Methods of Financing the North Dakota Local Cost Share of the Diversion Project

By Brian D. Neugebauer, Southeast Cass Water Resources District Bond Counsel, Ohnstad Twichell Attorneys

Financing-300Although no final decisions have been made by the Diversion Authority on exactly how to fund the North Dakota local share of the Diversion Project, it is expected that sales taxes in the City of Fargo and Cass County will fund a lion’s share of that cost. The voters of Fargo and Cass County have already given their approval for their sales taxes to be used for this purpose. During the initial design phases, the incoming sales tax has been sufficient to keep up with costs being incurred by the Diversion Authority. However, as the Diversion Authority expenditures increase to step up the pace of design, to start land acquisition, and especially to fund construction, incoming sales taxes will not be sufficient to keep up with expenses. As such, one or more bond issues will become necessary to maintain proper cash flow for the Diversion Project.

Staff is now looking at options on how to get the most funding at the lowest interest rate utilizing the two sales taxes. The most obvious method is for both the City of Fargo and Cass County to issue sales tax bonds for that purpose. However, there are four problems with sales tax bonds. First, in order to be marketable, there must be substantial coverage for the proposed debt service. As a simple example, if the debt service on a sales tax bond was $500,000 a year, there may be a need for $725,000 of sales tax receipts a year. That is, to be marketable in the first place, many financial advisors suggest having 1.5 coverage for sales tax bonds. The reason for this is that bond buyers are concerned that the amount of sales tax receipts may go down in the future, so they want extra coverage to insure being paid. With the recent recession, many cities across the nation have had significant declines in their sales tax collections, which have made bond buyers even more concerned about coverage than in the past. The proper coverage requirement can be debated, but the higher the coverage provided, the lower the interest rate, and the lower the coverage provided, the higher the interest rate, until reaching a point where the bonds are not even marketable.

The second problem with sales tax bonds is that bond buyers also require that there be a reserve fund of about 10% of the issue size. Buyers are again worried about sales tax fluctuations, and the reserve fund gives them that protection. However, it also reduces by 10% the amount of bond proceeds available to pay the local share of the Diversion Project.

The third problem is that the market does not let the issuer take advantage of the sales tax receipts climbing during the term of the bond. For the same coverage reasons set out above, the market will only size a bond issue on past sales tax receipts, not projected sales tax receipts in the future, thus reducing the size of the bond issue.

The fourth problem is that sales tax bonds are not backed by the full faith and credit of the Issuer. When Fargo sells refunding improvement bonds, under North Dakota law, the bonds are backed by the full faith and credit of the City, and as a result, the interest rate is lower on those bonds than if Fargo issued sales tax bonds. With a higher interest rate, more sales tax receipts would be required to pay interest, making less revenue available to pay the local share of the Diversion Project.

With these factors in mind, staff has discussed another possible financing vehicle which would still use the two sales taxes of the City and County, but avoid the problem areas discussed above. That vehicle would be the issuance of an improvement bond by the Cass County Joint Water Resource District. Without getting into the details of such an issue, the Water Resource District does have the authority to issue an improvement bond and assess all benefitting property their proper proportion of the Project.

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