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LOUISVILLE, Ky. (WDRB) – Moody's Investors Service lowered its confidence in the ability of arena officials to repay the construction debt on the KFC Yum! Center, citing the dependence on a special taxing district, high operating expenses and a lease with the University of Louisville that limits the building's profit potential.
Moody's downgraded $339 million of the $349 million bond issue Thursday – the rating agency's first action since announcing in May 2012 that it no longer viewed the bonds as investment-grade securities. This week's move dropped the rating by one notch on Moody's scale.
While Moody's has a lower opinion of the debt, it reversed its outlook to "stable," from "negative" on Thursday. All but $10 million of the bonds are insured.
Moody's analysis wrote in their report that they recognize the "recent positive changes" that have occurred at the arena, including the hiring of AEG as operator and a redrawn tax increment financing district, which helps pay off debt by capturing a share of sales and property tax increases near the building.
But Moody's doesn't believe those are enough to provide a financial cushion to the Louisville Arena Authority as a result of its agreement with U of L and debt payments that are set to drastically increase in the coming years. The credit rating agency also worries about the amount of money able to meet debt payments, which it described as a "historically narrow" ratio.
William Summers V, chair of the arena authority's finance committee, declined to comment. In a statement, the authority said it "regrets" the decision.
"Given all the noted improvements, and (debt service) coverage in the realm they anticipated, we do not understand the downgrade," the statement read in part. "The LAA is committed to continued improvement in fiscal performance and looks forward to further discussions with Moody's."
Credit rating agency Standard & Poor's also is expected to update its rating of the arena bonds in the coming months. In June, S&P maintained its rating of BBB- on the debt – one level above speculative, or "junk" status - along with a "negative" outlook.
S&P noted the volatility of tax increment financing, partly due to the recession, and indicated that those revenues may not increase as fast as had been predicted. An S&P analyst declined to share the agency's projections.
The revenue from the tax increment financing, or TIF, district was supposed to be the largest pot of money for the debt payments, but it has fallen short of projections of more than $30 million. It has generated $18.5 million, according to arena estimates, although arena officials note that the revenues are increasing.
"I think you've got to look at the growth rate there," arena authority chairman Larry Hayes said earlier this week. "I think you're going to see significant growth."
Lost in the discussion of the arena's finances is the impact the building has had on downtown, said Hayes, who also is secretary of Kentucky's economic development cabinet.
"I really look at where we're going," he said. "And we're certainly going in a positive direction with the (Aloft boutique) hotel announcement down there … the new restaurants that are opening up down here."
Since opening in 2010, the arena has hosted more than 110 events aside from basketball games, including tours for Elton John, One Direction, The Who and Bruce Springsteen.
But it's not the traffic into the arena that has posed financial challenges, but the unique way the arena financing was assembled in 2008 as the U.S. credit market began reeling.
Arena planners set aside certain pools of money to pay off debt. They include naming rights, suite revenues, sponsorships and the TIF revenue.
But with the TIF proceeds lagging, Metro government has increased its annual payment -- to $9.8 million from earlier contributions of $6.5 million – and there's been renewed discussion about the U of L lease and the possibility of a National Basketball Association franchise moving to Louisville.
Critics, including some past authority board members, long have argued for changes to the lease agreement with U of L, whose basketball teams are the building's prime tenants. The move to the arena from Freedom Hall helped establish the men's basketball program as the nation's most lucrative, bringing in a $27 million profit in 2011-12, according to ESPN.
The university's deal with the arena authority largely allows U of L control over scheduling in the building during basketball season and the bulk of some arena revenues, such as proceeds from private suite sales. U of L keeps 88 percent of those monies, for example.
Moody's analysts wrote that the authority's revenue-sharing lease with U of L "limits the authority's profit upside from the successful anchor tenant."
In October, U of L agreed to cap its share of annual sponsorship revenue in a move that is expected to produce more than $1 million for debt payments over several years.
Louisville Mayor Greg Fischer, who along with Gov. Steve Beshear appoints the arena board, said he's focused on improving the economy downtown, which in turn will benefit the TIF district.
"As that grows that's going to alleviate some of the financial pressure on the arena itself," Fischer said. "The city's there obviously with our contribution. There's a legal agreement in place with U of L. I don't think now is necessarily the time to address that."
U of L spokesman Mark Hebert said the university hasn't been asked to renegotiate its lease.
"This is the exact same agreement that was in place when the bonds were ‘A' rated," Hebert said. "We've exceeded all projections made as we moved into the arena and we have also worked closely with the arena's management to clear multiple dates and give the arena opportunities to be as successful as possible."