The law firm representing the trustee for a $250 million student housing complex accused the University of Oklahoma of predatory behavior in canceling a $6.4 million annual lease less than a year after the facility opened.
The accusation comes a month after S&P Global Ratings slashed the 2017 bonds issued through conduit Oklahoma Development Finance Authority eight notches to CC from the previous BB while retaining a negative outlook. The bonds lost their investment grade rating of BBB-minus on May 31, 2018, three months before the project opened.
"The reality is that the failure to renew the leases will be to the grave detriment of the citizens of Oklahoma," attorney David Dubrow of the firm Arent Fox wrote
The letter to OU and the law firm hired to represent it in the matter, Quinn Emmanuel, lays the groundwork for a lawsuit, demanding the preservation of all records and communication involving the Cross Village luxury apartment complex. Disclosure
OU maintains it was within its rights to terminate the lease, and that continuing "would have cost the University nearly $7 million annually and led to subsidizing a private entity, which the University cannot do with student tuition and fees," according to a spokeswoman.
Dubrow’s letter “contains numerous inaccuracies and misstatements about the University’s obligations,” OU said in response.
“Statements that you cannot trust or do business with the university or the state of Oklahoma are defamatory,” the statement said.
“The offering materials prepared by those parties repeatedly disclosed that the university would not service the debt or provide any part of the debt service,” the statement said. “The university chose not to renew the leases because the benefits observed during the first year did not justify the costs, and the university could not subsidize a sophisticated private company, especially one that is paying its own management millions of dollars.”
Dubrow, who has decades of experience representing public finance clients in bankruptcies and bondholder disputes, said he has never seen a state-funded entity walk away from a moral obligation such as the university’s pledge to provide $6.4 million in annual lease payments for parking and dining facilities at Cross Village developed by Provident Oklahoma Education Resources Inc.
“This outright betrayal is unprecedented by any governmental entity in Oklahoma and by any state affiliated entity anywhere in the United States,” he wrote. “It makes a mockery of the $2 billion subject to appropriation obligations in the State of Oklahoma.”
OU canceled its lease on the 1,219-bed Cross Village July 26 after secret negotiations that did not include the bond trustee. Shortly before announcing the termination, OU invited the trustee to join the discussions which had already been underway, Dubrow said.
S&P's Aug. 9 downgrade to CC was attributed to "insufficient project revenues to fund debt service and the draw on the debt service reserve fund for the Aug. 1, 2019, debt service payment," said S&P Global Ratings credit analyst Bobbi Gajwani.
“The negative outlook reflects the expectation that there will be insufficient funds to pay debt service due on Feb. 1, 2020, given low preliminary occupancy rates for the upcoming academic year and our expectation that POER will have to rely on its debt service reserve fund to meet its obligation,” Gajwani wrote. “Furthermore, though we have not spoken to the university, we do not expect any extraordinary support from the university given the termination of its full lease commitment and recent track record of lack of support and connectivity to the project.”
The bonds' first downgrade to BB with a negative outlook by S&P on May 31, 2018, came less than three months before the luxury apartments were scheduled to open. The original rating on the 2017A and B bonds was BBB-minus.
“In our view, despite repeated efforts by POER to partner with the university to facilitate increased occupancy, university cooperation and support has deteriorated,” Gajwani wrote. “Continued low projected 30% occupancy for the upcoming academic year 2019-2020 coupled with the recent scaling back of the university's agreement to lease all commercial and parking space for about $6 million annually render the project financially unviable, thereby triggering the current multi-notch downgrade.”
Although no default has occurred, such an event would allow the university to take possession of the luxury student housing, thereby diluting bondholder protection, according to S&P. The university owns the land on which the project is located and leases it to POER for a term extending beyond the 40-year final maturity of the bonds. Project ownership was expected to revert to OU after the bonds were repaid.
Dubrow’s letter said that OU’s “reckless repudiation” of its lease “makes the entire transaction appear like the university wants the project to fail for the pecuniary benefit of the university and at the expense of investors. Indeed, this impression is reinforced by reliable sources who have told us that the university's strategy is to drag things out until it can get ownership of the project at pennies on the dollar. This sinister plan is more like that of a vulture hedge fund than of a governmental entity.”
Cross Village opened for the 2018 fall semester with 28% occupancy and incomplete facilities, including the dining services. The management firm Balfour Beatty Campus Solutions was replaced by Capstone On-Campus Management on Oct. 15.
"The University has met all of its legal obligations, and in not renewing these leases is simply exercising the annual right to terminate that is specifically spelled out in the written agreement," OU's statement said. "The University does not believe the non-renewal will have any impact on the University’s credit rating."
Even with the OU lease intact, S&P questioned whether rents would prove sufficient to meet debt service. To boost occupancy, Cross Village reduced rents before the downgrade. POER is a non-profit branch of Louisiana-based Provident Resources Group Inc.
Cross Village was designed to meet specifications set by OU under then-president David Boren, a former governor and U.S. senator whose 24-year tenure as OU president was the second-longest in the university’s history. OU received a $20 million upfront payment under terms of the public-private partnership. The trustee could seek to recover the payment that was derived from the bond sale.
Boren’s successor, James L. Gallogly, an OU graduate and retired oil company executive, was only 10 months into his tenure when he announced his retirement in May.
Former law school dean Joseph Harroz Jr. is OU’s interim president.
On his first day as president, Gallogly fired chief financial officer Chris Kuwitzky, the chief audit executive, the executive for federal programs, the senior associate vice president for public affairs and the vice president for governmental relations. Those moves saved the university $1 million per year, he said.
Gallogly told regents in 2018 the administration had identified $20 million in savings for the next year, mostly by cutting third-party services and purchases. He blamed the Cross Village deal on financial advisors and told the OU Board of Regents the lease arrangements were contributing to an annual shortfall of funds.
"I was not aware of this until the afternoon of July 2, my first day in office," Gallogly told the board. "We have to pay rent on parking, it's significant and it's not in the budget. That's not acceptable. Hopefully we've found the things that aren't in the budget, but we've had a few surprises along the way."
With occupancy of OU residences at 63%, the university was losing $2.3 million on the facilities in 2018, according to Gallogly's report.
In announcing his resignation in May, Gallogly defended his moves to cut spending by nearly $48 million.
“As I began preparing the university budget for a June presentation, it became obvious that the Norman campus had been operating at significant losses for the last couple of years, had grown its debt, and had limited cash reserves,” he
Regardless of whom the regents choose to succeed Gallogly, the university made a commitment to the Cross Village project and is obligated to fulfill its end of the deal, Dubrow said. The OU lease accounts for about a third of annual debt service, he said.
“The university drew on its status as a respected and trusted state entity in order to seek investors for this project,” Dubrow wrote. “It assured investors that even though the leases for the commercial space and parking were renewable on an annual basis, the university intended to lease all of the commercial and parking spaces for the life of the bonds at the agreed upon rents. It did so with full knowledge and understanding that the offering statement for the bonds included long-term projections showing that the University would renew the leases and honor its lease payments.”
Bond buyers included major mutual funds and other sophisticated investors, Dubrow said. OU’s decision to renege on a long-term lease could taint not only OU’s credit but that of the state, Dubrow said.
“In the few other instances we know of where a governmental entity (in each case either a city or county) reneged on a subject to annual appropriation credit, the governmental entity suffered a severe downgrade and was either locked out of the marketplace for several years or was severely punished in the market place with high interest rates on its debt,” Dubrow wrote. “We expect a similar outcome for the University of Oklahoma once the rating agencies and market participants focus on the University's bad faith in not renewing the leases.”
The state of Oklahoma and its affiliated entities have more than $2 billion outstanding in the form of lease revenue bonds, certificates of participation in leases and similar instruments, according to Dubrow.
Oklahoma Bond Advisor Andrew Messer said he has not had any discussions with the rating agencies about how the OU decision might affect the state’s outstanding obligations.
“We are monitoring the situation and are confident that the state’s credit will not be affected by recent developments,” Messer told The Bond Buyer.
