DEBT DILEMMA

City Cen­ter not wor­ried af­ter bond rat­ings down­graded

The Morning Call - - FRONT PAGE - By An­drew Waga­man

Al­len­town’s Neigh­bor­hood Im­prove­ment Zone is grow­ing quicker than pro­jected, but it’s un­com­fort­ably re­liant on a few par­tic­u­lar busi­nesses to pay off the con­sid­er­able debt lever­aged to fuel down­town devel­op­ment, ac­cord­ing to Moody’s In­vestors Ser­vice.

Con­cerned for bond­hold­ers if any­thing should hap­pen to those busi­nesses, Moody’s down­graded its rat­ings of two Al­len­town Neigh­bor­hood Im­prove­ment Zone Devel­op­ment Author­ity pub­lic rev­enue bonds by two rungs in De­cem­ber. The new rat­ing of Ba3, a non­in­vest­ment grade that is still on the safer end of the sub­prime spec­trum, in­di­cates the debt has spec­u­la­tive el­e­ments “sub­ject to sub­stan­tial credit risk.”

The down­grade on 2017 bonds worth $210 mil­lion and May 2018 bonds worth $100 mil­lion re­flects Moody’s ap­pre­hen­sion with City Cen­ter In­vest­ment Corp.’s de­ci­sion to take on an ad­di­tional $148 mil­lion in debt through an­other ANIZDA bond sale in late De­cem­ber.

Although ANIZDA sold the 2017 and 2018 bonds, it was City Cen­ter, the spe­cial tax­ing district’s largest de­vel­oper, that in­curred the debt to re­pay con­struc­tion loans used to build

the Re­nais­sance Hotel and ini­tial of­fice and apart­ment build­ings down­town, as well as to fi­nance more re­cent projects.

Sim­i­larly, the $148 mil­lion in sub­or­di­nated bonds ANIZDA sold last month will pri­mar­ily fund devel­op­ment of the Five City Cen­ter com­plex. That plan in­cludes the 297,000-square­foot of­fice tower at Eighth and Hamil­ton streets that should be open by year's end, a 268,000square-foot apart­ment com­plex with 230 units, a 131,000square-foot apart­ment com­plex with 118 units, and two park­ing garages.

The three buck­ets of debt are se­cured and will be paid off with tax rev­enues gen­er­ated solely by City Cen­ter and its ten­ants. That's a more con­cen­trated tax base than the NIZwide one ser­vic­ing the $224 mil­lion in bonds the author­ity sold in 2012 to build PPL Cen­ter.

The NIZ has spurred nearly a bil­lion dol­lars in new and planned devel­op­ment down­town by al­low­ing most of the state taxes gen­er­ated in the zone — in­clud­ing those on in­come, sales and use, malt bev­er­age and liquor, and cig­a­rettes — to go to­ward con­struc­tion debt. These taxes, which make up the ma­jor­ity of the zone's tax rev­enue, are more sen­si­tive to eco­nomic fluc­tu­a­tions com­pared with prop­erty taxes, Moody's an­a­lyst Nicole Ser­rano said, con­tribut­ing to con­cerns about the tax base's re­siliency in the event of an eco­nomic down­turn or other un­ex­pected event.

In 2017, City Cen­ter gen­er­ated $47 mil­lion in tax rev­enue. About 86 per­cent of that to­tal was gen­er­ated by only five ten­ants. And just 10 ten­ants were re­spon­si­ble for 92 per­cent of that rev­enue.

The de­ci­sion to take on more debt in late 2018 has “ex­ac­er­bated our pre­vi­ously high­lighted con­cerns re­gard­ing tax­payer con­cen­tra­tion,” Ser­rano wrote in the De­cem­ber credit re­port.

“The 2017 and 2018 bonds are highly re­liant on a small group of tax­pay­ers; should rev­enues from this source be ma­te­ri­ally cur­tailed, it is un­likely that full an­nual debt ser­vice pay­ments could be made to bond­hold­ers,” Ser­rano wrote.

Moody's also af­firmed its Baa3 rat­ing for the 2012 arena bonds in De­cem­ber. Baa3 is the low­est in­vest­ment grade, or prime, credit rat­ing, but three rungs less spec­u­la­tive than Ba3. Moody's down­graded the 2012 bonds one step in Oc­to­ber 2017.

The out­look for all the rat­ings is stable, mean­ing Moody's does not ex­pect them to change over the next 12 to 24 months.

ANIZDA is com­fort­able with the cur­rent debt ser­vice cov­er­age for all of the bond is­sues, author­ity Ex­ec­u­tive Direc­tor Steve Bam­ford said Thurs­day. While he de­clined to com­ment specif­i­cally on the rat­ing agency's ac­tion, he said the author­ity has been “very pleased with how in­vestors have re­ceived all of the bond is­sues as they have been of­fered.”

J.B. Reilly, pres­i­dent and CEO of City Cen­ter, agreed, not­ing the down­grade didn't di­min­ish in­vestors' ap­petite for the De­cem­ber bond sale.

This is the first time ANIZDA has is­sued sub­or­di­nate bonds, which means that in the case of bank­ruptcy, in­vestors would be re­paid af­ter hold­ers of more senior, or first-lien, debt. The bonds were only of­fered to qual­i­fied in­sti­tu­tional buy­ers, and many of the in­vestors who got a piece of the 2017 and 2018 senior debt also bought the sub­or­di­nated debt, Reilly said.

“They un­der­stand the credit and were com­fort­able enough with the risk to buy more,” he said.

Ac­cord­ing to bond doc­u­ments, the 10 largest tax­pay­ers con­nected to City Cen­ter projects are, al­pha­bet­i­cally, Air Prod­ucts, BB&T, City Cen­ter, City Cen­ter Whole­sale, Cross Amer­ica Part­ners, Dug­gan & Mar­con, Dunne Man­ning, Le­high Val­ley Health Net­work, Mor­gan Stan­ley and Re­nais­sance Hotel.

The busi­nesses aren't ranked, but ac­cord­ing to an­other ANIZDA record, City Cen­ter and Air Prod­ucts were among the top five tax­pay­ers across the en­tire NIZ in 2017. LVHN, Dug­gan & Mar­con and BB&T were among the top 10.

Ser­rano said this week that the agency be­lieves the rat­ings re­main ap­pro­pri­ate “given all in­for­ma­tion cur­rently avail­able to us and our rea­son­able ex­pec­ta­tions of per­for­mance in the near term.”

Moody's down­graded the rat­ings a few days be­fore BB&T an­nounced it was elim­i­nat­ing its re­gional head­quar­ters in down­town Al­len­town. BB&T leases the top three floors at Two City Cen­ter and sub­leases two oth­ers. It can­not break its lease be­fore 2034, but it's un­clear how many of the 180 em­ploy­ees in down­town Al­len­town last month will re­main af­ter the re­struc­tur­ing. A bank spokesman did not pro­vide any new in­for­ma­tion this week.

City Cen­ter an­tic­i­pates BB&T will re­main one of its 10 largest tax­pay­ers in 2019 but ex­pects the NIZ rev­enues gen­er­ated by BB&T will drop this year and beyond, ac­cord­ing to bond doc­u­ments.

BB&T is not the only large City Cen­ter ten­ant plan­ning to re­duce its pres­ence in the NIZ. Air Prod­ucts an­nounced last Au­gust that it would not re­new its lease this sum­mer on the fourth floor of Two City Cen­ter, opt­ing to re­lo­cate 75 down­town em­ploy­ees to Trexler­town.

But Reilly said those losses will be dwarfed by the pres­ence ADP is bring­ing to Five City Cen­ter. The pay­roll pro­cess­ing gi­ant plans to fill 10 of the of­fice build­ing's 13 floors, mov­ing in the first of up to 1,600 em­ploy­ees this year.

Reilly also pointed out that the 2018 tax base will in­cor­po­rate rev­enue gen­er­ated by ten­ants of the 142,000-square-foot Tower 6, which opened last spring. That, he said, “will sig­nif­i­cantly di­ver­sify the tax­payer base.”

Reilly said he's com­fort­able with City Cen­ter's in­come cush­ion. Ac­cord­ing to a fore­casted rev­enue sched­ule ex­am­ined by ac­count­ing firm Baker Tilly, City Cen­ter ex­pects to gen­er­ate about $52 mil­lion in NIZ tax rev­enue this year — 1.56 times the $33.5 mil­lion it will pay an­nu­ally through 2042 to ser­vice the debt is­sued in 2017 and 2018. That cush­ion is pro­jected to grow over the next decade, as City Cen­ter rev­enue in­creases.

The NIZ over­all pro­duced $80.5 mil­lion in tax rev­enue in 2017, flat from the pre­vi­ous year but up al­most 40 per­cent from 2013, which Ser­rano ac­knowl­edged “sig­nals con­sid­er­able busi­ness devel­op­ment in the im­prove­ment zone.” The fact that res­i­den­tial build­ings are fully leased is also a pos­i­tive indi­ca­tor, she wrote. An­nual rev­enue avail­able to pay off the 2012 bonds is about three times the an­nual debt pay­ments.

City Cen­ter has fi­nanced its debt through ANIZDA be­cause in­vestors won't have to pay fed­eral taxes on the in­ter­est the bonds bring, giv­ing City Cen­ter a much lower in­ter­est rate (5 to 5.4 per­cent on the most re­cent bonds) than if they were tax­able.

The bond mar­ket also al­lows City Cen­ter to pay off its debt over a longer time frame than if it bor­rowed from a bank, en­abling it to spend more in the the short term on devel­op­ment, Reilly said. City Cen­ter will have com­pleted $800 mil­lion in devel­op­ment down­town when Five City Cen­ter is fin­ished.

Ac­cord­ing to the De­cem­ber bond doc­u­ment, ANIZDA may is­sue ad­di­tional sub­or­di­nate bonds for con­struc­tion or to re­fi­nance out­stand­ing sub­or­di­nate bonds. ANIZDA is not work­ing on any ad­di­tional bond is­sues and has not yet re­ceived any re­quests to do so, Bam­ford said.

APRIL GAMIZ/MORN­ING CALL FILE PHOTO

A view from the ninth floor of the un­der-con­struc­tion Five City Cen­ter in Septem­ber. ADP is ex­pected to be­gin mov­ing work­ers to the top 10 sto­ries of the build­ing this year.

MORN­ING CALL FILE PHOTO

City Cen­ter is de­pen­dent on just a few com­pa­nies for most of its rev­enue, but says that base is ex­pand­ing as it con­tin­ues devel­op­ment.

APRIL GAMIZ/MORN­ING CALL FILE PHOTO

City Cen­ter has taken on debt via bonds to get a lower in­ter­est rate and give it more time to pay it back so it can use more of the money on devel­op­ment.

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