Uniting sales tax and RLF for capital funding: Fayetteville, Arkansas case study

Stephen Davis, Budget Manager, City of Fayetteville, Arkansas
Blaine Bickel, Senior Management Consultant, Black & Veatch Corporation, Kansas City, Missouri

Fayetteville, Arkansas provides wastewater collection and treatment services to approximately 24,000 customers inside and outside the city on a retail basis and treatment services to one area community on a wholesale basis. The city's discharge permit allows for a split discharge into the White River and Illinois River watersheds, and the existing treatment plant is located in the White River watershed.

The city initiated a comprehensive wastewater system study in 1995 that resulted in the Wastewater Facility Plan published in 1997. The study was conducted to determine the wastewater collection system and treatment needs based on the year 2020 General Plan population projection of 85,090.

The study concluded that the city needed additional capacity to meet future needs based on the 2020 General Plan population projection. It described the treatment capacity of the existing wastewater treatment plant and the capacity required to support the city's future housing and business development plans. The city subsequently decided to construct a new treatment plant in the Illinois River watershed, which will eliminate the need for six existing pump stations.

Fayetteville is perceived by its customers as having the highest water and sewer rates in the region. In developing the financing plan for the new treatment plant, city staff and advisors considered those customer perceptions as well as the substantial number of system users who are visitors to the city.

Evaluation of Funding Options
The city retained Black & Veatch to evaluate three funding options: (1) Issuing revenue bonds that would be repaid from sewer revenue, (2) Securing a Revolving Loan Fund (RLF) loan that would be repaid from sewer revenue, and (3) Securing an RLF loan that would be repaid from sales tax proceeds. The consultant developed a spreadsheet model for calculating the additional sewer revenue required to meet anticipated increases in operation and maintenance expenses associated with the new facilities; pay additional principal and interest on revenue bonds or the RLF loan; and meet requisite debt service coverage. The analysis compared total project costs, impacts on future sewer revenue adjustments, and impacts on customers' sewer bills for the three options.

Option 1 — Issuance of Revenue Bonds with Principal and Interest Repaid from Sewer Revenues
Municipal utilities traditionally fund major capital improvements by issuing revenue bonds and repaying the principal and interest from annual revenues. The City of Fayetteville had previously used revenue bonds to finance wastewater system improvements.

Bonding capacity for revenue bonds is a function of the net revenue available after payment of operation and maintenance expenses. If revenue under existing rates is insufficient to meet debt service coverage requirements, rate schedule adjustments must be made.

Based on projected customer growth in the Fayetteville service area, revenue under the existing sewer rate schedule is estimated to total $9,389,000 in 2006, the initial year of operation of the new treatment plant. Assuming a 20-year life and an average interest rate of approximately five percent, issuance of $120,000,000 in revenue bonds will result in annual principal and interest payments of approximately $9,609,000, with approximately $72,180,000 in interest paid over the life of the bonds.

Analysis of Fayetteville's interest income and other revenue and the $4,054,000 in additional operation and maintenance expenses associated with the new facilities in 2006 revealed that implementing this option—issuing revenue bonds and repaying principal and interest from sewer revenues—would require a revenue adjustment of approximately 157 percent to meet projected revenue requirements in 2006. If sewer rates were increased by this percentage across the board, this funding option would increase the average sewer bill for a single-family residential customer from $17.60 to $45.27 per month.

Option 2 — RLF Loan with Principal and Interest Repaid from Sewer Revenues
The Arkansas Soil and Water Conservation Commission has committed to giving Fayetteville an RLF loan. This option assumes principal payments are made semiannually over a 20-year period with interest on the outstanding balance calculated at 3.25 percent. Annual principal and interest payments under this option were calculated at approximately $7,865,000, with approximately $42,296,000 in interest paid over the life of the loan.

Consideration of revenue and the additional operation and maintenance expenses associated with the new facilities led Black & Veatch to determine that this option—an RLF loan with principal and interest repaid from sewer revenues#151;would require a revenue adjustment of approximately 134 percent to meet projected revenue requirements in 2006. If sewer rates were increased by this percentage across the board, this option would raise the average sewer bill for a single-family residential customer from $17.60 per month to $41.19 per month.

Option 3 — RLF Loan with Principal and Interest Repaid from Sales Tax Revenues
Under this funding option, which proved most attractive and was ultimately adopted, the city is proceeding with an RLF loan and will draw upon that loan authorization during construction of the new treatment plant—similar to using a line of credit to pay construction costs. An annual interest rate of three percent must be paid on the outstanding balance during the three-year construction period; however, principal payments wouldn't begin until the treatment plant comes on line in 2006.

The loan will be repaid from the proceeds of a dedicated 3/4-cent sales tax, which was approved by the electorate in November 2001. The proceeds will exceed anticipated interest payments during the construction period, and this additional revenue will be used to reduce the outstanding principal amount of the loan in 2006.

Because all principal and interest payments will be paid from sales tax proceeds, the additional cost to be borne by sewer revenue is limited to increased O&M costs associated with the new facilities. A revenue adjustment of approximately 29 percent will be necessary to meet projected revenue requirements in 2006. If sewer rates are increased by this percentage across the board, the average sewer bill for a single-family residential customer would increase from $17.60 to $22.76 per month.

The city anticipates applying the sales tax proceeds accumulated in excess of interest payments during the three-year construction period to make an initial principal payment of more than $22 million in April 2006. In subsequent years, sales tax proceeds should approximate the annual principal and interest payments required to retire the balance of the loan by January 2015.

Sales tax funding appealed to Fayetteville's city council because it enables residents and visitors to share the financial burden for infrastructure improvement. Visitors are substantial users of Fayetteville utility services. Analysis of the city's sales tax revenue indicates that approximately 45 percent of local sales and use taxes are paid by visitors. Fayetteville is also a regional shopping destination for a seven-county area encompassing northwest Arkansas, eastern Oklahoma, and southwest Missouri. In addition, the city is home to the flagship campus of the University of Arkansas, a major area employer that has a student population of approximately 15,000 and attracts many visitors.

To reach Stephen Davis, call 479-575-8296 or send e-mail to sdavis@ci.fayetteville.ar.us; to reach Blaine Bickel, call 913-458-3614 or send e-mail to bickelbw@bv.com.