DALLAS — In the wake of a Moody’s Investors Service downgrade, the Arizona School Facilities Board is preparing to sell $62 million of refunding certificates of participation to help overcome the state’s record budget shortfall.
The COPs, expected to price this week or early next week, are designed to ease debt service in the current fiscal year by pushing payments farther into the future.
With the next lease payment on the existing COPs due Sept. 1, the board needs to get the refunding to market as soon as possible to avoid that payment, said Randie Stein, vice president at financial adviser Stone & Youngberg and a former interim director at the facilities board.
The refunding is led by senior manager Citi, with JPMorgan and Wedbush Morgan Securities as co-managers. Squire Sanders & Dempsey serves as bond counsel.
The certificates are expected to be insured by Assured Guaranty Municipal Corp., which carries ratings of Aa3 from Moody’s and AAA from Standard & Poor’s.
In the most recent pricing in June, Arizona COPs with an Assured wrap and a 5% coupon maturing in 2029 drew initial yields of 4.777%, a spread of 115 basis points against the generic triple-A Municipal Market Data average. In more recent trades, yields have fallen to 4.61%, or 100 basis points above the MMD average.
The upcoming deal is one of several debt offerings in 2010 intended to keep Arizona solvent. The struggling state has raised more than $1 billion from the sale and lease back of state buildings and leveraged $450 million of lottery revenues in May for another cash infusion into the general fund.
Reliance on one-time budget-balancing maneuvers was cited as a factor in Moody’s decision to downgrade Arizona to Aa3 from Aa2 and to lower the School Facilities Board COPs to A1 from Aa3. The A1 rating applies to all appropriations debt, which includes the certificates.
Last week’s rating action was the second in less than eight months as Arizona has been forced to deal with tumbling revenue and rising costs for state services. Despite the two downgrades, the government’s issuer credit rating is just one notch lower than it was last December because of ratings recalibrations.
The largest demand on the state budget comes from school districts. The deficit bonds were designed to raise payments that had been pledged to schools amid falling revenues.
“Due to enacted expenditure mandates, tax cuts, a significant slide in the housing market, and an increasing reliance on non-recurring budget solutions including the issuance of deficit bonds, state budget deficits and structural imbalance have grown materially since fiscal 2009,” Moody’s analyst Maria Coritsidis wrote in last week’s report.
According to a report from the Joint Legislative Budget Board last week, Arizona has used $12.5 billion in one-time budget solutions to deal with shortfalls over the past four years.
Debt and lease financings have accounted for $2.1 billion, with $2.2 billion from permanent spending reductions, $918 million from a penny sales-tax increase approved by voters May 18, and $1.5 billion in rollover and payment deferrals, among other actions.
Standard & Poor’s this month maintained ratings of A-plus for the school COPs and AA-minus for the state’s issuer credit rating, but the outlook is negative.
“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,” Standard & Poor’s analyst Matthew Reining wrote.
Arizona’s budget crisis has played out against a political drama that has at times pitted Republican Gov. Jan Brewer against GOP legislative leaders and, more recently, against state Treasurer Dean Martin.
In an extraordinary showdown that ended with Martin suspending his campaign to unseat Brewer in the August Republican primary, the state’s short-term borrowing became a political hot potato that forced the two top officials to revamp cash-flow plans.
After the treasurer ended plans to extend a $700 million line of credit from Bank of America into the current fiscal year, Martin blamed Brewer for failing to attend a meeting of the three-member State Loan Commission and failing to cast the decisive vote in favor of the loan.
Officials in Brewer’s office said the governor had heard no indication that Martin planned to end the loan agreement and they were shocked that the deal died so abruptly.
The state, through Martin, had relied on the line of credit several times in the previous fiscal year to make payments to the schools when revenues were unavailable.
Then, on Friday, after Martin suspended his primary campaign, he announced an agreement with Brewer to alter the payment schedule for school districts and reversed his previous statements that Arizona could not make it through the year without short-term borrowing or further budget cuts.
“While the cash-management plan will avert the need to borrow funds to pay general fund bills in the immediate future, the state still has a long way to go to closing the structural budget deficit that exists,” Martin said.
The new plan will smooth payments to school districts throughout the year instead of the original plan to pay seven monthly payments during the first five months of the year. Now, schools will get five payments during the first five months.
Because of the new cash-management plan, Martin said Arizona will not need outside sources of funds.
Voters will decide in November whether the state can take funds from programs that had dedicated revenue streams. With passage of those measures, the government will need little additional internal borrowing, Martin said.
“The cash-management plan we recommended, and the governor’s budget office plans to implement, will allow the treasurer’s office to focus on its core function of stretching the tax dollars paid to the state to earn funds for state agencies, local governments and the state general fund,” he said.
While most of the budget maneuvering, including the one-cent sales tax hike in May, was designed to protect schools from further cuts, they still took a hit.
The Arizona Department of Education saw $293 million in cuts in the 2010 budget.
Although the state is scheduled to receive $4.8 billion in grants from federal American Recovery and Reinvestment Act funding, it must maintain education funding at 2006 levels to qualify. The governor’s office projects that 73% of the fiscal 2010 expenditures are federally protected and 67% are similarly protected in fiscal 2011.
The School Facilities Board was created in 1998 by the Students First Act in response to a state Supreme Court ruling that found Arizona’s previous provisions for school district capital needs unconstitutional.
The Students First act requires Arizona to bring school facilities up to certain minimum standards, as well as to provide new facilities to accommodate enrollment growth.
Under the school leasing program, the Bank of New York Mellon Trust Co. acting as trustee, leases the assets to the SFB under a lease-to-own agreement. The board, 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 board for lease payments.
Debt service payments are due on a semiannual basis every March 1 and Sept. 1.
Under the terms of the lease and sublease agreements, the school districts are ultimately responsible for the operation and maintenance of the facility, including insurance requirements.
The school districts currently own or lease the sites and will own the facilities at the end of the lease term.