Reno’s bond rating at risk
The city of Reno temporarily dodged an economic bullet this month when an Irish bank granted forbearance of payments on a $7 billion bond issued to fund a downtown parking garage.
When the city issued the bond in July 2007, few people were expecting the economic meltdown that was coming in 2008, according to Reno Deputy City Attorney Jonathan Shipman.
At the time, Fitzgerald’s casino owner and developer Fernando Leal was moving forward with the resurrection of the Golden Phoenix hotel-casino and the Montage condominium project and saw a ready market for the Fitzgerald’s parking garage on the corner of Center and Commercial streets, Shipman said.
The city acquired the land where the garage stands, and several other parcels, as part of its deal with Union Pacific Railroad to build the railroad trench though downtown. The bonds were used to build the garage, which the city leased to Leal for $38,000 a month. That revenue, over the 20-year life of the bond, would be used to retire the debt, officials projected.
Dublin-based Depfa bank purchased the bonds in 2007, just before the world eco0nomy plunged into recession. Fitzgerald’s Casino closed its doors in 2008, the Phoenix didn’t rise from the ashes and sales of the Montage’s condominiums are slow.
“If you had the condominiums and the people downtown that people were thinking would be coming downtown, then you would need that parking,” Shipman said. “It’s typical of a lot of cities across the United States that the developers came in to build condos, and then the economy turned, and the demand isn’t there anymore.”
As a result, Shipman said, the city now owns a parking structure for which there is no demand. Fitzgerald’s stopped making lease payments on the parking garage in October 2009, which was sufficient to trigger a default with Depfa Bank. However, Depfa granted the city forbearance in April, which expired in September.
In August, bond-rating agency Standard & Poor’s downgraded the city’s credit rating to A on its CreditWatch, which it said carried negative implications. Bond ratings vary from AAA (the best investment) to D (don’t touch these) so an A rating is just in the ball park as a good bet.
“The CreditWatch action reflects our view of the potential strain on the city’s general fund related to city’s previously issued series of taxable Fitzgerald lease revenue bonds, series 2007, which are unrated by Standard & Poor’s,” concluded S&P’s credit analyst Bryan Moore in a written statement.
Bonds are the way public entities raise money to finance large projects. They come in a variety of shapes and sizes: general fund obligation bonds are paid for from a general fund, revenue bonds are paid for only through revenue generated by the object of the bond, STAR bonds are paid for through sales tax anticipation, and so on.
The Fitzgerald bonds are revenue bonds whose revenue has dried up. Luckily for the city, they are also variable interest rate bonds. When the bonds were offered, an interest rate of 5.75 percent was assumed, but when the economy tanked, the interest rate fell to just 1 percent.
The differential has resulted in an unexpected windfall of $480,000 in the revenue fund that is being used to pay debt service ever since Fitzgerald’s closed the parking garage. In addition, the city has a reserve fund of $775,000 on deposit with Depfa leaving an outstanding balance of $6 million.
“Currently, we believe the ability or willingness of the city to honor its debt obligations is uncertain,” Standard and Poor’s concluded. “We believe that the city’s negative movement of general fund reserves, should they decline significantly as a result of resolving the series 2007 Fitzgerald lease revenue bonds obligation, could lead to downward pressure on the general obligation bonds.”
On Dec. 8, Depfa—taken over by Deutsche Bank after Depfa became insolvent—granted the city another forbearance with conditions. First the city had to deposit $154,150 into the bond’s revenue fund, over and above its regular debt service. The city transferred that amount from its Stabilization Fund. Second, the city has 90 days to either sell the property to Fitzgerald’s or find a new party to whom it can either sell or lease the property.
Shipman was part of the team that negotiated this new agreement, which is to last until Sept. 16, 2011. He said revenue bonds have a limited liability in that, if revenue falls short of projections, the bank can’t go after money from the general fund. Still, the money being paid to appease Depfa is coming from non-revenue sources.
Shipman says the city has some options, but none appear very appealing. It is unlikely Leal, who owes $500,000 in back rent, will want to reopen the garage and, given the lack of demand for parking, it is unlikely anyone else will want to assume the lease, either of which would help the city recoup its losses.
With $6 million outstanding, Shipman said the property is probably worth less than $2.5 million, leaving the city on the hook for the balance. But, although the price is right and the location is good, finding a buyer in today’s market is problematical.
“You could probably pull up in any city across the nation and there’s probably 10 deals like the Fitzgerald’s, but the problem is the economy,” Shipman said.
While the city tries to resolve the Fitzgerald’s issue, it is selling other parcels obtained from Union Pacific to raise money to help settle its debt with Depfa. Reno has many other bonds in play, and a negative rating from defaulting on this bond would be very bad for its credit rating.
Standard & Poor’s maintains that municipal bonds are among the safest investments, with only 18 bonds ever going into default. But according to Wall Street analyst Meredith Whitney, the municipal bond market is poised to collapse in much the same way as the housing market.
“It has tentacles as wide as anything I’ve seen,” Whitney told 60 Minutes on Sunday. “I think, next to housing, this is the single most important issue in the United States, and certainly the largest threat to the U.S. economy.”
Whitney said she expects to see 100 or more sizable defaults of municipal bonds over the next 12 months as federal economic stimulus money goes away, which could lead to another recession, or at least another government bailout. However, where that money would come from is anyone’s guess.