State will not be downgraded if Hyatt Regency Chesapeake Bay fails to make bond payments

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The bonds issued to pay for the construction of the Hyatt Regency Chesapeake Bay in Cambridge may fall into default next year.

The Maryland Economic Development Corp. expects to fall short next year on payments to investors who bought the bonds that funded the Hyatt Regency Chesapeake Bay, a state-owned golf resort hotel and conference center on the Eastern Shore.

Known as default, a failure to meet bond payments may increase investor scrutiny of MEDCO, a company created by the General Assembly to aid economic development throughout Maryland, experts say, but it will not affect the state's credit rating.


"No issuer, MEDCO included, wants to have a reputation of having bonds default," said W. Bartley Hildreth, a professor at Georgia State University and a director of the Municipal Securities Rulemaking Board, which oversees the municipal securities market.

MEDCO issues revenue bonds, which are funded by the money a particular project creates. Such bonds insulate the state and its political subdivisions, such as Dorchester County, where the Hyatt is located, from legal and financial responsibility for the bond payments.


But the Hyatt is poised to become the second state-owned resort to struggle with bond payments — investors agreed to a multiple-year moratorium on bond interest for the troubled Rocky Gap hotel in Western Maryland before it was sold last year. With two soured hotel deals, MEDCO may have difficultly attracting investors to buy its bonds for such a project in the future.

"If the market gets a notion that more and more MEDCO bonds are defaulting then you're going to find institutional investors not willing to invest," Hildreth said.

The Hyatt, built on 260 privately owned acres along the Choptank River in Cambridge, has been using reserve funds for portions of its semiannual debt payments since December 2010, according to documents sent to bondholders. On June 1, the state withdrew $2 million from the reserve, cutting the fund's balance to $2.3 million, about 15 percent of the amount required by its bond covenants.

"We will end up depleting our reserves, based on our projections, either later this year … or sometime next year," said Robert Brennan, executive director of MEDCO. "It means that the investors are going to be wanting to talk to us to figure out how are we going to fix this problem."

With the fall-off in leisure and corporate travel during the recession, the hotel has not been generating enough revenue to pay for its operations, let alone its bond payments, for several years, according to its financial reports.

As a result, it's likely that MEDCO will be unable to fulfill its obligations under the current repayment terms by June 2014, Brennan said.

Though not good for the project, a default won't affect the operations of MEDCO, which does not have a credit rating, or the state's financial standing, he said. The bonds are to be repaid solely from the resort's revenue, he said. Neither the agency nor the state is responsible for payments, he said.

MEDCO and its other projects, which include the Maryland Public Health Laboratory building under construction in East Baltimore, are shielded from the Hyatt's poor performance because MEDCO's "nothing more than a conduit" for financing, said Dick O'Brien, a municipal securities expert at brokerage firm Folger Nolan Fleming Douglas' Hunt Valley office.


Standard & Poor's Ratings Services, through a spokesman, confirmed that bonds like those used to finance the Hyatt's construction don't influence the state's credit rating.

"The investors are taking a risk because all they have access to is the revenue," Hildreth said. "These bonds are not carried on the financial statement of the state … so there's not a legal liability."

Congress authorized the Internal Revenue Service to allow public entities such as MEDCO to issue tax-exempt bonds to spur economic activity that may not be supported by private-sector financing, he said.

That's the scenario the Hyatt project faced in the late 1990s, Brennan said.

The state had selected the bid of a development group to build a conference center hotel and golf resort on the 350-acre site of a former state mental hospital in Cambridge. The group included Hyatt Hotels Corp., Clark Enterprises Inc., a Bethesda-based real estate construction and investment firm, and Quadrangle Development Corp., a Washington-based developer.

But the developers could not obtain financing "to do the entire project," Brennan said.


MEDCO struck a deal with the group to finance the construction by issuing more than $120 million in revenue bonds in exchange for public ownership. The state owns the hotel, marina and other improvements at the resort. Ownership will revert to the developers in the mid-2030s, after the bonds are repaid, Brennan said.

The Hyatt opened in 2002 and was performing well, mostly because of its large group business, Brennan said. The hotel's solid financial footing allowed MEDCO to refinance the bonds, originally issued in 1999 with interest rates near 8 percent, for about 5 percent in 2006, he said.

But when the recession struck, group bookings fell drastically and the hotel's bottom line slumped, he said.

The Hyatt bonds, only made available to institutional investors because of their risk, are owned by a handful of asset management firms, including Vanguard, Deutsche Bank and Franklin Templeton. One firm, Nuveen Asset Management LLC, holds about half of the bonds' value.

Investors like the tax-exempt bonds because they often produce higher returns than municipal general obligation bonds, which are repaid with government funds, including tax revenues, Hildreth said.

These investment firms will decide the future of the Hyatt in the event of a default, Brennan said. While they could decide to foreclose on the property — taking ownership away from MEDCO — Brennan said he thinks that's unlikely because their investment would no longer be tax-exempt.


"Their best value will be continuing in supporting a high-performance resort facility," said Brennan of the investors who meet regularly and know of the resort's financial difficulties. "There's no doubt in my mind that we're going to get back to stabilization."

The investors must determine whether they will recoup more money by keeping the Hyatt operating under the current ownership or by taking over the property, O'Brien said. The most likely outcome, he said, is that the investors will agree to restructuring the debt, perhaps by reducing the interest rate or the principal. That will allow the Hyatt's operations to continue uninterrupted.

Hildreth agreed that the investors are likely to negotiate some type of payment forbearance or restructuring to avoid declaring a legal default.

All but one of the Hyatt bondholders declined to comment or did not respond to requests for comment on the hotel's future.

Lord Abbett & Co. LLC, the third-largest holder of the Hyatt bonds, said through a spokesman that "it's still too early to tell" what the investors will decide.

"We don't even know if default's going to happen," said Jim Sansevero, spokesman for the Jersey City, N.J.-based investment manager. "It's premature to say."


Unless the investors take some type of drastic action, Brennan said, the hotel's operations will continue as normal. A Hyatt spokeswoman said the Chicago-based hotelier plans to continue managing the property.

The hotel has plenty of money to keep paying its vendors because operating expenses come before debt payments, Brennan said. There also are ample reserve funds for "repairs and replenishments" to keep the hotel up-to-date, he said.

"There's a lot of value that this asset brings" to Cambridge, said Brennan, citing 300 to 700 jobs, depending on the time of year. "From a realistic perspective, we will continue as a going concern."