Call to Order and Roll Call
The Capital Projects and Bond Oversight Committee met on Tuesday, June 20, 2017, at 1:00 PM, in Room 131 of the Capitol Annex. Senator Stan Humphries, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Stan Humphries, Co-Chair; Representative Phil Moffett, Co-Chair; Senators Julian M. Carroll, Rick Girdler, and Christian McDaniel; and Representatives Larry Brown, Will Coursey, and Steven Rudy.
Guests: Mr. Chris Brumett, Director of Asset Management, Kentucky Community and Technical College System; Ms. Elizabeth Baker, Planning Director, Budget Office, University of Kentucky; Mr. Scott Aubrey, Director, Division of Real Properties, Finance and Administration Cabinet; Mr. Ryan Barrow, Executive Director, Office of Financial Management; Mr. Mike Harmon, Auditor of Public Accounts; Ms. Sara Beth Gregory, Chief of Staff, Auditor of Public Accounts; Mr. Jason Rittenberry, President and CEO, Kentucky State Fair Board; Mr. Scott Cox, Chairman, Louisville Arena Authority, LLC; Mr. Mike Herrington, Attorney, Stites & Harbison, PLLC; Mr. Denis Frankenberger, a Louisville-based businessman; and Mr. Chris Gorman, Former Attorney General for the Commonwealth.
LRC Staff: Shawn Bowen, Committee Staff Administrator; Julia Wang, Legislative Analyst; and Jenny Wells Lathrem, Committee Assistant.
Senator Humphries read a resolution recognizing and honoring Representative Jim Wayne for his dedication, hard work, and many years of service to the committee. A motion was made and seconded to accept the resolution in honor of Representative Jim Wayne, and passed by unanimous voice vote.
Approval of Minutes (April 18, 2017 and May 9, 2017)
A motion was made by Representative Coursey to approve the minutes of the April 18, 2017 and the May 9, 2017 meetings. The motion was seconded by Representative Moffett and approved by voice vote.
Senator Humphries said that due to having a large presentation and discussion item on the agenda, action-only items would be presented to the members for roll call vote.
Correspondence Items
In regard to the May 9 meeting and the lack of a quorum, several correspondence items from the committee chairs and the various state entities were included in members’ binders. No action was required.
Information Items
Two information items were submitted for review: follow-up correspondence from the Division of Real Properties regarding three leases held by the Office of the Attorney General; and the Bond Market Update provided by the LRC Office of Economic Analysis.
Project Reports from the Universities
Mr. Brumett reported two new leases for the Kentucky Community and Technical College System Jefferson Community and Technical College. The leases, located in Jefferson and Bullitt Counties, have an annual cost of $399,775 and $204,992, respectively.
A motion was made by Senator Carroll to approve lease #PR-0007 in Jefferson County, seconded by Representative Coursey, and approved by unanimous roll call vote.
A motion was made by Senator Carroll to approve lease #PR-0079 in Bullitt County, seconded by Representative Coursey, and approved by unanimous roll call vote.
Ms. Baker reported a new lease for the University of Kentucky Barnstable Brown Kentucky Diabetes and Obesity Center. The off-campus space will house clinical, support staff, and administrative leadership. The total square footage is 5,691, at a cost of $26 per square foot, and an annual cost of $149,389.
A motion to approve the lease was made by Senator McDaniel, seconded by Representative Brown, and was approved by unanimous roll call vote.
Ms. Baker reported an off-campus privately held lease with G.F. Vaughan Tobacco Company. The lease will provide storage space and will free up space on the university’s main campus for more critical academic and educational use. The total square footage is 467,947, at a cost of .92 cents per square foot, and an annual cost of $430,000.
In response to questions from Senator McDaniel, Ms. Baker said because the university needed such a large amount of storage space, it was able to negotiate a good deal with the lessor. The space will be used for libraries and archives storage, moveable equipment storage, and office and classroom space.
A motion to approve the lease was made by Senator Carroll, seconded by Representative Moffett, and was approved by unanimous roll call vote.
One information item was included for the University of Kentucky. The university plans to consolidate project authorities for the 2014 and 2016 Renovate/Upgrade HealthCare Facilities Project. The total combined project scope is $430,000,000.
Lease Reports from the Finance and Administration Cabinet
Mr. Aubrey reported ten lease renewals for privately leased office space in various counties. The following leases were renewed under the same terms and conditions, the square footage cost and the annual rental rate will remain the same: Cabinet for Health and Family Services (CHFS), Franklin County, $1,127,854 and $116,761; CHFS, Boyd County, $331,023; CHFS, Clark County, $109,460; CHFS, Montgomery County, $125,874; CHFS, Pulaski County, $118,024; the Department for Juvenile Justice, Hardin County, $106,619; the Department for Local Government, Franklin County, $196,951; the Labor Cabinet, Franklin County, $578,784; and the Office of the Attorney General, Franklin County, $482,563.
A motion was made by Senator Carroll to roll the ten lease renewals into one roll call vote, seconded by Representative Moffett, and approved by voice vote.
A motion was made by Senator Carroll to approve the ten lease renewals, seconded by Senator McDaniel, and approved by unanimous roll call vote.
Mr. Aubrey reported two lease renewals in Franklin County with rate increases; Auditor of Public Accounts, $170,784 and Department of Workers Claims, $489,767.
A motion was made by Senator Carroll to approve the lease renewal for the Auditor of Public Accounts, seconded by Senator McDaniel, and approved by unanimous roll call vote.
A motion was made by Senator Carroll to approve the lease renewal for the Department of Workers Claims, seconded by Representative Moffett, and approved by unanimous roll call vote.
Representative Moffett commented that the square footage cost for most leases brought before this committee are below the county average rental rate. In Franklin County, where state government is the largest renter of space, the rental rates are above average. In response to Representative Moffett’s comments, Mr. Aubrey said that the average rates are somewhat skewed. A lot of the state leases have been in place for 20 plus years and the rates are comparative to those past rates which tend to drive the average down. Mr. Aubrey said that most of the new lease projects are $12-$14 per square foot.
Senator Carroll said the state plans to demolish the Capital Plaza Complex tower and construct a new state office building. In the process, there are several state leases in Franklin County that will be terminated, and many of the leaseholders are trying to extend these leases in contemplation of the demolition project. Senator Carroll commented that the lessors presently have the state over a barrel since the new state office building has not yet been built and good rental space is not available due to most of it being occupied by state government agencies. However, once the new office building is constructed, it will hold double the amount of state employees currently held in the Capital Plaza Complex tower. Additionally, Senator Carroll said that there will be a reduction of rental spaces available in Franklin County since one new state office building has already been completed and with the plan to build a new one.
Project Report from the Finance and Administration Cabinet
The Finance and Administration Cabinet has allocated $725,000 for the Barren River Lodge Concrete and Railing Repair project. The project is funded from the 2016-2018 bond-funded Department of Parks Life Safety Maintenance Pool. Allocations over $600,000 from such pools are to be reported to the committee. No action was required.
Report from the Office of Financial Management
Mr. Barrow reported one new bond issue: Kentucky Housing Corporation Tax-Exempt Conduit Multifamily Housing Revenue Notes (The Guardian Court Apartments Project), Series 2017, in the amount of $12,670,000.
A motion was made by Senator Carroll to approve the bond issue, seconded by Representative Coursey, and approved by unanimous roll call vote.
The Office of Financial Management submitted one new bond issue requiring no action by the committee: Turnpike Authority of Kentucky, Economic Development Road and Revenue Refunding Bonds (Revitalization Project), 2017 Series A and B, in the amount of $265,000,000.
The Office of Financial Management submitted two follow-up reports for previously approved bonds: Kentucky Higher Education Student Loan Corporation Student Refunding Revenue Bonds, Senior Series 2017A (Tax-Exempt ATM Fixed Rate Bonds), in the amount of $40,000,000; and Kentucky Economic Development Finance Authority Hospital Revenue Bonds, Series 2017A and B (Owensboro Health, Inc.), in the amount of $472,635,000. No action was required.
New School Bond Issues with School Facilities Construction Commission (SFCC) Debt Service Participation
Mr. Barrow reported four new SFCC school district bond issues for a total amount of $44,430,000. The bond issues will finance one new school construction project, refund outstanding bonds, and complete districtwide improvements for schools in Franklin, Harlan, Campbell (Newport Independent), and Pulaski Counties. With the exception of the Newport Independent School District, no tax increase was necessary to finance the projects.
A motion was made by Senator Carroll to approve the bond issues, seconded by Senator McDaniel, and passed by unanimous roll call vote.
New Local School Bond Issues with 100 Percent Locally-Funded Debt Service Participation
Two 100 percent locally-funded school bond issues were reported for Johnson and Pulaski Counties. The bond issues total $7,740,000, and the scope of work includes renovations to district schools and districtwide energy improvements. The bond issues did not involve a tax increase. No action was required.
Report of the Auditor of Public Accounts – Audit of the Louisville Arena Authority, LLC
In November 2016, the members of the Capital Projects and Bond Oversight Committee formally requested that the Auditor of Public Accounts perform a financial audit of the Louisville Arena Authority (LAA). The Auditor completed his report in May, and appeared before the committee to discuss the results.
Mr. Harmon said his office reviewed the 2016 financial statements of the LAA to determine its compliance with contracts. He stated that the arena’s viability is a public concern because Louisville Metro Government contributions and tax increment financing (TIF) revenues represent taxpayer resources that could be directed elsewhere. The audit had one finding: the LAA and the University of Louisville Athletic Association (ULAA) were not finalizing the net annual payment by the deadline established in the lease agreement. The net annual payment was calculated as $1,381,474 and $1,356,528 for 2016 and 2017, respectively. Mr. Harmon said late net annual payments could lead to cash flow issues for the LAA.
Mr. Harmon noted that the LAA is not clearly defined as either a public or a private entity; was neither created by an act of the General Assembly nor codified in statute; and that 75 percent of the income used to pay debt service for bonds issued, exclusive of the $75 million from the Commonwealth, to finance the construction of the arena is derived from taxpayer dollars. To date, about $8 million in principal of the approximately $350 million issued in 2008 has been repaid. Legislation passed in the prior session enables the TIF to be extended for up to another 25 years, increasing the time the TIF could be active to a total of 45 years.
Mr. Harmon offered some additional observations based on his office’s review of the LAA’s financial statements. He said the LAA should increase transparency and oversight. The 2006-2008 Executive Budget incorporated taxpayer protections as a condition of receipt of the $75 million contribution from the Commonwealth; requiring the LAA to comply with the Executive Branch Ethics Code, the Model Procurement Code, and the Open Records and Meetings Acts. However, budget language with these conditions was neither renewed nor otherwise codified. Additionally, Mr. Harmon said the LAA should be a component unit of the Commonwealth and included in the Commonwealth’s Comprehensive Annual Financial Report, which has been presented to the Finance and Administration Cabinet for consideration.
Mr. Harmon noted other issues including no internal staff, outsourcing of all operations, and no reporting of some revenue generated; making oversight of arena activities challenging.
Mr. Harmon said the LAA did not fulfill a monitoring safeguard in its loan agreement with the Kentucky Economic Development Finance Authority (KEDFA), which requires meeting targeted ratios of revenues to debt service. These targeted ratios have not been met for some time, and not meeting these targets should have prompted the LAA to obtain a consulting report with recommendations on increasing revenues. However, no such report was obtained. Also, an existing contract with the management operations company was extended until 2027 without competitive bidding or independent analysis.
Mr. Harmon presented a slide presentation that included, among other things, TIF projections, Kentucky sales and use tax receipts, LAA net assets, the ULAA net position and UofL basketball revenue. Mr. Harmon noted that TIF revenues have underperformed projections due to multiple factors, including a significant recession. In 2016 TIF revenues were less than two-thirds of what was originally projected, $5.5 million below target. When compounded over time, a lag of performance of the TIF presents significant challenges for the LAA. At the outset of this project, the LAA advisors referred to the UofL Department of Economics’s analysis of historical sales tax receipts. The analysis was based on data in tax growth rates; property tax receipts dating back ten years compared to sales tax receipts, which comprise the majority of TIF payments, dating back 16 years. The 16 year time frame included 1990-1991, a year in which there was a 1 percent increase in the sales tax rate in Kentucky. By including 1990 in the calculations as a starting year, the sales tax increase, which was a onetime policy change, was factored into the projected growth rate of sales tax receipts. The numbers on the tax analysis chart for Jefferson County were estimates as sales tax receipts were not tracked by county.
The sales tax receipts projections contributed to the unrealistic expectations of the TIF performance, to the point that it was originally intended that TIF revenues would enable paying additional principal ahead of schedule. No additional principal has been paid as planned. In 2015, 100 percent of TIF revenues were used for senior debt service, and in 2016 the vast majority of TIF revenues were also applied to senior debt service. Plans also intended for $3 million per year to go towards a renovation and replacement fund beginning in 2011 but this fund currently has a balance of $642,700, technically the balance should be about $18 million.
Mr. Harmon said the arena is an important venue for UofL, the City of Louisville and the Commonwealth of Kentucky. The arena should not rely on additional taxpayer support alone to be successful. To ensure the long-term sustainability of the arena, all parties benefiting from the arena, not just the taxpayers, should formally renew their commitments to the project.
In response to questions from Representative Moffett, Mr. Harmon said his office was not able to quantify the gross dollar amount the ULAA earned from the KFC Yum! Center. Sara Beth Gregory, Chief of Staff for the Auditor of Public Accounts, added that the LAA generates income that goes directly to the ULAA and is difficult to track. Mr. Harmon said some of the revenue that does not go directly to the LAA are items such as signage inventory and courtside seats sold by the ULAA, licensing of events at the arena, market value of suites and complimentary tickets. In addition, there are donations to the Cardinal Fund generated by basketball. Mr. Harmon said this financial information was not included because it was outside the scope of the audit. He explained that the primary mission was to review the financial statements and the contracts to ensure that LAA was complying with the contract agreements.
Representative Moffett said one of the fundamental pieces of information the public deserves to know is how much the ULAA is making from the KFC Yum! Center agreement and how much the KFC Yum! Center is actually making. He expressed interest in obtaining those amounts.
In response to another question from Representative Moffett regarding the negative impact payments to be made to the Kentucky State Fair Board (KSFB), Ms. Gregory said she did not have the exact dollar amounts of the payments, but provisions were included in the 2006-2008 Executive Budget to compensate the KSFB for its loss of income due to construction of the KFC Yum! Center. Mr. Harmon said the 2016 financial audit shows that the LAA made the $100,000 annual payment per the terms of the settlement with the KSFB.
In response to a question from Senator McDaniel, Mr. Harmon stated that if the LAA were to default on its bond payments, then UofL has the right of first refusal to purchase the arena after satisfying obligations set by the bondholders.
Senator McDaniel commented that the audit vindicated those who believed that historical tax data was manipulated in order to initiate the construction of the arena and asked for clarification of the obligations of the LAA for when the arena did not meet the contractual ratio of revenues to debt service.
Mr. Harmon explained that the ratio of revenues to debt service were consistently below the targeted 1.1 to 1 (or 110 percent of revenues) and that the required consulting report recommending ways to increase revenues was not obtained.
Senator McDaniel noted ULAA’s $15 million increase in annual revenue after the opening of the arena. He stated that the taxpayers are being fleeced and that it was not unreasonable to expect the university to pay an additional $2.5 million per year. He expressed his appreciation for the work of Auditor Harmon and Mr. Cox.
Auditor Harmon stated that even if the TIF had performed as projected, the largest percentage of payments would have been tax-supported and Senator McDaniel remarked that if the TIF projections were not inflated then the new arena may not have existed.
Senator Humphries thanked the Auditor for his report and invited Representative Wayne to comment. Representative Wayne thanked the Auditor for his report, and the committee for undertaking this effort. He recommended that there be ongoing oversight of the LAA by the committee, and suggested that regular reports from the LAA be submitted to the committee. He also encouraged the committee to consider formally asking the Auditor to conduct an audit of the ULAA.
Senator Humphries invited other guests to the testimony table to discuss the LAA audit. Speaking on behalf of the KSFB, Mr. Rittenberry said to his knowledge, the LAA and the KSFB have not reached an agreement on the net negative impact payments to be paid to the KSFB after moving the U of L basketball program from Freedom Hall to the KFC Yum! Center. He said there have been discussions, but no agreement has been reached. The net negative impact currently is about $13.5 million.
Speaking on behalf of the LAA, Mr. Cox said he appreciated the invitation to speak, and he thanked the Auditor for conducting the audit. He said his only concern was that executing the audit may have affected LAA’s ability to refund the arena bonds, but the audit was completed in a timely fashion.
Senator McDaniel asked Mr. Cox if there is an agreement between the LAA and the KSFB regarding the net negative reimbursement to the KSFB, and if so, what dollar amount has been repaid. Mr. Cox said the LAA has agreed to pay the KSFB $100,000 annually for a specific amount of years (10 or 15) to compensate it for the management fee it would have earned from managing the LAA. He said the LAA’s Board of Directors believes LAA does not owe anything beyond that. An Attorney General’s advisory report concluded that the LAA did not owe the KSFB beyond the $100,000 annually.
Speaking on behalf of the ULAA was Mr. Mike Herrington, an attorney with Stites & Harbison, PLLC. Mr. Herrington explained that the ULAA is a component of the university, and he was not sure what would be accomplished by having a separate audit of the ULAA. He said he would leave that to the staff of the ULAA to respond, and make them aware that the request has been discussed.
Mr. Denis Frankenberger from Louisville, Kentucky, and former Attorney General Chris Gorman were invited to the table to speak. Referring to the original bond indenture agreement, Mr. Frankenberger said the original TIF district projections were made by the State Budget Director, and the figures were untenable. The first nine years of the TIF were projected to be 19.5 percent compounded per year, and the increase from year one 2010 to 2019 was 425 percent.
In regard to the recently completed audit of the LAA, Mr. Frankenberger said without a corresponding audit of the ULAA, the results of the audit are inconclusive. He said an audit of the ULAA would identify all streams of revenue that flow directly to it.
Mr. Frankenberger next addressed the issue of the net negative impact payment due to KSFB from the LAA. He said this payment was a contractual obligation of the LAA to be paid to KSFB. Mr. Frankenberger said the agreement reached with KSFB was a cost reimbursement rather than a management fee. Of that $1.4 million, $1.1 million is still outstanding and is over four years past due.
Mr. Frankenberger commented on the debt associated with the arena, noting that total public subsidies for the LAA will be about $200 million, and with the passage of House Bill 330 by the 2017 General Assembly, the Commonwealth will spend $1.2 billion in arena subsidies which is an average over a 38 year period of $31.6 million per year. He said it seems like a taxpayer travesty that the ULAA makes approximately $28 million per year net of expenses on arena related activities without any investment, and the taxpayers put in $31.6 million per year.
Mr. Gorman said in his opinion, state and local government should not use its taxing powers for a Division I basketball program. If the Commonwealth and Jefferson County are going to give an additional $28 million dollars a year to one of the seven athletic programs around the state, it raises the question of what is to prevent the athletic directors from the other six institutions from requesting additional funding for their athletic programs. Athletics is a business that should not be supplemented by state and local government.
Mr. Gorman addressed the lack of available dates for conventions in the KFC Yum! Center due to the UofL basketball program’s use. When the KFC Yum! Center is not available for conferences and conventions due to use by the UofL Basketball program, the state misses out on increased opportunities to bring in additional revenue.
Senator Humphries thanked the presenters and the invited guests for appearing before the committee. With there being no further business, the meeting was adjourned at 2:30 p.m.