Lawmakers Call On ‘COPs’ To Get Around Bonding Limit
 
Lease-Purchase Of Buildings Helps State Keep Up With Budget Demands
 
 

By Mike McCloy
Arizona Capitol Times
March 21, 2003
 

How do you find $1 billion for public buildings when the state Constitution limits revenue bonding to just $350,000?

In Arizona, public officials have been going to the COPs for help. COPs, or certificates of participation in lease-to-buy deals, have been used by creative bureaucrats for nearly two decades to provide facilities for a fast-growing state run by a tight-fisted Legislature and populated with voters set to pounce on any proposed tax increase.

The trend started in California in the 1970s after that state’s voters passed tax-busting Proposition 13.

COPs came of age in Arizona in the 1990s when the state had to raise $55 million to buy out a bad contract for the ENSCO hazardous-waste operation near Mobile. Prisons were turned into cash cows, and for $5,000 a share, private investors became temporary owners of the cellblocks, gun towers, gas chamber and all.

Arizona got her prisons back in five years, and the COP holders recovered their investment, with tax-free interest, through lease-back payments that were considered part of the state’s cost of operating the prisons.

Since 1986, state COPs have been used to provide $480 million for everything from the Tonto National Bridge near Payson to Game & Fish Department offices in Flagstaff, Yuma and Kingman, and a dozen new office buildings at the Capitol complex in Phoenix.

COPs have funded $300 million worth of construction at the University of Arizona and $62 million at Arizona State University.

Interviewed in his new lease-purchased office at the Capitol, state Comptroller Clark Partridge said the prison-lease scheme may sound odd, but it was one of the easier ones to sell to investors.

“What’s the likelihood of the state defaulting?” he asked. “They’re not just going to turn all the people [inmates] loose.”

While Mr. Partridge calls COPs a “win-win,” they have been challenged by at least a half-dozen county grand juries in California.

Tax watchdogs complain that COPs are a slick way for bureaucrats to avoid the voters in racking up public debt. But the most the civil grand juries have done is request more disclosure from the government officials who issue COPs.

“The attorney general and bond counsel have to sign off,” Mr. Partridge said of Arizona’s COPs. “They would not be doing so if it was not constitutional.”

Flying Under Debt Caps


Still, COPs posing as lease arrangements do circumvent Arizona’s constitutional limit on general-obligation bonding and the requirement for voter approval of revenue bonds.

Timothy Blake, senior analyst for Moody’s Investor Service, said, “A lease obligation is technically not long-term debt because there is this annual decision whether to fund it or not. They can fly under debt caps and spending limits.”

But Arizona’s COPs aren’t sailing quite as smoothly as they once did. While lawmakers struggle with a $300 million general fund deficit this fiscal year and a $1 billion shortage for fiscal 2004, Standard & Poor and Moody’s Investors Service both have dimmed their outlook for COPs investors from “stable” to “negative.”

That means Arizona’s AA-minus rating could slip. Not that investors should worry. “The ones that we rate don’t default,” analyst Mr. Blake said.

To make sure they would not default and to boost the market for $400 million worth of COPs in January, the School Facilities Board purchased insurance for the issue. The rating automatically rose to AAA and the resulting cost is about 4 per cent to finance construction of 49 schools across Arizona.
The rate is probably a quarter-percentage point higher than bonds would cost because investors have to settle for school buildings as collateral rather than the “full faith and credit” of a government that issues bonds and convinces its voters to provide the revenue to service them.

Voter Approval Not Required


But no voter approval is required for COPs because they are not considered to be the kind of long-term debt that is restricted by the Arizona Constitution.

“It gives the Legislature a lot of comfort,” School Facilities Board finance chief John Arnold said. “They can say, ‘We did this without debt.’ “

But the Legislature must fund the lease-to-own payments every year or face the political calamity of closing schools and turning over the keys to a trustee for the COP holders.

Mr. Arnold plans an additional $250 million COP issue to build 30 more schools this fall. And as the state continues its pace among the fastest growing in the nation, more schools will be needed in fiscal 2004 and beyond.

Annual debt service could ramp up to $60 million, then $80 million in fiscal 2005, and $100 million a year later, officials said.

“Some people have said there needs to be a dedicated tax source,” Mr. Arnold said. “I don’t think there’s any way around additional tax dollars.”

Kevin McCarthy, director of the Arizona Tax Research Association, a tax watchdog, agrees. “The truth is that debt is debt and the impact on taxpayers is the same,” Mr. McCarthy said. “Running up debt through COPs just sidesteps the public debate.”

COPs and other lease-purchase and third-party contracts have been used by more than 300 government agencies at all levels in Arizona to pile up nearly $1.5 billion in debt, the Department of Revenue reported in December. Total debt for Arizona governments is about $20 billion.

Lawmakers ran head-on into COPs and other entanglements last month when they tried to raise quick cash by selling or leasing state property. They were frustrated to find that many state buildings are “owned” by COP-holders until the state pays off leases that can run 20 years and more.

Other buildings, such as university dormitories, that are not encumbered by COPs are pledged to help support revenue bonds.

But Chris Herstam, a former legislator and now chairman-elect of the State Board of Regents, defends COPs. He said they were used to bail the administration of Governor Fife Symington out of the ENSCO crisis in 1991.

“Lease-back arrangements have worked well for the state,” Mr. Herstam said. “Without that funding mechanism, the state would have been paralyzed in the past few years with regard to construction. I know of no abuse, which further fuels my confidence in COPs.”

But Deputy State