part of the Q & A, HVS told us that the new center will generate about 370,000 new room nights AFTER 5 YEARS. That breaks down into about 125,000 to 185,000 new visitors. Mr Hazinski said we currently sell about 8 million room nights in Davidson Co. So, his estimates are that we will improve our visitation numbers by about 4%.

But the magic of convention center consultants never ceases. In the face of this modest 4% increase in room nights attested to by HVS, they are nonetheless suggesting that the $2 convention center fee (a great measure of demand) will increase 20% in the first 5 years. The HOT taxes (a measure of demand and room rates) will increase 45%.

Also of interest is the fact that all forcasting is done after 5 years. Given that the next decade (Gov Bredesen's estimate not mine) will be some of the toughest years for state and local government in a pretty long time, if those 5 years don't go well, we could find that this project makes a bad situation worse.

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.

Goldman's Proposed Financing Structures - Part 1

Yesterday the Vice Mayor sent to the Council two presentations from the October 29th Convention Center Authority meeting. One came from the good people at Goldman Sachs who we have hired to underwrite the bonds for the Convention Center and Hotel.

Let's leave aside the question of why a group of unelected people (save the Vice Mayor) now have more information about possible financing structures than the folks responsible for approving it and look closely at Goldman's information.

There appear to be two approaches. The first approach is traditional tax exempt debt. The second approach is a mixture of tax exempt debt and something called "Build America Bonds." Build America Bonds are issued under a federal program that allows the local government to issue taxable bonds which normally bear an interest rate 30-40% higher than tax-exempt bonds. The federal government then returns to the local government the difference between the typical taxable rate and the tax free rate - or 35% of the interest cost. The federal government does not guarantee the debt nor does it pay for the project.

Whether we use Build America Bonds or traditional tax-exempt debt, the proposed structure looks similar. Goldman is suggesting that there be two types of bonds - let's call them Senior and Junior. Senior will have claim to all revenues earmarked for the project and will get paid before anyone else except for the operations of the building. To review, those revenues are:

• 3% of the 6% County-wide Hotel Occupancy Tax ( about $14 million a year but falling)
• $2.00 County-wide convention center fee (about $9 million a year)
• 1% County-wide rental car fee (about $1 million)
• $2.00 Airport Ground Transportation Tax ($365,000)
• All redirected sales tax from the Tourist Development Zone (your guess is as good as mine)
• All redirected sales taxes from the MCC campus (which definition is likely to include the convention center, the HQ hotel and another hotel - presumably the Renaissance)

Junior will only get paid for his bonds after Senior has his money. Because that puts Junior in a pretty precarious position were the revenues to come up short, Goldman is recommending a general fund pledge. Since state law prohibits the direct use of property taxes and the administration has promised not to use sales taxes, the part of the general fund being targeted are what we call "non-tax revenues."

Non-tax revenues make up about 9% of total revenue for Metro. It is collected from builders and developers in the form of permit fees. From homeowners in the form of alarm registration fees and fines levied for all sorts of stuff. We use the money for general government operations like fire, police, codes, zoning, etc.

Non-tax revenues are also pledged to the Sports Authority for LP Field and a Predator's associated bond issue. So, Junior will only get his money from these revenues after the Sports Authority. For the record, I do not think that the Sports Authority has ever used these non-tax revenues to pay bond holders but we are talking about much smaller amounts of money. Total Sports Authority debt secured by non-tax revenues is, I believe, a little less than $100 million. Goldman estimates that about $128 million will be available for Convention Center debt service.

If I am understanding Goldman's presentation, Senior will require something called 2 times coverage. Coverage is a bond term that refers to how much revenue you have versus how much debt service you pay. So, if your debt service for a year is $12 million, then 2 times coverage means you want to be taking in $24 million a year in revenue. Interestingly, total revenue available from known collections (excluding prospective collections of the TDZ and MCC campus) of tourist related taxes is about $24. Goldman appears to be suggesting that Senior will want 2x coverage today and is assuming no growth in collections over time. If that is the case, senior is only willing to assume risk for the project using numbers he knows today. He isn't going to depend on growth projections or the success of the project.

In some respects, Junior is a bit more of a gambler. He will only want 1 times coverage - meaning the the amount of revenue we collect will be equal to the amount of principle and interest we will pay him. Junior is also ok with using growth projections to get to that 1x coverage. But he isn't stupid. Junior needs a back up plan and that plan is the general fund pledge. So, if the project doesn't turn out like he thinks it will, he will require Metro to dig into the general fund to pay him.

Depending on which approach is used, total principle and interest owed bond holders will be between $39 and $45 million. With only about $24 million in known collections, this means that growth in existing and prospective collections from the TDZ and the MCC will need to be between $15 and $21 million a year . Just to put the MCC sales tax collection number in context, the estimated sales tax collections (7.75%) at the current convention center are estimated at about $800,000 (source: Johnson Consulting). Sales tax collections from the current Renaissance Hotel are estimated at $3.2 million (source: Johnson Consulting).

It appears that the bond issue will be structured to defer retirement of debt from the early years 2013-2015 to the later years, 2016-2043. This deferral will allow more time for those prospective revenues to grow but they are still going to have to move steeply up the curve -almost doubling in 4 years.

Here are a couple things to keep in mind as this proposal unfolds:

WHAT ABOUT THE HOTEL?

If all the existing and prospective taxes are going to pay for the convention center, how will the hotel be funded? At the meeting in September, Goldman all but ruled out private capital. The most skin Marriott/Phelps Portman appears willing to put in the game is about $10 million in "key money." Is the plan to get Nashville pregnant with a convention center so we have to approved a hotel that is supported mostly or entirely by the general fund? That was the plan in Knoxville. Voters caught on and took it to a referendum and won. But the prospective revenues presume a 1,000 room HQ hotel. Who will buy the convention center bonds with such a big missing piece? Or perhaps we should just wait and the hotel financing will be presented at the next convention center authority meeting.

Reserve funds protect bond holders not the city.

In Dallas, the public apparently thought that reserve funds would protect their general fund in case their new hotel project went bad. What no one told them until after the deal was inked is that if a city needs to tap its reserve funds to pay bondholders, there is a requirement that those reserves be replaced - sometimes within 30 days. In Dallas, the replacement money will come from the General Fund.

Capitalized Interest in a neat trick to make sure there are no bad news stories for the first few years.

Capitalized Interest is actually an accepted tool whereby you over-borrow, put the excess in the bank and use it to pay bondholders while the project is being constructed and hence, not making any revenue. One Goldman term sheet I saw, has that over-borrowing paying the bills until 2016. I will let you figure out why they chose 2016.

Revenue projections rarely meet expectations - especially when there is some sort of general fund pledge.

Because there is likely to be a general fund pledge for the majority of this project, the professional bond investors are not going to care what the projections are. They know Nashville's credit is good and they will look to that to pay them if the project hits the skids. So, the projections are really more a political tool than a financing tool. The projections are to make elected officials feel like they can vote for the project because the professionals have assured them everything will be fine. If it turns out everything is not fine, elected officials can then blame the professionals for their poor projections.

Without a general fund pledge, the checks and balances of the market work much better. The professional bond investors would then carefully scrutinize the projections, do their own analysis and decide if the investment was sound.

Finally, as you review the financing always remember what Warren Buffet said: "If you want a really short career became a convention center consultant that recommends against building a convention center."

As always, call me if you have any questions.