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SUMMARY
The Office of the Auditor General has conducted a performance audit of
capital project financing at Arizona State University (ASU), the University of
Arizona (UA), and Northern Arizona University (NAU) pursuant to Arizona Revised
Statutes (A.R.S.) §41-2958. This audit was conducted under the authority vested
in the Auditor General by A.R.S. §41-1279.03 and is the second in a series of
three performance audits of the universities. The other two audits focus on
technology transfer programs and information technology security.
The universities' capital expenditures for fiscal years 2005 through 2007
reflect significant capital development. The universities spent slightly more
than $1 billion during this period. Approximately $754 million was used for
constructing new academic and research buildings, parking structures, residence
halls, and other facilities. The remaining $253 million was used for renovating,
repairing, and improving existing facilities. State support for the
universities' research goals, as well as enrollment growth demands and other
factors, has fostered capital development.
The universities' capital development process is overseen by the Arizona
Board of Regents (Board) and the Legislature's Joint Committee on Capital Review
(JCCR). Specifically, the Board reviews and approves the universities' capital
plans and all projects, or groups of related projects, with an estimated total
cost of $2 million or more. In addition, the Board must approve any debt
instrument used to finance capital projects. The JCCR reviews projects financed
with bond proceeds, acquired through lease-purchase agreements, or through
indirect or third-party financing.
Universities have several options to pay for
capital projects (see pages 11 through 22)
Universities have several alternatives to choose from to pay for capital
projects as they encounter growing infrastructure needs. ASU, UA, and NAU have
primarily used debt in the form of revenue bonds and certificates of
participation (COPs) to raise the money for their capital projects. As of June
30, 2007, the universities had a total of approximately $1.8 billion in
outstanding debt obligations and will additionally pay more than $973 million in
interest on these obligations over the next 33 years, between fiscal years 2008
and 2040. Nearly $959 million in principal was issued between fiscal years 2003
and 2007 for 61 major and minor capital projects. UA relies mainly on COPs to
pay for its capital projects while ASU and NAU rely more on bonds.
The universities have also relied on third-party financing arrangements to
support capital development needs. In 2002 through 2007, the universities
initiated 18 projects through these arrangements. Although the nature of
third-party arrangements varies, they commonly involve leasing university land
to a third party that builds a facility on the land. Many of the universities'
arrangements have involved issuing tax-exempt bonds through nonprofit
corporations affiliated with the universities, while a smaller number have
involved partnerships with local governments, for-profit companies, or a
combination of government and the private sector. ASU has used these
arrangements more extensively than UA or NAU. During the audit, UA and NAU
finance officials expressed a preference for using more traditional financing
approaches, while ASU uses a mix of approaches. Similar to bonds and COPs, some
of the universities' third-party arrangements result in long-term debt,
specifically a long-term lease payment that is paid over a long period of time.
As of June 30, 2007, the universities owed more than $135.5 million in principal
and $105.2 million in interest on lease obligations associated with third-party
financing arrangements that end in 2045.
Finally, the universities have also occasionally used cash, donations, and
federal grants to pay some capital project costs.
Universities follow good debt management practices
(see pages 23 through 28)
The universities generally conform to recommended debt issuance and
management practices, although some improvements can be made at UA and NAU. In
addition, all three universities have good credit ratings.
The National Association of College and University Business Officers, other
professional organizations, and finance literature recommend several practices
for issuing and managing debt. Following these practices helps ensure that the
universities do not acquire too much debt or pay too much in interest and other
debt-related costs. Recommended practices include adhering to debt limits, using
a professional finance team, grouping projects to save on issuance costs, using
credit enhancements, using a mix of variable- and fixed-rate debt, and
refinancing debt when appropriate. The universities follow all of these
practices.
However, one recommended practice that is not uniformly in place is a debt
management policy. A debt management policy provides overall context and general
direction for an institution's use of debt, establishes parameters for issuing
and managing debt, and provides internal guidance to university officials so the
institution does not exceed acceptable debt levels. ASU has formal debt
management guidelines that contain all of the elements recommended by
literature. UA has only a draft policy, and it does not include a recommended
provision for monitoring compliance with federal tax law requirements on the
private use of facilities constructed using tax-exempt debt.1 UA
should include provisions for monitoring private use, and then finalize and
implement its debt management policy. Finally, NAU does not have a debt
management policy and should develop and implement a policy or formal guidelines
that contain the elements recommended by literature.
Universities follow recommended practices in
third-party projects (see pages 29 through 36)
The universities follow practices that allow them to mitigate potential risks
and liabilities associated with entering into arrangements with third parties,
which may include partnerships with local governments and the private sector.
Third-party financing arrangements can entail risks such as potential impact to
the universities' debt capacity; potentially paying higher interest rates than
the universities; potentially conflicting goals between the third parties and
the universities; confusion in the roles and responsibilities of the third
parties and universities; an increase in number of contracts and contract
complexity; and a lack of university control over the development, design,
construction, and operation of projects.
Professional literature identifies several practices that may mitigate some
of the potential risks associated with third-party financing arrangements. These
practices include financing projects through a component unit rather than a
private developer, verifying third parties' qualifications, including purchase
options and maintenance requirements in project contracts, and conducting
feasibility studies. However, because third-party projects are often unique,
some practices may not always apply. Auditors reviewed nine of the universities'
third-party projects initiated between 2002 and 2007 to determine whether the
universities followed recommended practices identified in professional
literature to mitigate third-party project risks. Auditors found that the
universities used the recommended practices to mitigate these risks.
Other pertinent information (see pages 37 through 42)
As part of the audit, auditors gathered other pertinent information regarding
how the universities pay for building renewal. Building renewal refers to major
activities undertaken to preserve buildings and maintain their expected useful
life. The universities annually request state appropriations to pay for building
renewal using a state-approved funding formula. However, between fiscal years
1999 through 2008, the universities received only 14 percent of their total
requests. Because of limited state funding, the universities have used debt to
address some of their building renewal needs. Between fiscal years 2003 and
2007, the universities used or dedicated nearly $94.3 million in debt proceeds
(including both bonds and COPs) for building renewal projects that were eligible
for state funding. Despite this, the universities reported, as of June 30, 2007,
an estimated $419 million in deferred maintenance.
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The Internal Revenue Service (IRS) defines private use as "trade or
business of a nongovernmental person." At the universities, private uses can
include retail stores or restaurants operated by private firms in campus
buildings and conducting certain research on behalf of private industry in
university laboratories. |
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