Kentucky's bond-funded broadband P3 under fire for overruns

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Trouble is brewing for Kentucky’s novel statewide broadband internet network.

Mike Harmon, Auditor of Public Accounts, said Thursday that the prior Democratic administration’s program to install broadband across the Bluegrass state is rife with cost overruns and “botched” procurements.

Harmon, a Republican, is an elected state official.

“Significant structural changes occurred between initial procurement and the final version of the project that shifted costs and responsibilities to the Commonwealth,” Harmon said in a letter to Phillip Brown, executive director of the Kentucky Communications Network Authority, which manages the program known as Kentucky Wired.

A 125-page report by Harmon’s agency answers a series of questions about the structure of the project, discusses contracts and the public-private partnership used for the project, and includes information about Kentucky’s obligation to continue annual appropriations for debt service.

“Whether the Commonwealth’s obligations are practical, or ‘moral,’ the decision to back revenue bonds with continuing appropriations is the decision of each legislature,” the report said. “The moral obligation theory is important in that it appears to have committed the Commonwealth to repayment of the bonded debt for practical purposes, if not legally. This commitment changes the risk dynamic of KentuckyWired and the incentives of the various parties.”

In 2015, the Kentucky Economic Development Finance Authority financed the project to install a fiber-optic “middle mile” broadband system on utility poles by issuing $232 million of senior tax-exempt revenue bonds and $58 million of senior taxable revenue bonds.

The project was spearheaded by former Gov. Steve Beshear because many Kentuckians, especially in rural areas, lacked access to high-speed internet service.

On Wednesday, Fitch Ratings maintained its Rating Watch Negative on KEDFA’s BBB-plus rating.

Fitch said its Negative Watch reflected continued uncertainty regarding the execution of a global settlement agreement among the state, the concessionaire, and the design-build contractors resolving contractual disputes.

The project’s 30-year concession agreement is with a consortium called KentuckyWired Operations Co. LLC, whose investors are Macquarie NG-KIH Holdings Inc. as 75% owner, Ledcor US Ventures as 15% owner, and First Solutions LLC, which owns 10% of the company.

A memorandum of understanding between the state and concessionaire was signed March 30 that “appears to address key issues and remedies outstanding supervening events by extending the project's construction schedule and covering added costs,” said Fitch analyst Sean Su.

Fitch, which didn’t mention Harmon’s audit, called Kentucky Wired a first-of-its-kind project when the bonds were issued in 2015.

In April, Moody's Investors Service revised its outlook to stable from negative and affirmed the Baa2 rating on KEDFA’s bonds to reflect “the positive resolution of key outstanding disagreements” between parties involved in the project to build a $324 million, 3,393-mile statewide middle-mile fiber optic network.

Gov. Matt Bevin’s office did not immediately respond to a request for comment about Harmon’s audit.

Brown, director of KCNA, said Friday that his agency has plans to “thoroughly review” the audit findings.

“Even prior to receiving this report, KCNA had identified and begun the process of addressing many of the same issues noted by the auditor,” Brown said. “Although not contemplated by the project agreements, KNCA has taken significant steps to enhance general direct oversight of the project by increasing its staff and internal expertise in construction and construction monitoring.”

Brown also said KCNA “will continue our efforts to correct the problems and delays that were present from the KentuckyWired project’s inception in 2015.”

In August, Brown told the Legislature’s Capital Planning Advisory Board that an aggressive schedule was partly the blame for increasing the state’s risks and costs, according to Louisville radio station WFPL.

“Its design sought such an aggressive schedule for completion that it came with an excessive amount of risk,” Brown reportedly told the board. “It is risk that Kentucky bears the burden for covering.”

The project was supposed to be completed in phases, with the first phase going live in 2016. That segment is now scheduled to be completed in 2020. Some of the delay has been attributed to difficulty getting agreements to attach the fiber to existing poles across the state.

Earlier this year, the Legislature passed a budget that classified debt-service appropriations for Kentucky Wired as necessary government expenses, but didn’t include line-item funding for the bonds. After Gov. Matt Bevin vetoed the budget, the Legislature adopted a budget amendment providing for the payment of debt service from the general fund.

The amendment also authorized the issuance of up to $110 million of bonds to pay for a tentative settlement agreement with the private parties involved with the project. Those bonds haven’t been issued yet.

The Kentucky broadband project was The Bond Buyer’s 2015 Deal of the Year award winner. That year it also won the Council of Development Finance Agencies’ Excellence in Development Finance Project Award.

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Revenue bonds Public-private partnership Disputes and judgments Kentucky Economic Development Finance Authority Kentucky