Under Ducey, Arizona issued bonds that got bigger, riskier, farther-flung. Now some of them are in trouble

Eastern Michigan University renovated a parking garage. A charter school in Vineyard, Utah, wants to expand. There’s a new Hilton Garden Inn in Harlingen, Texas. 

And Arizonans better hope each one of these developments succeeds. 

Arizona is quietly tied to the fate of these and other far-flung projects because their financings were run through an arm of state government — the Arizona Industrial Development Authority — so that each could be built more cheaply.

Some of these projects are risky. Seven have shown signs of financial trouble, including the parking garage in Michigan.

Since its inception in 2016, the Arizona Industrial Development Authority has issued more than $8 billion in bonds — long-term loans sold to investors — with more than half of that money flowing to projects or entities outside the state. 

The Arizona authority’s appetite for projects was even greater. Its board green-lit more than $12 billion in deals, some of which never came to fruition and never received investor funding.

Patrick Ray, a private contractor who runs the bonding program, says the board issues exotic bonds to fulfill a mission: generate revenue for the state that doesn’t come from taxpayers. 

According to figures provided by Ray, the bonding program has brought in $19.1 million over the past three fiscal years. Put in perspective, that amounts to a 0.05% rounding error in state budgets totaling nearly $37 billion over the same period.

But not all that money is accounted for. A spokesperson for the Arizona Commerce Authority, the agency that state statute says is the destination for the funds, said it had only received $14.5 million from the Industrial Development Authority. The fate of the remaining funds could not be determined.

Meanwhile, others involved in the program collect substantial revenues from the issuances of the bonds.

At least $110 million has been paid out to a rotating cadre of middlemen — the investment bankers who set up and peddle the investments and the lawyers who iron out the details, according to documents available on the Electronic Municipal Market Access website. 

In order to keep the money flowing, the Arizona Industrial Development Authority, under Ray’s direction, has taken on increasingly larger and more complex deals. And put the state’s reputation on the line should the bonds fail.

Two of the authority’s bonds are in default, a financial black eye for Arizona. Five more have warned investors of trouble, according to the research firm Municipal Market Analytics.

In one of the defaults, the borrower stopped making interest payments on $22 million used to finance the conversion of mine waste to fertilizer in Congress, Arizona. Another worked out an agreement to postpone part of its interest payments on nearly $400 million used to purchase senior living complexes in the Midwest. 

The portfolio of the Arizona Industrial Development Authority is sprinkled with colorful and exciting projects with eye-watering dollar amounts.

But, there is a reason the bond world is typically devoid of excitement, said Alan Maguire, former chief deputy to the Arizona treasurer and former president of Maricopa County’s Industrial Development Authority. The market prizes stability and rock-solid investments, even if they seem repetitive.

“There’s a boredom factor,” Maguire said, speaking generally. That might lead some in the bond world to tiptoe toward greater risk in order to make slightly more money. “But soon,” Maguire said, “you’re hanging off the edge of the Grand Canyon.”

Reporters from The Arizona Republic, assisted by three journalism students from the University of Texas, reviewed thousands of pages of financial documents and lawsuits connected to more than 100 bond offerings across the United States. Reporters also interviewed dozens of sources, including financial experts, lawyers, politicians, bond investors and others affected by the Arizona Industrial Development Authority’s deals.

Among the findings: 

• The Arizona Industrial Development Authority has supported an increasing number of risky projects. It has issued bonds as a favor to major banks so they could move assets between divisions or get loans off their books. It involved itself in a complicated swap transaction reminiscent of deals that led to the Great Recession. And it supported two bonds that — based on documents provided to the board in advance of their approvals — don’t contain enough information about the underlying projects to enable the authority or bond investors to scrutinize what’s really going on.

• During its five-year history, the authority’s board of directors — hand-picked by the governor — has approved deals quickly, unanimously and with little debate. One of the board meetings, in September 2019, in which members approved $1 billion in bonds, wrapped up in 14 minutes.

• The Arizona Industrial Development Authority has shifted away from the types of rural projects that were supported by its predecessors — public projects like jails, medical facilities and fire trucks — in places like Three Points, Cobre Valley and Nogales. 

• While the authority’s objective is to raise money for the state, it’s not clear what that money is being used for. The fees earned by the authority are squirreled away in a fund at the Arizona Commerce Authority. One year can’t be accounted for. In another year, none of it was spent. A spokesman for the Commerce Authority said a portion of the money was tagged for “research and marketing efforts.”

• As the state affixes its financial reputation to ever-riskier borrowers, its name will be associated with each failure. Because of its lack of due diligence, the authority issued bonds for Harvest Gold Silica, run by John Owen, a businessman with Texas ties whose companies faced allegations of fraud in filings by state securities regulators. Now Harvest Gold’s $22 million in bonds are in default, and the authority’s name is on the second line of a federal lawsuit in which investors claim the company committed fraud and used the authority to give it a sheen of credibility. (Owen denies these claims, and the authority is not a defendant in the case.)

While Ray laments having anything to do with financing Owen’s company, he said the Arizona Industrial Development Authority is still in good shape.

“At some point, everybody expects there’s going to be a default on conduit revenue bonds,” Ray told The Republic in October. “With 110 borrowers, one of them is going to be either dishonest or incompetent or stuff happens. And so I think the industry fully expects an occasional default.”

Taxpayers are not financially liable should its deals go south. Bond documents say in capital letters that the state of Arizona will not pay off investors should a project go bust. 

But a string of defaults would be seen as a lack of good governance, as Arizona’s governor, by state and federal statutes, serves as the overseer of the authority’s doings. He personally signs off on many of the deals.

Ducey’s office did not return requests for comment on the Arizona authority’s bonding program.

Board approval can be used as a first step, allowing a project to let other investors know the project could enjoy the advantage of being funded by tax-free bonds. Some of the projects — a prison in Honolulu, Hawaii, a baseball complex in Hutto, Texas — never got off the ground.

Byron Schlomach, head of the free-market 1889 Institute in Oklahoma, said that Arizona has placed a “stamp of approval” on the projects, some of which he reviewed at the request of The Republic. It makes them seem like surer bets for bond buyers. He said that could come back to bite the authority if a deal fails.  

“I have a hard time believing that if one of these things goes belly up that some people aren’t going to come along and sue the state at least for deceptive practices,” Schlomach said.

‘No harm, no foul’

The bond market, at its most basic, functions like this: A developer seeks a loan to finance some project. For example, an affordable housing complex or a charter school. Investors front the money, agreeing to be paid a specified sum of interest each year as, essentially, the price of renting out their money. After a negotiated period of time — possibly 10 years, 20 years, or 30 years — the investor is paid back the initial investment.

The interest rate that determines those annual payments is typically low. But it’s stable. And that is what most bond buyers are seeking: a steady income with minimal risk

It’s completely different from the stock market.

Think of the stock market like a casino, where some knowledge of the games and some luck can turn risks into rewards.

The bond buyer would not be interested in any of the games. They would instead be interested in the money to be made in the parking garage, bar, or the lease on the building — the real sure bets.

The stock market is a place where investors hope to make money. The bond market is a place where someone with money stores it for safekeeping, albeit while earning a small annual interest payment, trusting they will get it all back in 10 or 20 years.

Government bonds, those issued by cities or school districts, backed by the ability to tax residents, are generally considered safe investments. Unlike a business, which might lose all of its money and shut down, a government entity can keep collecting taxes to pay its debts.

Bonds issued by industrial development authorities — such as the Arizona Industrial Development Authority — are different. They are backed solely by the revenue generated by the project — the rents paid by apartment dwellers or the hourly rates paid by those who frequent a parking garage.

And having an industrial development authority issue the bonds allows them to be tax-free, making them more attractive to investors who are willing to make a little less money, knowing that they won’t have to pay taxes on their earnings

But because these bonds are issued by a development authority created and overseen by the government, they are still considered “muni bonds” in the parlance of bond investors, safer than those in the purely private market.

Most states restrict their government-created development authorities to issuing bonds within their own jurisdiction, typically keeping it within the authority’s own city or county, said Toby Rittner, president of a national association of development authorities.

A handful of states, he said, allow out-of-state projects, but only if there is a substantial nexus with the home state, like maybe a charter school or medical facility putting a location in a neighboring state.

Only one other state, Wisconsin, allows its authority to fund projects out-of-state without restriction, Rittner said.

Congress tightened up the rules around development authority bonds fearing they were being used for private enterprises, like fast-food restaurants or department stores, Rittner said. The new rules required that projects be placed on an agenda and approved in a meeting open to the public. The tax-exempt deals also need to be approved by an elected official in the issuing jurisdiction.

The aim, Rittner said, was for the deal to not just be scrutinized to see that it made financial sense, but also that it had a dose of political or common sense.

“Someone who was beholden to the public interest saying, ‘I have to present this to the citizenry,’” Rittner said.

The Phoenix City Council approves projects approved by the board of the Industrial Development Authority of the city of Phoenix. The Maricopa County Board of Supervisors approves those passed by the board of the Maricopa County Industrial Development Authority.

The Arizona Industrial Development Authority also has a public approval process. But it runs differently, and much more quickly than it does in either Phoenix or Maricopa County.

After the deals get approved by the Arizona Industrial Development Authority board, its members vote to adjourn, then the same people convene as the board of the Arizona Finance Authority. That board, as defined in state statute, oversees the actions of the Arizona Industrial Development Authority.

The same people, now meeting as the Arizona Finance Authority board, approve the actions they took just minutes earlier.

The process, Ray said, was intentionally designed to be quick. While Phoenix or Maricopa County might have to place an approved project on a meeting agenda, the Arizona authority can move much faster, shaving two weeks or 30 days from the approval process, he said. 

Maricopa County’s IDA has watched the projects approved by the Arizona IDA, but its executive director, Shelby Scharbach, said it has not changed what projects the county entertains.

“Our board is focused on Arizona,” Scharbach said. “They didn’t have an appetite to do out-of-state transactions.” 

Scharbach said the county’s IDA was focused on economic development in the Phoenix region. It intentionally caps the amount of fees it charges, she said, so those don’t serve as barriers to any worthy project.

Bryant Barber, an attorney with Lewis Roca who provides legal advice to Phoenix’s industrial development authority, said that body will entertain the occasional out-of-state project if it finds it has merit. 

The city’s authority earns higher fees on those projects, Barber said, charging developers for its expertise. He said it puts those funds back into charities, targeting smaller ones that don’t have a ready flow of donors.

Development authorities in general are a tool, Barber said. They can be used to provide a direct benefit — an affordable housing complex or senior living facility in the community — or the indirect benefit of money made in the transaction going to charities.

But, Barber said, in either case, the benefit should be apparent. “This is a significant set of powers,” he said of the ability to issue tax-exempt bonds. “What are you doing with that tool?”

It is not clear what Arizona does with the money earned by its development authority.

By statute, any excess funds go not to charitable organizations but to a specific economic development fund.

That fund, overseen by the Arizona Commerce Authority, had $9 million in July, according to budget documents. It spent no money the prior fiscal year, which ended in July, according to the documents.

In its budget request, the Arizona Commerce Authority said it planned to spend $2.4 million in the coming year in the category of professional and outside services.

Those services involved “research and marketing efforts,” as described by a spokesman for the Arizona Commerce Authority in an email. Those efforts, the spokesman said, included “prospective client identification and outreach” that ensured the state’s competitive position.

The spokesman, Patrick Ptak, did not respond to a request for more specifics, such as which professionals were hired, or what outside services were received, or any tangible benefits the state commerce department could point to.

‘Mission to give money to the state’

The Arizona Industrial Development Authority was created through legislation pushed by Ducey during his first term, part of an overall restructuring of the Arizona Commerce Authority, itself designed to promote economic development within Arizona.

The freshly minted authority subsumed the work of three other IDAs that focused on projects in Arizona, like a hospital in Cobre Valley, a business incubator in Flagstaff or a court complex in Nogales.

An early plan had the authority also subsuming the Water Infrastructure Facilities Board, but lobbying convinced lawmakers to allow it to remain independent. The worry was that the long-standing board, which funds water and wastewater projects throughout the state, would have its sterling AAA bond rating tarnished if it were lumped in with the expanded authority.

The other boards were created with specific missions.

The International Development Authority was launched to work on infrastructure near Arizona’s border with Mexico, with the aim of fostering trade. It never got past the launch phase. The Health Facilities Authority, as its name implied, concentrated on health facilities. The Greater Arizona Development Authority worked on economic development in rural Arizona.

Mignonne D. Hollis, who served on the Greater Arizona Development Authority board, said it was a highlight of a career spent serving smaller state communities.

“I loved it,” said Hollis, executive director of the Arizona Regional Economic Development Foundation. “It really made a difference in these rural communities.”

A review of the Arizona Industrial Development Authority’s meeting minutes show that it originally issued bonds for Arizona entities: a charter school in south Phoenix, an assisted living facility in Yuma.

But, in December 2018, after Ray was named the manager of the bonding program and had his name placed on the authority’s banking account, the entity adopted a new strategic plan. 

No longer would it be content with its mission of promoting economic development and boosting the “prosperity and health for residents of the State.”

Rather, it would work to raise revenue — both to fund itself and to transfer monies to the state, meeting minutes show. The authority would work to “maximize the payment of unrestricted revenues” to Arizona “by expanding the scope and volume of our revenue-generating activities.”

Ray said the board did so because the statute that allowed the state authority’s creation specifically said that any excess funds at the end of the year need to be returned to Arizona. 

“Because by statute we’re required to do it,” Ray said, “we figured that must be part of our mission to give money to the state of Arizona.”

At its next meeting, the authority approved a $130 million deal funding a student housing complex at North Carolina Central University and a $32 million deal allowing the construction of the Hilton Garden Inn in Harlingen, Texas.

Over the next few years, the authority would also approve the issuance of bonds tied to the construction of a highway south of Lincoln, Nebraska, and a power center anchored by a WinCo in Meridian, Idaho.

​Then, there was a convention center and hotel on the north coast of Puerto Rico, a $300 million development that came before the Arizona Industrial Development Authority three times, gaining approval at each meeting. From there, it went to Ducey for his signature, which he granted.

​Not all of the Authority’s projects, however, have been welcomed in the places where they were proposed to be built.

​Read the rest of the article here.