Deal in Focus

Arizona Back to Selling Buildings

DALLAS — Arizona expects to raise $300 million for its general fund today by mortgaging state office buildings, prisons, and other property in its second issue of certificates of participation this year.

Senior manager Morgan Stanley will take retail orders first with co-managers Barclays Capital, Citi, Stone & Youngberg, and Wells Fargo Securities. RBC Capital Markets is the state’s financial adviser,  Squire, Sanders & Dempsey is bond counsel, and Greenberg Traurig is underwriters’ counsel.

The COPs are insured by Assured Guaranty, providing a AAA rating from Standard & Poor’s and Aa3 from Moody’s Investors Service. Both carry negative outlooks. The certificates carry underlying ratings of A-plus from Standard & Poor’s and Aa3 from Moody’s, also with negative outlooks.

The 2010B issue is the second time this year Arizona has raised money to pay bills from the sale and leaseback of state buildings. In January, it sold $735 million of COPs at an average interest rate of 4.57% over 20 years. The deal drew more than $1 billion of orders.

“For the state to be able to borrow $735.4 million over a 20-year period at an interest rate of 4.57% is very helpful in addressing the state’s fiscal challenges, and reflects well on investors’ view of the state and the governor’s efforts to address budgetary concerns going forward,” said David Raber, interim director of the Arizona Department of Administration.

Despite the state’s weakened fiscal condition and need to address projected budgetary shortfalls in the current and future fiscal year, investor interest was high due to the dependence on the facilities used as collateral, Raber said. The facilities sold in January included the Executive Tower, legislative buildings, the Department of Public Safety headquarters, various state prison facilities, and other assets.

Similar buildings are being sold this week, including the Arizona State Hospital, the Department of Public Safety building in Tucson, more state prisons, and state fairgrounds buildings.

Some of the properties to be sold were covered by COPs that expire Sept. 1, provided the state makes its final lease payment of $25 million. The total value of the properties to be sold in the 2010A and B deals exceeds $1 billion, according to the Department of Administration, which oversees bond sales for the state.

The Legislature authorized the sale and leaseback of the buildings as part of the budget solutions for fiscal year 2009-10, which ends June 30. The assets are nominally sold to a bank trustee and immediately leased back to the state for the 20-year term of the financing.

Arizona retains control of the facilities and continues to operate them as it normally would, subject to making the annual lease payments. The bank trustee uses the proceeds of the certificates sold to investors to buy the facilities from the state. At the end of the financing term, when the certificates are repaid, the facilities are automatically released as collateral.

The decision to sell the state buildings prompted criticism of the Republican Legislature and Gov. Jan Brewer, particularly from Treasurer Dean Martin, who is running against Brewer in the Republican primary for governor in August.

“It was a mistake to sell the Arizona Lottery revenue and our state buildings because it continues to put our state’s credit rating at risk and looks foolish to the rest of the country,” Martin said.

The lottery revenue was used to leverage a $450 million revenue bond issue last month. The proceeds of that issue were also used to pay state operating costs.

For the 2010-11 fiscal year, which starts July 1, the state added one cent to the sales tax to raise $1 billion per year for three years. That increase was approved by voters last month to avoid deeper cuts in education and other services after years of reductions amid falling revenue.

“The state will face ongoing cash-flow pressures until permanent state spending aligns with permanent revenues,” Martin said. “Ironically, passing a temporary tax increase makes IOUs more likely in the future.”

Even with that additional sales tax revenue, Martin said, Arizona will have to issue more IOUs in the form of warrants if voters do not also approve fund sweeps from state agencies. In the November election, voters will be asked to adjust the First Things First program, which would move an estimated $325 million in tobacco tax revenue used for childhood services into the general fund.

Another ballot measure would transfer $123 million from land conservation funds into the general fund. The budget also includes $60 million in relief from refinancing debt from the Arizona School Facilities Board.

Through May 12, Arizona has issued $86.5 billion of treasurer warrant notes at a cost of $3.5 million and an average interest rate of 0.93%, according to Martin.

With the two series of COPs, the state will make lease payments twice a year, peaking at $85.7 million in September 2029. For investors, the greatest risk is that the state will not appropriate lease payments in any given year.

The COPs are allowed under Arizona’s constitution because, technically, they do not encumber future legislatures with debt payments along the lines of general obligation bonds. Under the constitution, the $350,000 of GOs allowed is so small that they are effectively banned. However, some lawmakers are considering raising the limit on GO debt.

Arizona’s fiscal crisis — considered the worst in the nation on a per-capita basis — took its most serious turn in 2008 with the collapse of the housing bubble. The Legislature and then-Gov. Janet Napolitano were forced to deal with budget shortfalls beginning in 2007.

Since their peak in fiscal year 2006-2007, revenues have fallen about 34% as major social services grew. The state Medicaid system added more than 200,000 new members last year.

With Napolitano’s ascension to the Obama’s administration as secretary of homeland security in 2009, Brewer, then Arizona secretary of state, became governor, returning the office to GOP control.

Brewer faced an immediate and ongoing fiscal crisis, requiring her to call a series of special sessions of the Legislature in 2009. With disagreement over how to solve the budget crisis, the governor refused to sign the first budget presented to her after the constitutional deadline last July. In March, she signed a budget that included a sales-tax hike designed to help overcome a $2.6 billion shortfall.

Throughout 2009, the government continued to operate with an unbalanced budget that prompted a series of downgrades.

Standard & Poor’s lowered Arizona’s issuer rating one notch to AA-minus from AA on Dec. 23. The same day, Moody’s downgraded the state to A1 from Aa3. Both agencies maintained negative outlooks, citing the state’s continuing financial troubles and use of one-time solutions to its revenue crisis.

Calling the fiscal 2010 budget “an ever-evolving document,” Standard & Poor’s outlined Arizona’s chronic shortfalls that prompted seven special sessions over a year’s time.

“We believe continued significant financial deterioration — including potential prolonged budget-balancing inaction in the event of further revenue declines — could also impede a return to structural budgetary balance, which could pressure the rating,” analysts wrote. “If the state were to bring its financial performance into a more structurally balanced position, we could revise the outlook to stable.”



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