The Balsams Risk Anaylsis

Editor's Note: The following is a risk analysis submitted tot he BFA for the Balsams project. See story by Erika Cohen.

The purpose of this memo is to explain and quantity the risk to the BFA and State of the proposed $28 million Balsams guarantee.

Background – The proposed Balsams project involves the acquisition and redevelopment of the historic Balsams to include resort style amenities and 228 for sale residential condominiums (420 beds) that will be sold as “time shares”. Total project cost is $143 million - $45 million in equity, $50 million in for sale asset construction debt, and $48 million amenity asset construction and redevelopment debt. The State, through the BFA, is being asked to guarantee $28 million of the debt.

All project financing, both the loans and the equity, must close before the commencement of construction, and the resort, or amenity, facilities and for sale housing will be built concurrently.

Guaranteed Loan Repayment and Structure – The proposed structure for the $28 million of State guaranteed financing is a bond that would be issued by the BFA for the developer, Dixville Capital, and guaranteed by the State. The bond would be secured by a co-first mortgage on the resort assets (with the other $20 million of amenity debt) and be repaid by an assessment on all the resort property. Like in a tax increment finance district or a special assessment district, property in the district would be assessed to pay their portion of the annual bond payments. The BFA would have the remedies available to municipalities for non-payment of property taxes, including the ability to lien individual properties for non-payment.

Nature of Risk – Development projects such as this involve several types of risk: financing risk, construction risk, sales risk, and operational risk. Since all the project financing must close concurrently before construction begins, there should be minimal financing risk.

 Construction risk includes cost over-runs and contractor failure. These risks can be mitigated by the bank having a third-party review the cost estimates and plans beforehand, requiring firm bids for the work, carefully monitoring construction progress, requiring the use of reputable contractors.

Sales risk is the risk that the developer will be unable to sell the timeshare units. This is fully the bank’s risk since they are providing this financing, and they are mitigating the risk by requiring the developer to have unconditional presales of $25 million prior to loan closing.

Finally, operational risk is the risk that the completed resort will not make enough money to service its debt. This could be the result of costs being higher than projected, occupancy and room rates being significantly below projections, or some combination of these factors. The bank is trying to mitigate this risk by having a hospitality consulting and appraisal company review the resorts projections.

State/BFA Exposure – I have attempted to quantify the risk to the State/BFA of a foreclosure on the attached spreadsheet. There are 2 scenarios outlined: the resort initially just meets the BFA’s 80% loan-to-value requirement and the resort initially has a 50% LTV, per the bank’s initial commitment letter. The proposed bond would be structured as interest-only for 3 years so the first principal payment would not be due until the second half of 2019. Since the developer will start out with some initial working capital, the project should operate successfully through at least 2020. The risk is in the ensuing 3 or 4 years, when the debt will not have amortized very much (17 years proposed for bond).

Absent any information on the forced liquidation value of a resort such as this (this should be in the final appraisal), I have developed 3 scenarios, with the State/BFA recovering variously 1/3, ½ and 2/3 of the initial appraised value. Using these assumptions, the total net State/BFA exposure would be as much as $7 million to $13.5 million. This sum would have to be paid to the bank within 30 days of sale of the resort.

It should be noted that even in a foreclosure situation, the assessment district would remain, and any subsequent owner of the resort, as well as the existing unit owners, would have to keep paying assessments until the balance of the bond was paid off. For example, if someone were to buy the resort at foreclosure in 2021 for $20 million, the $13.54 million bond balance would still be recovered from assessment district payments. The payment schedule would have to be adjusted to reflect the smaller loan balance and the decreased property values, but the State/BFA would eventually recover its money.

State/BFA Sharing of Risk -  The proposed guarantee of the $28 million bond would be the largest guarantee of private debt in BFA history. The previous record was an $8 million guarantee of a $10 million loan to Gorham Paper & Tissue. At the time of the Gorham guarantee, the BFA immediately reserved $1,600,000, or 20% of the guarantee exposure, because of the size and risk of the guarantee. The Gorham project involved the retention of 200 high-paying jobs, so the BFA exposure was $40,000/job.

The BFA currently has a net position (or equity) of $21.5 million. Conventional bank lending guidelines are that a loan should not exceed 15% of equity, or $3.23 million. Given the public purpose of the BFA, and the strength of its existing reserves, it would not be imprudent for the BFA to go to 30%, or $6.5 million. This would be in line with the net exposure of the Gorham guarantee.

Should the BFA Board decide to recommend the guarantee of the $28 million bond for the Balsams redevelopment project, it will need to be clearly communicated to the Executive Council that the BFA is in a position to cover the first $6.5 million of any loss; the balance would have to come from the State.