Wednesday, May 12, 2010

Ratings agency may downgrade tax-free arena bonds, cites uncertainty regarding taxable junk bonds; Prokhorov could still fill the gap

Update: the Star-Ledger reports that Prokhorov is buying the bonds. Second update: Actually, it's a loan.

One day after the Atlantic Yards arena groundbreaking in March, ratings agency Standard & Poor’s (S&P), citing “uncertainty” about the plan for arena financing, withdrew its rating (of junk) for $106 million in taxable bonds needed for the arena financing structure. Because of that, S&P warned that it could lower the ratings on the tax-free bonds “in the next few months.”

Should that occur, that would push the $511 million tax-free bonds issued by the Brooklyn Arena Local Development Corporation (BALDC) into a rating below investment grade, the level that was needed to market the bonds in the first place.

However, that wouldn't scotch the deal; the bonds have already been sold to investors. And, given that Russian billionaire Mikhail Prokhorov now has bought 80% of the team and 45% of the arena, he surely has an incentive to fill the gap either with equity or by buying the taxable bonds, as he had been rumored to do months ago, thus restoring the rating.

Still, it's a curious situation--why haven't Prokhorov and Forest City Ratner resolved this?--and it was curious timing.

Barely investment grade

Before the tax-exempt bonds were sold last December, S&P rated them BBB-, the lowest investment-grade level. Moody’s, which rated only the tax-free bonds, also gave them its lowest investment grade: Baa3. Bonds for the new Yankees and Mets stadiums got the same rating.

The financing gap, yet unfilled, could lower the rating and indicate a higher risk that the bondholders would be repaid.

Other events could lower the rating, such as delays in construction or loss of expected sponsorship revenue.

The need for junk bonds

While the New York City Independent Budget Office last September estimated that $678 million in tax-exempt bonds would be sold, the sum was considerably lower, $511 million, leaving a gap to be filled by riskier taxable bonds.

Why? It’s unclear, but the developer and state officials may have estimated that the foregone property taxes on the arena site—which would be deflected into PILOTs, or payments in lieu of taxes—were insufficient to repay $678 million in bonds.

(Last June, I questioned the city’s dramatic reassessments of property on the arena block, suggesting that was engineered to increase the PILOTs.)

Or it was simply the maximum amount of debt to which the ratings agencies would agree to apply an investment-grade rating.

Start-stop sales sequence on taxable bonds


In December, S&P rated the $146.8 million in taxable arena bonds as B, which is "very speculative." S&P assigned "a recovery rating of '6' to this debt, indicating our expectation of negligible (0%-10%) recovery in the event of a payment default."

Project Finance magazine suggested that the taxable bonds—issued by a separate entity, the Brooklyn Arena Holding Company (BAHC)--might be bought by Prokhorov, slated to own 80% of the Nets and 45% of the arena company.

On December 21, S&P withdrew its preliminary ratings, indicating that the notes were not sold but would be marketed in 2010.

In early February, a smaller amount of taxable bonds, $106 million, was put on the market. S&P issued the same 'B' rating and, for the first time, announced an interest rate: 11%.

There's no indication those bonds were purchased.

Rating withdrawn

The March 12 revision by S&P drew little attention, though Reuters reported the ratings agency's statement, "At this point, there is uncertainty as to the final terms and conditions of any new funding approach."

The full report (which I got yesterday, after learning of it belatedly) is fairly cryptic, stating that the rating for the taxable bonds was withdrawn “because the sponsors decided to pursue an alternative financing strategy to that originally presented to Standard & Poor's.”

The rating on the tax-exempt bonds “was predicated on a capital structure that assumed issuance of debt at BAHC.”

“At this point, there is uncertainty as to the final terms and conditions of the new funding approach,” S&P said. “We are placing LDC's 'BBB-' rating on CreditWatch with negative implications. The negative CreditWatch indicates that we could lower the ratings in the next few months."

Strengths, weaknesses, timing

The rest of the report cites, as per previous reports, multiple strengths regarding the project (the arena should be built on time and budget, with a high level of contractually obligated income) as well as weaknesses (uncertain demand for the arena, risks associated with discretionary spending, and competition from other facilities).

In February, S&P said that construction was expected to be completed by May 1, 2012. The March report offered no prediction. Last month, a Forest City Ratner executive said it must be completed by early July 2012.

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