First published in The Record on Sept. 29, 2013

Wall Street “Big Boys” weigh the risks At America’s biggest Construction job

James Colby is what’s known on Wall Street as a “big boy,” a sophisticated investor who manages at least $100 million and is willing to certify to federal securities regulators that he understands risky and complex financing plans well enough to bet large sums of other people’s money on them.

That potentially makes him very important to the future of the proposed American Dream entertainment and retail complex — specifically the plan to tap as much as $800 million in public bonds to help the private developer Triple Five finance its resurrection of the Meadowlands project once known as Xanadu.

Colby is one of a relatively small number of high-powered investors who specialize in the sort of financing envisioned for American Dream — high-yield municipal bonds, which combine more risk than traditional government bonds with higher returns. He and his counterparts will have a lot to say about the fate of Triple Five’s plan to transform the empty white elephant that looms over the Meadowlands into a year-round shopping and entertainment destination. They ultimately are in control of how much capital is raised and at what cost.

More than a dozen high-yield municipal bond buyers and analysts interviewed for this article said there could very well be significant investor interest in the American Dream bonds. But they all expressed concern about the size of the offering and some wondered whether the promised return would be high enough to sufficiently attract investors.

Colby, for one, thinks $800 million is a lot of money in a market niche that has been shrinking recently.

“There’s no doubt the market has been weak,” said Colby, portfolio manager and senior municipal strategist at the investment firm Van Eck Global, whose clients include pension funds and other institutional investors. “They’ll have to do a very good selling job of convincing buyers.”

Those concerns underscore a decision made early on in the process by Triple Five and the public officials who have been working with them. Though issued by a public entity and offering tax-free returns, the bonds envisioned would come without government guarantees, backed instead only by the revenues generated by the project itself. That decision inoculates the public from exposure in the case of a default, but adds hundreds of millions of dollars to the cost of the project — money that otherwise would go to pay state and local taxes.

State officials made it clear from the beginning that Triple Five, unlike the previous developers for the project, would be able to count on government help in obtaining financing — so long as that didn’t expose the public to any risk.

Led by Governor Christie, they have touted American Dream for the economic benefits it will generate, including the thousands of construction and permanent jobs it will create.

Triple Five — the owner of the nation’s largest mall, the Mall of America in Minnesota — says American Dream will bring a regional shopping and entertainment mecca to Bergen County, as well as a stop for international tourists.

The company says it will spend $1.8 billion on American Dream — to complete the interior and remodel the controversial façade of the existing 2.3-million-square-foot structure, and to add a 639,000-square-foot indoor water and amusement park.

In addition to the public financing, it says it will spend $200 million of its own money and find private financing to cover the rest of the cost.

Since unveiling the American Dream plan in 2011, the company has secured the land-use and environmental permits it needs. But the effort to secure the public component of its financing plan has dragged on.

Triple Five spokesman Alan Marcus had no comment for this article. “It would be premature to comment until the financial structure of the deal is complete,” he said Friday.

Few offerings bigger

In Wall Street’s high-yield bond market, American Dream is shaping up as a big deal. In early September, the Bergen County Improvement Authority tentatively agreed to sell up to $800 million in tax-free, high-yield municipal bonds to help Triple Five get American Dream up and operating.

Only a handful of such offerings have ever been larger, said Triet M. Nguyen, managing partner of bond counsel firm Axios Advisors. The majority of issuances in the high-yield market range between $10 million and $150 million, bond experts said.

“Eight hundred million is large for the municipal bond world,” said Robert Slavin, a staff writer at Bond Buyer, an industry publication.

The complicated public financing plan also involves the state Economic Development Authority and the borough of East Rutherford; all three entities must formally sign off on the plan before the bonds would be offered for sale.

The $800 million is a cap, and the final offering would likely be somewhat lower. In a scenario included in the BCIA-approved plan, the bonds offered for sale would total $738.5 million — $484 million issued in the name of East Rutherford, which would forgo future property tax payments that would be used instead to pay off the bonds, and $254.5 million via an agreement with the EDA to redirect sales taxes and other state taxes generated on the project to bondholders.

Triple Five and its backers say the tax breaks don’t represent a public cost because they never would have been generated in the first place had the state and East Rutherford not agreed to help finance the project.

Even $738.5 million would qualify as a very big deal, the experts say.

“Wow,” said Bob Donahue, managing director of Municipal Market Advisors, a New York company that advises individual and institutional bond buyers. “That certainly is one of the larger deals ever in the high-yield market.”

These will not be boring, vanilla municipal bonds, experts agree. A traditional municipal bond might raise, say, $1 million to pave a town’s streets and it is backed by the credit of the issuing government. Most are “general obligation” bonds, which means if the town fails to repay, taxpayers are on the hook.

Because such bonds are backed by significant collateral — the taxing power of the government — they are among the safest investments on the market. But they also pay relatively low interest. The going rate on traditional municipal bonds is currently about 3 percent, said Herman R. Charbonneau, manager of public finance at Roosevelt & Cross, a Manhattan-based bond broker.

American Dream’s bonds will involve significantly more risk. They are “revenue” bonds, which means investors are repaid only with revenue generated by the project itself. They are also “non-recourse,” meaning that if American Dream defaults, investors cannot seek repayment from the issuing government bodies — in this case East Rutherford or the BCIA.

If American Dream fails, the only option for investors is to try to win some redress from the project itself.

“If it’s specifically stated as non-recourse, then it’s buyer beware,” said David B. Thompson, CEO of Phoenix Advisors, a bond-counsel firm based in Bordentown. “If the project goes under, you’re out of luck as an investor. You cannot go after the public entities.”

High yield, high risk

Far from being repelled by such bonds, some investors embrace the risk because it brings higher returns. Investors currently demand 6 or 7 percent for high-yield bonds, Charbonneau said, somewhat higher than the rates laid out in the American Dream plan reviewed by the BCIA.

“These bonds attract investors who are willing to take on greater risk in return for greater yield,” Donahue said

Another major advantage: IRS rules allow bonds like those proposed for American Dream to be tax-free, a designation that significantly increases the effective return for wealthy investors.

In addition to extensive research performed by investors, the bonds will be reviewed by teams of experts hired by East Rutherford, the county, the EDA and the state Local Finance Board, providing an added layer of scrutiny.

“It’s a very specialized product and you really do need to have a top-notch research team to analyze all this stuff,” said Nguyen, who’s also the author of a recent book on investing in the high-yield market.

The result is that American Dream bonds could fill an attractive niche for investors, combining high returns with tax-free status.

“I get a lot of safety and extra yield, and I don’t have to pay taxes?” Donahue said. “I’m in.”

Finally, the American Dream bond offering may be attractive to investors because it is very big. The high-yield municipal bond market is highly centralized. Just a handful of large firms control the lion’s share of such bonds, Nguyen said, and those bonds are highly concentrated in a small number of sectors including Puerto Rico’s debt and state tobacco settlement bonds.

An offering of this scale would allow fund managers to diversify their holdings into a new sector. And the sheer volume of American Dream bonds increases the likelihood they could be traded on the secondary market, further increasing their value.

“There is a certain preference for the nine-figure deal, because a larger offering means there will be more buyers,” said William C. Rhodes, a partner at Ballard Spahr, a bond counsel firm.

Bond market is down

But there’s a downside to the jumbo size of the American Dream bonding plan, the financial experts said, especially now. The total value of the high-yield municipal bond market dropped from $46 billion in May to $35 billion in September — a 28 percent decline, according to data supplied by Bond Buyer, the trade publication. Amid concerns about the possibility that the Federal Reserve might raise interest rates, Detroit’s bankruptcy and Puerto Rico’s economic crisis, many investors sold their high-yield bonds in search of either greater safety or higher returns.

“There have been fairly large-scale redemptions” in recent months, Charbonneau said. “Their appetite for buying bonds has shrunk.”

If enough buyers cannot be found, the bond offering could be derailed, several analysts said.

“I would ask myself is there capacity in the high-yield market to purchase such a large speculative bond,” said Donahue.

“It is a substantial deal size, particularly in this environment,” said Nguyen, who noted that the market tends to be volative and could rebound in the near future. “The bond market is in disarray.”

In addition, the fact that the revenue needed to repay the bonds is based largely on retail sales at a new mega-mall will not necessarily put investors at ease.

“It’s hard to underwrite revenue in that case because you can’t underwrite economic cycles,” said Randel Beamon, senior credit analyst at Kemper Corp. who, like Colby, was interviewed at a recent conference of high-yield municipal bond investors in Old Greenwich, Conn. “They can make an argument, but it’s still hard to know which way the economy will go.”

Other bond buyers questioned whether the interest rates incorporated in the preliminary Triple Five proposal reviewed by the BCIA are overly optimistic. It calls for a private placement in which Goldman Sachs, the Wall Street investment bank, will sell the bonds to a small group of pre-arranged buyers at interest rates of 5.5 and 5.7 percent on the two types of bonds, according to the proposal filed with the county.

That’s below going rates, which currently range between 6 and 7 percent for such risky unsecured debt, Charbonneau said.

“For them to talk about 5.5 or 5.7 percent, that seems to be uncharacteristically low,” he said.

Finally, there is the baggage of Xanadu and the fact that it failed twice under the stewardship of two other developers — before Triple Five took over and put forth the American Dream plan.

“It doesn’t preclude anyone from doing the deal,” Rhodes said of Xanadu’s track record. “It would have to put everyone’s antenna up just an inch higher.”

How will all these questions get answered? Carefully and slowly, bond buyers and analysts said. The maximum amount Triple Five can seek to borrow will be based on projections of how much American Dream will be worth each year over the life of the bonds, which in the case of the East Rutherford component stretches for more than 30 years. To account for annual fluctuations in American Dream’s performance, that figure will be cut by roughly 20 percent, providing a cushion in case the project falls short of those projections.

Next, Goldman Sachs will offer the bonds for sale with a given interest rate. If buyer demand is high, the rate could be dropped, reducing the cost of interest and allowing Triple Five to borrow more money. On the other hand, buyers may decide the project is too risky and demand a higher interest rate, reducing the amount available to Triple Five.

Either way, the final bond totals and interest rates won’t be decided until the week the bonds go on sale.

“The wiggling takes place in slow motion in the days immediately preceding the final contract,” Charbonneau said.

A representative of Goldman Sachs declined to comment.

Borough has a say

Before Wall Street investors get a chance to weigh in, the bonding plan must be vetted and secure a formal signoff from officials in East Rutherford, the EDA and the BCIA, as well as the state Local Finance Board. The timeframe for those approvals is unclear.

Because the American Dream site falls within its borders, East Rutherford figures prominently in the deal; the lion’s share of redirected tax money to repay borrowers would come from the payments in lieu of taxes, or PILOTs, it would share with Triple Five.

“We’re the people who own the PILOT,” said East Rutherford Mayor James Cassella, “so the only way they can do it is through us.”

That makes some elected officials and residents of East Rutherford very nervous.

“It’s going to put East Rutherford taxpayers in jeopardy,” said Edward Ravettine, a Borough Council member.

That would be true in a normal bond sale, experts say. But when it comes to high-yield, non-recourse bonds, such rules do not apply. The deal will attract a small subset of investors known as “qualified institutional buyers.” Each must sign a representation letter, colloquially known on Wall Street as a “big boy” letter, certifying to the federal Securities and Exchange Commission that he manages significant amounts of capital and understand the risks.

Should the project fail, those letters insulate East Rutherford from lawsuits, bond experts said.

“That’s why they sign it,” Donahue said. “It says they can’t sue and claim, ‘You didn’t inform me that these bonds are risky.’ It proves they all know upfront.”

That’s especially important to the elected officials who must agree to the deal.

“No risk, no cost, or no deal,” Casella said at a recent Borough Council meeting.

Beyond that, there is concern in East Rutherford that the financing plan represents an unfairly generous tax break for Triple Five. Under the previous financing deal for Xanadu, the developers agreed to pay East Rutherford between $1.85 million and $9.85 million per year, for a total of $164 million in the first 20 years.

The deal laid out in the BCIA documents gives East Rutherford far less. Triple 5 plans to pay the borough between $500,000 and $750,000 annually, for a total of $11 million during the first 20 years of the project, according to the company’s public-financing application. Those amounts could rise or fall every year based on an annual reappraisal of the property, said Robert Tuteur of the Blank Rome law firm, who is serving as bond counsel for the county improvement authority.

East Rutherford will not accept such a figure, Cassella said during a recent council meeting.

“If those numbers are correct, we’re not signing it,” he said, describing his negotiations with Triple Five. “There’s a lot more money on the table.”

At the state level, the EDA “has requested all kinds of information from the developer,” Tuteur said. “They are another set of eyes.”

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