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Second of Three Parts

Peter Elia's company borrowed $1.5 million from the city in 1995 to develop plans for a trade center near the Peace Bridge. The complex was never built, and Elia's company stiffed the city for almost the entire loan.

Developers took out a $1.9 million loan from the city in 1990 to help convert the YMCA building into Olympic Towers. The project later defaulted on the loan, and Buffalo repaid two-thirds of the debt.

A Chicago developer borrowed $8.5 million in 1996 to build a hotel adjacent to Roswell Park Cancer Institute. The project is nearly $2 million in arrears, leaving Buffalo to pay the delinquent bills.

This is banking, City Hall style.

Anxious, if not desperate, to spur development, Buffalo officials have used one of their key economic tools -- Section 108 loans backed by federal Community Development Block Grant funds -- to finance risky business deals and questionable city initiatives, a Buffalo News investigation has found.

The result is a lot of bad debt the city is stuck paying for out of its block grant funds -- money that could otherwise go to revitalize ailing neighborhoods and provide programs for low- and moderate-income residents. This year, the city is spending $4.3 million, or 22 percent of its block grant budget, to pay the debt.

Over the past decade, $35.8 million in block grant funds went to repay Section 108 loans. That has chewed up 17 cents of every block grant dollar received, compared with a national average of less than 4 cents, a reflection of the wariness with which most cities approach the loan program.

"They used the 108 money for projects that were simply too risky, and they lost an awful lot of money," said John J. LaFalce, who questioned the city's use of federal funds while representing the area in Congress until his retirement in 2002.

During the lifetime of the 22-year-old program in Buffalo, businesses have defaulted or are years behind in making payments on $23.1 million of the $37.6 million they've borrowed, The News found.

Businesses have defaulted on 39 percent of the money they've borrowed, compared with a national average of 9 percent. Add to that the delinquent loan made to the hotel near Roswell Park and the rate is 61 percent.

In addition to lending to businesses and developers, the city has run up a $21.1 million tab, three-quarters of it on Mayor Anthony M. Masiello's watch, borrowing Section 108 money to pay for public projects such as restoring buildings and purchasing fire trucks.

Kim Harman, former executive director of Eastside Pride, a grass-roots organization familiar with the city's use of the loan program, faults city officials for gambling tax dollars on risky projects, especially when the money could be put to better use elsewhere in the block grant program.

"The money is being used as last-resort financing for private investors' projects. It could be used to pay for youth programs, senior programs, housing rehabilitation, innovative crime prevention," she said.

Andrew J. Rudnick, president of the Buffalo Niagara Partnership, the region's leading business group, agreed city officials have done a poor job.

"The way in which the program was administered is the poster child for the need for more business and development savvy on the part of the city. You cannot make loans to businesses that don't make sense," he said.

Masiello said that while a few loans were clearly mistakes, he is satisfied for the most part with the performance of the Section 108 loan program. In many cases, he said, the loans provided needed financing for projects vital to attract investment to nearby properties.

"I wish we had more private-sector investment. It's coming in dribs and drabs, but it's coming," Masiello said.

Developers default

Buffalo was flush with more federal aid during James D. Griffin's tenure as mayor than it is now, but of a different sort. In the 1980s, the city used $39.3 million in federal Urban Development Action Grants to build high-profile projects, including the Key Towers, Goldome Bank and the Hilton and Hyatt hotels.

During that time, Griffin tended to use Section 108 loans for relatively small projects, generally under $500,000, and typically not in downtown. But the UDAG money was drying up by the time Masiello took office, and he turned to Section 108.

The program is now the largest of the dozen-plus federal lending programs the city has used the past two decades. The city has made 39 Section 108 loans, totaling $58.6 million, since 1982. Moreover, it has become the city's primary lending tool during Masiello's tenure, amounting to 52 percent of money lent.

Projects, in order to receive Section 108 financing, must eliminate blight or benefit low- or moderate-income residents. The loans are particularly attractive because they carry flexible repayment provisions, allowing City Hall to fund riskier projects that banks and investors shy away from.

The loans must be approved by the Common Council, development agencies controlled by the mayor and the federal Department of Housing and Urban Development. Cities are responsible for paying them off, using block grant funds, in the event a developer defaults.

That's what has occurred in Buffalo -- over and over again. Seventeen loans -- 15 to businesses and two to the city -- worth $18.6 million were issued during the 16 years of the Griffin administration. Seven defaulted, either during his tenure or later on, after Masiello refinanced the loans trying to save them from faltering.

During the 10 years of the Masiello administration, the city has issued 21 Section 108 loans -- 14 to businesses and seven to the city -- totaling $43 million. Six defaulted.

The city last year spent a record $5.2 million of its block grant budget to pay off Section 108 loans for defaulted private projects and public initiatives. That was 26 cents on every dollar. This year, it's $4.3 million, or 22 percent of the block grant budget.

"That's money that should be affecting the day-to-day life of the residents," said North Council Member Joseph Golombek Jr., chairman of the committee that reviews the mayor's proposed block grant budget.

In addition to $1.54 million to the Elia project near the Peace Bridge and $1.9 million to the developers of Olympic Towers, which initially included Paul Snyder Sr., defaulted projects under both Griffin and Masiello include:

An $800,000 loan to former Chief City Judge Wilbur P. Trammell to renovate a low-income apartment building at 400 Elmwood Ave. He got jail time after pleading guilty to falsifying expense reports related to the work.

A $1.7 million loan to the Towne Gardens Plaza owners to renovate and refinance a shopping plaza on William Street and rehabilitate housing.

A total of $8 million for five projects in the Theater District -- Market Arcade Cinema, Journey's End Hotel, an office building at 620 Main St., a youth hostel and the Irish Classical Theater and adjoining apartments.

While the city is required to pay off the defaults with block grant funds, it recouped some of its losses by negotiating partial payments or taking possession of the property.

For example, the city took possession and later sold the office building at 620 Main St. Through legal action, the city took control of the property near the Peace Bridge that Elia once owned.

Risky borrowing

Each of the 13 deals that fell apart did so for its own reasons, but many shared common attributes.

In general, the city "wasn't restrictive enough" in extending many of the loans and later did a poor job monitoring them, said Timothy J. Wanamaker, the city's top economic development official as executive director of the city's Office of Strategic Planning.


"The problem in Buffalo is developers have it backwards," said Stephen T. Banko III, who heads the local HUD office.

"Everywhere else, they put the deal together, get what they can from private sources and come to the government if they have a gap. In Buffalo, they all come to the city first -- 'what can you give me?' -- then they go get their financing," Banko said.

The city hasn't shied away from making loans to high-risk ventures. Officials note that's the point of government loan programs -- step in where the private sector dares not venture. But the terms of City Hall's loans often left the city vulnerable to defaults.

Section 108 loans accounted for most of the equity in some projects, meaning developers had little at stake personally and that banks and investors weren't sold on the deals. For example, the $2.84 million lent to the Market Arcade Cinemas in a Section 108 loan, along with other city lending, accounted for all of the project's financing. The loan for Elia's Gateway International Plaza amounted to 91 percent of financing, city records show.

Making some loans even riskier, the terms of some borrowings called for most of the money to be paid at the back end of the loans, in what is commonly called balloon payments.

In still other instances, the city made loans to refinance projects already in trouble.

"Many of these were gap financing; no one else wanted to help," Masiello said.

The mayor said the loans for the Trammell and Elia projects are his two regrets. He termed the Elia loan "a big mistake."

And the Trammell project?

"We were sold a bill of goods," he said.

Meanwhile, the city's biggest Section 108 loan -- the High Street hotel -- hasn't defaulted but is behind in its payments.

Biggest loan shaky

In 1996, Buffalo lent $8.5 million to the developers of a 100-room hotel on High Street expected to attract families of patients at Roswell Park, Buffalo General Hospital and other nearby medical facilities.

A HUD monitoring report following construction of the project -- initially called the Medical Inn, then Pillars Hotel and now Doubletree Hotel -- found serious problems with both the developer and the city. The report characterized the city's management as sloppy, inattentive and in violation of numerous federal regulations.

The developer failed to establish required hiring goals and violated terms of the deal by using money borrowed from a bank rather than funds secured from investors to pay for a portion of its equity, the HUD report found.

The city, meanwhile, improperly used funds targeted for housing to help finance the hotel and failed to adequately monitor the project, making only one on-site visit while the hotel was under construction.

The city failed to follow proper procedures that "could have resulted in the federal funds being placed at unnecessary risk," the HUD report concluded.

The city took steps to correct the problems and restructured the project's financing after the developer fell behind in payments. The hotel continues to struggle, however, and has paid just $1.2 million of the $3.2 million due thus far. The city was left to foot the remainder.

Moreover, the hotel has created only 42 of 85 projected jobs.

The city gave the hotel owners a two-year grace period on repaying the Section 108 loan, instead accepting partial payments as cash flow permits. Monthly payments have been made only twice, however, indicating continuing problems.

Masiello said, however, "I still believe in the project."

In addition to lending to developers for private ventures, the city has made increasing use of the Section 108 program to finance public projects. They are repaid with block grant funds.

Used for city projects

Since Masiello took office, the city has made $16.1 million in Section 108 loans for seven public projects, compared with $5 million for two projects under Griffin.

The increased borrowing during the Masiello years is on top of a dramatic increase in the sale of municipal bonds, the traditional way of paying for public projects.

"I made a decision early on that the neighborhoods and downtown needed a serious infusion of capital investment," Masiello said.

Some of the Section 108 loans for public projects made under Masiello have been unorthodox, most notably $2.34 million spent in 1996 to buy fire engines.

Of a more traditional vein was $2.33 million to build Bill Gaiter Parkway and an industrial incubator on the northeast side of the city, which is generally regarded as a successful undertaking.

One of the costliest public projects involved a $3.7 million loan to rehabilitate the abandoned Market Arcade and an adjoining building. The loan repayments, with interest, have topped $7 million the past 10 years.

"The preservationists would say it's great. My accountant would say you're crazy," said Mark Goldman, an entrepreneur credited with sparking the redevelopment of Chippewa Street.

In its biggest Section 108 loan to itself, the city borrowed $7.7 million in 1999 to complement a federal housing grant to redevelop a 70-square-block area of the East Side for homes. The initiative has been a bust.

HUD last fall revoked the remaining $1.5 million of the $5.5 million grant after determining the city had mismanaged the initiative. Only 125 of 344 planned houses had been built, and a significant amount of money had been spent on ineligible work.

Five years into the loan, the city has relatively little to show for the investment, although Masiello maintains the area is "gradually gaining the confidence of the residential investor."

In the meantime, the bill has come due: The cost this year alone tops $920,000.

Not popular elsewhere

Most cities shy away from using the Section 108 program extensively.

"Some cities won't touch the 108 program because of the risk to their block grant allocation," Wanamaker said.

The 1,175 communities that receive block grant aid across the nation collectively spent between 3 and 4 percent of their allocation on Section 108 repayments for the 2003 fiscal year, compared with about 20 percent in Buffalo.

Buffalo's spending is not only high compared with the national average, but also compared with 19 cities and urban counties whose block grant allocation is closest with Buffalo's, including Pittsburgh, Cleveland and Boston.

A News comparison of figures from 2001-02, the last year that national figures were available, showed Buffalo's spending ranked the second-highest, surpassed only by Dallas.

What's more, most cities spending a significant portion of their block grant budget on Section 108 repayments are doing so out of design, mostly for housing initiatives. Nine of the 20 cities and urban counties included in The News comparison didn't spend any money on Section 108 loan repayments; for five others, they accounted for less than 1 percent.

Buffalo hasn't made a Section 108 loan since 1999 but is now contemplating two.

One, of about $3 million, would be used to redevelop Central Park Plaza. Plans to convert Memorial Auditorium into a Bass Pro store call for a $7.3 million loan through the Section 108 program, plus an additional $2 million through another program.

The city will be more careful when and if it resumes using the program, Wanamaker said.

"We were not restrictive enough. Now we're trying to bring it back to the center," he said.

That means using "extremely low risk" loans, he said, or loans that are regarded as a catalyst to a spinoff development and job creation that would create "a lot of community benefit."


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