DEBT DILEMMA
City Center not worried after bond ratings downgraded
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.