If there is any silver lining to the dark cloud of Hercules’ financial problems it could become apparent today when California county auditors distribute hundreds of millions of dollars in property tax money to cities and counties that operated the state’s 397 former redevelopment agencies.
For unlike many of its sister municipalities, Hercules is slated to receive its full share of tax revenues that would have been paid to the city’s redevelopment agency (RDA) had it not been abolished four months ago – an amount estimated to be a little over $4 million.
That money will be used to make payments on an estimated $311 million in debts incurred over the past decade by the city’s troubled redevelopment program, although it will fall short of what’s needed to make every payment scheduled for the next six months, suggesting Hercules’ officials will have to sharpen their pencils.
But things could have been worse, except for an by the California Department of Finance a few days ago when it reversed a decision that would have reduced the city's property tax share by 20 percent. The state’s initial decision disallowed a payment of about $825,000 to Catellus Corp., which was involved in the original development of the upscale Victoria by the Bay neighborhood.
Many other cities aren’t so lucky, and the fact the state finance department is standing pat on most of its original decisions has underscored how California’s plan for doing away with redevelopment agencies is turning out to be considerably more complicated in practice than it was in theory.
Legislation abolishing redevelopment – Assembly Bill 26 – streaked through the state legislature last year with the speed of a bullet train, being introduced on May 19 by Democratic Assemblyman Bob Blumenfield of Van Nuys and signed into law 40 days later by Gov. Jerry Brown.
What the governor signed was a 42-page document outlining a complex structure for abolishing RDAs and establishing successor agencies that would be responsible for overseeing repayment of all former RDA debt over a period that could extend for decades, and imposing a process by which these debts would be validated.
Easier Said Than Done
But writing and passing the law has proven to be a remarkably smoother process than enforcing it. Despite the fact that California’s state Supreme Court upheld the law following a costly legal battle, it continues to generate controversy and to invite legal challenges seeking to define its ambiguous and sometimes contradictory mandates.
In the past two months alone, more than a dozen cities, non-profit organizations and a private company have filed lawsuits against the state claiming the new rules are being applied in contradiction to the legislative intent, that the department of finance has been overreaching in its administration of the law, and that current policies would leave many cities unable to fully meet their bond debts and other financial obligations.
In short, the law aimed at abolishing half a century of redevelopment in California has raised more questions than it answers. And nowhere is that more apparent than Hercules, which faces payments on its former RDA debt during the first six months of the new fiscal year that alone exceed by more than $5 million the city's preliminary general fund budget for the entire year.
In theory, redevelopment was designed to eliminate urban blight while creating jobs and affordable housing within designed redevelopment areas. Property tax collections in these areas were frozen at a base level, and any taxes generated by the increase in assessed value of that property created by new development -- the so-called “tax increment” -- was earmarked for affordable housing and other redevelopment activities.
So you take a cow pasture, an abandoned and decaying industrial plant or litter-strewn downtown lot, put new houses and a shopping center on the land and suddenly the incremental tax gain on the property is worth a lot more than it had been before. However, under the old redevelopment laws, this property tax 'increment' could not be used to fund police, fire departments or schools.
Although property and sales taxes have always been the bread and butter of every city, the formula becomes complicated when redevelopment is thrown in. Residents were still paying their property taxes, but that money wasn’t all going to pay for city services that taxpayers had grown to expect.
City’s Tax Revenue Declines
For example, over the past eight years Hercules has received $83.7 million in tax increment revenue. Its largest distribution -- $13.1 million – came in 2008 when real estate values were booming. This was followed by significant declines since 2009. The total tax increment for the current 2011-2012 fiscal year is $9.3 million, of which the second distribution is being made today.
Theoretically, the new law abolishing redevelopment would free up billions of dollars in former tax increment revenues and other assets that state lawmakers -- themselves desperate for additional money to balance their own huge general fund deficit -- could grab to help fund education and various other special tax districts that previously were getting only scraps from the redevelopment table. By passing along some of former RDA money to school and community college districts, the state could reduce the amount it would have to pay from the general fund for education.
Smooth as it sounded on paper, abolishing redevelopment soon proved to be as complicated as getting the 20-something-year-old out the door and into a life on his own; they could leave the nest, but they left in their wake a sea of borrowing and college loans that couldn't be ignored and had to be repaid.
The trick for California was devising a scheme where redevelopment debts would be paid and anything left over would be redistributed. Lawmakers believed Assembly Bill 26 would do just that.
In fact, the governor’s revised state budget for the 2012-2013 fiscal year has anticipated $1.4 billion in revenue could be obtained by picking the bones of redevelopment – a projection the non-partisan Legislative Analyst’ Office (LAO) described as being “subject to considerable uncertainty” in a report published two weeks ago. The LAO reported there was significant risk in the state counting it’s chickens before they hatched – pointing out that in addition to imprecise estimates of tax revenues reclaimed from former RDAs, county audits of other assets that could be subject to seizure by the state would not be completed until July, and it was likely that any order to transfer assets would be challenged in court.
Payment Schedules Now Required
Under the new law, assessing what RDAs owed was a two-step process. First was identifying “Enforceable Obligations” – debts that absolutely had to be repaid, such as debt service on bonds, contract payments and other legal commitments -- a task many municipalities accomplished even before the Supreme Court issued its decision last year. The second step required by the law, was the preparation of a “Recognized Obligation Payment Schedule” (ROPS), a document identifying specific debts, the purpose of the debt and a schedule of payments on that debt for a six-month period. The ROPS would have to be prepared and submitted to the finance department, the state controller and county auditors twice each year prior to the distribution of tax increment revenues. This process would be repeated until all debts were paid in full.
What has precipitated the current dispute – and related litigation – are decisions by the state finance department concerning what is and what is not a Recognized Obligation listed on the ROPS. Since April many successor agencies have received “Review Letters” from the state questioning or denying obligations contained on the ROPS. These denials, in essence, prohibit county auditors from disbursing funds for the specific payment scheduled outlined on the payment schedule.
If, for example, the initial denial of the Catellus obligation not been reversed, the county auditor would have been forced to withhold $825,000 that had been scheduled for the city’s August payment.
The money owed to Catellus stems from Victoria by the Bay, a subdivision that was supposed to have been a boon for the city.
The subdivision sits on land once occupied by Pacific Refining, which shut down its refinery operations 1995. A few years later, the old refinery and the cow pastures surrounding it were purchased by Hercules LLC, a subsidiary of the giant Catellus Development Corp., which is now owned by TPG Capital, a private investment firm.
Lucrative Development Deal
In 2001, following several years of discussions, the city signed an agreement giving Catellus exclusive rights to develop the area. To reimburse the developer for the costs of acquiring, dismantling and cleaning up the former refinery, Hercules agreed to give Catellus a large share of the tax increment revenues from the subdivision.
By 2006, Hercules had paid Catellus $7.5 million of the tax increments collected from Victoria by the Bay. However, with such a huge amount of money pouring out of city coffers, officials began studying their 2001 agreement with the developer and unilaterally decided Catellus had been paid enough.
In 2007, Hercules stopped its redevelopment payments to Catellus and issued bonds that included funds earmarked to pay off the developer in one lump sum. But in January 2008, after a year of missed payments, Catellus sued for the money it claimed the city owed.
Hercules fought back, saying Catellus had received more than its fair share of reimbursements from the project, and further argued that the developer had overstated the reimbursable value of land and roads involved in the deal by $50 million. The city further claimed Catellus never actually built any of the homes, parks or even streets in Victoria by the Bay. According to court records, the city alleged Catellus had sold those rights to other developers and by 2003 “had realized over $102 million from these sales.”
Hercules’ calculations were outlined in a legal filing with the court just as the case was set to go to trial in April 2010. But after spending more than $1 million to defend itself, the city settled the case out of court and no trial was ever held.
Over the past decade, the city has paid Catellus more than $20 million in tax increment payments and still owes $53.3 million.
The state's decision that the Catellus obligation was an unallowable expense of the former RDA would not have meant Hercules didn't have to pay it, but it could well have deprived the city money that could be used to pay bond and other debts.
A Change of Mind
Relying on that denial, Catellus, sued the state last week seeking an order prohibiting any funds for payment from being withheld. A hearing on that lawsuit scheduled on Tuesday was cancelled after the finance department changed its mind.
What prompted that reversal is unknown. Officials at the finance department have not responded to Patch requests for comment. However, it's possible Hercules’ unique situation with respect to the Catellus obligation may have been a factor.
Instead of having to rely on current tax increment revenues to make Catellus payments, Hercules has more than $11 million in cash earmarked in trust accounts that were established as part of two bond sales in 2007. That money can only be used to pay the developer. The new law specifically states that payments required under bond indentures – as in Hercules’ case – are enforceable obligations that cannot be denied.
Andrew Sabey, the San Francisco attorney representing Catellus, said his client had not authorized him to discuss any aspects of the situation.
Moreover, since the money held by the city’s bond trustee is does not come from tax increment revenues, and at the current semi-annual payment schedule will not be exhausted for almost eight years, it would appear the city will not have to worry about that particular debt for the near term.
The significance of state denials is obvious: If a particular debt is not an approved obligation, the county auditor is prohibited from disbursing tax increment money to make the debt payments outlined on the ROPS. These denials have the potential for creating severe financial problems for cities, since many of them are their RDA’s successor agencies responsible for paying the bills. If tax increment distributions can’t be used, the city itself is presumably responsible for funding money to make the payments.