Siren call of economic development: A cautionary tale from Vadnais Heights

St. Paul wants a new ballpark. Mankato pines for a civic center and Rochester hopes to expand the one it’s already got. Civic boosters say all these projects will pay for themselves.

But woe betide those who fail to heed the experience of Vadnais Heights, a suburb of some 12,500 souls that sits betwixt Arden Hills and White Bear Lake.  Its involvement in the construction of a sports complex put it on the hook for bond payments it couldn’t meet. And now the town is taking a drubbing from Moody’s and Standard & Poor’s, the two giant bond-rating agencies.

But first, a brief refresher course on municipal finance.

Each year towns and cities petition the state to float bonds to finance civic improvements. If the Legislature says “no,” which it did to the three requests above, local governments have to pay for them on their own.

They have two options. They can increase property taxes or issue bonds, which are repaid from future tax revenues. Because few public officials in the current economic climate dare to boost taxes, municipalities these days opt for bonding.

Usually the money goes for classic public works: schools, roads, bridges and water treatment plants — big items a town needs that it can’t finance in one fell swoop.

Civic centers and sports venues are not exactly necessary public works, however. So instead of issuing tax or general obligation bonds, towns create economic development authorities or other entities, which issue revenue bonds. The income from the civic center or arena goes to pay them off. Twenty, 30 or 40 years down the line, the town will own the thing without ever having spent a dime. (By then, of course, the facility is usually obsolete, but that’s another story.)

One twist

And so it went in Vadnais Heights, except for one twist. The town, according to City Manager Gerry Urban, never had any particular passion to build a sports complex. But in 2009, Mark Bigelbach, a former Vadnais council member, brought the project, along with Community Facilities Partners, a Deephaven nonprofit, to city officials. “They wanted to build a sports complex but they couldn’t get the funding,” says Urban.

Maybe. Everybody seems a little fuzzy on how the deal came about. CFP’s purpose, according to Steve Collins, a marketing and advertising executive and company principal, is to assist towns, colleges, schools and other public entities to build things they want. “We help them assemble the financing, the plans, the architects, the builder and so on.” For its efforts, CFP receives a fee, in this case, says the nonprofit’s counsel, Dan Nelson, $100,000.

Depending on whom you talk to, either the developers or the city’s financial advisers projected that advertising and fees paid by local teams who used the complex would bring in $2.4 million a year, enough to underwrite its operations and make bond payments. In 30 years, the city would own it and pocket any future profits.

So, the town’s economic development authority floated $26 million worth of bonds. The proceeds went to CFP to put up the building. Six months later, in November 2010, a shiny new 200,000-square-foot Vadnais Heights Sports Center opened for business. I haven’t visited, but in photos, it looks pretty spiffy. And it has everything anybody might want in such a building: two regulation hockey rinks, domed soccer fields, batting cages, a 100-meter track, volleyball courts, space for concessions and so on.

Only problem was, revenues were scantier than projected. Obviously, the recession bears some of the blame. But when I asked people what happened, they told conflicting stories, none of which really seemed to explain what happened.

Collins says that Bigelbach, whose company managed the facility, withheld information about accounts. Nelson says that CFP wanted Vadnais Heights to assign management to its parks and recreation department, but the town didn’t want to add to its payroll. An audit concluded that Bigelbach’s company was sloppy. He disputes that any mismanagement or even messiness was involved. In any case, the city fired him a few weeks ago.

Sad fact

Who or what was to blame is at this point irrelevant. The sad fact of the matter is that revenues fell very short. According to a report from Standard & Poor’s, the complex earned only $300,000 in 2011, the first full year of operation. That’s about 20 percent of what’s owed bondholders. Worse, by the terms of the deal, Vadnais Heights is obligated to come up with the remainder.

So the city coughed up $582,000 for its debt service for 2012 and hundreds of thousands more to cover operating expenses. In 2013, Vadnais Heights would owe bondholders $1.6 million, or 36 percent of its 2010 budget. To raise that much money without touching the budget, it would have to hike property taxes by 30 percent. Likely fearing a tar-and-feathering, the City Council voted unanimously to sever its tie to the sports complex and not to pay the revenue bonds.

Only days later, the bond-rating agencies swooped in like avenging angels to smash Vadnais Heights’ credit-worthiness. S & P reduced the rating of the revenue bonds from A- to CC or “highly vulnerable,” a drop of 13steps. (Moody’s didn’t rate those bonds.) That’s understandable since nobody knows if the investors will ever be repaid. But both Moody’s and S & P went the extra mile and downgraded Vadnais Heights’ ordinary general obligation bonds; they went from third best rating to junk status.

Mayor Marc Johannsen did not respond to MinnPost’s requests for comment, but he told Bloomberg News that the credit cuts were “unfair” because the city had always met its obligations.

The city won’t immediately feel the downgrade. Its bonds will simply drop in price enough so that their yields will reflect what the bond-rating agencies believe are their greater risk. The problem comes when Vadnais Heights wants to float new bonds for roads, schools, sewers and other municipal improvements. The interest rate could top 15 percent.

So, all ye supporters of public convention centers, arenas and whatnot — and I’m talking to you too, Vikings fans, with your stadium backed by a dubious stream of electronic pull-tab revenue: beware of municipal projects that supposedly pay for themselves. If something paid for itself, a private business would probably do it.