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Failed Cleveland TIF on Hot Seat

AUG 17, 2010 8:01pm ET
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CHICAGO — The looming foreclosure on a downtown Cleveland landmark could have implications for tax increment financing debt sold for the project and TIF-backed borrowings across the state and nationally, say some Ohio bond attorneys.

A Cuyahoga County judge recently issued a foreclosure decree on the Old Arcade shopping center and Hyatt hotel property after the owner missed mortgage and debt service payments on $6 million of outstanding TIF debt.

As part of the case, the bond trustee, U.S. Bank NA, has argued that a future owner should be required to continue to make debt payments under the original TIF financing agreement.

The original agreement features a key additional security — minimum service payments tied to a mortgage — that ensure TIF payments are sufficient to cover debt service regardless of the property's valuation.

"This will have serious economic repercussions beyond this case," attorney James Grove of Cleveland-based Nicola, Gudbranson and Cooper LLC wrote in a court filing on behalf of U.S. Bank.

Such additional security features are playing an increasingly important role for bondholders of TIF-backed debt. Declining real-estate valuations could mean TIF payments are insufficient to meet debt service payments.

So-called naked TIF financings, those with no additional security, pose greater risk that bondholders could lose their investment as payments decline along with the tax rate, said market experts.

"Depending on how the judge rules, it could have an effect on TIF financings across Ohio and nationally," said a local bond attorney who works on TIF transactions.

"The concern from a bondholder's standpoint is the basis for how a stressed asset is handled in a foreclosure case," the attorney said. "If a judge sets aside the obligation for the property owner to make those minimum service payments going forward, it would cast a very large shadow over the use of that tool as a financing security technique, and could have a significant limiting effect on the abilty to use TIF revenue bonds in the future with that sort of security feature."

Private developer Arade LLC, made up of a Chicago developer and Hyatt Corp., in 1999 launched the $62 million Arcade project to develop the historic landmark into a hotel and indoor shopping center. Cuyahoga County, acting as a conduit issuer, in 2000 sold $7 million of taxable industrial development revenue bonds on behalf of the developer.

The debt was privately placed through Griffin, Kubik, Stephens & Thompson Inc. The bonds carry insurance from Asset Guaranty, which a county official said has covered recent debt payments. Radian Group Inc., parent of Radian Asset Insurance Inc., acquired Asset Guaranty in 2001.

Thomson Hine LLP was bond counsel on the original transaction, and now represents Arcade and Hyatt Corp. in the foreclosure case.

The project included $3 million in loans from Cleveland and Cuyahoga County. The county has all but given up on seeing a return on its loan, said James Herron, chief development officer for the Community and Economic Development Division.

"That's commercial lending in the United States in 2010," Herron said "It's a beautiful building, and a civic investment, and we're going to move on."

Herron noted that the hotel — which is expected to remain open — is located just blocks from a new long-planned $450 million medical mart and convention center that is set to break ground next year.

Despite the bond insurance and additional minimum service payment security, bond documents for the TIF debt warn investors of uncertain returns in the case of foreclosure or bankrupty.

"Exactly what they were warning in the bond disclosure is coming to fruition in this case," said the bond attorney. "That's what we're seeing play out here."

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