DALLAS — After years of financial struggle, the outlook for Arizona and debt issued on behalf of the state School Facilities Board is improving, according to credit analysts.
Both Standard & Poor's and Moody's Investors Service revised their outlooks on Arizona to positive in advance of this week's $225 million refunding of School Facilities Board debt, five years after the last downgrade.
"The positive outlook reflects our belief that there is at least a one-in-three chance we could raise our issuer credit rating on Arizona one notch within the next year," analysts David Hitchcock and Matthew Reining wrote in affirming the A-plus rating on the SFB's certificates of participation.
S&P downgraded Arizona's issuer credit rating to AA-minus from AA in 2009.
Moody's positive outlook on its Aa3 Arizona rating also comes five years after a downgrade.
Moody's analysts Kenneth Kurtz and Lisa Heller attributed the positive outlook to "recent strong economic trends and the expectation of continued growth in the near term, combined with improvement in the state's liquidity and general fund balances."
The 2014 COPs, rated A1 by Moody's, represent the second refunding of 2003 and 2004 issues, making the certificates taxable.
The new issue will be priced Tuesday through negotiation with senior manager Bank of America Merrill Lynch, with managing director Jeffrey Bower as lead banker. Grant Hamill, managing director at Stifel, Nicolaus & Co. is financial advisor.
Dean Gray, executive director of the Arizona School Facilities Board, said the board has $1.02 billion of COPs outstanding, $387.7 million of school improvement revenue bonds and $109.9 million of state school trust revenue bonds.
No maturities are being extended as a result of this refunding. Almost all of the debt service savings will be taken upfront in fiscal 2015 to provide about $7 million to $9 million of state general fund budget relief, according to S&P.
After relying on the sale of state buildings, leveraging the state lottery, deep spending cuts and a temporary sales tax to make ends meet since 2009, Arizona is on track to achieve structural balance in fiscal 2016, the analysts said.
One obstacle in that path could be court rulings that require the state to repay funds withheld during the recession.
The Arizona Supreme Court ruled Sept. 26 that the state did not provide inflation adjustments in school funding during fiscal years 2010-2013 as required under voter-approved Proposition 301, although it budgeted an inflation adjustment in fiscal 2014.
"Whether the court ruling affects only future years' budgets, or requires a full retroactive back payment of about $1.2 billion in prior-year missed payments, is still under litigation," Hitchcock and Reining noted.
"In our opinion, the ruling diminishes future state expenditure flexibility on school funding," they added. "Approximately 60% of the general fund was protected from legislative budget reductions in fiscal 2013 due to voter initiatives and federal expenditure requirements."
Another court ruling also overturned earlier pension reform that reduced pension cost of living adjustments.
At the urging of Gov. Jan Brewer, lawmakers and Arizona voters approved a temporary one-cent sales tax increase in 2010 to get the state through its leanest years.
The sales tax rate hike produced about $924 million per year, allowing Arizona's fiscal picture to improve greatly in fiscal years 2012 and 2013. However, the temporary sales tax surcharge expired June 30, 2013 contributing to a combined fund balance drawdown in fiscal 2014 to $1.1 billion, or 12% of general fund expenses.
Arizona plans to use the large accumulated surplus built up earlier to continue to bridge budget deficits until fiscal 2016, when it projects structural balance.
The state ended fiscal 2014 with an estimated $601 million unreserved general fund balance, a huge improvement from fiscal year-end 2009, when the state had essentially nothing in its rainy-day fund and a negative $481 million general fund balance.
The state budget office estimates that fiscal 2015 will have a structural general fund deficit of about $193 million, after 5.5% assumed revenue growth. However, the state joint legislative budget committee projects lower 3.6% revenue growth and a larger $492 million structural deficit.
The School Facilities Board was created in 1998 by the Students First Act in response to an Arizona Supreme Court ruling that found the state's previous provisions for school district capital needs unconstitutional.
Students First requires Arizona to bring facilities up to certain minimum standards, as well as to provide new facilities to serve enrollment growth.
The Bank of New York Mellon Trust Co. N.A, the trustee, leases the assets to the SFB under a lease-to-own agreement and the SFB, in turn, subleases the facilities to the school districts under separate sublease agreements.
The obligation of the SFB to make lease payments is absolute and unconditional, subject to annual appropriations by the state legislature and annual allocations of such appropriations by the SFB for lease payments.
Each series of COPs is separately secured by its own lease, with lease security consisting of the of school facilities financed by each series of COPs or the COPs that were refunded. Debt service payments are due on a semi-annual basis every March 1 and Sept. 1.
Under the terms of the leases and sublease agreements, the school districts are ultimately responsible for the operation and maintenance of the facilities, including insurance requirements. Each series of COPs is separately secured by its own lease, with lease security consisting of the of school facilities financed by each series of COPs or the COPs that were refunded.
The tax that backs the SFB's $800 million of outstanding debt expires on June 30, 2021, which places a limit on bond maturities. The state levies the 0.6% tax on the sales or income from retail activity but excluding hotels, mining, and certain other types of business.
The SFB refunded more than a third of its outstanding debt in March 2013 with a $315.4 million taxable issue.
While Arizona is still growing, the pace of school construction has slackened since the recession hit the state in 2008.
Plummeting home values had wide-ranging effects, including construction-related sales tax declines, personal wealth loss, and decreases in assessed value that affected local governments.
The S&P Case-Shiller Phoenix metropolitan housing price index fell 56% between June 2006 and September 2011, before bouncing back 44% through February 2014. The rebound includes a 13% increase in the past 12 months, although prices are still well below the pre-recessionary peak.
Even during the downturn, however, the state's population growth remained above that of the U.S., with affordable housing prices appearing to be a draw for new arrivals.
The state joint legislative budget committee estimates a median home price in the Phoenix area of $195,000 as of February 2014. IHS Global Insight Inc. forecasts 2.3% job growth in 2014 and 2.8% in 2015, driven by construction, retail, and service sectors, although it also estimates that job levels are still only at 94% of the pre-recessionary peak and forecasts job levels will not return to pre-recession levels until 2015.
"Fundamentally, we believe Arizona still enjoys a broad and diverse economy supported by a growing population of 6.6 million that for now, following recent declines in construction employment, has employment sector concentration similar to that of the nation," Hitchcock and Reining wrote.
