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Louisville debt debate: Which is the bigger disaster, KFC Yum! Center or Metropolitan Sewer District? (The answer will surprise you.)

by Terry Boyd

Insolvent cities across the United States. (Click to enlarge.)

(Editor’s note: Due to technical difficulties, a rough draft of this story was accidentially posted. This is the final version.)

There are lots of ways for cities to go broke, something more and more municipalities are doing across the United States.

Yesterday, Troy, Mich. defaulted on $14 million in debt from tax incremental funding district bonds issued to build a community center. Before Troy, it was Harrisburg, Pa., and Stockton and San Bernadino in California.

The question now is, “Is Louisville broke, but we just don’t know it yet?”

Louisville has two looming issues: Derivatives related to the Metropolitan Sewer District’s $1.5 billion-plus in debt issues, a story we broke, and shortfalls covering construction bond issues for the KFC Yum! Center.

But which is the iceberg toward which the Titanic is headed?

Yesterday, the Courier-Journal reported the Louisville Arena Authority voted to ask Louisville-Jefferson County Metro Government for $3 million just in case.

The authority apparently will tap the entire maximum $9.8 million the city is obligated to pay annually to service $349 million in arena bonds should the arena and its taxing district fail to generate sufficient revenue.

Insider Louisville has interviewed multiple sources, and there is agreement on this: The shortfalls with the downtown arena will pass, but MSD’s problems won’t go away, because no one knows how bad they are.

What we know is that MSD bought fixed-to-floating interest rate swaps under the Abramson Administration – risky derivatives Fischer Administration officials say NO utility should have ever bought.

When we broke the story back in July, the MSD derivatives loss stood at about $32 million. Now, the loss is reported on the MSD books at $108 million, more than a 300 percent increase in two months.

True, the loss, in accounting terms, is an “unrealized loss.” That is, no money changes hands unless MSD officials try to unwind their derivative position. But that doesn’t mean there won’t be losses before the contracts expire in 20 years.

Why? Because when MSD officials bought the derivative, they were making a bet that interest rates would rise. Instead, the major indices have remained at about 2 percent or have dropped to just above 1 percent. Which means MSD’s losses will increase as long as interest rates stay low, as will fees related to the contracts.

In our minds, the question becomes, did Arena Authority officials also fall for the interest rate swaps scam?

Insider Louisville has asked the Beshear Administration for Arena Authority financial documents for months. That request has never been honored.

So we called Kelly Downard, Metro Council member for District 16 and a fiscally conservative Republican and asked, “Are there Arena Authority interest rate swaps?

“No, (the arena) isn’t MSD!” Downard said.

Downard’s position is that the six-square-mile tax increment financing district ultimately will produce sufficient revenue to more than cover the arena debt obligation. Had the city not lost a large company in the taxing district, “we would have had more money this year than (the Arena Authority) could spend,” he said.

Downard added that upping the number of events by adding an NBA team and more concerts at KFC Yum! Center doesn’t address the bond servicing shortfall because the lion’s share – 80 percent – of event revenue goes to the University of Louisville’s Athletic Association, not to bond holders. That’s a symbiotic relationship, he said.

“U of L is our Walmart, the anchor tenant in our mall,” Downard said.

 Another contributing factor to arena finances was a cost overrun due to mismanagement by the Kentucky State Fair Board.

Now, new management – Los Angeles-based AEG Facilities – guarantees $1 million per year up front, he said.

But Moody’s Investors Services doesn’t agree with Downard’s position.

Right now, the arena authority is paying only the interest on the $348 million, which totals about $525 million with interest over 20 years.

In late May, Moody’s downgraded the arena bonds to a junk rating, because Moody’s analysts doubt the tax increment financing district revenue can service the debt.

Arena Authority officials had projected 2012 revenue from the taxing district of $14.9 million but will likely take in less than $6 million. The arena TIF district generated only $2.1 million in 2011 versus a forecast of $6.7 million.

Getting a bead on public debt issues at all from the conventional media is impossible, because in 2012, newspapers typically don’t have the financial expertise to do the heavy lifting required to write about municipal debt.

The Courier-Journal is the exception, with two capable reporters, Marcus Green and Chris Otts.

On Sunday, Green had a story saying all was well – that the Louisville Arena Authority is going to liquidate some investments to raise about $5 million, part of the difference between what KFC Yum! Arena and the surrounding taxing district were supposed to generate, to cover the $349 million bond issue, and what it actually is producing.

What Green’s story didn’t make clear is that liquidating the investments may be seen from the rating agencies’ perspective as window dressing, shifting money from one pot to another, said Chris Tobe, a financial expert and former Former investment committee member and trustee at Kentucky Retirement Systems from 2008 to 2012.

It could also be a net negative because of the transaction costs of liquidating the investment,  and the gain may not be as large as it first appears.

Tobe said he finds it ironic that the CJ story celebrates the $5 million gain for the Yum stadium bonds, but minimizes the $108 million loss in MSD interest rate derivatives, due to the exact same cause,  falling rates.

“In fact the MSD losses are more solid than the stadium gains,” he said. “If these investment are the municipal (Guaranteed Investment Contracts) they appear to be, it may be very had to realize this market gain.

“Municipal GICs sometimes have excessive penalties to cash out early and many have been under … investigation by the Justice Department.

“Louisville residents should be more concerned with MSD since it passes on its losses directly in rate increases to residents,” Tobe said.

Then yesterday, Green reported all bets were off as the Authority voted to ask the city for $3 million more than the $6 million needed to maintain the $20 million to be paid this year on Arena Authority bonds, running dangerously close to the $10 million cap the city is legally committed to pay annually in the debt servicing shortfall.

Business First quoted Metro Council President Jim King as saying, “I don’t think there’s anything to worry about.”

Well, there you go ….

We tried to talk to with King, but got no call back from him or from Metro Council spokesman Tony Hyatt.

The majority of cities and states that are insolvent are struggling due to pension shortfalls. Kentucky, for example, is among the worst offenders, Tobe says.
But there are also problems related to projects that seemed like a good idea at the time, including utilities.
Take the notorious Harrisburg, Pa. incinerator, an incinerator that was supposed to pay for itself, but has put a $1.5 billion hole in the budget of a city with only 50,000 residents. Do the math. Only now are legal officials getting at the heart of what appears more and more to include criminal acts.

So, what’s going on with MSD’s finances? Which the Courier hasn’t covered.

Louisville city government could join the dozens of municipalities and states that are suing London-based Barclays PLC over manipulating a key interest rate called the London Interbank Offered Rate, or LIBOR. LIBOR rate manipulation may be a factor contributing to the 33-percent increase in MSD’s derivatives losses.

But Tobe says MSD joining the suit is unlikely, because it would throw open the utility’s books. Which would expose why MSD officials bought those derivatives, and who made huge fees from those sales.

From Tobe:

Warren White of First American Municipals, Inc., a firm so secret it does not even have a web site, is a new name in the mix.  SEC documents show First American is run by Patricia Poprik, who was drawn into the FBI muni investigations in Philly in the early 2000’s.

Another advisor, Michael Garner of  Enhanced Financial Solutions – formerly IMAGE  – who has also had his run ins with the FBI is also still below the radar.

Insider Louisville is not the New York Times. But sources are sending us more financial documents related to MSD’s finances, as well as documents related to KFC Yum! Center.

We intend to devote more resources to combing through dozens of documents to connect the dots, and to understand what’s really going on.

More as we uncover more.

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