Ratings agency Moody's cautious toward Barclays Center's financial prospects in pandemic (as of November), but says billionaire Tsai offers backstop

In an 11/9/20 report on the Credit Profile of the Barclays Center--actually its parent entities--ratings agency Moody's offered a sober assessment of the arena's prospects in the wake of the coronavirus pandemic, suggesting that strengths were counterbalanced by cloudiness going forward .

That document was produced before the announced plan to re-start the NBA season in December and then to welcome fans later this month, nor the arrival of a third Brooklyn Nets star, James Harden.

It did not reassess the credit rating, which had been downgraded to Ba1, the highest rank of junk in October 2019, in the wake of struggles caused by an onerous contract with the New York Islanders. And the negative outlook for that credit rating has persisted since then.

It's been a rough few years. Rival ratings agency Standard & Poor’s had downgraded the bonds to junk--BB, in their hierarchy--even earlier, in June 2019.

But S&P in June 2020 was directed by arena operators to cease maintaining a rating, as shown in the screenshot. Ratings agencies are paid by the client, so that may have been a move to save money and/or to stave off further assessments perceived as negative or misunderstanding.

(The fine print: Brooklyn Events Center, aka ArenaCo, was set up to manage the construction, operations and maintenance of the Barclays Center. Empire State Development, a state authority, owns the Arena and the land, which it leases to the state entity Brooklyn Arena Local Development Corp., which issued the tax-event bonds and subleases the arena to ArenaCo, which pays off the bonds via payments in lieu of taxes, or PILOTs. That fig leaf of public ownership offers significant savings compared to taxable bonds.)

Many unknowns persist

The Moody's report acknowledged many variables and unknowns:

Much will depend on the duration and trajectory of the virus and the uncertainty related to the level of in-person fan attendance at Nets’ home games, concerts and other events when the Arena does reopen. The Arena's exposure to demand risk has left it vulnerable to shifts in market sentiment during these unprecedented operating conditions, and the Arena's financial performance remains vulnerable to the continuing virus outbreak.

Given pandemic-related wariness, that could lead to lower revenues from sponsorship sales and/or lower prices for premium seating,  Moody's warned, though it said the addition of stars Kevin Durant and Kyrie Irving should drive ticket sales. 

Moody's did not address the role of Harden, which further boosts interest in the Nets and makes a longer playoff run more likely, bolstering potential revenues. (It also raised the team's payroll.)

According to Moody's, the arena has been losing money but has paid its bills without drawing down $80 million in reserves, thanks mainly to capital contributions by billionaire Joe Tsai, who owns the arena company, the Brooklyn Nets, and New York Liberty.

Strengths and weaknesses

Moody's cited credit strengths, including Tsai's role, the New York media market, the arena company's existing reserves, and multiple revenue streams. The Nets/arena have a new CEO, John Abbamondi, tasked with building the business.

Such strengths are counterbalanced by the uncertain impacts of the pandemic, including questions about consumer demand; weak underlying cash flow even before the pandemic (the arena has "historically underperformed financially"); and a looming increase in debt service on the horizon, starting in 2026.

In other words, they'd better get it together in the next five years.

Income covers debt service?

Moody's generously--to my mind--calculated a debt service coverage ratio (DSCR) of just 1.05x for FY 2020, indicating that the arena had enough money, albeit barely, to cover debt service. 

By contrast, I calculated that operating income was well below the amount needed to cover debt service, which would lead to a DSCR underwater, below 1. 

Note: though Investopedia defines DSCR as "taking net operating income and dividing it by total debt service," Moody's included a $13.5 million "capital contribution" from Tsai, which made up for the weak operating income.

That allows the rating agency to avoid a trigger for a ratings downgrade. Read strictly, it's clear the arena didn't--and likely won't--have enough income from operations to pay its debts. Then again, a ratings downgrade is supposed to be a warning, and the presence of a billionaire committed to backstop the payments should counteract that.

Based on previous guidance, Moody's should have already downgraded the bonds to a lower notch within "junk," since the this past year's 1.05x metric is below the 1.20x threshold previously set. But Moody's offered an asterisk.

"However, in light of these unprecedented developments," the ratings agency said, "we will see how 2021 is expected to play out and what the future DSCR trajectory is for the project with and without the assistance from Mr. Tsai."

This kind of flexibility is not uncommon in the world of sports finance. Sportico columnist JohnWallStreet wrote 12/3/20 how lenders did not want to find teams in default, despite violations of lending terms:

That does not mean the financial institutions lending to pro teams and their owners are going to declare those loans to be in default, though. Conversations with a trio of sports bankers... indicated that the far more likely scenario is banks and bond issuers waiving or amending covenants so that the borrower can remain in compliance and simply extracting a fee for the additional risk they’re taking on.

What's next?

According to Moody's, arena "leadership is evaluating every possible option, including streaming concerts and fan-less events, but nothing has yet been determined, and all options are on the table." (As we now know, the cost simply of COVID-19 tests adds $200 to the cost of a Nets ticket.)

Ultimately, "the Arena is expected to host approximately 150-200 events per year, including Nets and Liberty games," according to Moody's, offering a generous range.

Will the loss of the Islanders help, as long predicted? Well, the arena will avoid the poor fit of hockey. However, Moody's warned, "future revenue streams may be less predictable in part because sponsors, a longer-term source of contractual cash flows, attribute less value to advertising at other events such as concerts and shows compared to sporting events." 

Going forward

Moody's negative outlook reflects its estimate that DSCR will remain below 1.2x, but says an upgrade to a stable outlook might happen if the arena books events and DSCR exceeds 1.2x. 

Moody's noted that the arena company's DSCR was above 1.5x for FY 2016 and FY 2019, but dipped to 1.23x in FY 2017 and 1.03x in FY 2018. That was due the obligation to pay the Islanders a fixed fee, coupled with an inability to reap revenue from the hockey business.

Not only does the arena have reserves to pay the $3 million in monthly payments in lieu of taxes (PILOTs), Tsai's contributions have helped avoid raiding them, according to Moody's.

Note that, for now, more than 30% of those required PILOTs ultimately gets returned to the arena to be used on operations and maintenance, or O&M. By 2026, the debt service component of PILOTs will increase, cutting the O&M kickback to about 17%.