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CA's Stem-Cell Agency Still Considers Issuing $400M in Debt Despite Deal to Balance Budget

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California's stem-cell agency will stick to its plan of incurring debt by selling bonds to private investors despite an agreement hashed out by Gov. Arnold Schwarzenegger and state legislative leaders aimed at plugging a $42 billion shortfall over 17 months in the state's budget, an official for the agency said last week.

"It will actually improve, we think, the ease with which we'll be able to do the private placements. It won't eliminate the need for them," California Institute for Regenerative Medicine spokesman Don Gibbons told BioRegion News last week.

CIRM announced earlier this month it plans to privately sell $200 million in bonds in the current and next fiscal year in case CIRM is unable to access public capital.

It had said it plans to use the cash to better manage cash flow so it can pay a variety of current and planned grants supporting studies into new stem cell-based treatments, and previously approved awards to researchers developing new facilities for stem-cell work.

"If we get in the state queue for some publicly placed bonds, that means we'll have to place fewer privately. We assume that somewhere in the fiscal year between July of 2009 and July 2010, that we'd get some public bonds," Gibbons said in an interview.

It is currently too early to say how much funding would be issued privately and publicly, Gibbons said. "Who would have guessed we wouldn’t have a budget until Feb 19?"

According to Gibbons, private placement offers CIRM some advantages since the private placement is likely to draw different investors than those inclined to buy bonds through the traditional public market. They include social investors who support CIRM's work, as well as more bottom-line-oriented investors who would be drawn to the likely higher interest rates that private bonds can yield.

To certain investor sectors, such as institutional investors already exempt from taxation, CIRM could offer taxable bonds that generally offer slightly higher interest rates, Gibbons said.

He said a private placement would offer CIRM the advantage of obtaining cash "quite a bit" sooner — how much sooner is not known — than if it had to first wait for the state to go through the roughly $7 billion backlog of bonds approved but unable to be issued for existing programs cited to CIRM's governing board by an aide to Gov. Arnold Schwarzenegger, to finance before obtaining funding.

California has some $47.9 billion in general obligation debt. The recently resolved budget stalemate caused the rating agency Standard & Poor's to downgrade its rating on that debt from A-plus to A, the lowest of any state in the US. Another agency, Moody's, placed the state on its "Watchlist" for a possible downgrade.

"We don’t want to be standing in line in front of schools and sick people for those bonds," Gibbons said. "We think we can attract a different set of investors through the private market, and not compete with the state and the needs of the state. We don’t want to compete with the other needs of the state, but yet we want to keep our program going forward."

"A research enterprise needs to be sustained to be really effective. It can't do well with ups and downs," Gibbons added, noting that several years of reduced or flat National Institutes of Health budgets have hobbled research programs nationwide — a trend that would be reversed under President Obama's new $787 billion American Recovery and Reinvestment Act [GenomeWeb Daily News, Feb. 17].

"Our goal is to sustain our efforts, sustain our momentum, sustain our progress, so that we can keep the program going," he said.

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Discounted ‘Wiggle Room’

Since its creation in 1995, a year after California voters approved a referendum, Proposition 71, designed to issue $3 billion in bonds to help fund stem-cell research, CIRM has approved 279 grants totaling more than $693 million. The agency also has four active requests for grant applications.

• Disease team research awards (RFA 09-01)
• The first of two parts of a Basic Biology Awards program (RFA 08-07)
• Conference grants (PA 08-06)
• Early Translational Research Awards (RFA 08-05)

According to Gibbons, CIRM must also ensure it has the cash flow to fund the second and following years of previously announced multiple-year grant awards, and administrative costs, limited to 6 percent of CIRM's annual spending. The agency is allowed to issue up to $300 million in bonds each of the stem-cell effort’s 10-year horizon. Instead, it will issue $200 million in new debt during the current and following fiscal years.

"We're trying to stay on schedule. We're trying to keep up all of our grant reviews, all of our requests for applications, and then expect that we will have enough cash on hand to meet the obligations," Gibbons added. "That $200 million this year and next year is what we think we will need to do that with some cushion and wiggle room."

For the 2009-10 fiscal year, CIRM would spend just under $189.4 million, which is down 0.4 percent from just over $190.1 million in 2008-09. CIRM's work force would rise in '09-'10 over the current fiscal year by a single half-time position, to 42.8 positions. By law the agency cannot have more than 50 positions.

"CIRM currently has cash reserves of $160 million, which can fund all existing commitments through at least September," the agency announced in a statement posted earlier this month on its web site. It was in that statement that CIRM disclosed plans for its private placement.

Gibbons said CIRM representatives met Feb. 18 with Lockyer, whose office signed off on allowing a private placement of state general obligation bonds for CIRM.

"They will then complete the term sheets within the next couple of weeks. Once the term sheets are done, it's a question of, ’How quickly can we sell them? [Lockyer's office] is not going to sell them for us, so how quickly can we find those people?’ I'm not going to hazard a guess," Gibbons said

Tom Dresslar, a spokesman for Lockyer's office, did not respond to written questions submitted last week by BRN. In a statement to the California Stem Cell Report, Dresslar would not say how quickly the state would resume public bond sales.

"We need to analyze the product (the budget) and get a firm handle on cash flow before we can say anything about how the budget will affect our ability to return to the bond market," Dresslar told the Report, an online news outlet focused on CIRM, on Feb. 19.

California has not participated in the public bond market since last Dec. 17, when the Pooled Money Investment Board, the entity that invests the state's money, froze financing from the Pooled Money Investment Account for $3.8 billion in a combined 5,600 bond-funded infrastructure projects statewide — all but about 300 of which had been halted or delayed as a result of the action, according to Lockyer's office.

Soon after the budget agreement was announced, the finance department announced that work would resume on 276 road, school, and other public works projects.

The freeze resulted from a shortage of operating cash that state officials blame on the budget stalemate and the economic turmoil that has all but frozen the nation's financial markets. California last issued general-obligation debt in June 2008, a month before the start of the current fiscal year, which ends June 30.

On Jan. 16, the PMIB eased the freeze by giving the state the green light to spend $650 million on infrastructure projects through June 30, and gave the finance department responsibility to decide which projects are urgent enough to warrant exemptions from the freeze.

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Even less money than that is available for infrastructure projects, since Lockyer's office has confirmed that $130 million of the $651 million has been set aside for administrative costs.

PMIB is a three-member panel chaired by Lockyer, and including state Controller John Chiang, and State Director of Finance Michael Genest. The PMIA is managed by the investment division of Lockyer's office.

CIRM would be at least the third state-created agency to pursue the private-placement route for general obligation bonds. At its last meeting on Feb. 18, PMIB approved a policy allowing two state-created agencies to proceed with private placements of state general obligation bonds: $200 million by the San Francisco Bay Area Toll Authority, the agency that collects tolls from motorists crossing the San Francisco-Oakland Bay Bridge and six other state-owned toll bridges crossing the bay; and $200 million by the Los Angeles County Metropolitan Transportation Authority.

And a few years ago, when a legal challenge by Proposition 71 opponents blocked CIRM from issuing bonds, the agency privately placed about $44 million in bond-anticipation notes, or BANs. Once the litigation over Prop 71 ended [BRN, May 29, 2007], the state sold $250 million in taxable bonds for CIRM that received an A+ grade by Fitch Ratings.

"Those BANs were sold when the economy was booming, riding high on the housing bubble. Today those sorts of investors are feeling the pinch like all the rest of us — perhaps in some cases even more so,” longtime CIRM observer John Simpson, stem-cell project director at Santa Monica-based nonprofit Consumer Watchdog, wrote in a commentary posted on his website earlier this month. “It is by no means clear that a significant amount can be raised for CIRM by selling bonds privately."

A financial professional selected by Lockyer's office as its financial advisor for the CIRM BANs told CIRM's governing board, the Independent Citizens Oversight Committee, that it will most likely need to undertake a new private placement even with a budget agreement in place.

"While you have significant cash resources, it's clear that in order to continue with your mission, you need additional funding," the advisor, Doug Montague, founder of Montague DeRose and Associates, told the ICOC at its Jan. 28 meeting, according to a transcript of the meeting posted on CIRM's web site. "In order to make sure that the international community retains its confidence in the integrity of your program and its viability, and your ability to attract the best researchers and the best minds, you need to have the cash balances."

At PMIB's last meeting, Lockyer acknowledged that his office had received "a lot of inquiries" from various state agencies interested in pursuing their own private placements.

The rush to private placements reflects ongoing fear that the budget accord won't be enough to get California's fiscal house back in order, as long as the economy continues to be weak

Like budgets in many states, California's operates at a structural deficit caused by ongoing expenses that exceed ongoing revenues. "There's been an inability on the part of the state leaders to resolve it, partly because voter initiatives reduce their flexibility," Douglas Offerman, a senior director with Fitch Ratings and the bond rating agency's lead California analyst, told BRN last week.

"With the budget question resolved, we would expect the state to take some steps to move forward on the capital spending going forward. They'll also need to return to some of the bond authorizations," Offerman said in an interview.

Fitch has maintained it’s A+ rating on California debt, but with a "negative" rating watch signaling a possible downgrade. Asked if the budget deal could stave off a downgrade, Offerman replied: "We're waiting to see what the budget agreement means. We haven’t had a chance to speak to the state yet. There are a lot of implications that we still have to understand better. We're still getting our arms around that, I guess I'd say."

California's budget picture is further clouded by a law requiring state spending plans to be approved by two-thirds majorities of both the state Assembly and state Senate. Schwarzenegger, a Republican, has sided with the Democratic leaders of both houses of California's legislature. But those leaders preside over majorities smaller than two-thirds — giving the Republican minority more power than minority parties enjoy in most states to block agreements by holding out for policy changes more to their liking.

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California Republicans had insisted that Schwarzenegger and the Democratic legislative leaders balance the state budget through spending cuts rather than taxes. The stance was strong enough for GOP state senators last week to suddenly replace their leader, Dave Codgill (R-Modesto) with Dennis Hollingsworth (R-Murrieta), in an overnight caucus.

A day later, on Feb. 19, however, lawmakers ended a marathon 45-1/2 hour session by rounding up the barest minimum of votes needed for a budget agreement. The final GOP vote, state Sen. Abel Maldonado (R-Santa Maria), came after leaders in the state Senate met his demands to kill a proposed 12-cent-a-gallon increase in the state gasoline tax, as well as hold a May 19 referendum on freezing the pay of lawmakers when the state operates at a deficit — and a June 10, 2010, referendum on abolishing party primaries for statewide office.

If voters approve the latter change, the top two vote-getters in a primary would square off in a general election, regardless of party. Maldonado, who lost a 2006 party primary for controller, has acknowledged he remains interested in seeking a statewide elected position, so the end of party primaries could help him by making it harder for Republicans unhappy with the taxes in the budget accord to replace him with another GOP candidate.

Schwarzenegger and state legislative leaders agreed to an array of new taxes and spending reductions that include:

• A one percentage point temporary hike in the state sales tax, to a highest-in-the-nation 8.25 percent, not counting local add-ons — projected to raise $5.8 billion. The hike would sunset on June 30, 2011, if state voters on May 19 pass a ballot question setting a state spending cap based on inflation and population growth— and June 30, 2012, if voters reject the measure.
• A 0.25 percentage-point increase in the state's income tax, set to generate $3.7 billion, and end after 2012. The tax could be reduced by about half if California receives $1.8 billion it expects under Obama's economic stimulus measure.
• An increase in the vehicle license fee from 0.65 percent to 1.15 percent, set to raise $1.5 billion. The increase would end June 30, 2013. Schwarzenegger won office in 2003 in part on a promise, which he fulfilled, to cut the car tax.
• A cut from $300 to $100 in the amount of the deduction state taxpayers can claim for dependent care, expected to raise $1.4 billion.
• A total $15 billion in cuts to state programs, with public education spending taking the hardest hit at $8.6 billion.
• Elimination of two state holidays, one-day-a-month worker furloughs, and changes to state overtime rules, projected to raise a combined $1.4 billion.

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