Burlington’s Quest for Fast Internet Slows Credit Rating
Burlington, Vermont’s most-populous city, is on the verge of losing its investment-grade bond ranking with a municipally backed project to bring high-speed Internet service siphoning taxpayers’ funds and prompting a property-tax increase.
In the Lake Champlain city’s April sale of taxable general obligations, debt maturing in November 2023 was priced to yield 4.63 percent, or about 2.9 percentage points above similar-maturity Treasuries. The yield spread grew to about 3 percentage points last week, data compiled by Bloomberg show. In 2009, the city issued similar securities maturing in 10 years at a spread of about 1.1 percentage points.
With a mediator unable last month to settle a lawsuit by a Citigroup Inc. unit over the Internet project, Moody’s Investors Service is warning that the city of 42,000 risks being downgraded to junk. Dean Sandros at Meridian, Idaho-based United Heritage Life Insurance is considering parting with his Burlington holdings.
“It might be time to take a gain and be done with them,” said Sandros, who oversees $400 million in munis.
Burlington, where Ben & Jerry’s opened its first ice cream shop in 1978, carries debt equal to 1.5 percent of the tax base, a load more typical of a municipality rated A, according to Moody’s. Its Internet adventure began in the 1990s, when cable companies refused to bring high-speed service to the city, said Joan Shannon, the city council president. So residents voted to start Burlington Telecom and build their own fiber-optic network.
In 2002, the city struck a deal with Scottsdale, Arizona-based Koch Financial Corp. to fund the project, which was expected to bring in $22 million in the first decade of operations, according to papers filed by Citigroup unit Citibank in a 2011 federal-court lawsuit. The lender took action four years after it agreed to refinance the deal and signed a leasing agreement that would eventually allow Burlington to take ownership.
“Considerably more was spent to build out the system than had been initially projected,” said Mayor Miro Weinberger, a 43-year-old Democrat elected last year. “There’s been real criticism about how that spending was done.” Subscriber levels never met forecasts, he said, while declining to provide details.
Burlington, home of the University of Vermont, joins localities from Minnesota to Pennsylvania facing fiscal challenges after embarking on projects to boost their economies or expand municipal services.
A development agency for Moberly, Missouri, last year defaulted on bonds issued for an artificial-sweetener plant that was never built. Pennsylvania’s capital, Harrisburg, was thrown into state receivership by an incinerator project that doesn’t generate enough cash to cover its obligations.
In Vermont, Burlington Telecom spent $45 million more than its revenue from 2005 to 2009, according to a report by Larkin & Associates, a Livonia, Michigan, accounting firm hired by the city. The costs included construction for which the company “overpaid,” according to a 2010 report by a group composed of seven Burlington business leaders and citizens.
From 2007 to 2009, facing mounting costs, the municipality transferred about $17 million to Burlington Telecom from its general fund. A state order put a stop to the payments, citing a provision in the city charter protecting taxpayers from losses incurred by the venture.
In its suit against the Vermont city, New York-based Citibank sought $33.5 million -- equivalent to 59 percent of the municipal budget -- to recover back payments and construction costs from the city’s general fund. Last month, the two sides failed to settle through mediation.
“From a credit perspective, it is about what the city could potentially lose,” Geordie Thompson, a Moody’s senior analyst in New York, said in an interview. The company ranks the city Baa3, the lowest level of investment grade.
“We see this situation occur when a local government becomes involved in a service of some sort that has representation in the private sector and is open to significant competition,” Thompson said.
Weinberger says the city didn’t guarantee Burlington Telecom’s debt. Yet its potential to drain municipal resources further is giving investors such as Howard Cure, managing director for muni research in New York at Evercore Wealth Management, reason to avoid the municipality’s securities.
“This would be something, for our firm, that we would stay away from,” said Cure, whose New York-based firm oversees $4.7 billion. “What we like to see is cities sticking to their knitting.”
The last lease payment Burlington Telecom made was in November 2009, according to Citibank’s complaint filed in Burlington federal court. The court has ordered the parties to be ready for trial by Jan. 1.
“We are continuing to proceed with litigation due to the city’s failure to honor their contractual obligations, including the return of equipment we financed,” Mark Rodgers, a Citigroup spokesman, said by e-mail.
Citibank’s suit against Burlington claims breach of contract and asks the court for compensatory damages of $33.5 million. It also seeks undetermined punitive damages and the removal and return of equipment leased to the city.
Burlington, in an answer filed in December 2011, said it made offers to return or replace the equipment. It blamed Citibank for the failure to meet financial projections because it “reneged on a promise” to offer additional financing to complete the work.
It also alleged the lease agreement was terminated when the city council decided not to budget funds for it in fiscal 2011, and thus no more payments were required by law. The city said it had suffered damages of at least $70 million, which represented the venture’s losses and damage to the city’s credit rating.
The city asked U.S. District Judge William Sessions in December to dismiss Citibank’s complaint. He has yet to rule on the request.
Not all investors are ready to bail out of Burlington.
“I don’t think all city enterprises make money all the time,” said Phelps S. McIlvaine, a portfolio manager at Saturna Capital Corp., a Bellingham, Washington-based firm that oversees $4 billion and holds some Burlington bonds.
“You look at their overall credit and not necessarily the credit of one specific operating entity,” McIlvaine said.
Weinberger, a political neophyte who graduated with a bachelor of arts degree from Yale University and a master’s degree from Harvard University’s John F. Kennedy School of Government, ran on a platform of fiscal responsibility and says his administration has “turned around longstanding practices that had led to debt.”
He said Burlington Telecom is making an operating profit, though it still can’t repay all that’s owed under the original agreement with Citibank.
To inject more into the general fund depleted by the transfers to Burlington Telecom, Weinberger led a campaign that increased the property tax by $58 per $250,000 of home value. It was needed to back April’s $9 million general-obligation sale and address Moody’s concerns. Seventy-two percent of residents voted for it.
While campaigning for the tax increase, Weinberger said the city’s near-junk bond rating was “beneath us” and said “it would be as though we were some dying Rust Belt city.”
In the $3.7 trillion municipal market this week, issuers led by California Health Facilities Financing Authority plan to sell a combined $8 billion with 30-year yields at the highest since January 2012. Interest rates on the maturity have risen for six straight weeks, the longest stretch since February.
Benchmark 30-year munis yield 3.67 percent, compared with about 3.3 percent for federal debt of a similar maturity. The ratio of the two yields, a measure of relative value, is about 111 percent, the highest since April 5. The higher the figure, the cheaper munis are relative to Treasuries.
Munis have lost 1.6 percent this month through June 13, compared with a decline of 0.1 percent on Treasuries, Bank of America Merrill Lynch data show.
The Vermont case is Citibank N.A. v. City of Burlington, 11-00214, U.S. District Court, District of Vermont (Burlington).
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