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.