CHICAGO — Sioux Falls, S.D., is heading to market in coming weeks with a $119.2 million sales-tax-backed bond issue that marks the city’s largest borrowing to date.
Proceeds will help finance the construction of a 12,000-seat arena attached to the city’s convention center and existing event center. Officials hope the new three-building complex will spark more commercial development and they are already considering several proposals for a new hotel.
“This will be the largest bond issue the city has done,” said the city’s finance director, Tracy Turbak. “It’s been an identified need of the community for quite a number of years.”
The bonds are backed by Sioux Falls’ so-called second penny sales tax. The 1% piece of the total 6% sales tax rate is dedicated solely to capital projects and debt-service payments.
The bonds also feature a backup appropriation pledge from the city. Standard & Poor’s rates the deal AA-minus and Moody’s Investors Service Aa2.
Sioux Falls, with a population of about 153,000, is the largest city in South Dakota. It enjoys strong financial and service industries, and a low unemployment rate, which was 4% as of last October.
Its sales tax serves as one of the city’s most important revenue sources, with the 1% “first penny” accounting for nearly half of general fund revenue.
Under state law, the sales tax applies to nearly all products, from food and clothing to utilities. The city has the strongest retail area in the state, attracting shoppers from a 100-mile radius and serving as the largest source of taxable sales in South Dakota.
Sioux Falls suffered a dip in sales tax revenue in 2009 during the national recession. Since then, however, the revenue source has rebounded.
Officials expect to enter the market with the $119.2 million bond sale in the next few weeks. The city will take competitive bids.
Public Financial Management Inc. is the city’s financial advisor. Perkins Coie LLP and Sioux Falls-based Davenport Evans Hurwitz & Smith LLP are co-bond counsel.
Officials are hoping to sell naming rights before they set a sale date to help determine how much of the issue will be taxable. The bulk of the $119.2 million issue is expected to be tax-exempt, according to Turbak.
The borrowing will include serial bonds with a 22-year final maturity. The city has pledged to maintain the 1% “second penny” sales tax rate for the life of the debt.
Turbak said the city considered 30-year bonds but decided it would be able to handle a 22-year maturity based on projected sales-tax cash flow.
“We’re quite conservative here in Sioux Falls, and we like to pay off our debts as quickly as we can, as opposed to some places that like to stretch them out,” he said.
The bond issue will nearly double Sioux Falls’ outstanding sales-tax-backed debt, pushing it to $277 million.
Voters last November approved an advisory measure by a 58% margin, authorizing the City Council to move forward with the new arena project.
Local economic development officials expect the new facility will attract larger concerts and regular sports events, and that the expanded space will bring new conventions.
“The old arena was built about 50 years ago, and in the last 50 years Sioux Falls has grown a lot,” Turbak said. The city’s population has increased 25% over the last decade.
“The election results have spurred additional interest,” the finance director said. “Our community development office is reworking the master plan for that area with the expectation that there will be additional commercial development.”
Construction is set to start this summer with the new facility opening by fall 2014.
Some of the proceeds from the upcoming bond offering will be used for a debt-service reserve fund that will total 125% of the maximum annual debt-service payment.
Credit analysts note that in addition to the cash-funded reserves, the bonds are expected to feature maximum annual debt-service coverage of 2.03 times and an additional bonds test of 1.50 times. The city has also pledged to follow a 2.0 additional bonds test in practice.
The second-penny sales tax generated $44.1 million of revenue in 2010, which increased 5% in 2011 and is expected to see another 3% boost in 2012.
“We believe that although local residents responded to the economic downturn by curtailing their spending, as indicated by 2009’s performance, the city’s more stable economic base helped temper the drop and led to a quicker recovery in 2010, with its 6.2% increase in taxable sales,” Standard & Poor’s analyst Helen Samuelson said in a report on the upcoming bond issue.
Moody’s noted that Sioux Falls is the economic engine of South Dakota. But it also warned that the new arena could pressure the city’s general fund if operations fall short of expectations, which currently project the arena will generate anywhere from $1.1 million to $2.6 million annually.
Naming rights alone could generate up to $500,000 annually, according to Turbak.
Offsetting that risk is the city’s ability to tap a 1% entertainment tax to cover operating shortfalls, Moody’s analysts said.
“We expect the city to be able to sufficiently manage this undertaking, which we believe carries some degree of enterprise risk,” Moody’s said in a recent report.
The first penny of the tax is used for the general fund. The city has a history of general fund surpluses and strong reserves. It ended fiscal 2010 with general fund reserves equal to 38.4% of general fund revenue.
Sioux Falls’ last bond sale was a $70 million water and sewer transaction in 2007. The city’s current capital improvement plan through 2016 calls for $383 million of projects.
Of that, $178 million will be funded with cash from sales tax revenues and the rest will be funded with revenue from water and sewer systems.
If current market conditions hold, Sioux Falls will be entering a seller’s market that features record-low rates. Turbak said the city expects a total interest cost of under 4%.
“We could not have timed this any better,” he said. “Sioux Falls has wanted and needed this for a long, long time, and it’s the community’s good fortune that rates are as favorable as they are now.”