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Arizona COPs Feel The Heat

DALLAS — Last week’s downgrades of Arizona’s debt by two rating agencies will have its most immediate impact on the sale of $735 million of certificates of participation to raise cash for the financially strapped state early next month.

But the continuing negative outlooks from Moody’s Investors Service and Standard & Poor’s illustrate Arizona’s ongoing financial distress as lawmakers continue efforts to balance the budget.

With the current budget running $1.5 billion short of revenue, lawmakers next month will also face a $3.6 billion shortfall in the fiscal year starting July 1.

In an emergency meeting of her cabinet last week, Gov. Jan Brewer made no effort to ­minimize Arizona’s fiscal peril.

“We are faced with some of the worst days in our 97-year history,” she told the cabinet. “We’re in a state that’s living off credit, off its borrowings, and off money we owe parties we didn’t bother to seek loans from but just simply haven’t paid. Arizona’s cash-flow difficulties are so profound, we’re living on borrowed time. And the clock never, ever stops ticking.”

With most of the state budget going toward education, Arizona’s biggest concern is funding schools. To maintain payments to school districts as required by law, Treasurer Dean Martin has been forced to borrow funds, both internally and externally.

The COPs, expected to be issued on or about Jan. 13, will provide funds for a school aid payment due in February. The debt will be secured by lease payments made by the state on state buildings.

Although Arizona has sold and leased back buildings before, this deal is believed to be the first designed to use proceeds for state operating costs.

Public schools are potentially affected by the downgrades as well. The state’s issuer rating from Standard & Poor’s fell to AA-minus from AA, and the one from Moody’s fell to A1 from Aa3. But the ratings on the COPs, which are used to finance school construction, dropped to A-plus from AA-minus and to A2 from A1.

The downgrade affects the underlying rating of $580 million of certificates issued by the Arizona School Facilities Board in November 2008. The school COPs retain AAA ratings from Standard & Poor’s due to insurance provided by Assured Guaranty Municipal Corp., but that rating has a negative outlook.

The 2008 COPs were used to fund construction of school facilities in the current fiscal year and to reimburse the state’s general fund for construction paid for with cash in fiscal 2008 and 2009.

Under the school lease arrangements, the School Facilities Board must make lease payments, subject to annual appropriations by the Legislature and annual allocations by the board. The SFB agrees to use its best efforts to make lease payments on more than 20 school facilities under construction or recently completed.

At her cabinet meeting, Brewer outlined a multi-point plan to reduce spending, including deferred payments to public schools and universities.

“The heart of our crisis is cash,” Brewer said. “We needed to borrow $700 million just to get through December. In January, we plan on borrowing an additional $700 million by financing significant state assets.”

Arizona’s issue of “deficit bonds” was cited as a factor in Moody’s downgrade of the credit and the negative outlook.

“The downgrade of the state’s issuer rating reflects Arizona’s ongoing economic and financial weakening, leading to significant revenue underperformance, sizable budget deficits, significant structural budget imbalance, and increased tightening of liquidity,” analyst Maria Coritsidis wrote in a report also researched by backup analyst Kimberly Lyons and senior credit officer Edith Behr. “In addition, it reflects a depletion of reserve balances, and a strong and ongoing reliance on one-time resources to balance the state’s budget, including issuance of deficit bonds.”

Standard & Poor’s cited 2009’s sharp 18.4% drop in tax revenues — the largest percentage loss in decades, including a nearly 25% drop in individual income tax collections.

“Coming on the heels of a fiscal 2008 budget in which revenue forecasts were lower than original projections, fiscal 2009 was a very challenging year for state revenue,” analysts Matthew Reining and David Hitchcock wrote.

Through four special sessions in the current fiscal year, lawmakers continued to trim spending, with the most recent session cutting the shortfall only slightly to $1.5 billion. While praising lawmakers for making additional cuts, Brewer urged them to get ahead of the falling revenue curve.

“At the current pace, we won’t even resolve the 2010 budget deficit until 2013,” she said.

While analysts note the state’s low ratio of per-capita debt, the falling revenue makes Arizona one of the hardest-hit states in the nation in terms of budget crises.

The S&P/Case-Shiller national housing index composite found a 22% year-over-year decline from September 2009 in the median sales price for existing single-family residences in the Phoenix market. That represents the second most negative one-year change performance of the 20 cities listed in the index, second only to Las Vegas.

Despite the large decline, prices are showing signs of stability, analysts note. Prices are up 6% from May 2009, which was the lowest price in 10 years. Data from the Mortgage Banker Association show foreclosures starts are still increasing but at a much slower rate.

As of November 2009, one in 185 homes received a foreclosure filing, ranking Arizona the fifth-highest in the nation in foreclosure filings, according to a report released by RealtyTrac Inc.

Brewer, a Republican, envisions a voter-approved increase in the sales tax as one way out of the budget crisis. Under her plan, voters would be asked next spring to approve the tax hikes for three years to ease the strain of falling revenue.

However, Standard & Poor’s notes the difficulty of squeezing a tax increase out of the state’s conservative voters.

“Voter-approved propositions have made it more challenging to raise revenues while simultaneously protecting voter-approved programs,” analysts wrote. “Proposition 108 requires a two-thirds legislative vote (or a general voter majority) to increase state revenues. Given the state’s budget impasse in mid-2009, this requirement comes at an especially challenging time.”



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