Gordon Gekko at Goldman Sachs, placing the KFC Yum! Arena debt.

Louisville and Greece now have something in common: Both have bonds that have been downgraded to “junk” because of a bleak outlook when it comes to our servicing public debt.

Two days ago, without anyone much noticing, Moody’s Investors Service downgraded the underlying rating on the Kentucky Economic Development Finance Authority’s Louisville Arena Project Revenue Bonds to Ba2 from Baa3.

For the non-bond vigilantes, that’s two ratings below Baa, where high-risk junk rating begins and investment grade ends – along with low interest rates.

Not that this was unexpected: Moody’s put KEDFA on notice back in December this was coming unless Louisville officials figure out some way to increase tax revenues in the tax increment financing district around the arena, which was projected to be chock full of retail, hotels and restaurants by now.

Instead, Metro Louisville is covering the spread with our tax dollars.

The restaurants are the only part that actually happened on Main Street, with Whiskey Row/Iron Quarter sitting there empty.

Here’s where optimism and reality intersect in the Moody’s report:

* Steady growth in TIF district sales taxes will be needed to support debt service going forward.

Hmmmmm.

Our sources tell us the current partners – mostly Brown-Forman heirs – are promising a miracle while quietly trying to hand off the Main Street restoration next to the arena to someone with, you know, a plan.

Another complication is that the Kentucky State Fair Board, which runs KFC Yum! Center for the Louisville Arena Authority, decided to give all of Harold Workman’s friends and relatives raises with what would have been profits, as Moody’s notes (in a round-about way.)

This is from the lengthy but very readable Moody’s report:

RATINGS RATIONALE

The downgrade principally reflects the lower than expected state sales TIF revenues, high operating expenses of the arena, increased dependence on the Metro Louisville’s additional payments, and the weakened financial metrics going forward. The rating outlook is negative. The negative outlook reflects the uncertainty of TIF revenue growth as well as the narrow debt service coverage ratio going forward. Current near to midterm coverage ratio forecasts fall short of initial projections even after taking into account the expected growth of future TIF revenues. TIF revenues may not fully support the arena’s debt service as initially projected in the near future.

The Ba2 rating is also based on the arena’s performance on the Category A and B revenues which were above forecast. While the arena generated ample revenues, the operating expenses of the arena were substantially higher than the forecasted amounts, thus negatively affecting the net operating income.

 The project has $319 million Series 2008-A bonds, $15 million Series 2008-B bonds and $9.9 million Series 2008-C bonds. The Series A bonds include $284 million of current interest fixed rate bonds, and $26.9 million of capital appreciation bonds. The Series B bonds are taxable fixed rate bonds. Both issues are insured by Assured Guaranty (Aa3; rating under review for possible downgrade). The Series C bonds are unrated and uninsured.

STRENGTHS:

*Strong support from the state and Metro Louisville decreases the demand risk for the arena

* Strong attendance record for the arena’s anchor tenant, the University of Louisville’s men’s basketball team, provides stability

* Arena successfully booked large numbers of non-university events in 2011

* The contract granting the TIF can only be canceled with approval of the bond trustee

CHALLENGES:

* State sales taxes, a proxy for TIF sales tax revenues experienced significant declines in 2009, although stabilizing in 2011 and 2012

* Steady growth in TIF district sales taxes will be needed to support debt service going forward

* The TIF district exempts eight projects from payment of all or some of the taxes supporting the project. (Future projects could be added to TIF district exemptions by action of the legislative council of Metro Louisville, but not without approval by the state and the authority.)

* The increased operating expenses incurred in 2011, unless managed, could further hamper the profitability of the arena

* LAA will be required to reimburse the Kentucky State Fair Board, which operates Freedom Hall, for any loss of net income due to the new arena

OUTLOOK

The negative outlook is based on the uncertainties surrounding the arena within the next two years including the TIF growth, arena’s operating expenses, and the amount of the additional payment that will be provided by the Metro Louisville.

What could change the rating – UP

Improvements on the debt service coverage, replenished reserves and greater than projected sales tax growth in the TIF district and arena revenue growth could have a positive impact on the rating.

What could change the rating – DOWN

Lower than projected growth in revenues, particularly sales taxes, shortfalls in debt service payments, and use of senior debt service reserve could result in further downgrade. Significant changes to the TIF district exemptions which impact the projected debt service coverage could also place downward pressure on the rating.



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