DALLAS - Arizona will call on the debt market to help finance schools in the state for the first time since 2005 with this week's negotiated sale of $581 million of certificates of participation by the Arizona School Facilities Board.
The state has been responsible for funding public school construction since 1998, and in 2003, 2004, and 2005 issued similar COPs under an identical program to provide the necessary money. The ASFB currently has $479.3 million in outstanding debt from the five sales during that period.
The Legislature replaced that funding with a pay-as-you go program, financed from the general fund, in the budget for fiscal 2006. However, the state's economy began cooling in 2007 and worsened in 2008, and earlier this year debt financing was revived as the chief funding source for school construction in the fiscal 2009 budget.
Proceeds from this week's sale will provide $344 million to reimburse the general fund for school construction expenditures in fiscal 2008 and earlier years and $117 million to reimburse the state for construction appropriations in fiscal 2009. New school facilities will receive $120 million, including $8 million allocated by the Legislature for facility costs associated with full-day kindergarten.
A retail sales period is scheduled for Wednesday, with institutional sales on Thursday. The COPs are rated A1 by Moody's Investors Service and AA-minus by Standard & Poor's.
There was no consideration given to postponing or delaying the sale due to market conditions, according to Grant Hamill, managing director of Stone & Youngberg LLC, the financial adviser for the School Facilities Board.
"This sale is being driven by the needs of the state of Arizona in addition to the needs of projects financed by the board," Hamill said. "Because of the large portion of the proceeds that will reimburse the state for expenditures already made, there is a strong desire by the state to have this sale and get those dollars back into the general fund."
The underwriting team includes senior managers RBC Capital Markets and JPMorgan, with co-managers Citi, Merrill Lynch & Co., Ramirez & Co., and Wachovia Bank NA. Squire, Sanders & Dempsey LLC is the ASFB's bond counsel.
A decision on bond insurance will be made at the time of the sale, Hamill said.
"We had good bids from Assured Guaranty and Financial Security Assurance, and we'll evaluate those to see if bond insurance makes sense in the market we're in closer to the sale," he said.
A good retail period is crucial to a successful sale of the board's debt, Hamill said.
"Our goal was to orient this sale to the retail investor, to generate a significant amount of interest from that sector," he said. "We hope it will develop its own momentum. But if there is not sufficient interest to complete the sale, we could pull it from the institutional period and bring the balance back to the market in the first half of 2009. We are not going to chase the market. It probably won't happen, but we are prepared to do so."
The structure of the deal is identical to the earlier sales, according to John Arnold, executive director of the ASFB. The board issued a total of $900 million of COPs over fiscal years 2003, 2004, and 2005 to finance local school construction in 30 of Arizona's 228 school districts.
Each district that uses the proceeds to build schools will lease the facility sites to Bank of New York Mellon Trust Co. as trustee. The trustee will then lease all the sites plus improvements to the School Facilities Board under a master lease, and the board will sublease the facilities to the districts. The certificates will be supported by the board's payments, appropriated by the Legislature, under a lease-to-own agreement. When the 15-year notes mature, the districts will own the facilities.
"We're returning to exactly the same process we had before the Legislature preferred to replace debt financing with general fund revenues to pay for schools in this state," Arnold said. "We're on a year-to-year basis with this, and future efforts will be determined by state revenues."
If the current outlook prevails in Arizona, the state may be looking at more debt sales for school construction.
Officials said general fund collections in the first quarter of fiscal 2009 are down $200 million, some 9% lower than expected, due to continued declines in sale and income tax revenues. The governor's budget office now expects a budget shortfall in fiscal 2009 of up to $800 million, with the Joint Legislative Budget Committee estimating the shortfall at between $700 million to $1.1 billion by the end of the fiscal year.
"I think the state's school financing plan will be evaluated by the Legislature year to year," Hamill said. "It is completely dependent on the state budget situation."
The tight budget has caused a slowdown in school construction in Arizona, Arnold said.
"We have a moratorium on school construction right now," he said. "The Legislature gave us the authority to finance projects that were under construction, but no new construction was authorized. The last high school we started was in February."
All the projects financed with the proceeds are expected to be completed by Sept. 1.
Under the state's school financing plan, the ASFB provides districts with money to build a basic school. If a local school district wants amenities such as a gymnasium or landscaping, it must ask voters to approve a tax override or authorize the sale of bonds.
The board's sale was originally sized at $593 million, but a school district that was to receive $12 million to upgrade its cooling system instead opted for a bond issue to pay for the equipment, Arnold said.
The board provides funding on a square-foot basis, he said, which has been raised recently but is still at a bare-bones level.
"We raised the funding due to the rapid increase in construction costs since we began this program," the board's executive director said. "Construction inflation was at the 13%-a-year level in 2004, but then it dropped to 7% in 2006. It's about 4% to 5% now, which is better than the peak but still significant."
The slowdown in Arizona's economy is not only lowering the construction inflation rate, Arnold said, but is also reducing the influx of new students.
"Student growth has slowed from an average of 20,000 new students a year to an overall state increase of about 10,000 this school year," he said. "Some of the faster-growing districts are still under tremendous pressure to build enough facilities and we have a moratorium on financing new schools."
In addition to $479 million of outstanding certificates of participation, the ASFB also has $573 million of outstanding sales tax bonds and $200 million of outstanding revenue bonds backed by State School Land Trust and State School Permanent Fund expendable revenues.
