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Vadnais Heights Breaks Pledge in Downgrade Debacle: Muni Credit

A $25 million sports complex that wasn’t supposed to cost taxpayers money has left a Minneapolis suburb on the hook for about a third of its annual budget and with a credit rating 12 levels lower than it was in July.

Vadnais Heights, a city of 12,453, sold bonds through its economic-development authority to finance a 200,000-square-foot (18,600-square-meter) sports center in 2010 with amenities such as ice rinks and soccer fields. It joins localities across the U.S. that have seen their credit ratings cut after failed bets on sports and industrial projects intended to spur growth.

The Minnesota city, named after French-Canadian settlers, had its general-obligation grades from Standard & Poor’s and Moody’s Investors Service cut to junk from third-best in the past two months after it opted to stop making appropriation payments for the sports complex’s debt following this year. By the end of 2012, disbursements may total about $2 million, compared with an annual budget of $4.9 million.

“If the city’s own finances got into trouble, you’d have to assume they’d also look for an out from their regular G.O. bonds,” said Matt Fabian, managing director at Concord, Massachusetts-based Municipal Market Advisors. “It does show erosion of cities’ willingness to pay bondholders.”

Forced Choices

The so-called superdowngrades -- rating cuts of three or more levels -- highlight a renewed focus on municipalities choosing between making bond payments and cutting services as they recover from the recession that ended in 2009. Moody’s said in July that the bankruptcy decisions by three California municipalities since June show distressed cities may view debt service as a “discretionary budget item.”

The credit cuts are “not fair and it’s not reflective of the overall financial condition of our city,” Vadnais Heights Mayor Marc Johannsen said in a phone interview. “We’ve never missed a bond payment in the history of the city, and we’ll never miss a bond payment that we’re obligated to do.”

In addition to cutting the city’s credit, S&P lowered the rating on the lease-revenue bonds sold to finance the Vadnais project by 13 steps on Aug. 21, to CC. That’s 10 levels below investment grade and down from A-. The development authority issued the debt on behalf of Community Facility Partners Vadnais Heights LLC, a private, non-profit corporation, according to S&P. Moody’s doesn’t rate the debt.

Yield Jump

A bond maturing in 2036 traded Aug. 31 at an average yield of 15.2 percent, up from 5.3 percent on Aug. 20, data compiled by Bloomberg show.

The Vadnais Sports Center opened in November 2010, seven months after the agency issued the securities. It offers two National Hockey League-size rinks, soccer fields, batting cages, volleyball courts and a track, according to its website.

Part of the goal was to give the local high school “home ice,” said Sue Banovetz, who was mayor at the time the project was approved and is now director of external affairs at the University of Minnesota Duluth.

The venue was supposed to generate enough revenue to pay the debt service, with the city stepping in only in the case of a shortfall. Instead, based on 2011 data, it can cover less than 20 percent of bond payments, according to S&P.

Obligation Ending

Vadnais Heights is covering the revenue gap through year- end. That will bring the amount the city has appropriated to as much as $1.9 million since the complex opened, said Joe Murphy, a councilmember since 2007.

The city agreed to finance the center because it would be “a gateway to the community,” Banovetz said. “We thought the sports center, combined with the commercial development we saw taking place, would revitalize a corner that was an eyesore.”

Smaller communities are more vulnerable if such projects don’t go as planned since their economies are less diverse, said Howard Cure, director of municipal research at New York-based Evercore Wealth Management LLC.

“If they’re really relying on some sort of revitalization based on this one facility, you’re really risking a lot,” said Cure, whose company oversees about $3.5 billion.

Vadnais Heights isn’t alone in dealing with the consequences of a local venture gone awry.

Two states away, Moberly, Missouri, was stuck last year with $39 million in debt sold to lure a Hong Kong-based artificial-sweetener plant project that collapsed. It had promised about 600 jobs in the town.

Deal Sours

The city didn’t appropriate funds, and S&P dropped its issuer rating to B, the fifth-highest junk level, from A in September 2011. The grade on its industrial-development agency fell to CC from A-, identical to Vadnais Heights. It was dropped again in March, to D, after a payment default.

Bonds sold by the agency for the plant and due in 2024 traded Aug. 31 at an average yield of about 21 percent, up from 6 percent on Sept. 21 last year, the day before the downgrade, Bloomberg data show.

Also in the past year, Wenatchee, Washington, had its general-obligation rating cut two levels to BBB by S&P in December because it failed to support a regional sports arena that defaulted on notes. The authority financing the stadium plans to sell about $49 million in nonrated bonds this month to retire the debt, according to an offering document.

The fallout from Vadnais Heights to Wenatchee isn’t deterring other municipalities from financing stadiums.

Hockey Venue

Allentown, Pennsylvania’s third-largest city, plans as soon as this week to sell $235 million in bonds rated Baa2, two steps above junk, for an arena to be used by an affiliate of the NHL’s Philadelphia Flyers.

The site is set to open in 2014, according to offering documents. The city of about 119,000 is 80 miles (129 kilometers) from Harrisburg, the state capital, which has been pushed into insolvency by a failed incinerator project.

The bonds will be backed by receipts from a district around the site, including sales, business and income taxes on residents working in the zone. The debt isn’t supported by the city’s general-obligation pledge.

In Vadnais Heights, council members cleared the project knowing the city’s bond rating was at stake, said Banovetz, the former mayor.

“We need to have our government doing core services,” said John Kossett, 56, who lives and works in Vadnais Heights. “When they built the sports center, it didn’t make any sense to me. They didn’t know what they were getting into.”

In the $3.7 trillion muni market, yields on top-rated tax- exempts due in 10 years declined the past three weeks, to about 1.75 percent, Bloomberg Valuation data show. The record low was 1.63 percent in July.

Following are pending sales:

SUFFOLK COUNTY, New York, home to Long Island’s Hamptons beach communities, plans to issue $105 million in tax- anticipation notes as soon as this week, according to data compiled by Bloomberg. (Added Sept. 10)

ILLINOIS plans to sell $50 million of debt as soon as this week through competitive bid, data compiled by Bloomberg show. Proceeds will finance information-technology projects, according to bond documents. S&P last month downgraded the state one level to A, sixth-highest, after lawmakers failed to reduce retirement costs during a special session. (Updated Sept. 10)

To contact the reporters on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net; Romy Varghese in Philadelphia at rvarghese8@bloomberg.net

To contact the editor responsible for this story: Stephen Merelman at smerelman@bloomberg.net

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