One day before first Prokhorov-Tsai transaction, New York State agreed to amend Barclays Center lease to deliver more cash to money-losing arena operator

When, in 2016, New York State approved a refinancing of the bonds for the Barclays Center, allowing a lower interest rate and thus smaller payments to bondholders, that offered a clear but indirect benefit to the arena operating company, then owned by Mikhail Prokhorov.

Because required PILOTs (payments in lieu of taxes) remained consistent--having been set earlier to correllate with tax assessments, enabling tax-exempt bonds, which offer the arena operator savings compared to taxable bonds--a larger component of those payments could be reserved for O&M (operations and maintenance costs) reimbursements, thus saving the arena operator from paying them. The PILOTs go both to bondholders and the O&M Fund.

From 2016 bond document: click to enlarge

That increased the amount of O&M funds from some $3 million to more than $11 million a year, as I wrote, and it was part of why Bloomberg characterized the move as Barclays Center Refinancing Saves $90 Million for Prokhorov.

It turns out, however, that it wasn't immediately easy to apply the savings, which is why in 2018 New York State quietly--even stealthily--approved another change to help the arena operator, as described below. That change may have been exaggerated to bond investors, as I describe.

Limits on the O&M Fund

As stated in the 2016 Official Statement (or prospectus) for the bonds, the O&M Fund could be used for:

certain Arena operations and maintenance expenses, such as costs of heating, ventilation and air conditioning, utility and energy systems (including costs of gas and electricity), the costs of Builder's Risk and Property Insurance and capital improvements to the Arena.

That, however, apparently did not exhaust the O&M Fund nor reflect the reimbursable expenses at other city sports facilities financed with PILOTs.

(It's not clear why the lease was written that way in the first place, but maybe perhaps the arena builder/operator, Forest City Ratner, was overoptimistic about revenues and/or did not anticipate how a refinancing would leave a new cushion for the O&M Fund.)

Moreover, given an onerous deal with the New York Islanders and other pressures, the arena was struggling financially, unable to cover operating expenses.

So a change was made one day before the 4/11/18 sale by Mikhail Prokhorov, until then 100% owner of the Brooklyn Nets of a 49% stake in the team to Joe Tsai, at a valuation of $2.35 billion. At the time, Prokhorov still fully owned Brooklyn Events Center (aka ArenaCo), but in September 2019, he would sell the rest of the team, and also ArenaCo, to Tsai.

A change in the lease

So, at a 4/10/18 meeting that I and others ignored (because it got no publicity), arena operators went back to the Brooklyn Arena Local Development Corporation (BALDC), the special-purpose state entity that issued the bonds, to amend the Arena Lease Agreement to allow more expenses to be reimbursed by the O&M Fund.

From 2018 BALDC resolution

(BALDC is an arm of the Job Development Authority, which is an alter ego of Empire State Development, the gubernatorially-controlled state authority that oversees/shepherds Atlantic Yards. But sometimes it seemed like Goldman Sachs was in charge.)

The amendment added significant additional reimbursable expenses--to my eye, most notably, cleaning/janitorial services,  and Arena-related maintenance and repair costs. According to the resolution (also at bottom):

In the prior fiscal year, ArenaCo generated insufficient operating revenues to cover the operating expenses of the Arena. As a result of the 2016 PILOT Bond refinancing, additional funds are anticipated to be available for deposit in the O&M Fund. AreanaCo has requested that the Corporation amend the Original Lease pursuant to the terms of a Second Amendment to the Agreement of Arena Lease to include in Landlord O&M Costs certain additional operating costs, including cleaning and janitorial services, trash collection and disposal, utilities, insurance, graffiti removal and Arena-related maintenance and repair costs. The inclusion of these additional Landlord O&M Costs is consistent with the leases for other sports facilities financed in the same manner as the Arena.

(Emphasis added)

What bondholders were told: O&M

Note that, in a 5/18/18 presentation to bondholders, excerpted below, the categories were described more expansively.

That presentation adds the categories Concession Facilities, Ticket Offices and Booths, Security/Other Event Personnel, and First Aid Facilities/Medical Personnel, which were not in the resolution. That seems... fishy.

• Cleaning and Janitor Services (including snow / ice removal and supplies for the premises)
• Trash Collection and Disposal (including recycling)
• Utilities (including gas, water, electricity, HVAC, telephone and sanitary and storm services)
• Insurance (including property and liability insurance)
• Graffiti Removal (including vandalism repair)
• Concession Facilities
• Ticket Offices and Booths
• First Aid Facilities / Medical Personnel
• Security / Other Event Personnel
• Maintenance and Repair (interior and exterior structures, areas, building systems, utility systems, sewer systems, foundations, equipment, fixtures existing within the Arena and costs for all personnel, supplies, materials, parts, labor and equipment necessary for maintenance and repair)

A bonus for the arena operator

In that investor presentation, bondholders were told, "ArenaCo expects to receive a greater level of annual O&M reimbursement as a result."

That seems logical.

Then again, when asked if the refinancing helped Prokhorov, state official Marion Phillips III had said, "Actually it doesn't, because the bonds are repaid by PILOTs. Whatever excess there is from lowering the interest rate goes into a reserve account, held at Mellon Bank, a trustee appointed by ESD, that money goes into reserve to pay for maintenance of the building."

"It doesn't benefit Prokhorov in any way?" he was asked again.

"Not to my knowledge," he responded.

Well, Prokhorov owned ArenaCo.

What bondholders were told: the transaction

The main message of the investor presentation was to explain how, because the sale reallocated certain annual revenues from the arena to the team, Prokhorov was immediately required to put $345 million in escrow to backstop arena finances.

That fund, slightly depleted, was later liquidated and refunded to Tsai as team owner when, in 2019, the team/arena transactions closed and revenues were reallocated from the team to the arena. That's why I recently argued that the Nets sale should not have been seen as a record.

Other messages regarded the purported strength of the PILOT bonds and the prospects for improved arena business.