Kentucky’s failure to fund broadband initiative imperils state ratings

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With Kentucky’s commitment to its award-winning broadband initiative in doubt, Fitch Ratings said the state risks a rating downgrade after lawmakers failed to fund the related debt in the state’s two-year budget.

Ratings of the public private partnership called Kentucky Wired also are at risk, Fitch said, if the state fails to meet its obligations in the contract between the state and private partners building the statewide system.

“A commonwealth budget dispute regarding appropriations and additional bonding authority for the Kentucky Wired public private partnership project puts the ratings of related project debt and the commonwealth itself at risk, and also raises questions about the viability of PPP projects in Kentucky,” said Fitch analyst Eric Kim.

A failure by Kentucky to meet its obligations under the P3 contracts, Kim said, will also create uncertainty among market participants, including contractors, infrastructure investors, and lenders regarding the vitality of P3 finance for infrastructure more generally.

Fitch has an issuer default rating of AA-minus on the state, with a stable outlook.

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

Fitch, the only agency to rate the deal, assigned a BBB-plus and a stable outlook to the bonds.

In October 2017, Fitch said it placed Kentucky Wired’s BBB-plus on rating watch negative to reflect uncertainty about the agreements between the state, the concessionaire, and the design-build contractors to remedy outstanding events by extending the project's construction schedule and covering added costs.

Since its inception, the startup project has experienced challenges with construction activities, largely due to delays in obtaining pole attachment agreements. As of mid-March, project officials said they had made “significant progress” obtaining the agreements, with only about four outstanding.

More than 700 miles of the network has been completed, although some top lawmakers have said they consider the project a “boondoggle” and believe it should be stopped.

Kentucky Gov. Matt Bevin vetoed the state budget on Monday because he said it failed to provide debt service on bonds issued to build the state’s broadband internet system, decimated emergency reserves, and lacked full funding for services such as Medicaid and prisons.

Bevin said the state agreed to bring broadband to remote areas of Kentucky where “people who feel left out and have been promised for years before I ever got here that efforts were going to be made to bring them into the 21st century digitally.”

“The obligation is on every man, woman and child in this state to pay those bonds off into the future and yet a budget comes forward that doesn’t even include funding of that debt,” he said.

Bevin also vetoed HB 366, a related tax-reform bill that also contained revenue-raising measures to support the budget that state Budget Director John Chilton said would raise $50 million less than lawmakers projected.

Lawmakers return to Frankfort Friday and Saturday to consider overriding Bevin’s vetoes.

Though the budget classified debt-service appropriations for Kentucky Wired as necessary government expenses, lawmakers didn’t include line-item funding for the bonds.

Fitch said it considers the necessary-government-expense designation a “solid financial commitment” by the state, which would require the governor to find offsetting budget actions to ensure funding.

In a related issue, the Kentucky Communication Network Authority overseeing the project sought an additional $110 million of bonding authority from the Legislature to pay for a tentative settlement agreement with the private parties in the P3 to resolve issues delaying the project.

The bond measure, Senate Bill 223, never received committee hearings.

Fitch said failure of the Legislature to authorize funding for the settlement agreement through SB 223 or another mechanism, “threatens the viability of the settlement agreement and the project itself.”

“It would also raise concerns for Fitch about Kentucky's willingness to abide by terms of the project agreement and could lead to negative rating action on the project debt, the commonwealth's counterparty obligation rating, and Kentucky's issuer default rating,” Kim said.

Kentucky’s statewide high-speed internet system has been called a first-of-its-kind P3 deal. Its financing was the Bluegrass state’s first availability payment concession.

The project involves constructing more than 3,200 miles of a fiber-optic “middle mile” system, and was initially projected to cost $324 million. Fitch called it a unique, first-generation telecommunications project.

Kentucky has a 35-month construction contract and a 30-year concession agreement with a consortium called KentuckyWired Operations Co. LLC. The consortium’s 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.

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Public-private partnership Internet of things Revenue bonds State budgets Matt Bevin Kentucky Economic Development Finance Authority Kentucky