District of Columbia: Status of the Sports Arena
Released: 1996-12-31T00:00:00

Letter

Background

The District of Columbia government (acting through the Mayor and the District’s Redevelopment Land Agency) and District of Columbia Arena, L.P. (DCALP)—a limited partnership formed by the owner of the Washington Bullets and the Washington Capitals—have agreed that DCALP will build a sports arena (estimated to cost about $175 million) and the District will be responsible for financing certain predevelopment costs.

The District agreed to be responsible for the following predevelopment costs: acquiring land, including the purchase of property not then owned by the connecting the Gallery Place Metrorail station to the sports arena, relocating District employees from two buildings on the site to other demolishing buildings, remediating soil, relocating utilities, and securing all regulatory approvals necessary for construction of the sports arena.

To finance the predevelopment costs of the arena, in August 1995, the District received a $53 million loan commitment (line of credit) from a consortium of banks led by NationsBank and Crestar Bank. In January 1996, the RLA issued about $60 million in revenue bonds backed by the Arena Tax and paid off the $36.6 million portion of the line of credit used. The Omnibus Budget Support Act of 1994 (Arena Tax Act) as amended, provides for a Public Safety Fee (Arena Tax) to be levied on businesses located in the District based upon the annual District gross receipts of such businesses. The Arena Tax is due on or before June 15 of each year. The Arena Tax Act also authorized the RLA to pledge the Arena Taxes as security to repay loans to finance predevelopment activities.

Further, the Arena Tax Act provides that if, on or before December 1 of each year, the Mayor estimates the Arena Tax revenue is less than $9 million, the Mayor is required to raise the Arena Tax rates to provide for an estimated revenue of not greater than $9 million. The Arena Tax was first levied in fiscal year 1995. During the first year of the Arena Tax, most of the Arena Tax collections were used to fund predevelopment activities. In subsequent years, the Arena Tax will be used to pay principal and interest (debt service) on the bonds as required by the bond resolution.

As previously stated, the District is responsible for the predevelopment costs of the arena. DCALP, the developer, is responsible for arranging and repaying the financing needed to pay all costs associated with the design, development, construction, and operation of the sports arena.

Objective, Scope, and Methodology

To obtain information on the status of the arena project, we reviewed relevant contract agreements, vendor invoices, and the bond trustee’s disbursement records supporting the predevelopment costs. We also reviewed various financial reports and bank statements for Arena Taxes collected and deposited as of August 1996.

We interviewed District officials from the Arena Task Force, the Office of the Corporation Counsel, the Office of the Treasurer, the Department of Finance and Revenue, and the RLA. We also met with trustees for the lockbox (into which dedicated tax collections are deposited) and the bonds. In addition, we discussed the construction progress of the arena and the Metrorail connection with officials from DCALP and the Washington Metropolitan Area Transit Authority (WMATA). Further, we interviewed officials from Merrill Lynch regarding the structure and pricing of the bonds. Finally, we interviewed officials from Standard & Poor’s Rating Service (S&P) and Moody’s Investor Service (Moody’s) concerning the rating of the bonds.

We did not audit the arena’s predevelopment cost estimates or evaluate the financing to determine if the reported amounts were correct. The amounts for the predevelopment costs and financing were provided by District officials and, where applicable, were verified to disbursement records maintained by third parties acting as trustees for either tax collections or bond proceeds. Accordingly, we do not express an opinion or any other form of assurance on the arena’s predevelopment cost estimates or its financing.

We also did not audit the reported taxes collected and deposited for the sports arena project. We, therefore, did not determine if the District government accurately identified the universe of taxpayers or reported all dedicated taxes for this project. However, we reviewed monthly statements provided by the lockbox trustee to determine the amount of taxes collected and placed in escrow for this project. Our review built on previous work, and we conducted our review from March 1996 through December 1996 in accordance with generally accepted government auditing standards.

Predevelopment Project Costs

As of October 18, 1996, estimated predevelopment costs had increased from about $55.2 million to about $55.8 million or by a net amount of about $617,000 (1 percent), since our last report. The District’s predevelopment activities consist of four major categories: (1) acquiring land, (2) constructing the Metrorail connection, (3) relocating District employees, and (4) demolishing two buildings, remediating soil, relocating utilities, and using consultants to secure regulatory approvals.

All land has been acquired for the arena site. However, the final cost for one of the parcels of land acquired will be determined by the outcome of legal proceedings. Construction of the Metrorail connection is about 25 percent complete as of October 18, 1996. All District employees have been relocated; however, office improvements on the new space have not been completed. Finally, the two old buildings have been demolished and relocating utilities and securing regulatory approvals are nearly complete as of October 18, 1996. The District is awaiting final bills for these activities.

The District’s Project Manager for the sports arena stated that based on the project’s current status and known estimates for predevelopment costs, as of September 30, 1996, the District does not expect to exhaust the $5 million capital reserve fund established to cover cost overruns. We verified that no funds had been expended from the capital reserve fund. The changes to the predevelopment costs are highlighted in the following table.

Metrorail Connection

As of October 18, 1996, the total cost for the Gallery Place Metrorail connection was estimated at about $19.4 million, a $2.4 million increase from our last report; but the District’s cost remains the same—$3 million. The majority ($2 million) of the increase reflects the cost of needed construction changes to the station because of the sports arena. For example, new vent shafts will be added in order to accommodate the construction of the sports arena. This increase was offset by the developer’s contribution of $2 million to the cost of the Metrorail connection. The other $360,000 increase reflects a decision by WMATA to upgrade the station elevators from hydraulic elevators to traction elevators. The funding for this upgrade is being provided by WMATA.

As of October 18, 1996, the Metrorail connection budget contained a $1.1 million reserve for contingencies (as shown by note c to table 1)—a decrease of $400,000 since our last report. WMATA officials stated that their maximum responsibility to the project is limited to their $2.4 million contribution. They also stated that they will not absorb any unanticipated costs. WMATA officials stated that an example of unanticipated costs is the discovery of asbestos in sections of the duct work running through the station’s mezzanine. According to the District’s Project Manager for the sports arena, the $50,000 approximate cost for the removal of the asbestos is being funded out of the Metrorail connection contingency reserve.

Building Demolition and Environmental Soil Remediation

The demolition of the two buildings formerly located on the arena property has been completed, and final bills are forthcoming. The budget of $1 million has not changed.

Costs to remove hazardous and contaminated soil have increased as excavation progresses. The revised budget for soil remediation was $3.52 million as of October 18, 1996, an increase of about $2.58 million from the $940,000 reported in our last report. In a testimony before the RLA board, the District’s Deputy Corporation Counsel stated that the District will take legal action against the source of the contaminants if compensation is not made to the District by the source.

The property on which the arena is being built contains contaminated and hazardous soil based on archeological digs, tests performed for the environmental impact statement, and tests performed by the developer. The extent of the amount of contaminated soil was underestimated by the original tests, which estimated that the site contained about 7,400 tons of petroleum contaminated soil and hazardous waste. As discussed below, the actual amount of contaminated soil was almost 15 times the original estimate.

The site originally had residential and commercial buildings. According to the District’s Project Manager for the sports arena and an official from DCALP, when the land was cleared some 20 years ago, oil storage tanks in buildings and in the ground were not removed. As a result of the demolition of the buildings, contaminants were leaked into the soil. Both contaminated (petroleum) and hazardous (cleaning fluid) substances have been found in the soil. As part of its agreement to purchase the parcel of land owned by WMATA and the Far East Trade Center Associates, L.P. (FETCA), the District received a credit of about $569,000 from FETCA for the removal of contaminated material.

As of October 1996, according to the District’s Project Manager for the sports arena, 13 underground oil tanks and 4 water separators were removed from the site, along with 109,000 tons of contaminated soil and approximately 5,100 tons of hazardous soil. Most of the excavation of the hazardous and contaminated soil has been completed. According to a DCALP official, in the spring of 1997, it will be necessary to remove a temporary dirt ramp from the site to complete the excavation process. Tests done on the soil on both sides of the ramp show the soil to be contaminated. Therefore, the District’s final cost for soil remediation will not be known until the spring of 1997. The District has hired a firm, Environmental Consultants and Contractors, Inc., to monitor the removal of all contaminated and hazardous material.

Utility Relocation

Our last report showed a budget of $4.6 million for utility relocation—$4.3 million for Bell Atlantic to relocate utility lines under G Street and $300,000 for the relocation of other utilities. Included in the $4.3 million budget was an estimate of $1.4 million for overtime costs to meet the revised November 30, 1995, deadline to relocate Bell Atlantic utility lines. As of October 18, 1996, the budget for Bell Atlantic utility lines has been reduced from $4.3 million to $2.5 million or by $1.8 million;while the amount of $300,000 for the relocation of the other utilities has remained the same. The revised budget for total utility relocation is now about $2.8 million. According to the District’s Project Manager for the sports arena, Bell Atlantic was able to accomplish the relocation of the utility lines within the scheduled time frame without having to use premium time (overtime) as originally estimated. If Bell Atlantic had had to use premium time to relocate the utility lines, the hourly charges would have been one and a half to twice the cost of normal time.

Leasehold (Office) Improvements

To begin construction of the arena project, the District demolished two office buildings that previously provided office space for its employees. The employees were relocated into District-owned and leased office buildings. To pay for office improvements, a budget was established at $5 per square foot or about $972,000. Since we last reported, this budget for leasehold improvements has increased by $372,000 and, as of October 18, 1996, totaled about $1.34 million. According to the District’s Project Manager for the sports arena, the increase in the budget for office improvements is attributable to increases in improvements at the leased space at 800 9th Street, SW, which were not provided for in the original budget but were requested by the agency occupying the space—the Department of Human Services. The District leased four floors of office space at 800 9th Street SW and is required by the lease to pay for the renovation to the new space.

According to the District’s Project Manager for the sports arena, this cost is considered a qualifying predevelopment cost of the arena project. However, we found that this cost was funded from the District government’s appropriated funds rather than from funds available to pay allowable arena predevelopment costs. We informed the District’s Chief Financial Officer of this matter, and he agreed to recoup the funds from the arena project’s predevelopment funds.

Arena Tax Revenue Collections

According to the District’s Debt Manager, Arena Tax collections for 1995 totaled approximately $9.3 million, exceeding the original projection of $9 million. The District forecasts Arena Tax collections of $9 million for each year the bonds are outstanding. We verified that the $9.3 million was collected for 1995 and transferred by the lockbox trustee to the escrow account.

Between May 15 and May 23, 1996, notices were sent to District taxpayers informing them that the 1996 Arena Tax was due on June 15, 1996. According to the District’s Debt Manager, approximately $9.4 million had been collected for the 1996 Arena Tax through November 30, 1996. We also verified that this amount was transferred from the lockbox to the bond trustee. In contrast to the 1995 tax collections, most of which were used to pay the arena’s predevelopment costs before the RLA bonds were issued, the 1996 tax collections, as required by the bond resolution, were used to make the payment—principal and interest of $5.9 million—due November 1, 1996, on the RLA bonds.

The bond resolution requires that any additional tax collected over the required payment be placed in a fund and be used to redeem the term bonds earlier than their due date. As mentioned, $9.4 million in Arena taxes were collected through November 30, 1996. In addition, interest of $165,337 was earned on deposits in the Debt Service Accounts. Of these amounts, about $5.9 million paid the debt service due on November 1, 1996, $2.2 million was deposited into the Super Sinker fund, and the remaining $1.5 million will be applied toward the May 1997 debt service payment. The District’s projections of Arena Tax revenues at the current level of $9 million annually appear sufficient to redeem the bonds by the year 2002.

Financing Predevelopment Costs

In August 1995, the District secured a $53 million loan commitment from a syndicate of banks led by NationsBank and Crestar Bank to finance predevelopment costs for the arena project. This loan was subsequently paid off in January 1996 from the proceeds of an approximate $60 million bond sale arranged by the RLA.

The funds originally available to pay the arena’s predevelopment costs and establish a debt service reserve totaled $66.6 million. The make up of these funds consisted of (1) $57.4 million in net bond proceeds (after financing costs) from the sale of RLA Revenue Bonds in January 1996 and (2) $9.3million in 1995 tax collections from the dedicated Sports Arena Tax. Of the $66.6 million available, $11 million is held in reserve in two parts. A mandatory $5 million capital reserve required by the bond resolution was established to pay for cost overruns. In addition, a $6 million reserve was established for debt service. As shown in table 1, the current estimate of total predevelopment costs is $55.8 million. The unreserved amount of $55.6 million and the $5 million capital reserve for cost overruns are available to pay this current estimate. As of September 30, 1996, we verified that no funds have been used from the mandatory capital reserve. In addition, barring unforeseen cost increases over established reserves, the District has sufficient funds to pay its estimated predevelopment costs.

RLA’s Bonds Received Interest Rates Similar to Investment Grade Securities

During the July 1996 testimony before your subcommittee, concerns were raised regarding the interest rates to be paid on the bonds issued to finance the sports arena’s predevelopment costs. We analyzed relevant information regarding this matter.

The RLA was advised by a number of investment bankers, as part of its financing strategy, that in order to improve the desirability of the bonds to investors, the bonds must be structured in a way to reduce default risk. Specifically, the bonds had to have: a dedicated revenue stream, with the legal requirement to increase the Arena tax, if revenues at any time did not cover debt service, a lock-box mechanism under the direct control of a trustee who directly collects dedicated revenue receipts pledged for debt repayment, and a Super Sinking fund to allow the District to redeem bonds early at par.

When the bonds were issued in January 1996, the bond resolution reflected the advice of the investment bankers as described above. At that time, the RLA sold $44.5 million of term bonds redeemable on November 1, 2010, at an interest rate of 6.05 percent and about $15.4 million of serial bonds redeemable between the years 1996 and 2000 at interest rates ranging from 4.5 percent to 5.4 percent.

Prior to the bond sale, the bonds received a split rating from two rating agencies—Moody’s and S&P. Moody’s rated the bonds as investment grade (Baa) and S&P rated the bonds as noninvestment grade (B). An official of S&P told us that it did not give an investment grade rating to these bonds because they were unable to separate the District’s financial condition and its credit from this transaction. Moody’s rating of “Baa” is its lowest rating of four ratings for investment grade bonds. According to officials from Moody’s, the rating was based upon legal provisions insulating the Arena Tax revenues from the District’s financial difficulties and pledged arena revenues offering adequate debt service coverage.

Even though one of the two ratings the bonds received was noninvestment grade, Merrill Lynch officials stated that relative to prevailing market conditions at the time of the bonds issuance and the split rating, the bonds were well received by investors. This was indicated by strong demand from investors which resulted in various bond series being oversubscribed between 2 to 10 times the amount of bonds being sold. Given this demand, the Merrill Lynch officials stated that the RLA bonds were repriced. In addition, Merrill Lynch officials stated that the bonds were priced (carried interest rates) based primarily upon (1) their structure rather than the District’s financial condition and (2) the prevailing conditions in the bond market at the time the bonds were sold. Consequently, they said that they believed the bonds’ interest rates were similar to interest rates on investment grade rated securities.

Construction Status

As of December 10, 1996, according to a DCALP official, the erection of structural steel beams for the roof of the arena had started. DCALP officials expect the roof to take about an additional 4 months to complete, depending on weather conditions. The roof is expected to be in place by summer of 1997. DCALP stated that the arena should open in late 1997.

Agency Comments

We obtained oral comments from the Mayor of the District of Columbia and the Chief Financial Officer on a draft of this report. They concurred with the information presented.

We are sending copies of this report to the Chairmen and Ranking Minority Members of the Senate and House Appropriations Committees’ Subcommittees on the District of Columbia; Senate Committee on Governmental Affairs, Subcommittee on Oversight of Government Management and the District of Columbia; and the Ranking Minority Member of your Subcommittee. If you need further information, please contact me at (202) 512-9510. Major contributors to this report are listed in appendix I.

Major Contributors to This Report

Accounting and Information Management Division, Washington, D.C.

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