To Avoid a ‘Catastrophic Situation,’ East Lansing Refinances the DDA’s Debt (Again)

Almost 14 years after East Lansing’s Downtown Development Authority (DDA) acquired $5.6 million in debt to buy the Evergreen Avenue properties to support a big redevelopment deal with Scott Chappelle – a deal that never came to fruition – that debt has finally been refinanced to a fixed rate.

City Council voted to authorize the refinancing to a fixed rate on Dec. 6, 2022. The refinancing closed on March 1, with a signature from Mayor Ron Bacon on behalf of the city.

The DDA, which uses public funds to pay its obligations, will now be paying a 4.86% fixed rate on bonds issued to pay off the long-standing debt.

If the DDA doesn’t pay off the debt earlier than the loan is now set to end, in 2035, it will have paid a total of almost $4 million in interest and fees for that $5.6 million it borrowed back in 2009.

Without this refinance, the DDA risked financial “catastrophe,” according to the city’s financial adviser.

The bonds that just closed refinanced bonds taken out in 2015. Those bonds refinanced debt taken out in 2009. The 2015 bonds were variable rate and structured in such a way as to create a ticking time bomb that would go off in April 2025.

The variable rate on the 2015 bonds was calculated using an index plus a margin (a percentage rate added on top of the index rate). Originally, the index used was LIBOR, the London Interbank Offered Rate, which Forbes has described as “a key benchmark for setting the interest rates charged on adjustable-rate loans, mortgages and corporate debt.”

When LIBOR was phased out, the DDA’s bonds’ index was switched to SOFR, the Secured Overnight Financing Rate. “SOFR is the main replacement for Libor in the United States,” according to Forbes. “This benchmark is based on the rates U.S. financial institutions pay each other for overnight loans.”

One problem with the previous bonds having a variable rate of interest was that it made the debt’s costs to the DDA unpredictable. But the bigger problem was that the 2015 bonds were written in such a way that the interest would go up by an extra 3% in 2025. It would go from the current rate of SOFR plus a 1.4% margin to SOFR plus 4.35%.

When the City of East Lansing’s financial adviser Steven Burke, president of Municipal Financial Consultants Inc. (MFCI), spoke to Council about this situation on Dec. 6, he explained that with the margin increase that would occur in 2025, the DDA would be paying 8.405% if current rates hold. If interest rates were even higher in 2025, the cost of the obligation would be even more.

Burke came back to Council this week to answer questions about how the authorized fixed-rate refinancing turned out, and he said there were three reasons the debt had to be refinanced now.

“The number one issue,” Burke said, was avoiding “a catastrophic situation where the DDA could no longer make the debt service payments because the interest rate rose so high.”

The taxpayers of the City of East Lansing are on the hook for the DDA’s debts. If the DDA couldn’t make its payments, the City would have to find the money to meet the DDA’s obligations. And the City has its own financial challenges.

The second reason Burke gave for the need to refinance now was “for the DDA to get budgetary clarity so they would know what their debt service would be going forward each year.”

Converting from the variable rate to the fixed rate makes the payments stable and predictable.

The third reason was to save money. Based on a comparison of the current SOFR rate and the fixed rate obtained in the refinance that just closed, Burke estimates the DDA will save $883,000 in interest, assuming the DDA takes the full term to pay off the debt.

Without this refinance, the DDA could ultimately have paid upwards of $5 million in interest and fees on an original debt of $5.6 million. As it is, it will be only about $4 million if the debt isn’t paid off until 2035. (If paid off sooner, less money will be spent on interest.)

The intention of the refinance had been to get the lowest rate possible but also try to obtain a loan that would allow the DDA to pay off the full loan as soon as one year from the start of the loan.

But Webster Bank, the bank that provided the refinance, insisted on a three-year “call.” That means the earliest the loan can be paid off is April 1, 2026.

City Attorney Tony Chubb told Council this week that there’s no way the DDA will have the money to pay off the debt in less than three years anyway. Even if the DDA sold the Evergreen Avenue properties, it would be unlikely to obtain more than $2 million, because the land is now worth nowhere near what the DDA paid for it.

“The DDA currently has around $600,000 to $800,000 in its reserve,” Chubb said, “and it only pulls about $1.5 million a year [in taxes], so in a year, absent a tremendous cash infusion from the City, it would never have the money to pay off the bond.”

After Council authorized the refinance in December, Burke sought bids from banks, got nine offers from five banks, talked with City staff and settled on going with Webster, which offered the lowest rate with a three-year call.

Burke told Council this week, “In consultation with the mayor, we discussed it, and [we discussed] the best financial situation for the city going forward, given the uncertainty of this [Evergreen Avenue] property selling in the very near future and the amount that that property would bring.”

If the DDA does sell the property soon, Burke said, the DDA could invest the proceeds in U.S. Treasury bonds and earn interest roughly equivalent to what it will be paying on the debt.

This debt, first created in 2009, has now been restructured four times.

Those four restructurings took place in 2012, 2015, 2018-2019, and 2023. Every time the debt was restructured, fees were paid, typically being rolled into the new debt.

In the case of the refinance that closed early this month, the fees were relatively low. Burke’s company was paid $19,348 for being the city’s municipal adviser. Roger Swets of Dickinson Wright was paid $22,175 as bond counsel (attorney).

By comparison, when the 2015 bonds closed, Robert W. Baird & Co. was paid $29,500 as a placement agent ($6,000 more than Burke was paid this year), and Miller Canfield was paid $46,000 as bond counsel (over twice what Swets was paid this year). Costs have been saved since Councilmember George Brookover has insisted on bidding out for more city services, including for municipal financial advice and bond counsel.

Another difference between the 2015 and 2023 bonds is that, in 2015, Baird wasn’t working for the city as its financial adviser. Baird was working effectively as a broker for the bonds.

Paperwork from the 2015 bonds, obtained through the Freedom of Information Act, show that Baird “seeks to serve as an underwriter (or placement agent)…and not as a financial advisor or municipal advisor.” That was the deal that led to the variable rate with the big margin increase set for 2023.

By contrast, Burke was hired and paid specifically to attend to the city’s best interests.

The DDA is set to meet tomorrow (Thursday, March 23) at noon for its regular monthly meeting, and the published agenda shows plans to discuss the DDA’s finances.

At the last meeting, on Feb. 23, the DDA engaged in an unusual big-picture discussion of how to handle its finances. The Board discussed how to rework the DDA’s financial and legal standing to give the DDA more decision-making power than it currently enjoys.

In the protracted exchange, DDA board member Luke Hackney floated the idea of the DDA consciously working to pay off the Evergreen debt as soon as possible, to minimize further spending of public money on interest. At that time, the rest of the DDA did not engage with Hackney’s idea.