There is an intricate 30-year City plan to procure a $ 120MM new high school. It is risky because there are so many steps in the plan and each step has risk. The risks have been identified and there are mitigation plans to help keep each risk from occurring, but there is little or no contingency planning for the situations if the risks were to come true. Some call this stress testing, sensitivity testing or modeling.
For example, the City says the worse consequence of many of the risks would be that taxpayers would have to pay the $ 7.4 MM bond payment every year with permanent higher real estate taxes of 15.5 to 18.5 cents. But, how would that tax increase impact our home values? What other impacts would the large tax increase cause? Why haven’t we asked one of our highly paid consultants to investigate the possible consequences to home values if taxes were to increase 15.5-18.5 cents, which would make Falls Church City will be 40-50% higher than neighboring jurisdictions?
I asked the City Manager, Wyatt Shields, about risk impacts and, later, asked that the City send me everything they had on risk assessments and risk modeling for the $ 120MM new high school plan.
- Risk: Non-Adoption of the Modified CIP.
Last summer, with information available from their financial consultant, Davenport and Company, City Staff and the Planning Commission recommended that City Council adopt a Modified CIP that would delay some capital projects in order to help limit the risk of the $ 120MM new high school plan. The City Council voted for the Full CIP, however, so this risk mitigation opportunity is no longer available. This is important because we have a project that is riskier because City Council did not heed the advise of City Staff.
- Risk: City cannot net approximately $40 MM from the land deal.
The City will not issue bonds unless they sell or lease the land for “enough” money. Getting enough money depends on many sub-risks and circumstances (site survey, infrastructure, raw land value, market timing, zoning, WMATA/VDOT issues etc.) which are discussed in detail in the second link above. If the City cannot make a good enough deal, the City will not issue the bonds, and the $ 120MM new high school program will not go forward. This sensible plan would be better if the City would identify now, the “enough” value.
- Risk: Interest rates rise above 4%
The City plans to issue bonds in three rounds and assumes the interest rates on the bonds will average 4%. What if interest rates increase significantly? The basic impact would be an increase in the yearly bond payments but how high can our payment go without a negative impact on school and city services. And, how might this effect the developer of the commercial site?
This is how Alvarez and Marshall (A&M), consultants to the City, addressed the interest rate risk in their September 2017 report (see link 2):
“Interest Rate Risk Interest rates have remained at historic lows, facilitating access to cheap capital for development across the region. Should interest rates rise following developer selection, but prior to transaction closing, value may be negatively impacted.
Mitigation Technique: Limit project delays to execute prior to increases in benchmark rates and define a rate threshold within which the developer must continue to deliver promised value.”
Alvarez & Marshall, also added this on page 11:
Recommendation 2: Conduct a risk assessment and work to mitigate risks to the City and Project.
Consultant Davenport & Company addressed the interest rate risk in a Memo dated November 2016 talked about interest rate risk at length (see link 2), and said this:
“Moreover, since the cost of capital (interest rate) on future borrowings is not locked in until the bonds are issued, the City faces exposure to fluctuations in future interest rates. This creates risk to the City’s CIP Funding Plan because future borrowing rates might well exceed the estimates contained in the funding model, thereby increasing future debt service costs. Generally speaking, the longer the period of time of exposure and the more the borrowing is weighted toward the back end of such period, the greater the theoretical risk to the City. Davenport would be happy to run interest rate sensitivity cases, if asked, that would highlight the effects of higher rates.”
Why did the City ignore the recommendations from their consultants?
- Risk: Major Repairs needed at GMHS before new high school is ready
This is not a risk I’ve seen identified by the City, but under the $120 MM high school procurement plan, students will stay in the existing GMHS facility for about the next four years. We’ve heard from the Superintendent that repairs and replacement of roof, elevator and HVAC systems at GMHS could run up into the tens of millions of dollars. Do we have a financial contingency plan if we are forced by circumstances to make one of these very expensive repairs before the new high school is complete? Has there been an engineering study to determine the likelihood that these three expensive systems can be patched-up for 4 years?
- Risk: Increased Operating Costs
The Superintendent says to expect costs at the school to increase 4% and the City Manager says to expect City revenue growth at 2.5% (recently, he said, FY2019 will be a better 3%). In a mathematical sense, this situation would lead to funding gaps of $ 5 MM per year or more within 5 years. In a practical sense, City leaders tell us since we cannot print money, we will just have deal with our situation every year as part of the budget process. We can’t spend more than our revenues. Or, can we by borrowing or other schemes that would kick the can down the financial road? It would be risky to not face these tough budget choices head-on each year…. just like it was risky to approve the Full CIP.
City Council doesn’t have a choice when it comes to paying back our bond debt. Davenport & Company tells us what would happen in their risk discussion of November 2016 in a Memo to the City Manager:
“ A related risk in this area is Virginia’s constitutional post-default intercept of state aid to pay debt service. In the example cited above, a future council could make revenue choices that would lead to a shortfall and a possible default on the City’s general obligation bonds. In that instance, the commonwealth would immediately withho1d state funds, including disbursements for education, and divert those funds to pay City debt service. Thus there is a risk that future councils, which have the ultimate taxing power, could put the City in a situation where not only the general government is in financial trouble, but that such problems cou1d affect the School Board’s operations.”
- Risk: Construction Cost Escalation
This is any easy risk to anticipate as it’s been part of our recent history. The City did not send me any results of modeling for cost overruns.
The City should have a contingency plan and model to understand and then deal with a construction cost overruns of, say, 10%, 20 %, or 40 %. How would we get the extra money, and how would it impact other aspects of City operations and CIP plans?
I asked the City Manager specifically this question about cost overruns and impacts and this is the one question he did not answer (see first link).
7. Risk: Insufficient Net Revenue from 10 Acres
We expect $ 3.2 M in commercial net revenue by the year 2031 from the 10 acres of land we sell/lease for development at the GMHS site. Obviously, there are a number of factors that could cause the revenue figure to be higher or lower. Is there any contingency planning or modeling for drastically reduced net revenue projections? Is it just to raise taxes as necessary? How is the gap between the bond payment of $ 7.4 MM and the $ 3.2 MM in available revenue going to be closed?
8. Risk: Quality of Life Issues
There are plans is to bring in 1700 new apartments along Broad Street during the next 10 years or so. How many new residents will that bring? How many more cars? How will so such an increase in population in such a short period effect our City? At the very least, has there been a traffic study?
Risks have been identified by the City. There is a mitigation plan associated with each risk; that is, a plan to make the risk less likely to surface. It doesn’t appear to me there has been enough contingency planning for situations where the mitigation plan has failed and the risk materializes and is upon us. Multiple contingency plans for different circumstances would add up to a model of a general stress test or general risk assessment. I don’t see where the City has done this.