NOB/Navy Hill: What are “non-recourse” bonds?
This post is part of a series on the NOB/Navy Hill downtown development plan.
Happy new year! Before the holidays, I looked at what Mayor Levar Stoney and Tom Farrell’s NH District group were planning to build in their newly envisioned downtown, from apartments to retail to the shiny new coliseum. This week I’ll turn to the finances for the deal. In other words, how do they expect to pay for all this?
Before we can address that question, though, we should first answer another one: how does the city pay for anything?
Cities and other local governments MUST balance their budgets every year; unlike the federal government, they can’t just run a deficit. (As you may have heard, the feds have a bit of a problem with debt.) So they take in revenue – mostly from property taxes – and use that revenue to fund parks, garbage pickup, interminably long City Council meetings, etc.
But what if the city needs to do something BIG? They might want to buy a new fire truck or parks vehicle, or construct a new school building. You don’t want the budget to blow up one year to pay for it, and then go back down the next. Americans complain enough about taxes; imagine if their local tax rate jumped up and down every year like a roller coaster.
So for “big” purchases like these, cities CAN borrow money. (Local borrowing is actually a lot more complicated and wonky, but let’s just say it’s for these purposes alone.) Cities borrow in much the same way anyone does: city officials go to a bank and ask for a loan. This loan is called a municipal bond, or “muni” for short. Almost all cities and counties use these bonds to fund their big “capital” expenses, and include paying back a certain amount of debt each year in their regular budget.
(If you’re lucky enough to have 401k or investment money, you may have some money invested in “the bond market.” So banks might be using your money to lend to cities to buy garbage trucks. Good for you!)
The bottom line: just like a mortgage or auto loan allows individuals and families to afford a car or house without having to pay for it all up front, bonds enable cities to fund similarly big purchases. Bonds are basically how we can have nice things.
Which brings us back to the NOB/Navy Hill project, which wants to bring a LOT of nice things to downtown, including a new coliseum. The project plan requires the city borrow a LOT of money – over $600M, once you include all the interest we would need to pay back – to fund construction of the new arena, regrading Leigh Street, upgrading the Blues Armory, and other improvements. The city of course would use bonds to pay for this stuff. But it would then use the new tax revenue from a designated “TIF district” (more on this next time) to pay back the loan over the next 2-3 decades.
A big concern raised by opponents of the plan is the risk involved. What if construction, public or private, is slower than projected or even stalls? What if the arena doesn’t bring in as much economic development on surrounding blocks as promised? Basically, what if the project doesn’t generate enough “new” money to pay for the project – won’t city taxpayers be on the hook to make up the difference?
Not to worry, says the Mayor and developers: we will use something called “non-recourse” revenue bonds. Normally if you fail to pay back a loan, the bank can claim some kind of “collateral” to make up for their lost money. (If you fail to pay back your auto loan, the bank will take their collateral - your car - away.) But the bonds in this coliseum project would be backed only by the new tax revenue from downtown, and not by any other city property or revenues. So if the promised tax revenue doesn’t materialize, the bank has no “recourse,” or additional source of funds; the city won’t have to use other money to pay back the bond. As the Mayor said when he announced the deal last year, “The developers and bond holders will shoulder 100 percent of the risk for this project, and not the city.”
Sounds great, right? Well two problems, and big ones, with this “no risk” idea.
First, “non-recourse” bonds just mean the lenders can’t demand their money back from the city. But there still could be significant consequences for the city in terms of normal borrowing for fire trucks and schools. As one expert told Style Weekly’s Jason Roop last October, defaulting on a Navy Hill loan could hurt the city’s credit rating: “The rating agencies are not going to like that.” Why would lenders want to give money to a city that just failed to pay back a huge loan? It might be harder, or at least more expensive in terms of interest rates, for the city to borrow in the future.
But, this expert also noted, municipal bonds rarely default. “What often happens is, the city finds other ways to subsidize the project so the revenue bonds don't default.” There certainly would be tremendous pressure on the city to find other money to pay back the loan, to avoid default on such a high-profile project or even just to keep construction going.
But there is a second and bigger challenge to the project’s financing: the whole structure may not be exactly legal.
The state has laws that govern how cities can borrow and repay bond loans. As Jeremey Lazarus recently reported in the Richmond Free Press, the Virginia Public Finance Act basically prevents cities from doing what this project proposes – using property tax revenue to pay back a non-recourse bond.
This doesn’t make the project impossible. But it does mean the city has to set up a complicated financial structure where banks lend money NOT to the city government, but to the city’s Economic Development Authority, a quasi-governmental agency that would administer the loan. Such an arrangement might require an approval vote of property owners in the downtown area; may actually require backing by the city (directly contradicting the “no risk” claims); and would certainly require approval by 7 of the 9 City Council members, which might be hard to achieve with all of the questions surrounding the project.
And that’s if the arrangement is even legal. Such a large and complicated financial arrangement is possibly unprecedented in Virginia. A somewhat similar arrangement was used for construction of the Short Pump Town Center, and was challenged in court with an ambiguous conclusion. Similar court challenges could halt the whole financing scheme in its tracks.
[H/t to Jeremy Lazarus, Jason Roop, and Justin Griffin’s discussion on Facebook about all this complicated financial stuff.]
You don’t need to be a tax attorney to recognize that the financing for this project is way more complicated than the Mayor and developers claim. But as many observers have noted, maybe the reason why we haven’t yet seen an official project plan from the Mayor is that he, and the developers, are still trying to figure out a way to pay for it.
Next up: the TIF district explained. (There may be pictures.)