CHICAGO — Indianapolis will head to market next week with $98 million of debt that taps the Midwestern disaster-area bond program to finance a new private development to benefit Eli Lilly and Co. — a project officials say will transform the city’s central downtown business district.

The $155 million hotel and retail project, dubbed North of South, relies on a mix of public and private money. It features a hotel with a small conference center, 300 apartments, retail, and a new YMCA. The development is located on a site currently owned by Lilly, and adjacent to the pharmaceutical giant’s headquarters, that represents the largest chunk of vacant land ­downtown.

The bonds carry a repayment pledge of revenue from the city’s sprawling and lucrative downtown tax-increment financing district. The borrowing will also feature a moral obligation pledge from the triple-A rated city.

Indianapolis will loan most of the proceeds of next week’s bond issue to the developer, Buckingham Cos., which is expected to refinance with a traditional mortgage in 10 years when the city calls the bonds.

Officials said the bond issue is necessary because traditional private-bank financing remains difficult to obtain at an economical rate.

It’s the latest in a series of complex financings undertaken by Mayor Greg Ballard and will tap the city’s allocation of qualified midwestern disaster area bonds. It also includes a small taxable piece.

The 2008 federal Midwestern disaster area bond program allows an issuer to structure bonds for qualified projects as tax-exempt that would otherwise have to forgo the tax benefit because they benefit a for-profit company.

“This really is a more economic way to incentivize the project in today’s climate,” said Deron Kintner, executive director of the Indianapolis Local Public Improvement Bond Bank. “All we’ve done here is rather than the city incentivize the project with very, very large upfront subsidies, we are providing access to capital markets at our borrowing rates.”

The bond bank is the city’s borrowing arm.

The Indianapolis-Marion County City-County Council approved the project Feb. 28 in a 16-12 vote that reflected some of the controversy swirling around the deal.

Critics warn that the city is assuming too much risk with the financing and a city-held mortgage. But proponents tout the development’s importance to downtown and argue the structure features a number of protections.

According to Kintner, the buffers include the city-held mortgage, three years of capitalized interest, and a year’s worth of debt-service payments funded by the developer in addition to a traditional debt-service reserve fund backed by bond ­proceeds.

Officials also expect project revenue will provide strong coverage for the debt payments.

Instead of offering a handful of expensive subsidies as in the past, which can add up to a third of a project’s total cost, the city is offering access to the lower-cost municipal market, Kintner said.

Indianapolis will also spend $9 million for infrastructure improvements at the site.

“Risk-mitigation has been at the forefront of our discussions from day one,” the bond banker said. “We have the safeguards in place that we’ve minimized that risk to the point that this deal is no riskier than other financings the city has been involved with in the past.

“It’s a transformative project,” he added. “We’re taking 11 acres of underutilized parking lots and putting an extraordinary mixed-use development there that will transform the downtown.”

The final City-County Council measure approving the project prohibits the city from paying more than a 6.5% interest rate on the borrowing.

The finance team expects a total interest cost of just over 5% based on the current market.

Officials plan to price the bonds March 16 or 17.

JPMorgan is senior manager on the deal. Co-managers are Cabrera Capital Markets, City Securities, Hillard Lyons, Northeast Securities, PNC Capital Markets, and Siebert Brandford Shank & Co.

Crowe Horwath LLP is financial adviser and Barnes & Thornburg LLP is bond counsel.

The borrowing consists of $82.5 million of tax-exempt qualified Midwestern disaster area bonds and $15.7 million of taxable bonds.

All debt matures in 25 years, though the city expects to call the bonds in 10 years when the developer refinances with a private loan.

Moody’s Investors Service assigned an Aa2 rating to the debt, two notches off the city’s triple-A rating, due to the non-essentiality of the project and the risk of non-appropriation.

The rating also reflects the strong coverage and healthy reserve funds tied to the city’s sprawling downtown TIF district, according to Moody’s.

“While the current borrowing further leverages the city’s moral obligation debt commitment, we expect this to remain manageable given various reserves the bond bank has at its disposal that are available to support debt-service payments,” analyst Iliana Beltran said in report on the borrowing.

Standard & Poor’s had not released its rating as of Tuesday.

Indianapolis will loan $86 million of the bond proceeds to the developer and use the remainder to cover capitalized interest through 2014 and issuance costs.

The debt features a revenue pledge from the TIF district that encompasses most of downtown Indianapois. However, city officials don’t not expect to tap existing TIF revenue for debt payments.

Starting in 2014, debt-service payments will be made from income from the project and incremental property tax revenue generated for the TIF district.

The new issuance will add to the district’s current debt burden of $600 million, most of which is rated double-A based on the city’s backup pledge.

The TIF district is expected to generate roughly $53 million in fiscal 2011 after Indianapolis diverts $10 million to divide among all of the city taxing subdivisions.

Out of the $53 million, current debt-service payments will demand about $40 million.

The new project’s debt service is expected to total $7.5 million annually after 2014. Of that, $5.5 million is expected to come from project income and $1.5 million from new TIF revenue tied to the project, according to official estimates.

Moody’s noted that debt coverage is strong and conservative. Analysts added the city has a history of honoring debt payments with weaker commitments, as seen in its decision to pay debt service on 1991 and 1995 United Airlines maintenance facility bonds after the facility closed.

In February 2009, Indianapolis paid $19.5 million to a bond trustee to replenish a debt-service reserve fund following the downgrade of the bonds’ insurers.

The North of South development is culmination of more than a year of planning. Eli Lilly — the drug-making giant that is Indianapolis’ largest private sector employer — and the developer approached the city a year ago about the project.

Eli Lilly had planned to expand its research and development business and build a corporate campus that would help attract employees and compete with high-tech cities like Boston and San Diego.

Instead, the company will donate the land — about 14 acres — to the city, which puts the value at around $15 million.

The company will donate another $15 million to the project, and Buckingham will donate $7 million.

The YMCA is expected to finance construction of its new building through fundraising.

The state of Indiana has said it will chip in $6 million that would come from federal grants.

Praising the City-County Council for passing the measure last week, Ballard called the project a “milestone” for the city.

“While other cities are cutting services, Indianapolis continues to invest and grow, and North of South represents an innovative way to bring the life sciences industry, new jobs and private investment to the heart of downtown,” the mayor said in a statement.

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