The Louisville Arena Authority closed on the municipal bond financing of a $238 million arena in downtown Louisville, Kentucky in early September 2008. The project faced a substantial number of obstacles occurring over a multi-year period, as well as a series of last-minute hurdles with its financing. Although the bonds used to finance the construction of the Arena were issued in September 2008, the saga of the development and financing of the Arena began many years before.

Early discussions, dating as far back as 2001, involved a myriad of constituencies and political considerations, including a proposal for a $250 million arena to be located in downtown Louisville that could be used to host NBA games. By April 2005, the discussions on whether to build an arena in Louisville had progressed to a stage in which the Commonwealth of Kentucky, the University of Louisville and the government of metropolitan Louisville were considering the construction of a venue for the University's basketball teams.

The task force tasked

In April 2005, Kentucky's governor, Ernie Fletcher, appointed a task force to determine where such a facility should be built and how it should be financed. The intent was that the Governor would review the findings of the Arena Task Force and take its plan, or some version of it, to the General Assembly in January 2006. The site for the proposed arena was a major source of contention. The mayor of Louisville Metro preferred a downtown location, whereas the president of the University preferred an on-campus venue, though they agreed to abide by the task force's decision. But the Waterfront Development Corp., which had approval rights over all project designs near the city's Ohio riverfront, was firmly opposed to a new arena near the riverfront, saying it would discourage public use of the area.

Another primary consideration was that the University generated over 50% of its athletics budget from men's basketball operations and worried about the potential adverse economic impact of a venue change. It also believed that any new arena would need to present the University with opportunities to realise greater revenues than its current arrangements and wanted any new arena to contain a minimum of 60 suites, a figure nearly triple the number of suites in Freedom Hall.

The task force considered that the Kentucky State Fair Board (KSFB) was a possible operator of the facility, believing it to be capable and experienced at working with the scheduling requirements of the University, though it also considered other operators. The task force scheduled public hearings and created a web site so that the public could post comments. The task force recommended in September 2005 that the arena be owned and governed by an independent authority since this would permit bonds for the arena to be issued on a negotiated basis rather than the competitive bid prevalent on general obligation bonds. It also recommended that the KSFB manage the arena, but that the KSFB should hire a consultant to assist it with pre-opening services. It said that the University's men's and women's basketball programs should be the primary users of the arena, but it be designed in conjunction with the NCAA and also permit minor league sports activities.

The task force concluded that a downtown Louisville location would present the greatest spinoff alternatives for the Arena. Finally, it projected construction costs for the arena of $299 million at a downtown, riverfront location but only $192 million at a Kentucky State Fairground location. It suggested that these costs could be met in part through grant funds from the Commonwealth of $75 million, and revenues from a tax increment financing (TIF) district around the arena.

Siting and cost issues

The most immediate consequence of these recommendations was the formation of the Louisville Arena Authority to pursue the project. But the site recommendation was not the final word. In particular, opponents of the site by the river pointed to this option's higher cost compared to a fairgrounds location. This cost difference, however, did not take account of the different specifications of the two locations (the riverfront site included a hotel and parking facility), or the environmental remediation costs of the riverfront site.

By February 2006, however, when the University came out in favour of the riverfront site, the cost of this option had increased from $299 million to $381 million. This increase, however, meant that projected revenues from basketball and other events were no longer enough to meet projected debt service.

The authority's solution was to pair the arena with a 425-room hotel, whose revenues would contribute to debt service, but which would be financed separately. This hotel, however, would need to generate enough revenue to service this separate financing as well as contribute to the arena's debt service costs. The hotel's viability was a source of considerable uncertainty. The hotel plan also revived concerns about public access to the river, as well as concerns about flooding risk.

State and Metro funding

The proposed $75 million grant from the Commonwealth to the arena then subjected the project to state-level political controversy. The cost of the riverfront site proposals led the Kentucky House of Representatives to make the grant conditional on the arena using a third site, a former location of the Louisville Water Company, though the Senate did not specify a site. The Commonwealth's governor also vetoed $73 million in University projects, which the University interpreted as the result of the grant proposal, leading the University to distance itself from the project. A compromise was reached, and the grant legislation was passed in April 2006.

But the Commonwealth specified that the University would have scheduling priority in the Arena and made the grant contingent on the authority obtaining a funding commitment from Louisville Metro. It also imposed substantial disclosure requirements on the authority. In 2005 the mayor agreed to a funding plan that used metro's high rating (AA/Aa from S&P/Moody's) to enhance the financial profile of the arena project. The authority and metro put together a plan under which Metro would contribute a minimum of $206 million over 30 years, and expand the TIF district, in return for a split 55/45 of surplus revenues between the authority and metro.

This deal with Metro, however, was contingent upon approval from its council. The council agreement included a labour agreement that placed restrictions on the project's hiring practices and provided for union bargaining rights that would not allow the authority to get the most competitive price possible for the arena. The authority, state and Jefferson County (which encompasses Metro) put together an agreement that set goal for the project's hiring, but not before the city's mayor vetoed the council proposal, the first veto of his administration.

Despite these moves however, the balance of the Arena's cost was still too high to be debt funded without the completion of a TIF financing plan. By expanding the originally-contemplated one square-mile district to six square miles, the authority was able to dispense with including a hotel, because the revenues from the expanded TIF district would be sufficient to help fund the arena. The TIF district did exclude a number of parcels of land, where these parcels were dedicated to other development projects. The district would use 2005 calculations as the basis for incremental increases in taxes.

Moving out and moving in

The authority signed a management agreement with the Kentucky State Fair Board for the arena and set aside $750,000 per year for 2011 through 2013 to compensate the board for the loss of basketball revenues at Freedom Hall, where the University played its games. The authority also paid $21 million to acquire the land at the riverfront on which the arena would be built and a maximum of $66 million to relocate the operations of two companies from the site, as well as provide in-kind benefits to one of the companies. One of the two – LG&E – was a regulated utility, which meant that the relocation needed to gain regulatory approval and the site had to be checked for environmental defects.

The authority and the University of Louisville Athletic Association (ULAA) negotiated a lease agreement for the arena that laid down details of ticket prices, advertising and sponsorship revenues, the use of and revenues from suites, and the allocation of parking spaces in the garage to be built under the arena. In 2006 ULAA marketed all 24 of the Freedom Hall suites and paid a fixed rent amount to the KSFB as owner of Freedom Hall. In 2006, ULAA reportedly collected $1.6 million in suite revenue and paid $285,000 in rent for the Freedom Hall suites. In August 2006, it was projected that the new arena would provide the ULAA with at least $2.5 million more revenue per year than Freedom Hall, due in part to the arena's projected increase in luxury suites over the number of available suites at Freedom Hall.

The ULAA would use the arena for its basketball programs starting in the 2010-2011 season, would get a say in how the Arena would be built and the right to market the luxury suites and other premium seating at the Arena, paying 12% of the revenue from these areas as rent. The lease agreement also allowed the University to share in revenue from merchandise sales, and would receive a greater share of catering and concessions sales during University events than it had received under its lease at Freedom Hall. But it would lose roughly $220,000 in annual parking revenue, as it would have to pay for spaces at adjacent lots and under the new arena.

In late July 2006, the authority hired PC Sports to oversee the design and construction of the arena and negotiate its construction contract negotiations. In January 2007, it selected HOK Sport to design the arena and Mortenson to build it. The authority used a construction manager at-risk contract, which would shift some escalation in the costs of construction to Mortenson. In September 2007, Mortenson estimated that arena construction would cost roughly $254 million, including a contingency, but after several months of revision managed to bring this down to $238 million. The authority selected Learfield Sports and Team Services to pursue naming rights, sponsorship and advertising opportunities, signing it to a seven-year $15 million minimum contract.

The bond financing assembled

The authority mandated Goldman Sachs as underwriter for the proposed bonds, which were to be issued on behalf of the authority by the Kentucky Development Finance Authority (KEDFA). At the time of Goldman's appointment, the total projected cost of the Arena was $252 million and the total projected principal amount of the bond financing, including interest during construction, transaction costs and reserves but net of costs to be funded by Commonwealth grant or other sources, was $339.3 million.

The authority had to revisit the issue of the Metro's support for the arena, since the council objected to its financial commitment being used to meet operating expenses. The authority, mayor and council assembled a compromise under which the authority could only request funds from Louisville Metro in excess of specified minimum payments after other revenue sources, including naming rights revenues, sponsorship revenues and TIF revenues, had been exhausted. This compromise solution provided for guaranteed minimum payment levels from Louisville Metro totalling $206 million over a 30-year period ending in 2039, but, if needed from a cash flow perspective, up to $309 million over that period. The authority developed a complex flow of funds to both timely measure and request the appropriate level of funding and also to appropriately apply Metro's funds.

The authority awarded the contract to run concessions in the arena to Centerplate. Centerplate provided the authority with a $7.5 million loan whose principal would be forgiven pro-rata over 15 years, and would pay the authority a percentage of sales with a minimum payment of $2.5 million per year. The authority's obligation under this loan would be subordinated to any arena financing, with the minimum payment designed to provide some support to this debt.

Goldman Sachs then chose Ambac as bond insurer for the transaction after soliciting bids from several monolines, and Ambac retained DLA Piper as its counsel. At the time the underwriter looked to the insurer to raise the bonds' rating to AAA/Aaa (S&P/Moody's). Among the issues identified by the insurer's counsel was that funding for the parking garage for the arena needed to be firmed up. The deal team also needed to make sure that the project stayed within the $350 million cap set for the issue of tax-exempt bonds by the KEDFA, and to keep track of expenditures that would be considered private use, and that would have to be financed with taxable debt. The team's analysis indicated that $30 million of taxable debt would be required.

The financing hits bumps

On 7 December 2007, the Kentucky TIF Commission approved a special taxing district for an urban development project in downtown Louisville called the Center City Project, but this included a one block overlay with the arena's TIF district. However, the two TIF districts were amended to eliminate the overlaps, following a swap proposal from the authority's chairman. The arena TIF district was finalised in May 2008. By this time, the fall-out from the subprime credit crunch had already spread.

On 20 December 2007, Fitch Ratings placed Ambac's AAA rating on rating watch negative, and on 16 January, 2008, Moody's also placed Ambac's Aaa financial strength rating on review for a possible downgrade. Ambac was not alone, and as other monolines came under ratings pressure the entire municipal marketplace became focused on bond insurance and the likelihood of a downgrade.

The arena finance team began several months of review and consideration of various alternative financing structures, after receiving tentative underlying ratings for the arena of BBB-. The team considered a financing structure involving wrapped senior and unwrapped subordinate fixed rate bonds, as well as using variable rate bonds secured by a letter of credit provided by a syndicate of banks. The authority hired PNC Capital Markets as an adviser on the bond deal, and began talks with, among others, Assured Guaranty, which had then retained its AAA ratings.

In February 2008, Mortenson said that the projected cost of the Arena had been reduced from $254 million to $249 million, although the final price would not be determined until the middle of the year. The authority faced to challenges to its award of the construction, and while one failed, a second succeeded and forced a new bid for the construction of the arena.
In early May 2008, the authority settled upon a revised financing plan under which Assured would replace Ambac as bond insurer, although DLA would remain monoline counsel. The new financing plan contemplated roughly $280 million of variable rate bonds, sharply up from an April estimate of $100 million. Variable rate bonds typically have lower interest expense than fixed rate bonds, so restructuring allowed the authority to reduce debt service on the arena bonds. To provide liquidity for investors, the bonds would be secured by a standby bond purchase agreement between the authority and PNC Bank at the head of a syndicate of ten banks, as well as a wrap from Assured. The balance of the bonds would be fixed rate bond-insured bonds, some tax-exempt and some taxable.

The new plan also contemplated interest rate swaps and as of 1 April 2008, based on the then-projected arena construction cost of $249 million, debt service was projected to total $646 million over the 30-year term of the bonds, compared with the $665 million that was projected earlier in the year, because of the new variable rate structure for the bonds. It was also less than the $700 million debt service under the fixed-rate structure of Ambac-insured bonds. The authority did bear some risk of increased debt service if there was a rating downgrade of Assured, as had happened with other bond insurers, since the variable rate bonds would likely trade at higher interest rates as a result of such a downgrade or, under a worst case scenario, could result in termination of the liquidity facility supporting the variable rate bonds.

The new plan required that the proposed interest rate swaps be secured and incorporated in waterfalls in the bond documents, including the provisions relating to the Louisville Metro funds. Variable rate bonds pay interest monthly rather than semiannually, so additional changes were made to reflect the revised payment timing. Security and remedies also needed to be provided for PNC. Finally, the terms of the standby bond purchase agreement and interest rate swap agreements themselves needed to be negotiated.

By 30 June 2008, the financing was documented and a preliminary official statement, the disclosure document for the proposed bond issue, was mailed to investors, with a closing date set for 23 July. By 11 July roughly $78.5 million of fixed rate bonds wrapped by Assured had been sold and $280 million of variable rate demand bonds was set to be sold on 22 July. The authority entered into trades for the bonds' interest rate swaps, with their start set for 23 July. However on 21 July, as the executed documents were placed in the closing room and participants travelled to Louisville to attend the preclosing, Moody's announced that it was reviewing Assured's Aaa rating for a possible downgrade. The authority postponed the sale of the variable rate bonds and did not close on the fixed rate bonds, assuming that the delay would be for one week.

The Moody's announcement discussed viability and market demand for the financial guarantor business, and made similar comments about viable competitors such as FSA, rather than making comments about Assured's health. But the authority still faced a number of alternative financing plans, including increasing the amount of variable rate bonds and giving them default and liquidity support using bank facilities, and using a short-term construction loan, which would have allowed construction to start on time in late September. The authority unwound its its interest rate swaps at this time, receiving a termination payment of roughly $525,000.

On 12 August 2008 demolition began on the LG&E site, but as the disturbances in the financial markets increased the likely debt service for the arena, reducing its cost as much as possible became of paramount importance. The authority and Mortenson agreed a further reduction of construction costs, down to $238 million, reducing the total cost to $351.3 million, of which $263.1 million was for design, construction and administrative costs and $88.2 million was for acquisition and relocation expenses. Much of this latter cost had been funded with the $75 million grant from the Commonwealth. These figures also did not include the projected $33.5 million cost of the 760-space garage to be paid for and operated by PARC.

The authority said it held off on meetings, and presumably financing plans, after the "busted closing" to give Mortenson time to finalize the maximum price. Ultimately, the authority executed a guaranteed maximum price contract with Mortenson for $227.25 million, a figure which, together with an additional amount for furniture, fixtures and equipment and an owner's contingency, amounted to the $238 million construction price.

At the same time, recognising that there was only a small window of opportunity to complete the financing deal before construction had to start, the authority opted for a financing structure that combined senior taxable and tax-exempt fixed-rate bonds insured by Assured and privately-placed fixed-rate subordinate bonds. This structure allowed the authority to lock in its interest expense during the term of the bonds and avoid potentially protracted negotiations with a banking syndicate, offering the advantage that the LAA could, if the bonds sold, close well in advance of its September construction deadline.

The senior insured bonds would carry a AAA/Aaa rating due to the Assured bond insurance, and earned an underlying rating of BBa3 from Moody's. Hilliard & Lyons, a Louisville-based stock brokerage firm, agreed to underwrite the subordinate bonds. A second preliminary official statement for the revised financing was mailed to investors on 15 August, and the bond documents were hastily revised to reflect the new financing structure.

On 26 August 2008 the arena bonds were successfully marketed by the underwriter, and on 3 September 2008, the authority, the KEDFA, Goldman Sachs, on behalf of the underwriters, and Assured closed on a $349.2 million financing for the Arena. The final financing broke down into roughly $339.3 million senior fixed-rate bonds insured by Assured and $9.9 million subordinate bonds. Hilliard & Lyons purchased all of the taxable bonds, which was key to getting the transaction closed. At closing, a substantial amount of the proceeds of the bonds were invested in a guaranteed investment contract with AIG, which had offered the authority the highest investment yield in a competitive bidding process.

Hindsight a huge benefit

While conventional wisdom is that pricing and selling bonds during the last week in August would not provide for the best possible pricing, in hindsight the authority made a good decision. Shortly afterwards several well-known financial institutions collapsed or teetered, including AIG. Since the authority had invested substantial funds with AIG, it acted quickly to request immediate repayment of those funds. The authority was successful in terminating the AIG contract and recouping the funds. It re-bid the contract, and in the end obtained a higher interest rate from US Bank than AIG had offered.

As of this writing, the markets are still not open for business nearly to the extent they were in the summer of 2008 and are only starting to show limited signs of recovery in certain sectors. Had the LAA not gone to market when it did, it might have been unable to sell its bonds at any price and would then have faced the cost of ongoing demolition and construction activity without the required funding. The authority could have employed a strategy of continuing with what funding and construction loans it could get, relying on reopening of the markets or relief in the credit crunch prior to running out of funding, but such a strategy was high risk.

On 21 November 2008, Moody's lowered Assured's rating to Aa2. However, since Moody's announcement of a possible downgrade of Assured was disclosed to investors in the offering document, and since the bonds bear interest at a fixed rate, the impact of that downgrade was effectively shifted to holders of the bonds rather than to the LAA. Construction and marketing activities at the arena have continued apace.

The above article is the edited and abridged version of the case study, which was prepared for print publication. The full-length and unedited version follows.

Louisville Arena:  Getting the Deal Done Under Adversity

Introduction

The Louisville Arena Authority ("LAA") closed on the municipal bond financing of a $238 million arena ("Arena") in downtown Louisville, Kentucky in early September 2008.  That achievement is a testament to the determination, perseverance and creativity of the parties involved with the transaction.  As this case study will show, the Arena project was shepherded through to completion by LAA leadership despite a substantial number of obstacles occurring over a multi-year period.  Although such obstacles would likely have permanently derailed other transactions, even the most adverse financial market conditions since the Great Depression could not stop the inexorable drive to complete the financing and start the construction of the Arena.

The Study Phase: Arena Task Force

Although the bonds used to finance the construction of the Arena were issued in September 2008, the saga of the development and financing of the Arena began many years before.  As this case study is primarily focused on the development and financing of the Arena, we will pick up the Arena's story in late 2005 and not fully develop the earlier portion of the multi-year conversation between the Commonwealth of Kentucky ("Commonwealth"), the government of metropolitan Louisville ("Louisville Metro"), industry leaders, the University of Louisville ("University") and other state and local government players as these parties discussed, among other things, the location, cost, purpose, etc. of an arena to be built in Louisville, Kentucky.  Such early discussions, dating as far back as 2001, involved a myriad of constituencies and political considerations.  By way of example, early proposals involved a $250 million arena to be located in downtown Louisville that could be used to host NBA games; at the time, there was some thought that the Charlotte Hornets would relocate to Louisville after Charlotte, North Carolina had declined to finance a new arena for the team.  There was concern as to the potential impact that such an arena could have on Freedom Hall, the venue at the Kentucky State Fairgrounds then (and currently) used by the University's men's basketball program; this concern remained an integral part of the Arena's story.  Other concerns arose during this early period as well.  Should a new arena be managed by the Kentucky State Fair Board ("KSFB"), a Commonwealth agency that owns and manages Freedom Hall, or by another operator?  Should a tax increment financing ("TIF") district be established to provide additional revenues?   As will be seen as the Arena story develops, these issues continued to be important years later as the development plan for the Arena was hammered out.

By April 2005, the discussions on whether to build an arena in Louisville had progressed to a stage in which the Commonwealth, the University and Louisville Metro were considering the construction of a venue for the University's basketball teams.  On April 25, 2005, Kentucky Governor Ernie Fletcher appointed an 18-member "blue ribbon" task force ("Arena Task Force") to determine where such a facility should be built and how it should be financed.  Groups that supported an arena in Louisville envisioned a facility that would serve as an economic development engine not only for Louisville Metro but also for the Commonwealth as a whole.  However, there was still disagreement over the need for such a facility, and over its location: should it be built in downtown Louisville, at the Kentucky State Fairgrounds (adjacent to Freedom Hall), or on the campus of the University?  Acknowledging the contentious nature of the site selection issue, the Governor indicated to the Arena Task Force that he hoped its members would put aside any differences and reach consensus on the issue.  The Governor also specifically charged the Arena Task Force, which was headed by Kentucky Lieutenant Governor Steve Pence and Commerce Cabinet Secretary W. James "Jim" Host,  with: (i) considering the needs of the University, (ii) remaining mindful of the needs of citizens who can only take their families to events once a year as well as those of users of luxury boxes, (iii) conducting the process in as transparent a manner as possible, and (iv) evaluating all viable sites and financing plans.  The intent was that the Governor would review the findings of the Arena Task Force and take its plan, or some version of it, to the General Assembly in January 2006.  

The issue of site selection for the proposed arena was, as mentioned above, a major source of contention among the parties involved.  The Mayor of Louisville Metro preferred a downtown location, whereas the President of the University preferred an on-campus venue.   However, each of the foregoing agreed that the location should be determined by the Arena Task Force.  Other groups in the community, however, also had strong opinions with respect to the site selection issue.  For example, the Waterfront Development Corp., which had approval rights over all project designs near the Ohio riverfront in Louisville Metro, was firmly opposed to a new arena near the riverfront; its opposition largely related to concerns that such a facility would be an impediment to bringing the public back to the riverfront, would undo "view corridors" it had worked hard to create to allow the public to see the Ohio river, and would undermine other recent efforts in the area.   Other downtown groups supported a downtown arena, citing proximity to hotels, the Kentucky International Convention Center, and ample accessible parking.  

The proposed location of the arena was not the only issue for the Task Force to address.  Another primary consideration was University revenues.  It was reported that, for the 2005-2006 season, the University generated $21.48 million from its Freedom Hall men's basketball operations,  a figure which then accounted for in excess of fifty percent of the University's athletics budget.  Thus, both opportunities for revenue enhancement and the potential adverse economic impact of a venue change were extremely important to the University.   Additionally, the University believed that the terms of its lease with the KSFB for Freedom Hall were generous to the University; thus any new arena would need to present the University with opportunities to realize greater revenues than its current arrangements in order to gain the University's support.  For example, the University wanted any new arena to contain a minimum of 60 skyboxes, a figure nearly triple the number of skyboxes in Freedom Hall. 

To help the Arena Task Force and other constituencies remain focused on what the University believed it needed in a new arena, the University's executive committee of the Big East Facilities Task Force adopted a resolution providing for a "critical list of essential needs" for such a project.  That list included, among other items, priority scheduling for the University's men's and women's basketball programs, a share of concession and catering revenue larger than that realized by the University at Freedom Hall, parking (including a specified share of parking revenue), club seating (with the revenue provided to the University), at least 60 luxury suites (with substantially all the revenue in excess of a specified amount of rent provided to the University), and certain favorable signage and sponsorship revenue provisions.   As described below, these "essential needs" formed the framework of the University's subsequent lease with the LAA for the Arena through their incorporation into the final recommendations of the Arena Task Force.

The Arena Task Force also considered how an arena should be operated, how it should be financed and other topics.  As in 2001, the KSFB was considered to be a possible operator of the facility, as it was viewed as capable and experienced at working with the scheduling requirements of the University.  However, the Arena Task Force also considered other operators.  

Staying true to the Governor's request for transparency, the Arena Task Force tried to obtain public input on relevant topics.  It scheduled public hearings and created a web site so that the public could post comments.  Also, using the private airplane of an Arena Task Force member, the Arena Task Force visited arenas in Nashville, Memphis and Indianapolis in order to study their management and financing.

On September 30, 2005, the Arena Task Force presented its report to the Governor.  The report addressed several areas relating to development of the prospective arena: governance, usage, location and financing.  From a governance perspective, the Arena Task Force recommended that the Arena be owned and governed by an independent authority rather than by the University or another governmental unit.  The Arena Task Force concluded that ownership by an independent authority would permit bonds to be issued to finance the costs of the Arena on a negotiated basis; the concern was that, if the Arena was owned by the Commonwealth or certain other political subdivisions, such bonds would need to be priced at a "competitive bid" sale, a mechanism frequently used for governmental, general obligation debt but perhaps less appropriate for a project-type financing such as that contemplated for the Arena.  The Arena Task Force also recommended that the KSFB manage the Arena, due to its experience with similar facilities and scheduling for the University, but that the KSFB should hire a consultant to assist it with pre-opening services (e.g., sponsorship, planning, relationships with professional teams, promotion, etc.).  From a usage perspective, the Arena Task Force recommended that the University's men's and women's basketball programs should be the primary users of the Arena, which should be designed to adopt all of the "essential needs" elements identified in the Big East Facilities Task Force resolution passed by the University; however, the Arena Task Force also recommended that the Arena be designed in conjunction with the NCAA and permit minor league sports activities in addition to University basketball programs.  From a location perspective, the Arena Task Force presented an analysis of the various site alternatives, and concluded that a downtown Louisville location would present the greatest spinoff alternatives for the Arena.  Finally, from a financing perspective, the Arena Task Force projected Arena construction costs of $299 million at a downtown, riverfront location but only $192 million at a Kentucky State Fairground location.  The Arena Task Force projected that a portion of these costs could be defrayed by, among other elements, $75 million of Commonwealth grant funds and, in the case of an Arena constructed at the downtown Louisville location, revenues from a one-square mile tax increment financing ("TIF") district.

Proceeding to Development and Financing

Creation of Louisville Arena Authority

In December 2005, the Governor announced the formation of the LAA.  Jim Host, one of the two heads of the Arena Task Force, was appointed as the LAA's Chair.  To make sure all interests were appropriately represented, the LAA's board was appointed at both the Commonwealth and Louisville Metro level: ten of the members were appointed by the Governor and the remaining five by the Mayor of Louisville Metro.   The LAA's mission was to implement the recommendations of the Arena Task Force in developing an Arena which would serve as the home of the University's men's and women's basketball teams but also would be available for conventions, ice shows, and other sports activities. 

Selection of riverfront site

As described above, the Arena Task Force recommended that the Arena be constructed along the Ohio River waterfront in downtown Louisville, Kentucky.  This recommendation did not, however, resolve all of the controversy regarding the Arena's location, since the various alternative sites continued to have considerable political support within both the Commonwealth and Louisville Metro.   Thus, public discourse regarding the Arena site continued.  The potential cost savings of a location other than on the Ohio River waterfront figured prominently in this discourse.  In September 2005, the Arena Task Force had projected the difference in cost between a downtown, riverfront Arena and one at the Kentucky State Fairgrounds at $107 million.  In February 2006, studies demonstrated a $114 million price differential for locating the Arena at the riverfront as opposed to other locations.   A more detailed review of these two studies revealed that, in fact, part of the difference in cost resulted from the fact that the alternate site Arena would be more modest in scope than the riverfront version.  The plans for the alternate site Arena did not include a parking garage or a then-contemplated hotel (more completely described below); the projected cost of an alternate site Arena also excluded any environmental clean up costs, whereas those costs were an important element of the additional costs of a riverfront Arena, where the first step would be the clean-up of environmentally challenged riverfront industrial property.   Thus, the dispute, while on its face based on aggregate cost and location, was in some respects a dispute about the vision for the Arena and its role in the redevelopment of the community.  Another site-related issue raised during this ongoing public discourse was the potential for flooding by the Ohio River at the riverfront site and to what extent floodwalls could be built into the design of the Arena.  

In February 2006 the University, acting through a unanimous vote of its board of trustees, indicated that it wanted the Arena to be located at the riverfront site.   The University's basketball coach, Rick Pitino, clearly also preferred a riverfront site: "U of L wants the arena 'to make a statement,' Pitino said. 'Have it on the river where everybody can see.  Certainly, we have a right as a tenant to want it to be part of something.  And the board of trustees and athletic board want it on the riverfront.  Now if its not to be, we'll stay at Freedom Hall."

In late February 2006, the proposed riverfront Arena was envisioned as containing approximately 22,000 seats, suites available for rental by supporters and others, and a public plaza along Main Street in downtown Louisville.  The total estimated cost had increased from the Arena Task Force's initial estimate of $299 million for a downtown, riverfront location to approximately $381 million, a figure which included site acquisition, demolition and relocation costs for the existing businesses located at the proposed riverfront site.   Questions also remained as to aspects of the Arena's design.  The projected $381 million cost of the Arena complex had increased so much that the projected debt service on the bonds needed to finance construction now exceeded the projected revenues from the basketball and other events projected to take place in the Arena.  Accordingly, in mid-2006 the Arena was paired with a 425-room hotel, which was anticipated to generate revenues which would assist in defraying a portion of the Arena debt service costs.  The $69 million additional cost of constructing the hotel was projected to be funded with private financing, rather than bonds of the LAA.  However, inclusion of a hotel in the overall financing added an element of additional risk in that, in order to help amortize any portion of the Arena bonds, the hotel would first need to generate enough cash flow to cover its own financing.   The hotel element also introduced risks into the overall project involving projected demand for hotel rooms in downtown Louisville and the effect of scheduled competing hotel projects on potential demand for rooms at an Arena hotel.  Concern was expressed that constructing an Arena hotel was following a "build it and they will come" strategy which, while successful in some markets, had been unsuccessful in others; the question became whether the construction of the Arena, which might fill up for sporting events and create spill-over revenues for adjacent shops and restaurants, would otherwise create sufficient demand for overnight stays at the Arena hotel.  

Additionally, the decision to incorporate a hotel into the Arena complex was not without controversy from an urban planning perspective; concern was voiced that using a portion of the site for a hotel would result in reduced open space.  Since the Arena was to be developed in the middle of downtown Louisville, various groups discussed the optimal configuration of the Arena for the general public, taking into account among other things, (i) requirements for floodgates and/or other flood mitigation measures to protect both downtown Louisville and the Arena in view of the proximity of the Ohio River, (ii) access issues due to the proximity of bridges, (iii) the extensive frontage on Main Street and (iv) the desirability of a plaza which could be used as an urban space for concerts, etc.   

Public funding commitments

Even while the site and urban planning discussions continued, the Commonwealth was considering a $75 million grant  of its funds towards Arena construction.  Although this $75 million grant level was consistent with that contemplated by the Arena Task Force report, the timing of the grant discussions coincided with public discourse regarding the additional $114 million projected cost of locating the Arena on the riverfront; thus, the cost of the Arena became a source of political discussion at the Commonwealth, as well as in the media and Louisville Metro.  In late February 2006, the University called a news conference and affirmed the University's support for a riverfront Arena.   Shortly thereafter, a committee of the Kentucky House of Representatives ("House") considered including in the Commonwealth's grant legislation wording which would require the Arena to be located at an alternate site known as the Water Company Site (its former owner being the Louisville Water Co.) , in spite of the fact that the Arena Task Force had recommended the downtown riverfront location over the Water Company Site six months before, as described above, and in spite of the preferences of the University.  This renewed discussion of the site selection issue caused a stir and a clash between legislators and the University, which asserted that cost should not be the deciding factor in the debate over the Arena.  By early March, however, the House had passed a budget bill that included a provision requiring the Arena to be located at the Water Company Site.   A budget bill passed by the Senate in late March had not imposed such a restriction on the Arena site, creating a showdown between the two versions of the budget which would need to be resolved in a Conference Committee.   While the political jousting continued, the LAA had suspended operations until a budget compromise was worked out by the Commonwealth, which would provide for the $75 million grant for the construction of the Arena.  The LAA maintained that the decision on the Arena site should be made by the LAA.  

Further complicating matters, the Governor vetoed $73 million of University construction projects during this period, apparently at least in part since it was perceived that the University would benefit from the $75 million of grant funds for the LAA for Arena construction.  This reduction in capital project funding for the University triggered angry public statements from the University, which felt strongly that it should not be penalized as a result of the Arena construction.  The Governor's action also caused the University's support for the Arena project to waver.  As University President James Ramsey indicated, "We are totally happy to play at Freedom Hall, [a]nd don't let anyone say for a minute that a new arena is U of L's arena, or a new arena is for U of L."   As the Arena had been publicly portrayed in other forums as an Arena for the University's basketball program, President Ramsey's statement was widely viewed as a setback to the Arena project.  Ultimately, the Commonwealth and the University reached an agreement with respect to the vetoed University construction projects.  An integral factor in this resolution was an agreement by the Parking Authority of River City ("PARC") to do the financing of the garage to be built under the Arena.   PARC is an instrumentality of Louisville Metro which has expertise in constructing and operating parking facilities in Louisville.

Another topic of discussion at the Commonwealth was the Arena's potential effect on Freedom Hall, the venue at which the University had played its men's basketball games in the past and would continue to do so until the opening of the Arena.  To cement the KSFB's involvement in the Arena project, the Commonwealth stipulated as part of its grant enabling legislation that the KSFB would manage the Arena,  with complete day-to-day control over its operations, an appointment consistent with the Arena Task Force's recommendations.  Further, in response to concerns that the transfer of the University basketball program from Freedom Hall to the new Arena would impact the KSFB's revenues, the Commonwealth's grant legislation also provided that, during the term of the bonds the Commonwealth would issue to finance the grant, the KSFB would be reimbursed for any net negative impact on its operations resulting from such transfer.

The grant legislation was passed by the Commonwealth in April, 2006.  Not surprisingly in light of the ongoing controversy and dialogue while the grant legislation was being considered, the Commonwealth incorporated conditions to the grant in its legislation.    First, the Commonwealth specified that the University would have scheduling priority in the Arena.  The Commonwealth also specified that the recommendations of the Arena Task Force be followed.  As discussed above, those recommendations included the list of "critical needs" adopted by the University in 2005.   The legislation further specified that the release of grant funds was contingent on the LAA obtaining a funding commitment from Louisville Metro.   Finally, the legislation imposed on the LAA various measures designed to foster openness.  Thus, following passage of the grant enabling legislation, the LAA started to hold public meetings, subjected itself to open-records laws and started to send out requests for proposals (i.e., competitive procurement) as if it were a government agency.   Significantly, the grant legislation as enacted by the Commonwealth was silent with respect to the site for the Arena.

Thus, while the Commonwealth's grant funding legislation put in place a key component of the overall financial plan for the Arena, it also imposed additional requirements on the LAA and the Arena.  First, the Commonwealth made its funding contingent on Louisville Metro fulfilling a role with respect to financial support for the Arena.  Second, the Commonwealth protected the KSFB and Freedom Hall.  Third, the Commonwealth confirmed the role of the University as the prime tenant of the Arena.  Finally, by more clearly subjecting the LAA to "sunshine laws" (a direct opposition to the findings of the Arena Task Force on the advantages of an independent authority like the LAA), the Commonwealth indirectly set the stage for other stumbling blocks to be overcome by the LAA.

As described above, the Commonwealth made release of its grant funds contingent on a funding commitment from Louisville Metro.  The Mayor of Louisville Metro approached Chairman Host to discuss possible structures for Louisville Metro's funding commitment.  By the summer of 2006, these conversations had progressed to include members of the Louisville Metro Council ("Council") in addition to the Mayor's office and Chairman Host.    The group designed a funding plan for the LAA which would provide the LAA with financial support for an Arena bond financing and investment grade bond rating, but also a potential benefit to Louisville Metro.  Since Louisville Metro's credit ratings were AA and Aa by Standard & Poor's and Moody's, respectively, the group recognized that if properly structured, the funding commitment from Louisville Metro could be used to enhance the credit rating of the Arena project.  Specifically, a solid guaranteed commitment to the LAA from Louisville Metro would place the LAA's bonds on a more solid footing.  As a result, Chairman Host and Louisville officials developed a funding plan that committed Louisville Metro to provide guaranteed minimum support of $206 million over a 30-year period for the Arena.   An enhanced scope of the TIF district (further described below), together with the guaranteed Louisville Metro financial support, would provide the LAA greater revenues to establish an investment grade bond rating.  In addition, an agreement to share surplus Arena revenues between the LAA and Louisville Metro on a 55%/45% basis  would reduce the anticipated long term net impact of the Arena on Louisville Metro.

The financial terms of the agreed Louisville Metro funding plan also required, however, approval from the Council.  As the group moved to get Council approval, other forces managed to include into the agreement provisions relating to a "project labor agreement".  Many parties felt that these provisions, which required a "project labor agreement" with organized labor, created an "unfunded mandate" that would increase construction costs for the Arena.  Among other things, these provisions required with respect to Arena construction: (i) the payment of "prevailing wages," (ii) a goal of 20% minority participation, (iii) 5% female participation and (iv) that Kentucky and Southern Indiana residents get 75% of the Arena construction jobs, with at least 60% coming from the 15-county Louisville area.  Additionally, these provisions, which effectively granted union bargaining rights on the LAA's construction contracts, were inconsistent with the competitive procurement mandates included in the Commonwealth's grant enabling legislation.  In July 2006, Chairman Host cancelled the LAA's next meeting pending resolution of this issue.   While legal opinions were sought from the Jefferson County Attorney  and Kentucky's Attorney General  on the legalities of the issue, the operations of the LAA were placed on hold "given the 'precarious nature of funding'".   Louisville Metro Mayor Jerry Abramson vetoed  the measure, the first veto of his office, and worked with the Governor, Chairman Host and other business leaders to develop an alternative.  The resulting alternative called for something short of the full "project labor agreement": provisions, guaranteeing: (i) use of prevailing wages for each trade, (ii) goals for minority and female participation and (iii) goals of having at least 75% of the LAA construction jobs come from Kentucky and Southern Indiana residents and 60% of them from the Louisville Metropolitan Statistical Area,  as well as a mechanism to monitor how the labor goals were being satisfied.   As part of the ultimate resolution of the issue, Louisville Metro and the LAA entered into a Memorandum of Understanding  which set out, among other things, the Council's understanding of how the LAA would operate and the LAA's commitments to the various employment targets noted above.  The Memorandum of Understanding further provided that Louisville Metro's payment schedule for its Arena financial support would consist of thirty annual payments and that Louisville Metro could pay as little as $6.5 million in some years with, in each year, a specified minimum annual payment.  Ratification of the Memorandum of Understanding by the Louisville Metro Council on July 25, 2006 reactivated the LAA, which resumed its planning on the Arena. 

Thus by the end of July 2006, Commonwealth grant funding had been approved and a Memorandum of Understanding had been reached with Louisville Metro regarding its funding commitment for the Arena.  However, the balance of the Arena's cost was still too high to be debt funded without the completion of another element of the Arena Task Force's funding plan.  The Arena Task Force had advised that a TIF financing district in downtown Louisville could be used to raise additional funds for a downtown Louisville Arena.  The original Arena Task Force financing plan contemplated using revenues from a one-square mile TIF financing district to support the LAA's bonds.   However, this proposed one-square mile TIF financing district ("TIF District") was extended by the Commonwealth to encompass an approximately 6-square mile area including the projected Arena site, Louisville's central business district, and adjacent business and development areas.   However, a number of parcels were excluded from the boundaries of the TIF District so that Louisville Metro could provide development incentives to other projects with respect to such parcels.   Thus, for example, the parcels comprising the Museum Plaza and Fourth Street Live projects were excluded from the TIF District.   Once the LAA, the Commonwealth and Louisville Metro had agreed on its final parameters, the TIF District was established via an ordinance of Louisville Metro on December 7, 2006.  The TIF District pledged as credit support for its Arena financing certain anticipated incremental sales and property taxes from the TIF District, as its limits were drawn;  2005 sales and property taxes were set as the baseline for determining the amount of such incremental taxes.   The revenue stream from these incremental taxes was projected to be sufficient to permit deletion of the projected hotel revenues (and associated construction costs) from the Arena project financing scheme.  As a result, in late May 2007 the LAA decided to remove the hotel from the Arena project.   The Arena design would be reconstituted to provide for more public access and a larger public plaza.  However, other details relating to the financing remained to be finalized.

Moving to project documentation

As described above, the Commonwealth's grant enabling legislation had imposed on the LAA an obligation to have the KSFB manage the Arena and had also included provisions designed to protect the KSFB from certain financial losses at Freedom Hall.  As a result, the LAA started negotiating a management contract for the Arena with the KSFB, as recommended by the Arena Task Force.  The resulting management contract provided for the KSFB to be compensated by the LAA for losses in its Freedom Hall operations as a result of the loss of the University basketball program.  The LAA agreed to set aside $750,000 a year in each of its fiscal years ending December 31, 2011 through 2013 for this purpose.  

Shortly after the Commonwealth's adoption of the grant enabling legislation, the LAA met and formally selected the riverfront site for the Arena.  However, the LAA then had to obtain the desired riverfront property, which was already occupied and was being used for other commercial and industrial purposes.   Thus, starting in late summer 2006, the LAA negotiated site acquisition agreements with Humana Inc.  ("Humana") and Louisville Gas & Electric Co. ("LG&E").  The Humana site purchase agreement required Humana to relocate approximately 750 employees from its offices and required the LAA to pay approximately $11 million for the land and up to $2.8 million of relocation costs.   By the time of the closing on the Humana parcel in late December 2007, the LAA and Humana had agreed to a $3 million cap on Humana's relocation expenses,  in addition to which Humana would receive certain "in kind" opportunities and services, including rent-free use of a hospitality suite at the Arena for twenty years and certain branding or signage rights.   The purchase of the LG&E site also involved various complexities.  In order to transfer the property to the LAA, LG&E would need to abandon and relocate certain natural gas-fired electric generator units and transmission facilities located on the site, including two electrical substations.   Ultimately, the LAA agreed to pay $63 million of these relocation costs, in addition to the $10 million acquisition price for the LG&E site.   Further, as LG&E was a regulated utility, the sale of its property was subject to approval by the Kentucky Public Service Commission.   The logistics of the relocation of LG&E's facilities, which would have to be conducted in a manner that did not interrupt service to its customers, also required the LAA to negotiate special access agreements to permit the LAA to have access to the site during the relocation process.  The industrial nature of LG&E's facilities also required environmental diligence and potential remediation activities.  Thus, between the site acquisition costs and relocation and/or environmental costs payable to LG&E and Humana, the LAA's site acquisition costs totaled approximately $88.2 million, net of the "in kind" services provided to Humana.

During the same period in which the location of the Arena was selected, the management contract with the KSFB and the site acquisition agreements were negotiated and the final elements of governmental funding were lined up, the LAA and the University of Louisville Athletic Association, Inc. ("ULAA"), the affiliate of the University which operates its athletics programs and the intended primary tenant of the Arena, were negotiating lease terms for the Arena.  The lease agreement was drafted to include details on ticket prices, advertising and sponsorship revenues, the use of and revenues from suites, and the allocation of parking spaces in the garage to be built under the Arena.  By way of comparison, in 2006 ULAA marketed all 24 of the Freedom Hall suites and paid a fixed rent amount to the KSFB as owner of Freedom Hall.  In 2006, ULAA reportedly collected $1.6 million in suite revenue and paid $285,000 in rent for the Freedom Hall suites.   In August 2006, it was projected that the new Arena would provide the ULAA with at least $2.5 million more revenue per year than Freedom Hall, due in part to the Arena's projected increase in luxury suites over the number of available suites at Freedom Hall. 

The LAA's lease arrangement with ULAA provided for the use of the Arena for the University's men's and women's basketball programs starting in the 2010-2011 season.  The University, though ULAA, was granted a say in how the Arena would be built as well as the right to approve all colors, banners and logos inside the Arena,  it being specified that the Arena would be designed with "U of L branding".  ULAA also obtained the right to market the luxury suites and other premium seating at the Arena, paying 12% of the revenue from such areas as rent.  Of course, while the University, through ULAA, stood to earn substantial additional revenues from the Arena's 71 luxury suites and other premium seating, such incremental revenue would only be realized if ULAA proved successful in marketing such seating.  Other Arena perquisites covered by the ULAA lease agreement included a practice court/staging area, three corner party suites (one of the Arena's four party suites being reserved for the use of the LAA) and separate locker facilities for men and women.  The lease agreement also provided that the University, through ULAA, would share in revenue from merchandise sales, and would receive a greater share of catering and concessions sales during University events than it had received under its lease at Freedom Hall.  However, the University would lose some $220,000 in annual parking revenue under its Arena lease, as it would have to pay for spaces at adjacent lots at or under the new Arena.

Through all of the above, the selection of construction contractors and other key players and the Arena design process, an iterative process which utilized value engineering to sculpt an Arena that would work with available funding as described below, continued.  In late July 2006, the LAA hired PC Sports, a San Antonio sports consulting company, to oversee the design and construction of the Arena, including representing the LAA in connection with construction contract negotiations.   In January 2007, HOK Sport was selected to design the Arena  and M.A. Mortenson Company ("Mortenson") was selected to build the Arena.   The LAA, on the advice of PC Sports, elected to use a construction manager at-risk contract, a type of contract that would shift certain escalation costs of construction to Mortenson.   As of September 18, 2007, Mortenson estimated that Arena construction would cost approximately $254 million, including contingency funds.   The LAA, PC Sports, HOK Sport and Mortenson devoted a considerable amount of time and energy over a number of months to revising design plans, value engineering and correcting contingency amounts to reduce the cost of various Arena elements, a process which, as described below, was ultimately successful in bringing the cost of the Arena construction down to $238 million.

As sponsorship and similar revenues are an important component of the total revenues of sports venues such as the Arena, in 2006 the LAA began the process of identifying a naming rights sponsor for the Arena.  In February 2007  the LAA determined to proceed with the overall financing of the Arena without a naming rights deal in place and, at the same time, to hire a third party to act on its behalf in coordinating advertising, sponsorship and naming opportunities.   In late February 2007, the LAA selected Learfield Sports and Team Services ("Learfield") to pursue advertising, sponsorships and naming rights opportunities for the Arena on its behalf.  The contract provided for a guaranteed minimum payment from the LAA to Learfield of $15 million over its seven year term.   This guaranteed minimum structure helped support the LAA's projected cash flow, thereby enhancing its underlying bond ratings.

Lining up bond financing for the balance of the construction cost

By early 2007, the LAA was also working seriously on finalizing the Arena's financing scheme by arranging for bond financing to cover all Arena acquisition, demolition, and relocation costs that were not already covered by the Commonwealth grant, Louisville Metro funding or TIF District revenues.  The LAA selected Goldman Sachs & Co. ("Goldman") to act as underwriter for the proposed bonds, which were to be issued on behalf of the LAA by the Kentucky Development Finance Authority ("KEDFA").  At the time of Goldman's appointment, the total projected cost of the Arena was $252 million and the total projected principal amount of the bond financing, including interest during construction, transaction costs and reserves but net of costs to be funded by Commonwealth grant or other sources, was $339.3 million.

During the late spring of 2007, concerns were raised that a portion of Louisville Metro's financial commitment to the Arena, as approved in July 2006, would be used to pay Arena operating expenses (i.e., not just paying debt service or construction costs).  Chairman Host of the LAA, Mayor Jerry Abramson of Louisville Metro and Jim King, the majority Leader of the Democratic Caucus, met to discuss the situation in late April.  This group developed ideas to modify the flow of funds securing the KEDFA bonds to ensure that Louisville Metro funds would not be used for operating expenses.   Resolution of this issue took months of negotiation between the LAA, the Louisville Metro Council and the Mayor's office.  In the end, the Louisville Metro Council enacted an ordinance revising its 2006 funding commitments such that the LAA could only request funds from Louisville Metro in excess of specified minimum payments after other revenue sources, including naming rights revenues, sponsorship revenues and TIF revenues, had been exhausted.   This compromise solution provided for guaranteed minimum payment levels from Louisville Metro totaling $206 million over a 30 year period ending in 2039, but, if needed from a cash flow perspective, up to $309 million over that period.   To accommodate Louisville Metro's concerns that its funds be applied to debt service as opposed to operating expenses and that the LAA adjust the amounts requested for other operating revenues, the LAA developed a complex flow of funds to both timely measure and request the appropriate level of funding and also to appropriately apply Louisville Metro's funds.  The final ordinance also permitted the Louisville Metro Council to ask for an audit of Arena revenues and spending in the event that Louisville Metro became obligated to provide funds to the LAA in excess of the specified minimum payment levels for two consecutive years.  

Drafting and review of documents, including financing and disclosure documents, the lease with ULAA on behalf of the University, the management contract with the KSFB, and contracts providing for sponsorship opportunities and provision of concessions at the Arena, was underway.  With respect to concessions, Service America Corporation d/b/a Centerplate ("Centerplate") was selected as concessionaire and, under the leadership of the LAA, an innovative contract structure was negotiated.  In addition to an upfront $7.5 million loan from Centerplate to the LAA which could be used for concession area expenses, Centerplate also agreed to pay the LAA annual commissions based on a percentage of sales, with an annual minimum payment of $2.5 million, payable upfront.   The $7.5 million loan was structured so that its principal was forgiven by Centerplate pro rata over a fifteen-year period, with any remaining repayment obligations of the LAA being subordinated to the bonds.  The structure of this contract, which included both (i) an upfront loan, alleviating the LAA's need to include concession area capital expenditures as part of its bond issue, and (ii) guaranteed minimum annual commissions, provided additional support to the LAA's projected cash flow, thereby enhancing its underlying bond ratings.  KEDFA, the bond issuer, started to set in place the approvals requisite for the issuance of the bonds.

As things progressed, Goldman solicited interest from monoline bond insurers for the Arena bonds.  At the time, financial guaranty bond insurance policies served to raise the credit ratings of the subject bonds and thereby substantially reduce the interest expense paid on such bonds by guaranteeing the payment of principal and interest to bondholders.  In this case, a financial guaranty insurance policy would raise the credit rating of the Arena bonds from the rating of the Arena project to AAA/Aaa by Standard & Poor's and Moody's respectively.  In late summer, 2007, Ambac Assurance Corporation ("Ambac") was selected as the bond insurer for the transaction; Ambac retained DLA Piper LLP (US) ("DLA Piper") as its counsel.

The now fully composed finance team spent the fall of 2007 reviewing and finalizing bond documents; construction contracts; contracts for concessions; contracts for sponsorship, advertising and naming rights; and the ULAA lease.  DLA Piper noted during this process that, while PARC had been identified as the owner and financing provider for the parking garage to be constructed under the Arena, there were no commitments in place from PARC to provide funding or to coordinate the construction and design of the garage.  Thus, a key element of the overall financing package for the Arena still needed to be developed.  The team engaged in conversations with PARC and developed documentation that provided comfort that the funds would be available to PARC in the right amounts and at the right time to permit the Arena construction and the financing process to proceed as scheduled.

One of the key considerations during what, at the time, was believed to be the "homerun stretch" of the Arena financing was that the maximum amount of bonds which had been approved by KEDFA was $350 million.  Thus, the entire financing team was forced to make sure that the principal amount of the bonds (including debt service reserves, contingencies, interest during construction and other needed costs) did not exceed this limitation.  Another key consideration during this period was determining which Arena costs could not be financed with tax-exempt bonds due to potential "private use" (e.g., resulting from naming rights or other sponsorship opportunities, leases of space for concessions, etc).  This analysis, which was continuously updated until completion of the financing, required a portion of the bonds to be issued on a taxable basis to fund costs allocable to the excess "private use" areas.  In the end, this analysis required $30 million of bonds to be issued on a taxable basis.

Hitting bumps in the financing road

Revisions to local commitments

As described above, Louisville Metro had established the TIF District to support the Arena bonds in December, 2006.  However, actions in December 2007 by the Kentucky Tax Increment Financing Commission (the "TIF Commission") complicated the proposed Arena financing.  On December 7, 2007, the TIF Commission unanimously accepted an application for a special taxing district for an urban development project in downtown Louisville called the Center City Project.  The TIF district established to support the Center City Project included a one block overlay with the TIF district created to support the Arena financing.  Chairman Host, on behalf of the LAA, sent a letter to the TIF Commission offering to swap that block for another one.  The purpose of this proposal was to eliminate the overlap between the two TIF districts, thereby resulting in stronger revenue flows for both projects.   Final approval for the new Center City Project TIF district was given on December 27, 2007.   As a result, in May 2008, Louisville Metro clarified the scope of the TIF District by amending it to exclude, in addition to the Center City Project, certain other existing development projects within the area.

Financing caught in impact of "subprime" credit crunch

The Arena financing process and the drafting of related project documents continued to move along well until the "subprime" credit crunch hit in late 2007; the credit crunch had a swift and negative effect on Ambac, the bond insurer for the Arena bonds.  On December 20, 2007, Ambac announced that Fitch Ratings ("Fitch") had, while upholding Ambac's AAA rating, placed Ambac's rating on "rating watch negative."  On January 16, 2008, Moody's Investors Service ("Moody's") announced that it had placed Ambac's Aaa financial strength rating on review for a possible downgrade.  These announcements were amplified by roughly contemporaneous announcements by these and other rating agencies about credit watches and/or rating downgrades for other monoline bond insurers. The entire municipal marketplace became focused on bond insurance, the likelihood of a downgrade and, for perhaps the first time in the history of the industry, credit risks relating thereto. 

As a result of these market uncertainties, the Arena finance team began several months of review and consideration of various alternative financing structures, taking advantage of recently received tentative ratings on the underlying cash flows of the Arena (i.e., ignoring any credit enhancement) from two rating agencies of BBB-.   The team considered a financing structure involving senior and subordinate fixed rate bonds, the senior bonds having bond insurance.   Also, while the original plan was for the bonds to be fixed rate insured bonds, the team also explored structures involving variable rate bonds secured by a letter of credit, including one featuring a letter of credit provided by a consortium of banks.   The LAA sought additional financial advice as well, hiring PNC Capital Markets LLC as an adviser on the bond deal, to permit the "officials 'to have another set of eyes, to make absolutely certain that when we get ready to make the decision that it will be the right one.'"   The LAA also entered into conversations with, among others, Assured Guaranty Corp. ("Assured"), a bond insurer which had then retained its AAA ratings.

While this rethinking of the proposed financing structure was going on, progress also continued on the construction side of the Arena project.  In February 2008, Mortenson announced as a favorable development that the projected cost of the Arena had been reduced to $249 million, a decrease from the prior estimate of $254 million; the final price would not be determined until summer, however.   Additionally, challenges were made by disgruntled bidders to a contract award.  Whereas the first challenge would be resolved quickly in the LAA's favor based on a finding that it was not timely,  the second challenge, filed in late February, was lodged with Kentucky's Finance and Administration Cabinet.   In late May 2008, the LAA was directed by a Commonwealth ruling to cancel that contract.  As a result, the LAA had to resolicit bids for the job in question.   The additional administrative time that the LAA had to spend to address these challenges, including the bid resolicitation, were stumbling blocks for the LAA, but ultimately the LAA prevailed in these various procurement challenges.  Ironically, these challenges were indirectly an offshoot of the conditions imposed in the Commonwealth grant enabling legislation which imposed on the LAA certain procurement and competitive bidding requirements, as described above.

Restructured financing plan developed

In early May 2008, the LAA settled upon a revised financing plan.  This revised plan involved replacing Ambac.  Accordingly, the LAA engaged Assured as the new bond insurer for the bonds.  Assured engaged DLA Piper, formerly Ambac's counsel, as Assured's counsel, as DLA Piper's familiarity with the transaction and the documents would allow the transaction to move swiftly to completion. 

The structure of the financing had also changed in the revised financing plan.  The then-current plan contemplated approximately $280 million  of variable rate bonds (a substantial increase from the $100 million of variable rate bonds reported as being considered in April ).  Since, typically, variable rate bonds have lower interest expense than fixed rate bonds, the restructuring reflected the LAA's efforts to reduce debt service on the Arena bonds.  To provide liquidity for investors, the proposed variable rate bonds would be secured by a standby bond purchase agreement entered into by the LAA and PNC Bank ("PNC"),  as lead bank leading a syndicate of ten banks, as well as a bond insurance policy provided by Assured.  This standby bond purchase agreement was intended to provide liquidity for investors by permitting them to tender their bonds to PNC to promote marketability.   The PNC liquidity facility was designed to assure market confidence in the bonds but permit the LAA to capture the benefit of lower-interest variable rate bonds.  The balance of the bonds would be fixed rate bond-insured bonds, some tax-exempt and some taxable.  The revised financing plan also contemplated that the LAA would enter into interest rate swap agreements to hedge its interest rate exposure on the variable rate bonds.  As of April 1, 2008, based on the then-projected Arena construction cost of $249 million, debt service was projected to total $646 million over the 30 year term of the bonds, compared with the $665 million that was projected earlier in the year, a reduction of approximately $19 million due to the proposed variable rate structure for the bonds.  This projected debt service cost also compared favorably to the projected debt service cost in excess of $700 million under a fixed rate structure of Ambac-insured bonds.  The LAA recognized that it did bear some risk of increased debt service if there was a rating downgrade of Assured, as had happened with other bond insurers, since the variable rate bonds would likely trade at higher interest rates as a result of such a downgrade or, under a worst case scenario, could result in termination of the liquidity facility supporting the variable rate bonds.  

The new financing plan required revisions and additions to financing documents to deal with elements that were not contemplated in January 2008.  For example, the proposed interest rate swaps needed to be secured and incorporated in waterfalls in the bond documents, including the carefully negotiated provisions relating to the permitted application of the Louisville Metro funds.  Furthermore, variable rate bonds pay interest monthly rather than semiannually as had previously been contemplated, so additional changes were made to reflect the revised payment timing.  Security and remedies also needed to be provided for PNC.  Finally, the terms of the standby bond purchase agreement and interest rate swap agreements themselves needed to be negotiated.  Many of these structural modifications would entail revisions to substantial portions of the bond documents.  At the same time, the LAA was finalizing various open items relating to the Arena contracts, the lease with ULAA and other items.

Another bump in the financing road

By June 30, 2008, the financing documents had fallen into place and a Preliminary Official Statement, the disclosure document for the proposed bond issue, was mailed to investors.  July 23, 2008 was the planned closing date for the bonds.  By July 11, approximately $78.5 million of fixed rate bonds insured by Assured had been sold and, since the financing plan contemplated that all the bonds would close on the same day, the $280 million of variable rate demand bonds was scheduled to be sold on July 22 with a July 23 closing date.  The LAA entered into trades for the interest rate swaps on the bonds, the trades also having a delayed July 23 commencement date.  However, as the executed documents were placed in the closing room and participants traveled to Louisville to attend the preclosing, on the evening of July 21 Moody's announced that it was reviewing Assured's Aaa financial strength rating for a possible downgrade.  As a result the LAA, on the advice of Goldman, decided to postpone the sale of the variable rate bonds and did not close on the fixed rate bonds.  At that time, the LAA contemplated that the delay would be for one week, giving time for the markets to adjust to the announcement and digest Assured's response.

The Moody's announcement regarding Assured was interesting in that, while it focused in part on Assured's business, it also discussed viability and market demand for the financial guarantor business generally.  Moody's concluded its rating announcement as follows: 

"Moody's said that it will review the characteristics of Assured's portfolio, particularly within the structured segment, that could make the company susceptible to material losses as seen in the mortgage market. Moody's will also evaluate the company's business and franchise sensitivity to an erosion of market confidence, including any impact on financial flexibility. In addition, Moody's review will consider the likely strategic direction of the firm given the changing dynamics within the industry, as well as the potential implications of any future regulatory changes to the credit profile of the group." 

Concurrently with the Assured rating announcement, Moody's made a similar announcement with respect to FSA, the only other major bond insurance company remaining with Aaa ratings.  Thus, the action by Moody's was to a great extent market related, rather than a reflection on Assured in particular.

Although the LAA had contemplated closing on the bonds as planned after a week's delay, when that time came the LAA was again in meetings with Goldman to discuss its options for the Arena financing.  It was reported that the LAA discussed four alternatives.  One alternative involved the use of an increased amount of variable rate bonds secured by bank commitments; these bank facilities would provide default and liquidity support, thereby helping shelter investors from their concern as to Assured's financial condition.   This bank syndicate, again led by PNC, included a total of six banks.  Other alternatives apparently included a short-term construction loan,  which would have permitted the Arena construction to start on time in late September.   As the LAA weighed its various options, it had only two months of "wiggle room" to start construction in time to permit the opening of the Arena for the 2010 University basketball season.   The LAA decided to unwind its interest rate swaps at this time, receiving a termination payment in the amount of approximately $525,000.

In the meantime, while the financing plan was again being restructured, the LAA continued to focus on the construction aspects of the Arena project.  On August 12, 2008, demolition began on the LG&E site.   Further, as the disturbances in the financial markets increased the likely debt service to finance the Arena, reducing the cost of the Arena as much as possible became of paramount importance during this time.  Accordingly, as a result of negotiations between the LAA and Mortenson and design engineering efforts, agreement was reached on a further reduction of construction costs for the Arena. On August 28, the LAA announced that the construction cost of the Arena would be only $238 million,  reducing the total cost to $351.3 million; $263.1 for design, construction and administrative costs and $88.2 million of acquisition and relocation expense for the former Humana and LG&E properties.  Much of this latter cost had been funded with the $75 million grant from the Commonwealth.  These figures also did not include the projected $33.5 million, 760-space garage to be paid for and operated by PARC.   The LAA stated publicly that it had held off on LAA meetings, and presumably financing plans, after the "busted closing" to give Mortenson time to finalize the maximum price.   Ultimately, the LAA executed a guaranteed maximum price contract with Mortenson for $227.25 million, a figure which, together with an additional amount for furniture, fixtures and equipment and an owner's contingency, totaled the $238 million construction price.

 At the same time, recognizing that there was only a small window of opportunity to complete the financing deal prior to the start of construction on the Arena, the LAA opted for a financing structure involving (i) senior taxable and tax-exempt fixed rate bonds insured by Assured and (ii) privately-placed fixed-rate subordinate bonds.  This all fixed-rate structure permitted the LAA to lock in its interest expense during the term of the bonds and to avoid potentially protracted negotiations with a banking syndicate, offering the advantage that the LAA could, if the bonds sold, close well in advance of its September construction deadline.  The senior insured bonds would carry a AAA rating due to the Assured bond insurance, but they earned an underlying rating of BBa3 from Moody's.   A key element to the realization of this revised structure was the agreement of J.J.B. Hilliard, W.L. Lyons, LLC (Hilliard & Lyons), a Louisville-based stock brokerage firm, to underwrite the subordinate bonds.   A second Preliminary Official Statement for this revised financing was mailed to investors on August 15, 2008, and the bond documents were hastily revised to reflect the new financing structure. 

 On August 26, 2008 the Arena bonds were successfully marketed by the underwriting team.  On September 3, 2008, the LAA, KEDFA, Goldman, on behalf of the underwriters, and Assured closed on a $349.2 million financing for the Arena.  The final financing was composed of approximately $339.3 million senior fixed rate bonds insured by Assured and $9.9 million subordinate bonds.  Hilliard & Lyons purchased all of the taxable bonds, which was key to getting the transaction closed.   At closing, a substantial amount of the proceeds of the bonds were invested in a guaranteed investment contract with AIG, which had offered the LAA the highest investment yield in a competitive bidding process.

Post-closing

 After the long and complicated path described above, did the Arena project end up as a financial success story?  What happened in the aftermath of the Arena bond sale?  While conventional wisdom is that pricing and selling bonds during the last week in August would not provide for the best possible pricing, in hindsight the LAA made a wonderful decision.  On September 7, 2008, Fannie Mae and Freddie Mac were bailed out by the United States government; on September 14 Merrill Lynch was purchased by Bank of America in a "shot gun wedding"; on September 15 Lehman Brothers filed for bankruptcy; and on September 15 AIG's credit ratings were downgraded and it was bailed out by the Federal Reserve Bank of New York.  Since the LAA had invested substantial funds with AIG, the LAA acted quickly to request immediate repayment of those funds.  The LAA was successful in terminating the investment transaction and recouping the funds actions, whereupon it rebid the transaction, obtaining in the end a higher interest rate from US Bank than the original rate on the AIG investment.  

 The rest of the market was not so lucky, however.  The downgrades, the Lehman bankruptcy and the bailouts, coupled with investor anxiety with respect to the safety of their mutual funds and a much-publicized request from Arnold Schwarzenegger, the Governor of the State of California, for "bailout" funds for his State, caused a considerable disturbance in the municipal markets that effectively shut them down for most transactions until late October.  As of the April 2009 date of this case study, the markets are still not "open" for business nearly to the extent they were in the summer of 2008 and are only starting to show limited signs of recovery in certain sectors.  Had the LAA not gone to market when it did, it might have been unable to sell its bonds at any price and would then have faced the difficult situation of ongoing demolition and construction activity but an inability to obtain the balance of the required funding.  While the LAA would have had options such as a construction loan in such a circumstance, the magnitude of the required funding and the particularities of public-private funding schema developed for the Arena might have made getting such a loan difficult or impossible in the midst of the credit crunch.  Of course, the LAA could have employed a strategy of continuing with what funding and construction loans it could get, relying on reopening of the markets or relief in the credit crunch prior to running out of funding, but such a strategy was high risk.

 On November 21, 2008, Moody's lowered Assured's rating to Aa2.  However, since Moody's announcement of a possible downgrade of Assured was disclosed to investors in the offering document, and since the bonds bear interest at a fixed rate, the impact of that downgrade was effectively shifted to holders of the bonds rather than to the LAA (i.e., if the change in the rating affected the yield on the bonds, it would affect the market value of the holders' bonds but would not result in any increased debt service expense to the LAA).

 On the project side, construction is continuing.  The final guaranteed maximum price for the PARC garage ended up at just short of $32 million, a figure under original estimates.  Louisville Metro is proceeding with the issuance of the PARC bonds to fund the construction of the parking garage under the Arena.   On February 12, 2009, the Council approved the issuance of up to $39,000,000 in bonds by PARC to fund the Arena garage.   The PARC bonds were sold on February 24 and closed on March 4.  Bid protests have continued.   Unexpected construction costs totaling $4.8 million have arisen – in the form of long-forgotten brick building foundations, utility lines and railroad ties and trestles, all dating back to the 1800s – but the LAA has had adequate contingency funds to address the costs.  

 On the marketing front, concern has been voiced over the national economic downturn and its impact on potential subscribers for luxury suites at the Arena and on the pricing of any naming rights agreement for the Arena.  Perhaps these economic conditions will be a test for the University as to whether its fans are truly "die hard."  Unfortunately, the LAA and the University will have substantial company as other sports venues adjust to the economic times.   However, on March 2, 2009 the LAA announced its first Cornerstone Partner for the Arena, having agreed to a 10-year, $10 million partnership with Norton Healthcare ("Norton").  The arrangement includes operation by Norton of two Norton-branded first aid stations in the Arena for all University and other events as well an immediate care center open to the public year round via an exterior entrance at the front of the Arena.   On February 6, 2009, it was announced that the new Arena would host the NCAA® womens' final four volleyball championships in 2012, an announcement viewed as showing the strength of the new facility.  In making the announcement, Chairman Host said that he knows, "of no other time the NCAA has awarded a championship to an arena that is still a hole in the ground."   Additionally, the University mens' basketball team reached the Men's Elite Eight® in the NCAA® tournament, confirming its ability to fill the Arena seats; however, the success of the University womens' basketball program, which reached the Women's Final Four® in its NCAA® tournament, portends stronger than anticipated Arena revenues derived from increased interest in that program.  Maybe the Arena's luck has turned for good.