PURPOSE  

The purpose of this report is to present a proposal for prepayment of an outstanding note held by Strategic Hotel Capital pursuant to the Fourth Implementation Agreement dated September 1988 (later amended in August 1989, and May 1991), by and between the Redevelopment Agency of the City of Burbank and Strategic Hotel Capital as assigned (Hilton Hotel); and to receive direction from the Agency Board on said offer.

BACKGROUND

On June 13, 1977, the Redevelopment Agency entered into a Disposition and Development Agreement (DDA) with the Center at Burbank Airport, a general partnership company.  The partnership was formed to develop a hotel and office project located on a 7.82 acre parcel at the southeast corner of Hollywood Way and Thornton Avenue in the Golden State Redevelopment Project.

The project initially was to include a minimum of 200 hotel rooms and 25,000 square feet of office space.  The original agreement was amended to require development of a minimum of 250 hotel rooms and 50,000 square feet of office space. The project was completed in late 1980, and has been operating as a Hilton Hotel since that time.  The hotel has been successful, and the City and Agency have benefited from the development through additional Transient Occupancy Tax (TOT), Transient Parking Tax, and Property Tax Increment (TI) generated by the project.

Because of demand for additional hotel rooms and the desire on the part of the City for a Conference Center, in September 1988, a Fourth Implementation Agreement (Agreement) was entered into to allow development of a second hotel tower of approximately 220 rooms and a 28,000 square foot conference center.[1]  The agreement was with Burbank Partners, a limited partnership, formed for the expansion project.  The Agreement included the sale of 6 acres of the adjacent former Lockheed Building 85 site.

Before the hotel expansion and conference center began, the Agreement was amended in August 1989, to provide for the sale of 1.86 acres of additional land to Burbank Partners to allow the conference center to be expanded by 12,000 square feet from 28,000 to 40,000 square feet and to provide 230 additional parking spaces to support the development.  The hotel began construction immediately after the close of escrow and was completed in January 1991.

As part of the agreements, the Agency provided loans in the amount of $1,000,000 per acre to Burbank Partners for the purchase of the 6 acre and 1.86 acre parcels making up the expansion site.  Both of these loans were for a ten year period, but had acceleration clauses if the hotel operation reached a certain threshold.  The threshold was reached in September 1996 and those loans have been fully repaid.

AGENCY NOTE

In addition, the Fourth Implementation Agreement of 1988, called for providing necessary assistance to secure the hotel expansion and development of the conference center.  Even though the existing Hilton Hotel was very successful with an occupancy rate of approximately 80 percent prior to the expansion, because the hotel was to almost double in size from 280 rooms to over 500 rooms, the developer was concerned that the expanded project may exceed market demand in the near-term.  In order to be able to secure the necessary financing to develop the project, the Developer requested the Agency provide a mechanism in the DDA to cover a potential shortfall in operating revenue until the expanded hotel became profitable. The terms included a provision for Agency assistance if the hotel was operating at a deficit, but said assistance would be repaid when the hotel became profitable.  Additionally, the Agreement required that the assistance be limited to the actual revenue the City and Agency receive from the hotel expansion.

In order to make the transaction acceptable to the lender and investors, the Agreement provided that the Agency would loan funds to the developer in an amount equal to the TI and TOT generated by the project to cover any �Ascribed Operating Deficit� (a number based on a formula by which the sum of the debt service and return on investment exceed a base figure called the �assumed net� � also derived by a formula) experienced by the combined operations of the existing and new hotel towers (not the conference center).  This assistance is provided only if the hotel experiences an Ascribed Operating Deficit, and then only up to the lesser of $6 million or the cumulative total of the Ascribed Operating Deficit.  Based on the hotel�s actual operating performance after the agreement was executed, the Developer was entitled to receive $6 million in assistance.  The terms dictated that should the Ascribed Operating Deficit be greater than the available TI and TOT, the difference would be accrued to an �Agency Note� due the developer.  The Agency made continued TI and TOT payments on the Agency Note until the outstanding balance plus 8% interest was fully repaid in January 2002.

PARTICIPANT REPAYMENT NOTE

The Agreement required the Agency assistance to be treated as a loan to the hotel, which is defined as the �Participant Repayment Note� (�Note�).  The Agreement calls for the Note to begin accruing 8% interest at the earlier of ten years - after the commencement of Agency assistance payments, or after the first 12 months in which the hotel achieves a 65% occupancy rate.  However, the participant is not required to begin repaying Note until the hotel begins to generate �Ascribed Operating Excess� (a number based on a formula by which the assumed net exceeds the sum of the defined debt service and return on investment).  By the same token, repayment would be triggered by a sale or refinancing of the hotel, only if the sale or refinancing occurs after the hotel has achieved Ascribed Operating Excess.

In 1998, the hotel and conference center were sold to Strategic Hotel Capital, Inc, (SHC) and an assignment and assumption agreement was entered into releasing the previous owner, Burbank Partners, of its obligation on the Note.  The obligation of the Note was assigned and assumed by SHC (Participant) who agreed to repay the Note, and to be bound by all the terms and conditions of the Fourth Implementation Agreement.  A parcel map creating two separate parcels was required in order for Burbank Partners to sell the Hilton Hotel and Conference Center to SHC, while retaining the office building on the site.

DISCUSSION

Since the Agency Note was paid in full in January 2002, staff has been monitoring the payment of the Participant Repayment Note that is required to be repaid as follows:

• From Ascribed Operating Excess;

• From Sales Proceeds or Refinancing Proceeds (if at the Ascribed Operating Excess at the time of the sale or refinance) ; or

• Assumption by a Buyer and Release of the Seller.

The Fourth Implementation Agreement also states that the Participant may elect to prepay all or any of the Participant Repayment Note without penalty. 

An analysis completed in May of this year by Keyser Marston and Associates (�KMA�), the Agency�s financial analyst, estimated the balance of the Note to be approximately $8.8 million.  This balance includes accrued simple interest at 8% per year, and the deduction of a payment for the 2002 calendar year of $291,000 (the hotel achieved the �Ascribed Operating Excess� that year for the first time since the Agreement was executed).

PREPAYMENT OFFER

A proposal was received in April 2003 from SHC for a lump sum payment of $3 million in return for complete and final release of all liabilities under the Note and the Agreement.  After analysis and negotiation with staff, the offer was revised to $3.6 million in a letter dated August 22, 2003.  While the offer is contingent upon the Participant receiving final SHC Board approval, the offer is to pay the Burbank Redevelopment Agency $3.6 million within 10 business days after the necessary approvals are obtained, and the appropriate documentation evidencing the agreement is completed (Exhibit A).  SHC also states in the offer letter that they will seek their board approval in anticipation of the Burbank Redevelopment Agency meeting.  SHC cites many reasons for the offer including: 1) their estimated time frame to complete the pay-off of the loan � the year 2046; 2) that they do not anticipate reaching the �Ascribed Operating Excess� during the years 2005 through 2009, therefore, no payments would be made during those years; and 3) the economic downturn that continues to affect operations.

KMA prepared an analysis of the Agency Share that the Agency is entitled to each year as defined by the Agreement (Exhibit B).  The Agency Share is a percentage of the Ascribed Operating Excess.  The projected annual payments by the Participant to the Agency are not a set figure, but derived by a formula with several assumptions, and are by nature, variables which are uncontrollable by the Agency:

• The annual gross revenues;

• The prime rate;

• The annual interest rate; and

• The annual increase in the Consumer Price Index (CPI).

To estimate the value of the Note in today�s dollars, KMA estimated the Agency share payments assuming the best case assumptions and the Participants more conservative assumptions, as the worst case scenario.  The best case assumptions include interest rates remaining at today�s level through the estimated repayment period, and revenues increasing 3% per year.  The Participant assumed interest rate increases over the next few yeas, and lower revenue growth.

The analysis further estimates the net present value of the estimated annual Agency Share payments utilizing both sets of assumptions at various discount rates.[2]  The net present value of the Note is projected to range from $803,000 to $7.79 million.  The ultimate value will be dependant on the actual interest rates and revenue increases experienced during the repayment period.  In addition, the Agency�s analysis estimates the Note would be repaid by 2034, as compared to the Participant�s estimate of 2046.

The prepayment offer presented by the Participant represents approximately 41% of the current Note balance as estimated by the Agency�s financial analyst.[3]  Thus, the prepayment offer falls in the mid-point of the range of the present value of the Note (estimated to be between $803,000 to $7.79 million).  It is important to state that unlike a note that has defined variables and terms, there is no way to determine the exact present value of the Participant Repayment Note.   Therefore, the analysis completed estimates the present value of the Note that is dependant on the various assumptions described earlier, including future revenues of the hotel and future interest rates.

The following chart is a brief summary of the advantages and disadvantages of the $3.6 million prepayment offer:

CONCLUSION

As indicated in the above chart, there are advantages and disadvantages to accepting the prepayment offer.  Under the most optimistic assumptions, the Note will not be repaid for at least 31 years.  During that time, the Hilton may experience up and down revenue cycles during which there may be years the Agency does not receive a payment.  If the Agency accepts the prepayment of $3.6 million, the Agency achieves certainty regarding the repayment schedule and will have the use of the funds in the near term.  On the other hand, if the Agency does not accept the prepayment offer, the Agency may receive an amount estimated to be between $7.9 and $8.8 million, or may receive less than $3.6 million, depending on the success of the hotel.

Staff has discussed the prepayment amount and analysis with the Financial Services Director.  Understanding that the analysis is based on a set of assumptions, and that there are no guarantees on cash flows, staff is comfortable with using an 8% discount rate, as it ties back to the interest rate (also 8%) for the loan.  At an 8% discount rate, using the Participant�s assumptions, the estimated present value of the Note is $3.6 million dollars.

Staff is requesting direction from the Agency Board on the prepayment offer by Strategic Hotel Capital.  Based on the review of the prepayment offer and financial analysis, staff has concluded that using an 8% discount rate to establish a payoff amount is appropriate.  Furthermore, based on the cyclical nature of the hotel industry, possible future competition that may affect the success of the Hilton hotel (and future payment(s) to the Redevelopment Agency), and State Budget uncertainties; both Community Development and Finance staff recommend that the Agency Board accept the prepayment offer from Strategic Hotel Capital in the amount of $3.6 million.  If the Agency Board does not accept the prepayment offer, the Note will be monitored, and the Participant will be required to make payments when due.

FISCAL IMPACT

Staff is seeking direction from the Agency Board on how to proceed with the prepayment offer.  If the Redevelopment Agency Board accepts the offer, the Agency will receive $3.6 million that will be deposited in the Golden State Redevelopment Project Area fund.

RECOMMENDATION

Staff recommends the Agency Board approve the Agency Resolution accepting the lump sum offer of $3.6 million for payment in full of the Participant Repayment Note, and authorize the Assistant Executive Director to deliver the appropriate documents to the developer to be prepared by the City Attorney�s Office.  Furthermore, written documentation that the SHC Board has approved the offer is required.  The acceptance of the offer will expire on September 30, 2003 if no written documentation is received.