Cut! When film credits dried up, so did Raleigh’s payments

Raleigh Michigan Studios opened under a marquee of co-owners with names almost as renowned in Michigan as the Hollywood stars and directors they hoped to attract.

But the studio in Pontiac likely will miss a second consecutive bond payment to investors in August unless it lands another big-budget film production lease soon or the state eases its cap on film and digital media production incentives. 

That means a second payout by the Michigan State Employees Retirement System, which guaranteed most of the bonds and already covered most of the studio’s $630,000 interest payment to bondholders last month.

Still, under an unusual provision tied to federal tax credits, Raleigh Michigan could continue to operate for five more years without returning another dime. 

Michigan Motion Picture Studios LLC, which owns and operates Raleigh Studios Detroit in Pontiac, is co-owned by its CEO, Linden Nelson; John Rakolta, CEO of Detroit-based Walbridge Aldinger Co., which built the studio; A. Alfred Taubman, founder of Bloomfield Hills-based Taubman Centers Inc.; and William Morris Endeavor Entertainment, headed by co-CEO Ari Emanuel, brother to Chicago Mayor Rahm Emanuel. 

Those names helped the studio raise $18 million in a sale of private activity bonds for the project through theOakland County Economic Development Corp. But the bondholders, the state pension plan and institutional investors are all bound not to take any action if the studio is in default on outside investments totaling $48 million until July 2017 at the soonest.

Nelson said last week he was in meetings to court the production company of a new movie to film on location in Michigan, which he declined to name. 

Nelson is also hosting a tour to showcase the studio to members of the Urban Land Institute Michiganchapter in Detroit on March 20.

Raleigh Michigan has housed just one film project in Pontiac that qualified for state film incentives since it opened in early 2011 — “Oz, the Great and Powerful,” a prequel to the classic “Wizard of Oz,” which wrapped production in December under director Sam Raimi for a 2013 release. 

And while it is courting other film projects, a source familiar with the studio business said it is unlikely to make interest payments due Aug. 1 unless the state changes course on incentive restrictions adopted in February 2011. 

“It really all depends on the state of Michigan and whether or not they’re going to honor their commitment, made in 2008, to support the film industry,” the source said. “The studio was built based on that commitment. (If) the state pulls their commitment and their funding to a level that’s unsustainable, the bond payment will not be made in August.” 

Nelson declined to comment on the status of bond payments. Gov. Rick Snyder’s press secretary, Sara Wurfel, said the governor’s proposed fiscal 2013 budget released in February also continues to cap state film reimbursement incentives at $25 million, just as it has done for this budget year. 

“(Snyder) believes the film and entertainment industry does have value in Michigan but needed to have another way to be supported, other than this blank check for up to 42 percent of the cost of any project,” she said. 

“This new approach adopted (last February) is kind of leveling the playing field for businesses to excel and help Michigan thrive, regardless of their particular industry. He is sticking to that objective and is looking to give that a chance to work.” 

Falling short 

“Oz” had a Michigan budget of more than $104.8 million, according to records prepared by the Michigan Film Office, an agency of the Michigan Economic Development Corp. 

How much of that went to Raleigh is unclear. The studio received rental revenue of about $3.2 million, according to an annual report completed by the Film Office Thursday. But Raleigh may also have received a portion of another nearly $18 million spent on food, equipment and material rentals and other services 

Regardless, Raleigh has made $1.47 million in three payments to bondholders since Feb. 1, 2011, according to state officials and records obtained under the Michigan Freedom of Information Act from the Oakland EDC. 

The county agency agreed in 2010 to issue three series of private activity bonds totaling $28 million, with Michigan Motion Picture Studios as the private borrower, to help finance the studio project. 

The first series for $18 million was guaranteed by the state pension plan; the other two series totaling $10 million are subordinate bonds bought by the Michigan Motion Pictures co-owners themselves and/or their immediate families, with no guarantees. 

In return for guaranteeing the first series of bonds, the retirement system was to receive a 2.5 percent annual credit enhancement fee in quarterly installments. The fee was estimated to generate about $450,000 a year for the retirement system if payments came in on time, said Terry Stanton, communications director for the Michigan Department of Treasury, which acts as fiduciary for the state pensions. 

So far, the studio covered the first two interest payments on the guaranteed bond notes last year. But it failed to cover part of the third scheduled interest payment Feb. 1, so the retirement system made $420,000 of the scheduled $630,000 payment. 

No payments have been made toward the $1.4 million interest owed to date on the $10 million in bonds held by the studio owners. 

Those bonds are unsecured and can’t be paid until the guaranteed notes have been paid, said Robert Schwartz, member at Detroit-based Clark Hill plc and bond counsel for the Oakland County EDC.

The co-owners of the studio projected revenue of $230.4 million over its first 10 years, according to the Michigan Department of Treasury, which in 2010 reviewed the project and approved the state retirement system’s guarantee. 

That’s an average of $23 million in projected revenue per year, although lower revenue was anticipated for the first three, according to a report submitted to Treasury by Deloitte LLP in late 2009.

But even so, the estimate assumed a 50 percent occupancy rate in the first year for the studio’s 300,000 square feet of office space — separate from the 170,000 square feet in studio and mill space — which is nearly empty. 

“Unusual’ investor terms 

In addition to the bonds, the studio project financing also included another $5 million put up collectively by the studio owners, plus another $30 million loaned by U.S. Bancorp, which is the trustee of the bonds.

U.S. Bancorp created the Michigan Motion Picture Studios Investment Fund to hold its $30 million investment plus the $28 million in bonds.

U.S. Bancorp, Fifth Third Bank, Stonehenge Partners Inc. and the Michigan Magnet Fund each created Community Development Enterprises to collect seven-year, 39 percent federal New Market Tax Credits awarded to investments in projects in distressed areas.

Those tax credits were assigned to the investment fund, and U.S. Bancorp uses the credits. In exchange, Fifth Third, Stonehenge and Michigan Magnet are paid loan origination and management fees. 

U.S. Bancorp declined to comment to Crain’s.

Using the tax credits requires a “forbearance” agreement against collecting from a borrower in default over the seven years of the credits. In Raleigh’s case, that’s seven years from July 2010. The bonds also have the requirement because they’re part of the investment fund that creates eligibility for the credits. 

That means U.S. Bancorp would have to wait until July 2017 to recoup any delinquent payments on the $30 million loan, but that would be mitigated in part by having the benefit of the tax credits. 

Bondholders and the state retirement system aren’t so lucky. They don’t have tax credits and would have to wait until 2017 to take action. 

Albert Bogdan, chief business development officer of the Michigan Magnet Fund, said the reason for the requirement is straightforward: Without it, the tax credits would be lost if the investment — in this case Raleigh — were liquidated or repaid creditors too early. 

The New Markets Tax Credit program also has a goal of creating “patient capital” and giving enterprises in stressed areas time to succeed. 

“The tax credit is not contingent on the business being (immediately) successful,” Bogdan said. “It’s contingent on the money staying invested.” 

The seven-year forbearance clause for the bonds is a “highly unusual” provision for bondholders and bond insurers to live by, said Gina Torielli, professor and director of the graduate tax program at Thomas M. Cooley Law School in Ann Arbor.

Torielli and Frank Aiello, an associate Cooley professor and former banking attorney at Bodman plc, both said they could not recall any municipal bond or any other bond deal that included a provision like it.

“I’ve never seen something like that before,” Torielli said. 

Douglas Drake of Lansing, chairman of the nine-member state retirement system board, said the pension funds’ portfolio is “incredibly well-diversified” and covering Raleigh Studios will not endanger pensions. 

The retirement system had more than $10 billion in assets in late 2010. Drake and Stanton said the board does not make investment decisions and relies on Treasury as its fiduciary. 

“I am uncomfortable with these kinds of investments. Historically over the years there have been all kinds of these things that have gone bad,” Drake said. “These really need to be the rare exception.” 

Rebecca Sorensen, senior vice president and wealth adviser at UBS Financial Services Inc. in Birmingham and one of two board members of the Oakland County Economic Development Corp. who voted against the bond deal, said she was “saddened and disappointed” to see Raleigh Michigan miss a payment on the bonds.

But she also said the bond proposal had unconventional terms that were part of the reason she voted against it. 

Not alone 

Other studios and production companies are feeling the same pain, after relying on the original Michigan film incentives law as adopted in early 2008. 

Jeff Spilman, managing partner of Ferndale-based S3 Entertainment Group, said he let go of a staff of nearly 30 within weeks after the cap went into place last February, and he recently renegotiated his lease terms with his landlord so that he is only using about 1,500 square feet for his own office, of the 20,000 square feet that S3 used to occupy.

The rest is expected to be sublet for storage or warehousing space to another tenant. 
S3 obtained an incentive last year to produce a pilot episode of the proposed “Domestic Justice,” featuring Wayne County Circuit Court Judge Vonda Evans resolving family court disputes in a forum for participants and viewers. 

If the show is picked up by a television network, Spilman said, he hopes to shoot subsequent episodes on a set at Raleigh in Pontiac. 

“There’s no business model like before for filming in Michigan,” he said. 

“Midsize to large budget films are generally not coming here anymore because the environment is too competitive. Instead we have a crop of our own home-grown filmmakers doing stuff on ultra-low budgets. And that’s good, but it takes the larger, unionized films that pay people $25-$30 per hour within the industry to make the business model sustainable.” 

Eight film and digital media production companies have applications pending before the state for various incentives, worth a combined $13 million of the $25 million that the Film Office expects to allocate by the end of fiscal 2012, said film office director Carrie Jones. 

At 40 percent of project cost, that means the projects have a combined budget of just over $30 million. 

The Film Office approved 24 projects in 2011 for film incentives, seven of which have yet to be filmed in 2012, including “Domestic Justice.” That’s compared to 66 projects the office approved in 2010, including “Oz.” 

Sue Marx, documentary filmmaker and president of Birmingham-based Sue Marx Films Inc., and Marcia Fishman, executive director of the Screen Actors Guild chapters in Detroit and Philadelphia, both said theater contracts and production business have diminished greatly in the state in the past year.

Marx said she is not surprised to hear that studios like Raleigh may have suffered from the change. 

“We’re competing with some other states that have been doing this longer, and doing it better. It was just a budding industry here, that was moving along wonderfully well before (the cap),” Marx said. 

The 2008 legislation that created the film tax credit had broad bipartisan support, the source familiar with Raleigh noted, winning the vote of almost every Republican lawmaker in the state House and Senate. 

“As a result of that initiative that they took on, any reasonable person could have concluded that there was so much bipartisan support that this was going to be a nice 10-year plan, and they would review it at the end of 10 years,” the source said. “It didn’t last – it was eviscerated before the studio was even opened.” 

Since “Oz” wrapped, the studio’s pipeline is dry, the source said. 

“Hopefully there are some proposals, but the well has been for Michigan so poisoned, out in Hollywood, that nobody’s quite sure what the future’s going to bring,” the source said. “People don’t come and spend that kind of money with the uncertainty that there is.”

 

Article originally written Chad Halcom, Crain’s Detroit Business