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