TEXT-S&P revises Louisville Arena Authority, Ky. outlook to negative

Fri Dec 7, 2012 12:51pm EST

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Overview
     -- We are revising the outlook to negative from stable and affirming the 
'BBB-' rating on the Kentucky Economic Development Finance Authority's project 
revenue bonds issued for Louisville Arena Authority Inc. (LAA).
     -- The outlook revision reflects our view of LAA's continued reliance on 
potentially volatile tax increment financing (TIF) revenue and uncertainty 
about stabilized operating costs and direct arena revenue under the new 
operator.
     -- Although the 2011 amendment to TIF calculations and the recent 
replacement of the arena operator have strengthened the project, we anticipate 
that U.S. multi-use arena operator LAA's debt service coverage will remain low 
through the next two years. 

Rating Action
On Dec. 7, 2012, Standard & Poor's Ratings Services revised its outlook to 
negative from stable and affirmed its 'BBB-' underlying rating (SPUR) on the 
Kentucky Economic Development Finance Authority's Louisville Arena project 
revenue bonds, issued for Louisville Arena Authority Inc. (LAA). Assured 
Guaranty Corp. (AA-/Stable/--) insures the senior bonds. The bonds consist of 
about $319 million series 2008A-1 fixed-rate bonds and series 2008A-2 capital 
appreciation bonds, and $20.1 million series 2008B taxable fixed-rate bonds. 
We do not rate the $9.9 million of taxable subordinate series C fixed-rate 
bonds.

The outlook revision reflects our view of LAA's continued reliance on 
potentially volatile tax increment financing (TIF) revenue and uncertainty 
about stabilized operating costs and direct arena revenue under the new 
operator.

Rationale
Standard & Poor's SPUR on the Kentucky Economic Development Finance 
Authority's Louisville Arena project revenue bonds is 'BBB-'. The outlook is 
negative. Assured Guaranty Corp. insures the senior bonds.

Standard & Poor's rates the following bonds issued for LAA:
     -- $292.28 million secured IRB series 2008A-1 project revenue bonds due 
Dec. 1, 2042;
     -- $26.939 million secured IRB series 2008A-2 capital appreciation bonds 
due Dec. 1, 2024; and
     -- $20.1 million taxable fixed-rate series 2008B project revenue bonds 
due Dec. 1, 2021.

LAA has an additional $9.9 million of taxable subordinate series 2008C bonds 
due Dec. 1, 2025, but that series is unrated.

The outstanding amounts as of Sept. 30, 2012, were $292.28 million for series 
2008A-1, $33.22 million for series 2008A-2 (including accreted interest), and 
$20.1 million for series 2008B.

The 'BBB-' rating reflects our view of:
     -- The success of the University of Louisville's basketball program under 
Coach Rick Pitino in what we consider one of the strongest college basketball 
markets. The program is a top college basketball revenue generator with a 
consistent high-occupancy home crowd for men's games. 
     -- Strong government support for the arena, including an initial $75 
million state funding commitment, state increment tax revenue (TIF revenue) 
pledged up to $265 million (or 20 years), and a minimum of $206 million 
Louisville metropolitan government payments (and up to $309 million, with the 
larger annual payment available if other revenue is insufficient to make full 
debt service) over the term of the debt. 
     -- TIF revenue is incremental, but the tax increment threshold is 
inflated annually by 1.9% only if the arena achieved a cash retention covenant 
ratio (revenue plus some reserve balances to current debt service) of 1.3x in 
the previous calendar year.
     -- Management by AEG, a large and experienced operator for stadiums and 
event centers across the globe with a proven ability to book top concert 
headliners. The management contract also includes a guaranteed minimum payment 
from AEG, although we also anticipate that the arena will generate net 
operating revenue (excluding Category A revenue) above the level of this 
guarantee.
     -- The concessionaire's guaranteed payments of about 37.5% of projected 
operations and maintenance expenses. 
     -- The arena's success in meeting assumptions relating to revenue from 
naming rights despite the recent economic downturn. However, the strategy 
required a change to include cornerstone sponsors to gain larger sponsorship 
interest. 
     -- The existing fan base's move to the new arena and the near sellout of 
the facility under higher pricing compared with Freedom Hall. The men's team 
drew 21,832 people per game on average during its first season. High-end 
seating, including suites, has been largely contracted, at pricing consistent 
with base-case assumptions. 
     -- A fully funded $14.93 million senior debt service reserve and $990,000 
subordinated debt service reserve as of Sept. 30, 2012.

Partly offsetting the above strengths, in our view, are:
     -- The arena's debt service's substantial dependence on growth in TIF for 
payment on the bonds. Although the TIF region includes an economically robust 
zone, revenue from this source has been highly volatile and may not grow as 
fast as projected. (TIF revenue can be used to pay as much as 35% of annual 
debt service, with the project retaining any excess to replenish reserves or 
for early bond redemption.) 
     -- The ability of the arena to recontract sponsorship and arena capacity 
depends on the basketball program's long-term performance. 
     -- Although we anticipate that operating expenses will fall and stabilize 
during the next two years, the final stable level of expenses and consistent 
net direct arena revenue are somewhat uncertain. 
     -- Debt Service coverage is relatively low for the rating in the near 
term.
     -- Competition from other regional facilities and, to a lesser extent, 
Freedom Hall, in booking non-sporting events. 

The bonds are secured by three revenue streams: metro Louisville guaranteed 
payments, TIF revenue, and arena revenue. Each revenue stream was forecast to 
provide approximately equal contributions to debt service during the life of 
the project. 

We view the metro payments as favorable for the credit given that this revenue 
represents the commitment of a highly rated counterparty (Louisville-Jefferson 
County Metro Government; AA+/Stable). The Metro payments include a fixed 
minimum amount ($6.5 million in 2012) and an additional increment (which 
totals $3.3 million this year) to take the annual total pledge to $9.8 million 
in 2012. The increment is available to cover senior debt service if other 
revenue is insufficient, and the metro government has included the maximum 
amount in its current year budget.

We have viewed the TIF revenue as the most volatile and uncertain. This 
revenue comes from a pledge from the Commonwealth of Kentucky, and includes 
80% of incremental sales and property tax revenue in a six-square-mile zone 
that encompasses Louisville's central business district as well as an adjacent 
residential area and the I-65 corridor from the University of Louisville to 
the Ohio River. The TIF pledge also includes 80% of incremental income taxes 
earned on the arena site. Sales tax revenue has historically contributed the 
largest share of TIF revenue, and we anticipate that this will continue. 
Kentucky has pledged TIF streams for up to 20 years from the commencement of 
operations in 2010, subject to a cap of $265 million. TIF revenue can pay as 
much as 35% of senior debt service.

According to the original TIF grant agreement, the baseline year for tax 
amounts was 2005, and TIF amounts included 80% of incremental revenue above 
the baseline, with the baseline amount increasing by 1.9% each year. The TIF 
stream had to grow annually by at least this 1.9% hurdle rate for the project 
to realize any value when payments began in 2010. TIF payments are received 
one year after the accrual period, so TIF earned in the 2008-09 fiscal year is 
available for the arena in 2010. After exceeding the baseline in 2005 through 
2008, the TIF sales tax base fell dramatically (by 8%) in 2009, underscoring 
the volatility of TIF revenue contributions to the project. Property taxes 
were less volatile, and income tax revenue was high that year because of the 
presence of construction contractors on the site. The TIF payment for the 2009 
period came from property and income taxes and totaled $678,000. 

In September 2011, LAA and the Commonwealth of Kentucky agreed to redefine the 
calculation of TIF amounts for the project. Although the total pledged amount 
of $265 million does not change, the timing of payments has been brought 
forward. The base threshold in 2010 was reset to the same level as for 2005 
(about an 8% reduction from the previous calculation). The 1.9% inflation 
adjustment to the base tax revenue amount will occur only at the end of a year 
for which the arena project cash retention covenant exceeds 1.30x coverage. 
This covenant is defined as net project revenue including arena, TIF, and 
minimum metro payments, plus any remaining initial grant proceeds and any 
excess net cash flow held in reserves from the previous year (such as TIF 
payments above  35% of senior debt service), divided by annual senior debt 
service.

Management had previously anticipated the 2009-10 TIF amounts (received by the 
arena in 2011) to be around $900,000, but with this adjustment the figure has 
been confirmed at $2.17 million. The 2011 figure was $3.54 million, and 
management anticipates a 2012 figure around $5.4 million. Management 
anticipates reaching the $265 million cap in 2026. The TIF amendment to the 
covenant has reduced the impact of sales tax volatility on the project. Our 
forecast anticipates about 3% annual average growth in the tax base from 
2013-14 through the end of the debt term, with the cap reached in 2029.

We anticipate that project-related revenue will meet budgeted estimates. Arena 
revenue is broadly grouped into long-term contractual "Category A" revenue 
(which includes box and club seat sales, advertising, and naming rights) and 
"Category B" revenue (which includes all other revenue such as ticket sales 
and concession revenue). Naming and cornerstone rights were contracted at 
terms broadly consistent with the forecast, and the entire seating capacity 
sold, so we anticipate that Category A "contracted" project-related revenue 
will meet budgeted estimates. 

Under the management of the Kentucky State Fair Board (KSFB), the arena has 
achieved Category B revenue close to expectations, but has reported operating 
expenses that are greater than anticipated and greater than total Category B 
revenue. From its opening in October 2010 to the end of June 2012, the stadium 
has hosted 78 men's and women's basketball games, about 60 concerts and family 
shows, and 139 stand-alone events, and it has contracts with approximately 60 
sponsorship partners.

Although we anticipated that operating expenses would eventually fall to reach 
a more stable steady state as the arena ramps up operations over the first few 
years and management gains experience with the facility, the operating 
performance during the first 18 months at the arena was below our expectations.

However, in July 2012, LAA's new management sought to address this issue and 
replaced the KSFB with AEG as arena operator. AEG had previously worked as the 
booking firm at the KFC Yum! Center, but now presides over all operations. AEG 
has entered into a 10-year management contract and provided the arena with a 
sign-on payment as well as an annual guaranteed minimum payment. The arena 
will also receive any additional revenue after a fixed AEG management fee and 
an AEG incentive fee (paid as a percentage of the fixed fee if gross operating 
revenue exceed an escalating threshold). AEG is a widely recognized operator 
of facilities like the Yum! Center, and we anticipate a reduction in operating 
costs. 

Management anticipates hosting more concerts, shows, and sporting events in 
the 2012-13 fiscal year than in each previous year. The combination of a 
recovering economy and AEG's management ability has led to an increase in top 
name events such as Dave Matthews, Bon Jovi, Fleetwood Mac, and The Who at the 
arena since July 2012. This includes a five-day period in early November that 
included a sold-out Justin Bieber show, a Bruce Springsteen concert, a 
University of Louisville men's basketball game, a university women's 
basketball game, and a university women's volleyball game. We anticipate that 
AEG will continue to book similar top name concerts and performances, with 
resultant improvement in concession and merchandise sales at the arena. We 
also anticipate that additional popular events at the arena will incrementally 
improve TIF sales tax collections in the area.

The primary tenant at the arena remains the University of Louisville, which 
plays all home games for the men's and women's basketball teams as well as the 
women's volleyball team at the arena, and which has potential to play other 
teams' home games there. Louisville is one of the strongest college basketball 
markets in the country and the fan base remains high because of consistent 
strong performance.

Although AEG provide a minimum payment guarantee for each year of its 
management contract, our analysis does not rely on its credit strength, and we 
anticipate that the arena will earn Category B revenue in excess of the sum of 
operating expenses, the AEG guaranteed payment, and the AEG incentive fee.

The project also benefits from fixed interest amounts generated by the debt 
service reserves held in guaranteed investment contracts (GICs). Because the 
GICs extend beyond the debt term and are not drawn upon under our base case 
cash flow projection, we include this interest income in our calculation of 
debt service.

The project also has two subordinate expenses. We include major maintenance 
funding in our calculation of debt service coverage (DSC). The LAA project 
documents also include an annual provision to compensate Freedom Hall (the 
former home arena for the basketball teams) for lost revenue. This 
compensation was sized at $750,000 in the first three years of operation. 
However, these payments to Freedom Hall are subordinate and optional, and need 
only be made to the extent of available funds after operating costs, debt 
service, replenishment of reserves, and management fees. As such, we do not 
include them in our calculation of DSC.

Under our base case projection, we anticipate that the arena will call on more 
than the minimum metro payment for the next few years. We also forecast that 
the tax base for TIF amounts will grow by 5.75% in 2011-12 and 5% in 2012-13, 
and then by an average of 3% through the debt term. TIF amounts in excess of 
35% of debt service will be used to pay down principal. Seat and box revenue 
as well as naming rights revenue grow with inflation, and we anticipate that 
the arena will generate non-contracted revenue in excess of the AEG minimum 
guarantee. We forecast average DSC of 1.48x from 2013 through 2039 (ignoring 
the ratio in the final three years with smaller debt service obligations). We 
ran a number of stresses on this forecast, including reduction in TIF amounts, 
reduction in direct arena Category A and Category B revenue and revenue 
growth, an increase in operating costs, a doubling of major maintenance costs, 
and assumption of no interest from GICs. In our downside case, we assumed tax 
base growth of 1.5% from 2013-14, 2% growth in contracted Arena revenue, and 
no other arena revenue above the AEG guarantee. The DSC in this scenario 
averaged 1.24x, with a low of 0.97x. 

Liquidity
LAA's liquidity is adequate. The senior reserve and subordinated reserves are 
held in GICs with Berkshire Hathaway and were fully funded, with $14.9 million 
and $990 thousand, respectively, in November 2012. Interest payments during 
construction had been funded from bond proceeds, and that account was empty on 
schedule in 2011. The project also has a $3 million replacement reserve. This 
reserve is available to support debt service as well, and we anticipate that a 
small amount of this reserve will be drawn in 2012 to make debt service, and 
replenished in 2013. The project also benefits from a cash trap of residual 
cash flow due to the arena authority if the cash covenant is less than 1.25x.

Outlook
The negative outlook reflects our view of continued project exposure to 
potentially volatile TIF revenue and uncertainty about direct arena revenue 
and expenses in the near term. Although last year's amendment to TIF 
calculations and the recent change of operator sought to address what we 
viewed as the two most volatile sources of revenue for the project, the 
project remains exposed to underperformance in either TIF revenue growth or 
Arena net revenue. AEG is a professional and experienced operator, but the 
short operating history since AEG took over means some uncertainty in 
projections of Category B revenue. DSC should remain low for the rating in the 
near term, but the fixed contractual nature of approximately 50% of total 
revenue (metro payments and Category A revenue) somewhat mitigates this. 

There is no rating upside in the medium term. We would revise the outlook to 
stable if TIF amounts meet or exceed our projections and the arena sustains 
net category B revenues above the AEG minimum guarantee. Our ratings factor in 
a long-term debt service coverage of 1.4x or higher. 

We will continue to monitor the economic landscape and the arena operations 
and could lower the rating if an economic downturn leads to TIF revenue growth 
below our forecast  or if Category B revenue after operating costs does not 
exceed the AEG annual guarantee. We also may take rating action if the project 
starts to draw on the debt reserve accounts to meet debt service. 

Related Criteria And Research
     -- Updated Project Finance Summary Debt Rating Criteria, Sept. 18, 2007
     -- Project Finance Construction and Operations Counterparty Methodology, 
Dec. 20, 2011

Ratings List
Outlook Action; Ratings Affirmed
                                 To                From
Louisville Arena Authority Inc.
 Project revenue bonds           BBB-/Negative     BBB-/Stable


Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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