Burlington Avoids Junk by Saving Vermont Internet Venture

Burlington, Vermont, which was on the brink of a junk credit rating after diverting cash to a high-speed Internet project, has stepped away from the edge.

The state’s most populous city began seeking final approval this week for a plan to settle a $33.5 million lawsuit by a Citigroup Inc. (C) unit for $10.5 million. The litigation stemmed from back payments and construction costs at Burlington Telecom, a city-run fiber-optic network propped up with taxpayer funds. Residents passed a property-tax increase in 2012 to fund “fiscal stability bonds” and help fend off a rating cut.

After saying for almost two years it could drop Burlington below investment grade, Moody’s Investors Service raised its outlook to stable last month on the city’s Baa3 rating. Mayor Miro Weinberger said he expects a higher mark in the future, and investors agree, driving yields on some bonds to new lows.

“City taxpayers were never supposed to be in the position of taking on entrepreneurial risk,” said Weinberger, a 44-year-old Democrat elected in 2012. “Cities need to be very careful when they attempt to pursue entrepreneurial activities.”

Fallen Angels

The city of about 42,000 on the shores of Lake Champlain shows how the threat of a junk rating can spur lawmakers to action. The case defies a Moody’s prediction in October 2012 that more localities would sink to speculative grade, becoming “fallen angels.”

That fate befell at least three municipalities in the past two years that took on ventures that failed: Wenatchee, Washington, lost its investment grade over backstopping an events center agency that in November became the first municipal issuer fined by the U.S. Securities and Exchange Commission for misleading investors; Vadnais Heights, Minnesota, officials refused to continue appropriating funds for a youth sports complex; and La Grange, Kentucky, backed debt used to buy land for commercial development that mostly didn’t occur.

Niagara Falls, New York, last year saw its rating fall as low as Baa3 with a negative outlook, after which Governor Andrew Cuomo struck a deal with the Seneca Nation of Indians over a casino to keep the tourist destination solvent. Moody’s raised Niagara Falls to Baa2 in November, two steps above junk.

Financial Parallels

“In the case of Burlington, you could draw some parallels to Niagara Falls -- they were facing a specific issue” in the lawsuit they had to settle, said Geordie Thompson, a Moody’s analyst. “They had to solve that problem for their own financial wherewithal.”

After Moody’s dropped Collingswood, New Jersey, to junk in September 2011, officials within nine months restored the borough’s investment grade by refinancing debt. The community had guaranteed a loan for a condominium project that faltered after the housing market collapsed.

The ranks of junk-rated municipalities dwindled in 2013 for the first time in at least five years, according to a December report from Moody’s.

“Politicians seem to be using the rating agencies as a tool to push the plan forward,” said Lyle Fitterer, who helps manage $31 billion of state and local debt at Wells Capital Management in Menomonee Falls, Wisconsin.

Tax Backing

Weinberger said that after Moody’s dropped the city’s grade five months earlier, Burlington residents were more willing to back a property-tax increase of $58 per $250,000 of home value in November 2012.

The vision for Burlington is still a technology-driven economy, he said.

The idea for the venture began in the 1990s when cable companies refused to bring high-speed service to the city, where Ben & Jerry’s opened its first ice cream shop in 1978 and where the band Phish got its start. Residents voted to start Burlington Telecom and build a fiber-optic network.

The project was expected to bring in $22 million in its first decade, yet spent a combined $45 million more than its revenue from 2005 to 2009 as subscriber levels trailed forecasts.

Facing mounting costs, the municipality funneled about $17 million to Burlington Telecom from its general fund from 2007 to 2009. A state order stopped the payments, citing a provision in the city charter protecting taxpayers from losses.

Refinancing Deal

Citibank, a unit of New York-based Citigroup, sued in federal court in 2011 after it agreed to refinance the deal and signed a lease agreement that would eventually allow Burlington to take ownership.

Burlington and Citibank entered into a settlement in January that stipulated the bank would get $10.5 million. That included a $6 million bridge financing by Trey Pecor, president of Burlington-based ferry company Lake Champlain Transportation Co.

“We anticipate that our settlement will be completed as the parties have agreed,” Mark Rodgers, a Citigroup spokesman, said in an e-mailed statement. “We are pleased with the results and are happy to put this matter behind us.”

The financing will buy the city time to buoy its finances and Burlington Telecom’s, Weinberger said. The loan is backed by Pecor and the company’s property.

Sale Goal

“If I can help the city get through this time, we all win,” Pecor said in an interview.

The goal is to find a buyer for the enterprise, which serves about 4,600 customers. Pecor and the city would split the proceeds evenly if they find a purchaser during the first 36 months of the lease. Burlington’s share declines after three years. The municipality would divide its take with Citibank.

The Vermont Public Service Board, which met yesterday, needs to approve the settlement, Weinberger said. Moody’s said closing the agreement without altering current terms is one of four criteria that would improve the city’s rating.

Investors who stuck with Burlington were rewarded, as its bonds rallied after Moody’s outlook stabilized.

Tax-exempt general obligations maturing in November 2033 traded April 16 at an average yield of 5.11 percent, the lowest since the debt was issued Sept. 12, according to data compiled by Bloomberg. The rate is about 2.75 percentage points more than benchmark munis.

Though he considered selling his bonds last year, the city “didn’t look terrible, and we weren’t getting paid enough to get rid of them,” said Dean Sandros, who helps oversees $500 million in munis at Meridian, Idaho-based United Heritage Life Insurance.

“With their downside number now being limited with the agreement, that’s great,” he said. “We’ll keep them.”

To contact the reporter on this story: Brian Chappatta in New York at bchappatta1@bloomberg.net

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

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