Looking back: how the glitzy Barclays Center, seemingly successful, saw its bonds go to "junk" (plus: a looming challenge in 2026)
The narrative around the Barclays Center since its opening in 2012 has mostly been triumphant. Kudos from architecture critics. Strong numbers for ticket sales. And a seeming high value for the arena operating company--at least in the most recent transaction.
The operating company, Brooklyn Events Center, was sold in a deal that closed in September 2019, along with the remaining majority share of the Brooklyn Nets, by Russian oligarch Mikhail Prokhorov to Taiwanese-Canadian entrepreneur Joe Tsai.
But the arena's gauzy revenues have long translated into paltry profits, sometimes barely enough to cover debt service to pay off tax-exempt construction bonds and, most recently, requiring a capital infusion from Tsai.
Instead of paying taxes on property that's tax-exempt thanks to state ownership, the arena company makes payments in lieu of taxes, or PILOTs. The savings on tax-exempt financing were worth between $122 million and $146 million, depending on which estimate you choose.
Back in 2009, Moody’s estimated a robust DSCR of 2.85x, meaning that net revenues should be nearly triple the payment obligation. By December 2015, though, Moody’s noted that ratio had declined to 1.29x in the past fiscal year, from 1.62x the previous year.
In April 2018, S&P pointed to challenges from the Nets’ sale, because the arena would now collect just 30 percent of food and beverage sales from NBA games, down from the prior 100 percent. (NetsDaily said that the new allotment was the league standard and, indeed, this change was required by the league.)
“To bridge the gap in revenue loss,” S&P said, “a reserve account was established with a portion of the sale proceeds (estimated to be $345 million).” S&P warned, though, that “our preliminary calculations suggest that these features are not sufficient to support the current credit profile.”
Moody's, as I wrote in May 2018, affirmed the arena's Baa3 rating, suggesting that the initial phase of Prokhorov's sale of nearly half the team to Tsai actually rescued the arena's uncertain finances.
Not only had arena expenses been much higher than initially projected, the deal to bring the New York Islanders to Brooklyn--in which arena operators promised a fixed payment in exchange for control of revenues--proved a bust.
2019 downgrades
On 6/28/19, S&P downgraded the BALDC debt dramatically from from BBB- to BB, a two-notch drop to junk. (A one-notch drop, to the higher level of junk, would've been BB+.)
"The downgrade follows our determination that the revision of the Nets License Agreement last year--which diverts revenue away from the arena to the team--weakens the structure and is not wholly mitigated" by that new reserve account, initially funded at $327.8 million.
"The structural changes are not consistent with the conventional protections in a project financing," S&P stated, as if flummoxed by the new fund. "The potential for the License Agreement to be amended again in the future supports our view that the rating on the project will likely remain speculative grade."
On 10/1/19, S&P placed the arena rating on "CreditWatch Developing," noting that, upon Tsai's completion of the Nets' purchase and also the full operating company, "the changes initiated in 2018 have been reversed."
While S&P did say that that investors were very likely to be made whole in the event of a default, it found the financing plans confusing: "the ability to substantially modify the structure continues to be inconsistent with the conventional protections we typically look for."
On 10/23/19, Moody's finally declared junk, downgrading the arena bonds one notch, to Ba1 from Baa3, with a negative outlook.
Moody's rationale "principally reflects" the loss of that reserve account, thus requiring the arena to rely on ongoing revenues for both operating expenses and debt service.
Moody's noted that the DSCR for the fiscal year ending June 30, 2019 was 1.55x, while management--still cautious despite the expected better Nets performance--had budgeted DSCR for the next fiscal year to be 1.48x, "a stark improvement" over the figures for FY 2018 and 2017, 1.03x and 1.23x, respectively.
The difference between PILOTs and debt service leaves funds for operations and maintenance, or O&M, which goes back to the arena operator and thus saves them money. As I wrote yesterday, today more than 30% of those required PILOTs ultimately go back to O&M. By 2026, as the debt service component grows, the O&M kickback will be cut to about 17%.
Rest easy, bondholders?
The October 2019 Moody's report offered a significant reassurance to bond holders: "Specifically, Joseph Tsai has signed an operating support agreement whereby he unconditionally and irrevocably agrees to provide the Arena with all amounts necessary for the Arena to meet its expenses and payment obligations, including PILOTs, if necessary."
The price for the arena was some $1 billion, even if Forbes thought it was overpriced.
Clearly the New York City market, coupled with the scarce commodity of a professional sports team, drove the sale price, along with the confidence that--at least, pre-pandemic--the league's "socialist" economics (to quote Tsai) ensured a rising tide of revenues.
But the arena's gauzy revenues have long translated into paltry profits, sometimes barely enough to cover debt service to pay off tax-exempt construction bonds and, most recently, requiring a capital infusion from Tsai.
As I wrote yesterday, ratings agency Moody's affirmed the bonds rating at BB-, or junk, and decided not to downgrade the bonds, despite evidence for doing so, given the special circumstances of the pandemic.
Going to junk
Even before the sale from Prokhorov to Tsai was finalized in 2019, the arena's unimpressive fiscal record prompted Standard & Poor's (S&P), one of the two major bond ratings agencies, to downgrade the arena bonds to "junk," or speculative.
Shortly after the sale, the second ratings agency, Moody's, also downgraded the bonds to junk, citing revisions to the arena license agreement. Today only Moody's maintains a rating, which has a "negative" outlook, as I wrote.
The practical impact of that does not (yet) seem significant, though had the bonds been rated junk when marketed in 2009 they would had a much higher interest rates, making them tougher to sell, deterring institutional buyers. And those interest rates would have raised the cost of construction, perhaps prohibitively.
The current "junk" status would mean a somewhat higher interest rate if the bonds were refinanced or new bonds were issued--though that's relative to baseline interest rates, which have continued to drop.
Also, the junk rating would typically signal less reliable prospects for payment--except in this case billionaire Tsai has committed to backstopping the bonds. Moody's reports that Tsai has agreed to backstop any required debt payments, even if arena revenues are insufficient.
About those bonds
How did the arena builders/operators get tax-exempt financing for a nominally state-owned building, thus ensuring a lower interest rate--and requiring lesser payments from the borrower--than taxable ones?
The bonds were issued by the Brooklyn Arena Local Development Corporation, or BALDC, a special-purpose subsidiary of the state's Job Development Authority, an alter ego of Empire State Development, the state authority that oversees/shepherds the project. That state role enables tax-exempt financing, but does not leave public entities on the hook.
Instead of paying taxes on property that's tax-exempt thanks to state ownership, the arena company makes payments in lieu of taxes, or PILOTs. The savings on tax-exempt financing were worth between $122 million and $146 million, depending on which estimate you choose.
In 2009, when the bonds were put up for sale, they got the lowest investment-grade rating, one notch above junk: Baa3 from Moody's and BBB- from S&P. That ranking was common for local sports facility projects, like the new stadiums for the New York Mets and New York Yankees.
The arena was said to cost $934 million, including the transit connection and site work, though it's often been short-handed as a "$1 billion arena."
Shrinking debt service coverage
Those investment-grade ratings persisted for years, though the arena's financial returns were well behind projections. Ratings agency statements indicated a shrinking debt service coverage ratio (DSCR), a common metric used to describe the revenues available to pay off construction bonds.
Back in 2009, Moody’s estimated a robust DSCR of 2.85x, meaning that net revenues should be nearly triple the payment obligation. By December 2015, though, Moody’s noted that ratio had declined to 1.29x in the past fiscal year, from 1.62x the previous year.
Perhaps that's why Sports Business Journal in October 2014 estimated that the arena was worth just $750 million, based on revenue flow.
Prokhorov in 2016 bought the remaining 45 percent of the operating company and 20 percent of the Nets from original owner Forest City Ratner/Forest City Enterprises, with the arena company valued at just $825 million, or less.
Prokhorov in 2016 bought the remaining 45 percent of the operating company and 20 percent of the Nets from original owner Forest City Ratner/Forest City Enterprises, with the arena company valued at just $825 million, or less.
Soon he refinanced the bonds at a lower interest rate, saving perhaps $90 million and bolstering a shaky DSCR.
In August 2016, Moody’s predicted that, given such lowered payments, the debt would be easier to pay. DSCR could the reach a solid 1.9x, or nearly twice the money needed. That didn’t happen. The ratio in 2017 sunk to 1.31x.
2018: warnings mount
In April 2018, S&P pointed to challenges from the Nets’ sale, because the arena would now collect just 30 percent of food and beverage sales from NBA games, down from the prior 100 percent. (NetsDaily said that the new allotment was the league standard and, indeed, this change was required by the league.)
“To bridge the gap in revenue loss,” S&P said, “a reserve account was established with a portion of the sale proceeds (estimated to be $345 million).” S&P warned, though, that “our preliminary calculations suggest that these features are not sufficient to support the current credit profile.”
Moody's, as I wrote in May 2018, affirmed the arena's Baa3 rating, suggesting that the initial phase of Prokhorov's sale of nearly half the team to Tsai actually rescued the arena's uncertain finances.
Though the $1 billion transaction did divert additional revenues from the arena operating company to the team, as Moody’s explained, that reserve fund would mitigate expected “financial underperformance" from the arena going forward. Thus the arena was projected to meet a minimum DSCR of 1.38x.
Still, that had been the third ratings announcement in the past eight months with a “negative” outlook toward the bonds.
Not only had arena expenses been much higher than initially projected, the deal to bring the New York Islanders to Brooklyn--in which arena operators promised a fixed payment in exchange for control of revenues--proved a bust.
Moody's blamed not just the Islanders contract and the Nets transaction, but also a “several year decline in attendance at the Nets' home basketball games (although this may have stabilized),” as well as lower revenues from sponsorships, premium seating, and concessions.
2019 downgrades
On 6/28/19, S&P downgraded the BALDC debt dramatically from from BBB- to BB, a two-notch drop to junk. (A one-notch drop, to the higher level of junk, would've been BB+.)
"The downgrade follows our determination that the revision of the Nets License Agreement last year--which diverts revenue away from the arena to the team--weakens the structure and is not wholly mitigated" by that new reserve account, initially funded at $327.8 million.
"The structural changes are not consistent with the conventional protections in a project financing," S&P stated, as if flummoxed by the new fund. "The potential for the License Agreement to be amended again in the future supports our view that the rating on the project will likely remain speculative grade."
On 10/1/19, S&P placed the arena rating on "CreditWatch Developing," noting that, upon Tsai's completion of the Nets' purchase and also the full operating company, "the changes initiated in 2018 have been reversed."
While S&P did say that that investors were very likely to be made whole in the event of a default, it found the financing plans confusing: "the ability to substantially modify the structure continues to be inconsistent with the conventional protections we typically look for."
The loss of the reserve account, said S&P, adds risk. The closing of that account involved a payoff for the Nets, which gained that $328 million in exchange for allowing the license agreement to return to the original 2009 revenue formula, which allots the arena operator more revenue from game-day sales. (S&P by 2020 was no longer being paid to follow the bonds.)
Moody's pulls the "junk" trigger
Moody's rationale "principally reflects" the loss of that reserve account, thus requiring the arena to rely on ongoing revenues for both operating expenses and debt service.
Moody's noted that the DSCR for the fiscal year ending June 30, 2019 was 1.55x, while management--still cautious despite the expected better Nets performance--had budgeted DSCR for the next fiscal year to be 1.48x, "a stark improvement" over the figures for FY 2018 and 2017, 1.03x and 1.23x, respectively.
"However," stated Moody's, "the DSCRs for 2019 and partially for 2020 benefit from the supplemental revenue from the reserve, which has been eliminated." The ratings agency did its own calculation, not only removing the extra revenue, but also adding the new revenue sharing from the Nets, thus projecting DSCR for the next fiscal year at just 1.2x. Should that persist, that would portend a downgrade.
"This financial performance is well below our initial expectations, particularly given the volatility that now accompanies the Project with the elimination of the reserve," Moody's stated. "We also note that Barclays Center has historically underperformed financially owing to the volatility of team performance with the Nets, related variability in sponsorship and premium seating sales and the less predictable revenues and cash flow from event sales."
It did allow that improved performance by the Nets could drive more revenue, and that Tsai would likely institute operational changes. Today, the star-laden Nets are likely to play deep into the playoffs and increase TV ratings, both revenue drivers.
Escalating costs
There's a looming challenge: Moody's has warned that debt service begins to "escalate in 2026," putting more pressure on the arena operator. That's no so far off.
"This financial performance is well below our initial expectations, particularly given the volatility that now accompanies the Project with the elimination of the reserve," Moody's stated. "We also note that Barclays Center has historically underperformed financially owing to the volatility of team performance with the Nets, related variability in sponsorship and premium seating sales and the less predictable revenues and cash flow from event sales."
It did allow that improved performance by the Nets could drive more revenue, and that Tsai would likely institute operational changes. Today, the star-laden Nets are likely to play deep into the playoffs and increase TV ratings, both revenue drivers.
Escalating costs
There's a looming challenge: Moody's has warned that debt service begins to "escalate in 2026," putting more pressure on the arena operator. That's no so far off.
The chart below, which I created, was published in March 2017 when the arena operator was Prokhorov. (I just annotated it to add Tsai.) It indicates, via the green line, the steadily increasing increase in required PILOTs and the debt service component, which was shrunken after the 2016 refinancing but is slated to bump up in 2026.
The difference between PILOTs and debt service leaves funds for operations and maintenance, or O&M, which goes back to the arena operator and thus saves them money. As I wrote yesterday, today more than 30% of those required PILOTs ultimately go back to O&M. By 2026, as the debt service component grows, the O&M kickback will be cut to about 17%.
The October 2019 Moody's report offered a significant reassurance to bond holders: "Specifically, Joseph Tsai has signed an operating support agreement whereby he unconditionally and irrevocably agrees to provide the Arena with all amounts necessary for the Arena to meet its expenses and payment obligations, including PILOTs, if necessary."
"In addition," it said, "Mr. Tsai has signed an operating support agreement with the NBA whereby he is obligated to provide the Nets with all amounts necessary for the team to meet its expenses and payment obligations, including debt service."
So it's nice to have a billionaire backing the costs. That said, he surely wants to wring more revenue from the arena--see for example the (temporarily disruptive) new LED signage.
So it's nice to have a billionaire backing the costs. That said, he surely wants to wring more revenue from the arena--see for example the (temporarily disruptive) new LED signage.
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