Small Iowa city banks on arena's success to repay debt
Coralville, Iowa, wrapped up a $76 million financing package for a new arena that cost the city its investment grade rating.
The city sold $25 million of unrated taxable annual appropriation general obligation bonds last month. The bonds underwritten by Piper Jaffray sold in three tranches with maturities in 2023, 2025, and 2028 at costly yields of 7.5%, 8%, and 8.5%, respectively. Dorsey & Whitney LLP was bond counsel.
The overall financing plan relies on a mix of general obligation and appropriation backed borrowing to be repaid with targeted, mostly project-related revenue streams, some publicly offered and some privately placed, by the city of about 21,000 that borders Iowa City, home of the University of Iowa.
The school will use the facility, which is an anchor for the $190 million Iowa River Landing development, for its volleyball team.
About $18 million of the proceeds will provide grants and loans to ArenaCo, a non-profit community development corporation established by the city in 2017 to own and operate the arena and some related facilities. The remaining proceeds are being funneled to a debt service reserve fund, to make a capitalized interest deposit, and cover costs of issuance.
The city expects to repay the bonds primarily with tax-increment financing revenues and rental income. The rest of the project financing is coming from private bank loans, tax credits, cash contributions, sales tax TIF revenues through the Iowa Reinvestment Act, and property tax TIF revenues.
The city is providing about $76 million through cash contributions and loans to the project, which has a total budget of $92.4 million including reserves and transaction costs, according to the city. The arena project also includes some related facilities.
“All loans required to finance the project are secured and closed,” the city said in response to questions about the project sent to city finance director Tony Roetlin.
On Dec. 20, S&P Global Ratings downgraded the city to speculative grade, cutting its general obligation credit three notches to BB-plus from BBB-plus and its appropriation bonds to BB from BBB.
"The lowered rating reflects our view of the city's heightened debt burden with very high fixed costs, its exposure to high interest rates on its bank loans, and weakened financial flexibility and performance as the city moves forward with its plans to construct a major economic development project centered on an arena," said S&P analyst Helen Samuelson. The outlook is stable.
In August, Moody’s Investors Service withdrew its Ba2 annual appropriation rating on $15 million of outstanding debt due to “insufficient or otherwise inadequate information to support the maintenance of the ratings.”
The city said in a statement it “did not know for sure how the rating agency would respond” after an “extensive dialogue with S&P” and a visit by analysts to the project site.
The city has no other public offerings currently in the works that would feel the pain of a cut to junk, but officials said the city does have “some relatively small planned capital projects to fund, which are funded with a combination of debt issuance, cash, special assessments, and grants,” so at some point it may return to the market.
In addition to the $18 million that is coming from the December bond issue, the ArenaCo funding package relies on a series of privately placed issues with targeted revenue streams for repayment.
They include a privately placed $14.5 million general obligation note issue that is leveraging a loan under the New Markets Tax Credit Program established as part of the federal Community Renewal Tax Relief Act of 2000. It provides tax credit incentives to investors for equity investments in certified Community Development Entities, which invest in low-income communities.
The city also privately placed a $10.7 million general obligation note issue leveraging future income expected from a naming rights deal; a privately placed annual appropriation general obligation note issue for $7 million is expected to be repaid with TIF revenues; and a privately placed $8.8 million general obligation note issue leverages the Iowa Reinvestment Act to aid “transformative” projects and would be repaid with state sales taxes.
Another $11.8 million of cash contributions that is expected from land sales will go toward the project as well as future cash contributions of about $2 million prior to completion of construction “in the event that certain contributions expected to be received by the city relating to the arena project are not timely received,” according to city documents.
S&P said Coralville is like others in using its GO and appropriation pledge on debt for economic development projects but “what sets Coralville apart is the extent of debt it has issued.” That overshadows the city’s otherwise positive credit features.
S&P examined the preliminary loan documents and found no remedies under the events of default allowing for acceleration of the city's payments to the bank. The private placements are with West Bank and Great Western Bank. The interest on the bank loans is fixed for five years, but then resets with no maximum interest rate.
With the new debt, the city will have approximately $139 million in GOs, $200 million in appropriation debt and capital leases, and $27 million in revenue debt paid from enterprise funds and other non-tax sources. Debt service on all of the arena debt is approximately $4 million per year, until 2038 when debt service jumps to $28 million, according to S&P.
“In our view, the city's debt burden is unsustainable without restructurings,” S&P said. Debt service carrying charges are at 44.1% of expenditures.
The city’s credit profile benefits from a strong economy and strong budgetary flexibility with an available fund balance in fiscal 2017 of 45% of operating expenditures. The project and ongoing development are expected to enhance the local economy and increase valuation and tax revenue.
The offering statement for the $25 million deal outlines the repayment risks bondholders face. The city has appropriated the required debt service through mid-2020 but future appropriations will be needed. The cut to junk eliminates one incentive for the city to honor its obligations.
“In the event that the City Council of the issuer does not budget and appropriate funds for any fiscal year in an amount sufficient to pay the principal of and interest due on the bonds during such fiscal year, the issuer’s obligation under the bonds shall terminate and become null and void on the last day of the fiscal year for which the necessary funds were appropriated,” the offering statement says.
The city will neither own nor operate the arena project, and no income or revenues are pledged to bondholders.
If the development is delayed or if once constructed operations are not successful, the city “may determine to subsidize operations of the arena and fieldhouse” but if anticipated revenues fall short the city also warns it “may be unwilling to subsidize operations and less likely to make annual appropriations for debt service on the bonds.”
Whether revenue from rental income, a mixed-use retail center, and other sources meets projections could also influence the city’s willingness to honor its appropriation obligations and “if not realized, may cause the city to fail to appropriate funds to repay the bonds,” the offering statement says.
Other recent defaults on bonds issued for struggling projects underscore the risks.
Lombard, Illinois, put its appropriation pledge behind a portion of debt for a hotel and conference center. The project failed to generate sufficient revenues to cover debt service and the Chicago suburb reneged on its pledge and in 2017 the special development agency that issued the bonds filed for Chapter 11 bankruptcy.
Platte County, Missouri, last year reneged on an appropriation pledge to support bonds issued through a development corporation for a struggling retail center and is now asking the courts to endorse its position that it’s not legally required to honor loan provisions.
Both Platte County and Lombard lost their investment grade ratings. Market participants have said both highlight the need for investors to look closely at a project’s purpose to gauge future risks.
“While there is no material evidence of political or community resistance toward the project, the arena project does not, in our view, represent a basic city function and it is considerably larger in scope and complexity with inherently greater risk, compared to other city economic development projects,” S&P said.
A ceremonial groundbreaking took place last year and the arena is slated to open in 2020. The venue will hold up to 5,700 and host concerts and University of Iowa volleyball matches. It could also host hockey games if the project developers land a team.
The new arena and athlete training center are anchors designed to complete the transformation under a master plan for a once-blighted 185-acre area with a mixed-use development known as the Iowa River Landing that’s described as a partnership with the state and private investors thirty years in the making.
The arena project includes a five-court field house, hotel, museum space, storefronts for restaurants and retail, office space be leased by ArenaCo from a non-city entity, and an Iowa Fitness & Sports Performance Institute which will operate a multi-use training and rehabilitation facility for athletes.
The project also includes retail, residential, and commercial properties that will house the Johnson County Historical Society, Hawkeye Model Railroad Club, and the Antique Car Museums museum. A non-city entity will build and own a hotel.
An analysis by C.H. Johnson Consulting in February 2016 estimated the total economic impact of the district will be in excess of $1.4 billion over a 20-year period, according to city documents.