Am I interpreting this correctly? And am I to understand that OSEP will be the ones who will be in charge of computing the 10-yr improvement in EUI (which will then determine their bonus)?

Now, if by 6/30/2028 they i) spend less than $250M, and/or ii) increase the EUI by more than 25%, they get a (onetime?) bonus paid by OSU. According to the table on p. 2530: if, for example, EUI is improved by 35% for a cost of $200M, their bonus amounts to $70M. And in the extreme case EUI is improved by 40% with an expenditure of only $100M, then OSU will pay them a bonus of $150M.

SM : It seems there is another potentially significant cost that the administration accidentally forgot to include in their presentation of the CEMP agreement, having to do with the awarding of bonuses to OSEP in the event they surpass their Energy Use Intensity (EUI) 10-yr targets. This is discussed in Schedule 21 (pp. 2530 - 2531) of the final version of the FCA ( linked here ). If I am reading it right, they are anticipating spending $250M over 10 years to increase energy efficiency (as they measure it) by 25%. Of course, OSU is paying that $250M back with substantial interest.

It is relatively easy, by way of contrast, to estimate the impact of the provision by which OSU covers OSEP's maximum possible federal income tax liability for the interest OSEP will receive for lending OSU $250M for infrastructure improvements. This tax liability to OSU is what makes the effective interest rate paid by OSU on these loans rise from a nominal 6.5% to over 7.5%.

Truthfully, I would be shocked if OSU were agreeing to pay tens of millions per year in property taxes in a provision that seems almost an afterthought in the agreement. They might be considered not very smart for paying too-high interest rates, etc. But if the property tax liability were anything like what you have estimated, this deal would border on insanity and certainly should bring into serious question whether anyone responsible for this agreement at OSU is upholding their fiduciary duty, which includes understanding what they are doing financially. I suspect the OSU administration (thinks they) are going to pay very little because of this provision. Someone knowledgeable in the tax arena needs to check that.

HCA : I'm afraid I don't know enough about how such taxes work, nor how to interpret the relevant provisions of the agreement, so I can't hazard a guess about this. I hope someone outside the OSU administration who has such knowledge will be able to examine the agreement and estimate how much this commitment might increase the total cost to OSU.

Now OSU is claiming that the money they are getting from the CEMP partnership is not a loan. In other words, for tax purposes, this transaction should be viewed as a sale. If so, that would put the tax valuation of the "property" being "sold" at approximately $1B, potentially yielding an annual property tax bill of about $87M. This is in addition to the concessionaire fee that OSU will be paying, which starts out at $45M. And even if this is substantially discounted - say by 75% - this would still be an enormous addition to OSU's financial burden, adding at least another $1B in unadjusted tax dollars to the total cost over 50 years.

However, it seems that it may very well be substantial, for the following reason:​ the undiscounted tax rate for commercial property in Columbus OH is roughly 8.7% (i.e., $87/$1,000) (see http://www.franklincountyauditor.com/public/documents/pdf/eb2ba03b-fabc-f095-58ac88efd2023a50.pdf ). And the basis used for tax valuation of real property in Franklin County is often very close to the most recent sales price, if there was a recent sale.

SM : The fact that OSU has agreed to pay the to-be-incurred commercial property taxes associated to the assets being acquired by OSEP - and the resultant tax exposure to OSU arising from this deal - was an aspect of this arrangement that, for some reason, the administration never mentioned in their presentation of the CEMP agreement.

HCA: I can only speculate, as I did not notice anything about this in the concessionaire agreement. Maybe OSEP could "sell" back all the property that OSU has now "sold" to OSEP in return for a payment of $1 in the year 2067. Maybe OSU could treat the return of its property as a gift, but as a state entity would have no tax liability for it. In fact, now I have to wonder whether maybe OSEP could get a huge charitable deduction in 2067 for giving everything back to OSU. I hope not.

SM : Assuming this arrangement between OSU and OSEP is legal from a tax law perspective, at the end of 50 years OSEP will have fully depreciated assets and capitalized improvements worth well over $1B. How can this be "transferred" back to OSU?

All this tax business is so deeply buried, in arcane tax rules and detailed provisions of the concessionaire agreement deliberately withheld from the public until hours before the Board of Trustees' approval vote, that it's no wonder there has been no public outrage over it yet.

In other words, the taxpayers of Ohio not only suffer the indignities mentioned earlier, but under this agreement also pay OSEP’s local property taxes. And remember that OSU also will reimburse OSEP each year for even more—perhaps much more—than OSEP will pay in federal income taxes on the interest income it receives from OSU on the total of $250M in loans for infrastructure improvements.

Regarding local property taxes, I suspect you can't legally have your cake and eat it, too. That is, if you claim tax ownership of something to depreciate it for federal income tax purposes, probably you also own it for local property tax purposes. The maddening thing about this deal is that OSU completely insulates OSEP from its resulting property tax obligation by agreeing to pay all of those property taxes—which OSU does not pay now because OSU property is state property and not subject to local property taxes.

In other words, the taxpayers of Ohio and the rest of the US effectively wind up paying some of the private company's tax bill—the taxpayers of Ohio having first paid for the state assets that now have been "sold" to the private company in order that it can get this tax break.

HCA : Not only am I not an attorney, I'm also not a CPA. To me, it also seems like tax evasion, and I'm pretty sure that if you or I or any other normal individual engaged in such shenanigans we'd quickly find ourselves conversing with IRS agents. However, I understand that while this area is complex and in some respects confusing even for experts, it apparently is legal for a private company to have "tax ownership" of something even while title rests with, say, the State of Ohio. Evidently this requires some sort of concessionaire agreement that lasts for a fairly long time; hence the 50-year deals we're seeing here and with OSU parking. This kind of arrangement permits the private entity to depreciate those assets over a relatively short term, less than 50 years, thereby considerably reducing its tax bill during those years.

SM : The tax arrangements associated with this deal seem questionable at best. In particular, depreciating an "asset" that you don't actually own would seem to qualify as tax evasion. Is this arrangement actually legal? And, again, if they (OSEP) don't actually own the assets, then why should there be local property taxes for OSU to pay?

HCA : We'll have to wait and see if anything like that materializes. However, I'd be shocked if Mr. Chatas hasn't learned a lesson from the previous fiasco.

SM : Is there any hint of a quid pro quo involved with this deal, as there seemed to have been when Geoff Chatas was hired by the firm that signed the lease for the parking deal right after the deal went through?

HCA : It's hard to know what the Board of Trustees understood about this deal before voting to approve it. The media reported the BoTs admittedly did not examine a letter an opponent sent to them before the vote that outlined some financial issues one hopes they would have considered. Essentially all their deliberations take place behind closed doors. If you've ever attended a Board of Trustees meeting, or a meeting of one of its committees, you’ll realize it's all carefully orchestrated to make sure there is essentially no opportunity for public discussion or debate.

SM : Has the BoT approved a dangerous course of action without performing a “due diligence” investigation into all the details of the deal, and its implications, including the long-term financial viability of OSU?

As I mentioned before, I am trying hard not to submit to the temptation to impugn the motives of those who propose, promote, and approve dubious financial deals like this. I have no evidence that this isn't simply an act of desperation related to the apparent problems mentioned above. But if evidence of misbehavior surfaced, I admit I would be more disappointed than surprised.

While not suggesting anything truly sinister, these explanations raise serious questions about the competence of the OSU administration and especially the Board of Trustees: the many dubious provisions of this deal, the repeated efforts to hide those provisions from the public, the very idea that OSU might have reached a point financially where anyone would feel compelled to pull an end-run on borrowing limits, etc. If OSU is really at the end of its conventional borrowing rope for capital projects, who has been minding the store? The mantra seems to have been that interest rates are low so let's borrow now! If you have to borrow, sure, it's been a good time to do it. But maybe OSU's long-range planning for capital projects hasn't properly accounted for borrowing limits.

Solving the second problem, finding money for energy-related capital improvements, is a different matter. Borrowing from a private firm might have been the only way OSU could get enough money to make energy infrastructure improvements. It's just going to pay far more for these loans over the next 50 years than if it had gone through the usual financial markets where it has recently borrowed huge sums for the Medical Center, north dorms, and other capital projects.

Solving the first problem, increasing the endowment, clearly required some creative financing to disguise a big loan (with proceeds put into the endowment) as the "consideration" for OSU "selling" part of the campus to the lender. Surely conventional borrowing would not have been possible simply to raise money to put into the endowment. I find this aspect of the deal hugely objectionable in principle as well as a bad financial move. It just doesn't pass the smell test.

Second, I have to believe OSU's own claims that it doesn't have enough cash on hand to pay for the infrastructure improvements required to dramatically improve energy efficiency. So, OSU has to borrow that money if it wants to be seen as "green". Some $250M in such loans beyond the $1.015B up-front loan will come from the concessionaire, OSEP, for this purpose. Why borrow from a private entity at a high interest rate? OSU might be at or near its effective, or perhaps its legal, conventional borrowing limit, and cannot get $250M for new capital projects through normal channels. OSU has hinted as much in some of its recent press releases about this deal. In other words, OSU literally might be unable (as opposed to unwilling) to borrow enough to make the desired energy efficiency improvements in the conventional way by selling bonds to investors. If it wants energy efficiency improvements, it now has to pay dearly for them by borrowing these funds at a shockingly high interest rate.

First, the OSU administration wants to be seen (remembered) as having massively increased the value of OSU's endowment. I'm not sure why this is so important to them beyond personal aggrandizement; maybe endowment fund value is a factor in some sort of university ranking system in which they think they can make OSU move up. There is no doubt this motivation was at play in the parking deal a few years ago, and there is little reason to believe it is any less relevant today, the departure of Gordon Gee notwithstanding.

There’s no short answer to the question of what might have motivated OSU administrators to set up this deal. We know the state has not been generous with higher education funding recently, and it has severely restricted tuition increases for years. I therefore speculate that the OSU administration's feelings of desperation in the face of this pressure might have contributed to some unwise financial decisions, including this one. In other words, I want to offer an explanation in which people were misguided rather than sinister. At least two plausible motivations for the deal come to mind in this view.

HCA : It's not quite a credit-card interest rate, but the point of the question is spot-on. The effective interest rate is relatively high compared to what OSU would pay to borrow transparently and traditionally by selling bonds, as it has routinely done in the past to make significant capital expenditures.

SM : It seems like the OSU administration is taking a $1B+ cash advance on a credit card with a high interest rate, thereby trapping OSU in growing levels of debt for decades to come. What is motivating the OSU administration to launch OSU onto such a dangerous path? Could it be that there are hidden interests in play?

In other words, the additional financial burdens placed on OSU as a result of the unfortunate financial provisions of this deal cannot be viewed as being even partially offset by potential savings from energy efficiency.

Furthermore, the interest rate OSU will be paying on the $250M of capital expenditures to make energy efficiency improvements is outrageously high compared to the interest rate it would pay if it borrowed in a conventional manner through the credit markets rather than borrowing from OSEP. If OSU borrowed in the usual fashion it would still get the energy savings that will arise from this plan.

However, the $1.015B loan is completely independent of any such gains because it has nothing at all to do with energy usage or efficiency. It’s a (massive) sideshow tacked onto the energy deal—the tail wagging the dog. The energy efficiency savings would be realized even if OSU had not demanded this massive up-front loan as part of the deal.

HCA : There is little doubt that savings will be realized in this area. Other colleges and universities have invested in energy efficiency improvements and have documented nice savings, and of course almost everyone appreciates the idea of not wasting as much energy.

HCA : As explained in my article, I calculate there will be a significant annual cash-flow shortfall for many years: almost certainly for the next decade or two, probably for three or four decades, and perhaps for the entire five decades of the loan. On the plus side, however, the value of the OSU endowment in 2067 almost surely will be higher with than without the $1.015B loan, and 50 years from now any extra money will generate annual distributions that will no longer need to be used to make the escalating annual loan payments to OSEP. It is impossible to know how much extra value this will provide to OSU without predicting the performance of endowment fund investments and inflation for the next 50 years, among other unpredictable things. The downside effects are virtually certain and begin immediately, while the upside effects are uncertain and (if they arise) will not be seen for decades.

SM : What’s the timeframe in which you see this deal causing financial problems for OSU? And can we really predict what will happen over such a long term?

To start off, has this deal been finalized? Does the State have to approve it, for example? Or is this now a done deal?

SM : Your article certainly clarified a number of points left unaddressed by the administration's misleading presentation of the CEMP agreement. However, along with the FCA, it also raises some additional questions.

HCA: This is also my reading of the bonus provisions. The agreement stipulates a one-time bonus is to be computed in 2028, paid to OSEP in equal installments over the following 10 years. The bonus theoretically could be as much as $150M. But the bonus schedule strikes me as a bit odd, so I doubt OSU will pay the maximum bonus. The reason is that there is a significant incentive for OSEP to spend as much as possible of the $250M it has committed to fund energy conservation measures. This way, it gets not only the return on this $250M in loans (with OSU paying an effective interest rate that begins at over 7.5%) but also the opportunity to earn up to a $60M bonus for achieving energy efficiency gains that exceed 25%. In other words, I would be surprised if the OSEP loans to OSU for infrastructure improvements ended up being much less than $250M.









SM: We understand that part of the arrangement is that OSU has agreed to borrow, and pay back to OSEP, at least $250M for building and system improvements to enhance "sustainability". But the bidding for this is purely non-competitive. How is OSU going to avoid price-gouging on the costs?





HCA: I have noticed no mention of competitive bidding or protection against price-gouging in the concessionaire agreement, though there is some legal language about obtaining bids for infrastructure improvements. OSU is permitted not to authorize any particular improvement proposal from OSEP, but if it really wants to meet its energy efficiency goal then what can it do other than authorize the expenditure by OSEP to make the improvement, even if it's 10% or 20% more expensive than a price it might have gotten some other way? I'm not sure whether there are other provisions, e.g., state law, that mandate competitive bidding.









SM: Clearly there is a big push to boost the endowment fund at the expense of the long-range economic health of OSU. This will be a boon to the financial managers of that fund, whose annual service fees seem to be about 2-3% of the funds' value. In other words, this injection of capital into the endowment fund represents a windfall of $20-30M for those managing the fund. Who exactly manages the fund? And do those managers have any other business connections with members of the BoT?





HCA: The OSU web site (http://investments.osu.edu) says, "We implement the asset allocation model by partnering with external managers." I have no idea who those external managers are, but the OSU people involved are shown on this web site. If there were enough investigative journalists still employed to look into such things, maybe some connections between the unnamed external managers and the BoTs would be found. But I don’t know of any information that would suggest this.









SM: Does the return-on-investment quoted by the administration represent the gross return, or the net after all of these financial service fees have been paid?





HCA: The OSU web site (http://investments.osu.edu/portfolio-returns.html) says "net of fees," so I think it does account for management fees. LTIP, by the way, is the acronym used on that site for "long-term investment pool", i.e., the "endowment funds" (or at least the part of the endowment funds into which the $1.015B is to be put).









SM: The loan is $1.015B. With the payment schedule and a 1.5% increase on the payment per year, what would you estimate the total amount of money OSU will pay back in 2017 constant dollars? I understand this will require estimating what the inflation rate will be on average over the next 50 years.







HCA: I've created a simple spreadsheet [linked here] that contains some calculations of this sort. For those who want to examine it carefully, here’s a quick explanation.





Column D addresses your question. I've assumed the average annual inflation rate is 2.5% but you can change this in cell D2. With 2.5% annual inflation, the total fixed fee payment in 2017 dollars is almost $1.8B.





OSU administrators would surely argue that column C is more important: the net present value of the payment stream. Of course, based on how OSU modeled the parking privatization financials, they would want to use a ridiculously high discount rate of 9%. I believe it's common practice for companies to use a much lower discount rate when doing these sorts of calculations (which are arguably ridiculous in any case because you're trying to predict and summarize economic conditions over the next 50 years). Anyway, the NPV of the payments is under $1B even at an arguably reasonable 6% discount rate. So, OSU administrators surely would conclude that we should be happy to get $1.015B for this payment stream.

​

The problem is that neither of the above calculations is actually what we need. Moreover, both analyses require predicting inflation and/or market performance over the next 50 years, which makes them highly suspect. What really matters is how this deal compares to conventional borrowing: my argument is that OSU will be paying far more to borrow all this money from OSEP than it would pay with conventional borrowing.





In particular, if OSU sold bonds, there would be no adjustment of payments to account either for 2017 dollars or for net present value. There would be a fixed interest rate and OSU would pay interest each year on the remaining principal balance, which would not change. So, for example, if OSU borrowed $1.015B at 3.7% for 50 years, its interest payments each year would be fixed at $1.015B x 3.7%, or about $37.5M. However, at the end of 50 years, OSU would need to come up with $1.015B to pay back the principal. In the deal with OSEP, the payments start at $45M but there is no $1.015B principal payment due at the end of 50 years. So, is the payment stream OSU now faces a good deal or a bad deal compared to conventional borrowing?





To make a fair comparison, I claim you (first) need to look at the borrowed money as if it were amortized like a conventional 50-year mortgage, where some of each annual payment pays the interest on the remaining balance and the rest reduces the principal, so that after 50 years the principal balance is zero. For example, if OSU borrowed $1.015B at 3.7% for 50 years in this model, its interest payments each year would be about $44.9M. (I’ve chosen 3.7% as the interest rate in these examples because the annual payment is almost exactly $45M, the first annual payment for OSU in the actual deal with OSEP. However, the payment to OSEP actually increases by 1.5% each year so it reaches nearly $95M in year 50 rather than remaining fixed at $45M.)





The question then arises: how can we compute an effective annual interest rate with the unusual increasing payment stream OSU faces for the next 50 years? Here’s what I’ve done in columns E-H of the spreadsheet. It makes sense to me but is unfortunately a bit complicated. Basically, with payments increasing each year, this loan can be treated like a new loan with a new amortization schedule each year. In the first year, we know the principal balance ($1.015B) and the payment ($45M) and the remaining term of the loan (50 years), so we can compute the effective interest rate being charged on the principal balance in the first year (which turns out to be 3.719%). This allows us to compute how much of the first payment goes to interest ($37.752M) and how much goes to principal reduction ($7.248M). And this tells us what the principal balance is for the following year, at which time we effectively have a new loan for that amount with a term of 49 years. We also know the payment for the second year ($45M increased by 1.5%), so we repeat the calculation. And we do this each year. The effective interest rate increases each year until it is over 17% in year 50. To summarize this analysis, the interest rate OSU will be paying on the principal balance starts at 3.719% in the first year and increases each year to reach over 17% in year 50. Ouch!





Note that the calculation in columns E-H does not involve any assumptions about inflation or discount rates. It simply shows the annual interest rates being paid to borrow the money: rates that seem quite reasonable in the first few years and become increasingly usurious as the years pass.

​

It's still not clear what the "average interest rate" or the "effective interest rate" is for this kind of loan. Is it literally the arithmetic average of all these 50 effective interest rates (7.454%)? Is it the interest rate that, with fixed annual payments, would result in the same total of all payments (6.213%)? I think I can justify the claim that it's over 6% no matter how you look at it, but I frankly don't know how an accountant would define it. Perhaps someone could check this and/or do some kind of standard accepted calculation of the effective interest rate on this kind of loan, if there is one, and if it matters to anyone.





Even compared to the relatively high 4.8% interest rate paid by OSU for the $500M in “century bonds” it sold in 2011, an effective interest rate over 6% for a 50-year loan doesn’t seem particularly attractive. Interest rates are still low right now. You or I could get a 30-year mortgage at about a 4% interest rate. Even for a 50-year loan, one would hope OSU could get a comparable interest rate.





Why is the interest rate OSU is paying on the century bonds a relatively high 4.8%, then? I understand OSU chose to make those bonds taxable. Why, if it could have paid a much lower interest rate by making them tax-free (municipal) bonds? OSU said it planned to—and we hope it did—set aside a non-trivial portion of the bond proceeds to put into much riskier investments in the expectation (i.e., hope) that over 100 years those funds would have grown by far more than 4.8% annually, i.e., enough to pay off the century bonds’ principal a century from now. This kind of arbitrage, in which one borrows at the municipal rate and invests some of the proceeds at a taxable investment rate, evidently is not permitted by law. Sounds like a good law. It’s basically the same thing that prevents you or me from borrowing money on a home equity loan, investing the proceeds in the stock market rather than making home improvements, and deducting the interest paid on the loan.









SM: What could the OSU administration privatize next? All of its buildings? The main campus itself?





HCA: At the time of parking privatization, the administration made some noise about considering privatizing (or selling) the OSU Airport and the OSU golf courses. At some point, I heard a rumor about privatizing the dorms (which has been done by a few other universities) and another about the medical center. Gordon Gee vehemently denied any interest in selling/privatizing Ohio Stadium, but Michael Drake may have other ideas. Who knows what they'll think of privatizing next? The only thing that seems certain is that this will not be the last scheme to privatize OSU assets unless there is a lot more public pushback than we've seen on parking and energy management privatization.









SM: What type of transparency is there going to be regarding this entire process? Is there going to be effective oversight, or is the process going to take place behind closed doors?





HCA: If history is any indication, it will be done behind closed doors. OSU will report early and often that everything is going great and will pat itself on the back for having made a fantastic deal.

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