CHICAGO -- Hoffman Estates, Ill., will price a $71.5 million junior lien tax increment revenue bond issue tomorrow in a tax-exempt deal that officials said does not fall under the state's private-activity volume cap despite the fact the bonds are secured by Sears, Roebuck and Co.
Proceeds from the deal will be used to pay for public land acquisition and infrastructure improvements in and around a 788-acre development site, whereas Sears, which is the owner of all the land included in the tax increment district, is in the process of building its merchandise group headquarters.
The deal mirrors a related $112.4 million senior lien tax increment revenue bond issue sold by Hoffman Estates in October 1990 that also did not come under Illinois' private-activity cap.
In that deal, which was backed by a direct-pay, irrevocable letter of credit from the Union Bank of Switzerland, $82 million of the bond proceeds were granted to Sears as reimbursement for the mostly undeveloped land it acquired in the suburb, 29 miles northwest of Chicago.
While a tax increment deal is normally considered a private activity under the Tax Reform Act of 1986, the two deals were structured in such a way to take advantage of the 10% private-use, 10% private-security tests that define a bond issue as a private activity if both tests are met.
With the first deal, the private-use test was met because the majority of the bond proceeds went to Sears, a private corporation. Neither Sears nor any other private entity provided security for the bonds, however, which made the deal fail the security test, allowing the bonds to bypass the volume cap.
With the proceeds from the upcoming issue going toward public roads, utility and sewer work, as well as land acquisition, it fails the private-use test, while meeting the private-security test with Sears providing security for the bonds, according to attorneys at Chapman and Cutler, Hoffman Estates' bond counsel.
A key component of failing the private-use test is the planned presence of a village park fire station, municipal center, and a satellite campus of a public university on about 18 acres of the the 788-acre development site.
Another 85 acres will be used for public streets, eastments, and sewer lines. Steve Conlon, an attorney with Chapman and Cutler, said the public is expected to use the roads to access the facilities and cross through the entire site. While Hoffman Estates will use $12 million of bond proceeds to purchase the 103 acres from Sears, Mr. Conlon said the bond issue would continue to fail the public-use test because the ultimate use of the 103 acres is public.
Having Sears' guarantee behind the bonds "is what really makes this transaction tick," said Mark Florian, a vice president at Goldman, Sachs & Co., the senior managing underwriter for the deal.
Moody's Investors Service rated the issue A2, a corporate rating. A rating from Standard & Poor's Corp. was not available late Friday afternoon.
For its part, Sears has an unconditional obligation to pay principal and interest on the bonds if tax increment revenues are not sufficient. In addition, Sears, as it does for its own corporate debt obligations, has agreed to maintain its unencumbered assets of at least 150% of its liabilities.
"The idea of that is [Sears] has to maintain a substantial unencumbered asset position to ensure [the firm is] liquid and able to pay [its] debts," Mr. Florian said.
If Sears has to pay debt service on some of the bonds, Douglas Ellsworth, Hoffman Estates's finance director, said the retailer would be reimbursed with interest when incremental revenues become available. Mr. Conlon said the fact Sears may have to pay the debt service, however, does not meat the bond issue would meet the private loan test, also contained in the federal tax act. That is because Sears would essentially be lending the money to a public entity, an arrangement that would not meet the loan test, he said.
Sears has the ability to replace its security on the bonds if it substitutes, with the village's approval, a credit facility that carries a double-A or better rating. The substitution would also require the opinion of bond counsel that the bonds will continue to be tax exempt and that the substitute credit facility is enforceable.
"What we wanted to do is essentially comfort the investor that it for some reason Sears, which is a very large, very strong corporation, is not there guaranteeing the bonds, they'll have at least a double-A or better strong credit instrument in place instead of Sears," Mr. Florian said.
Mr. Ellsworth said potential investors, while looking at the yield on the bonds, are going to evaluate them from the standpoint of Sears ability to pay "because there is no known revenue stream at this time" to pay debt service after a few years on the junior lien bonds.
Underlying all of the bonds is Hoffman Estates' limited obligation, payable solely from a portion of tax increment revenues derived from the development. For the junior lien bonds, however, incremental tax revenues are not expected to be available until more development takes place on the remaining 570 acres of land.
"We're going to have to have more development kicking in in the late 1990s," Mr. Florian said. "By that time, we will need significant future development in order to pay these bonds just from tax increment revenues."
The 788-acre site along the Northwest Tollway is zoned for up to 12 million square feet of office, light industrial, hotel and retail development. For its merchandise group complex, Sears plans to use about 2 million square feet, leaving about 10 million square feet available for future development.
There are no "concrete plans" at the present time for any further development, according to Mr. Ellsworth, who added that Sears has disclosed the possibility of a hotel development on the site.
Still Mr. Ellsworth was optimistic the site would attract development just as the Sears Tower, the world's tallest building, did when it was built in the mid-1970s on the then-sparsely developed southwest corner of downtown Chicago.
Mr. Ellsworth pointed out the deal was structured to allow capitalized interest to pay debt service on the bonds in the first few years.
According to the preliminary official statement dated Oct. 11, $32.8 million of the issue will consist of current income bonds that carry maturities from 1996 to 2002. The other $38.7 million of bonds will be capital appreciation zero coupon bonds that mature from 2003 to 2008.
In addition, the junior lien bonds can use any revenues left over from the senior lien bonds, whose debt service was set up solely on incremental revenues from the Sears merchandise group development. But those revenues must first flow to Hoffman Estates and 14 other taxing districts for a share of the property tax growth and then to the $112.4 million of senior lien bonds.
A wrinkle in the revenue stream for both bond issues is the yet unknown, but potentially negative impact of a new law effective in 1992 that requires taxing districts in Cook County, where Hoffman Estates is located, to use their prior year equalized assessed valuation in calculating their levies.
Patricia Curtner, a partner at Chapman and Cutler, said this could lower the amount of taxes collected by the taxing districts and therefore lower the amount of incremental taxes collected from a tax increment district. In addition, a bill is pending in the Illinois General Assembly that would limit increases in annual property tax collections in Cook County to 5% or the rate of inflation, whichever is less. Ms. Curtner said it was premature to comment on the bill until it is in final form.
Co-managers on the deal are Bear, Stearns & Co., William Blair & Co., Grigsby Brandford Powell Inc., and Merrill Lynch Capital Markets.
The use of tax increment financing to fund Sears' acquisition of the Hoffman Estates site was made possible by a 1989 state law that enabled the financing to be applied to non-blighted so-called economic development areas. That and a $61 million in state grants succeeded in keeping Sears from leaving Illinois after it announced in 1988 it was putting the Sears Tower up for sale as part of a corporate restructuring and moving most of its operations to lower cost quarters.
Mr. Ellsworth said the construction on the group headquarters was on schedule for an August or September 1992 occupancy.
