The SRA Should Take Additional Measures to Ensure its Financial Solvency

Audit found that contingent liabilities and cash flow concerns could threaten the Southfield Redevelopment Authority's financial solvency.

Overview

The Southfield Redevelopment Authority (SRA) does not have a formal plan to ensure that it has sufficient revenue to meet its annual cash flow needs or to address its contingent liabilities,² which as of the end of our audit period exceeded $8 million. Not effectively planning for these financial needs could cause SRA to experience significant financial hardship, which could impede its ability to accomplish its mission to redevelop the former South Weymouth naval air station (NAS).

Contingent Liabilities

On June 30, 2010, the Massachusetts Development Finance Agency issued $30 million of Special Obligation Bonds³ (Parkway Bonds) to finance the development of the East-West Parkway. Concurrently, SRA executed a Parkway Financing Memorandum of Agreement with the Commonwealth. The proceeds of the Parkway Bonds were disbursed to SRA to reimburse it for a portion of the costs incurred in financing the parkway project. SRA does not make payments on the bonds, but under the agreement, if new state tax revenue generated by the redevelopment of the NAS does not meet certain projected amounts, SRA will become obligated to make certain payments to the Commonwealth. Since the issuance of these bonds, the Commonwealth has certified through June 30, 2013 that SRA is obligated to make $1,375,000 in payments to Massachusetts. The Commonwealth will not certify that any additional amounts are due from SRA until after fiscal year 2019. SRA has not developed any plans to pay for any additional obligations that may arise from this agreement should they become due.  

On December 15, 2011, the Navy sold 557 acres of land to the South Shore Tri-Town Development Corporation (SSTTDC) for $25 million. In exchange for the land, SSTTDC was obligated to (1) pay the Navy an initial payment of $2 million at closing; (2) issue a $10 million promissory note to the Navy, to be paid in 10 equal annual installments plus interest based on the US government’s 10-year Treasury note rate as of the date of sale; and (3) give the Navy a share of the proceeds received by SSTTDC or its master developer from land sales or ground leases to any developer that built vertical structures (e.g., housing). SSTTDC then conveyed the land to the master developer. An agreement between SSTTDC and the master developer assigned responsibility to the master developer for payment of the $2 million deposit and $10 million promissory note due the Navy. The master developer agreed to a decreasing $5 million letter of credit⁴ to secure its payments to the Navy, as well as a mortgage in the initial amount of $5 million on certain parcels of land it owned. Payments due under the $10 million promissory note were paid by the former master developer, LNR South Shore LLC / Starwood Capital Group, as agreed upon in the promissory note. However, the new developer, LStar Southfield, LLC (LStar), whose tenure began in May 2015, did not make the annual payments for 2014 and 2015, which should have been $928,807 and $898,454, respectively. Subsequently, in a May 2017 letter of agreement, the Navy agreed to defer payments due under the promissory note until December 18, 2018, if a further amended agreement could be reached by December 1, 2017. Otherwise, all payments would become due immediately.

The Navy also agreed to release the $5 million letter of credit. SRA (as successor to SSTTDC) is liable for repaying the current principal balance of the promissory note, $7,427,410, but has not made any plans to finance this obligation.

Cash Flow Concerns

SRA’s current annual cash flow requirement is approximately $2.1 million, of which about $1 million relates to debt service costs on outstanding infrastructure bonds.⁵

SRA derives its operating revenue from tax assessments and from developer fees payable to it under the Disposition and Development Agreements (DDAs) with its master developer. Under the 2017 DDA, SRA is entitled to be reimbursed by LStar for project review fees that are consistent with fees that surrounding communities charge for similar tasks, including fees for “filing, processing, third party peer review, monitoring and inspectional services, legal fees and other fees and charges associated with site plan approvals, subdivision approvals, building permits and similar licenses, permits and approvals.”

SRA is also entitled to annual developer fees, to be paid quarterly by LStar as reimbursement for any expected budgetary shortfalls, under certain conditions:

(i) the Authority establishes an operating budget, which excludes any and all purposes for which the Authority receives Project Review Fees from Project Escrow Accounts; (ii) the Authority's operating budget does not increase more than five percent (5%) from the previous fiscal year and did not increase more than eight percent (8%) over any consecutive five-year period; (iii) the Authority has pledged the greater of three hundred fifty thousand dollars ($350,000) in free cash or twenty percent (20%) of its total free cash reserves toward the operating budget or until the total certified free cash is five hundred thousand dollars ($500,000); and (iv) the Authority's ad valorem tax rate has not been set below $0.50. Notwithstanding the foregoing, in the event that the new operating budget increase of the Authority is more than five percent (5%), LSTAR will still be obligated to pay its annual Developer Fees, but the Authority will be required to pledge additional free cash for the operating budget expenditures in excess of that five percent (5%) increase.

SRA’s annual operating expenditures, other than bond payments, were about $2.5 million and $1 million in fiscal years 2015 and 2016, respectively. Excess cash requirements greater than SRA’s revenue are funded either by SRA’s free cash reserve⁶ or by payments made by the master developer. As of June 30, 2016, SRA had a free cash reserve of $2,272,568. Under the provisions of the new (2017) DDA, it is estimated that SRA’s free cash reserve will be reduced to $500,000. At that point, if the relationship between SRA and its master developer ends for any reason and SRA has not developed some other means of generating revenue, SRA’s past expenditures suggest that the agency will have insufficient operating capital to cover its operating expenses. In addition, should any currently contingent liabilities become payable by SRA, resources would not be available to meet those obligations.

Authoritative Guidance

SRA was established to, among other things, ensure that the NAS project is managed in a financially responsible manner that will ensure its long-term survival. Sound business practice dictates that organizations such as SRA set aside sufficient funding to address contingent liabilities.

In addition, Governmental Accounting Standards Board Statement No. 56 (Codification of Financial and Accounting Reporting) establishes accounting and financial reporting standards for going-concern considerations.⁷ The standard states,

Continuation of a legally separate governmental entity as a going concern is assumed in financial reporting in the absence of significant information to the contrary. Information that may significantly contradict the going concern assumption would relate to a governmental entity’s inability to continue to meet its obligations as they become due without substantial disposition of assets outside the ordinary course of governmental operations, restructuring of debt, submission to the oversight of a separate fiscal assistance authority or financial review board, or similar actions.

Reasons for Issues

SRA management said that they believed the amount of money they expected to receive from the master developer would be adequate to fund future operations. However, as noted above, there is no guarantee that any revenue that SRA may receive from the master developer under the DDA will be sufficient to fully fund its annual operating expenses and any payments that may become due as a result of its contingent liabilities, since the amount of these reimbursements is limited.

Recommendation

SRA should immediately develop plans and take the measures necessary to ensure that it can fund its contingent liabilities should they occur, in addition to making sure its future cash flow needs will be fully met. 

Auditee's Response

Facts that are of import in connection with the issues raised in the Draft Audit Report are as follows . . .

[There have been] additional extensions of time beyond December 1, 2017 within which to execute the [purchase and sale agreement, or PSA] amendment and the full execution of the Second Amendment to the PSA as of February 13, 2018, substantiating the agreement of the Navy, the Authority and LStar to provide a mechanism for reimbursing LStar for certain remedial activities on the subject property by crediting such costs against amounts that would otherwise be due to be paid by LStar on behalf of SRA pursuant to the Note. . . . With the Second Amendment to the PSA now fully executed, we intend to request that the Note be further amended to show that the Authority’s financial exposure is limited to the value of the remaining real estate and convert the Note to a non-recourse obligation. . . . 

As a legal matter, the Authority has the absolute right under its enabling statute (Section 6[s] of Chapter 291 of the Acts of 2014) to raise any amount of taxes, which is significantly above the caps as to which other municipalities in the Commonwealth are limited by. The Authority is not subject to proposition 2 1/2. Accordingly, in a scenario in which the Authority’s Master Developer was unable to continue with the project, the Authority would no longer be subject to its covenant under the DDA to keep its budget within the 5% increase per year or 8% increase over five years. Instead, the Authority could raise property taxes to meet its financial obligations. While the Authority does not expect this worst-case scenario to occur, it is important that the State Auditor’s Office recognize that we have a legal and readily implementable mechanism within which to address the risk of the contingent liabilities arising sometime in the future. . . .

With respect to cash flow concerns . . . we respectfully would suggest that we can easily negotiate with the Town of Weymouth to bill and collect on a quarterly basis to help address this concern as well.

Auditor's Reply

SRA states, “We intend to request that the Note be further amended to show that the Authority’s financial exposure is limited to the value of the remaining real estate and convert the Note to a non-recourse obligation.” Although we encourage SRA to pursue the revised amendments providing for a non-recourse note,⁸ until these amendments actually occur, the Authority’s contingent liability remains.

We agree that the Authority has the absolute right under law to impose such taxes as it may decide are necessary for its operations. However, we suggest that from a practical standpoint, imposing taxes beyond the current levels might be an impediment to the continued successful development of the project. We recommend that SRA, rather than taking a reactionary approach, create both short- and long-term financial plans that could be implemented in the event of a cash flow crisis.

2. A contingent liability is a potential liability that may become an actual liability depending on the outcome of a future event.

3. Special Obligation Bonds are limited obligations of the Commonwealth that are payable under the terms of a trust agreement.

4. In this case, according to the purchase agreement, a letter of credit means that “the line of credit shall decline in an amount equal to the amount of principal paid on the note by SSTTDC in each annual payment.”

5. In 2010, SRA issued bonds to fund infrastructure development on the South Weymouth NAS. Payments owed by SRA to the bondholders are funded by tax assessments on property owners within the Union Point development.

6. Free cash, as defined in SRA’s audited financial statements for fiscal year 2016, is “the Commonwealth of Massachusetts’s budgetary basis of accounting calculation of an amount similar to the unassigned fund balance at the end of each year and represents those funds that were not expended by the SRA. The SRA annually petitions the Massachusetts Department of Revenue to certify that the SRA has achieved a surplus and for permission to expend those funds during the succeeding year.”

7. Going-concern issues arise when an entity is at risk of having inadequate resources to sustain its operations beyond 12 months.

8. A non-recourse note is a loan that limits the borrower’s liability to the value of the collateral that the borrower put up to obtain it. If the borrower defaults, the lender can seize the collateral but cannot seek any additional compensation. impediment to the continued successful development of the project. We recommend that SRA, rather than taking a reactionary approach, create both short- and long-term financial plans that could be implemented in the event of a cash flow crisis.

Date published:	March 29, 2018