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New Mexico Scandal Cancels Bond Sales as Cities Borrow Elsewhere

Cities and school districts in New Mexico may face higher borrowing costs and have to scale back or delay projects after a scandal involving a phony audit halted bond sales by the state lending agency.

The New Mexico Finance Authority has used its favorable ratings to sell securities for billions of dollars in public public works over the past two decades. It canceled $145 million in bond issues and stopped funding larger loan requests after officials discovered its 2011 financial audit had been falsified said the agency's chief financial strategist, Michael Zavelle.

The authority's chief operating officer and former controller were arrested earlier this month. Moody’s Investors Service and Standard and Poor’s have put the agency’s ratings under review for possible downgrade as investigations continue in New Mexico, the state with the nation’s worst-performing economy. Local governments are trying to secure alternative financing for projects ranging from a dam in the small city of Las Vegas to infrastructure for a delayed housing development in Albuquerque.

“Clearly, this has not benefited anyone, and I think many entities across the state are in some way negatively impacted,” Zavelle said. “There is a broader impact: when you see these kinds of things coming out of the state of New Mexico, people wonder about how the whole state is run.”

Recovery Lags

The scandal at the lending agency, which was at the center of a pay-to-play investigation in 2008 involving then-Governor Bill Richardson, comes as New Mexico’s economic recovery lags behind the rest of the nation. Over the past year, New Mexico’s economy ranked the worst of the 50 states, according to the Bloomberg Economic Evaluation of States. There has been little job growth in New Mexico, where almost 51,000 jobs were shed from the peak in April 2008 to September 2010. It has added back only 2,800 jobs.

Employment losses in the construction sector have been particularly severe. From June 2006 to December 2011, nearly one-third of construction workers lost their jobs. The total number of people in New Mexico employed in construction declined by 18,800 over this period, and the state has since only added back 2,000 of these jobs.

“This is not good news for the construction sector, particularly in some of the smaller communities,” said Jeffrey Mitchell, senior research scientist at the Bureau of Business and Economic Research at the University of New Mexico. “Economically, we are looking at very small communities where individual projects can be relatively small by other standards but can be impactful. It is going to slow and postpone the kind of projects that are really needed right now.”

Poverty Level

The per capita income in New Mexico was $33,368 in 2010, one of the lowest in the nation, ranking it 46th out of 50 states. And more residents live below the poverty level -- 18.4 percent in New Mexico, compared to 13.8 percent nationally, according to the U.S. Census Bureau.

Cities and other entities that planned to finance projects through the agency are weighing their options and still trying to figure out what to do, said William Fulginiti, executive director of the New Mexico Municipal League, who also serves on the NMFA board. Some may try to wait until the finance authority can go to the bond market and start funding larger projects again -- which Zavelle said the finance authority hopes could happen as early as next spring, after new audits are completed. If they have projects that can’t wait, governments will look for their own financing, potentially taking a hit on cost, Fulginiti said.

‘More Money’

“My fear is that it is going to cost them more money,” Fulginiti said. “And the fact that it will cost them more money may mean lesser projects or lesser number of projects. We’re worried about that.”

Fulginiti said he knows of one city considering a loan with an interest rate almost double what it was expecting from the NMFA, which has a AAA rating from S&P and Aa1 rating from Moody’s on its senior liens. Both agencies are weighing a downgrade, which could mean higher borrowing costs in the future.

James Breeding, an S&P credit analyst in Dallas, said the rating company is awaiting the results of a forensic audit now underway and other investigations to see if there are findings, such as a systemic lack of financial oversight, that could warrant a downgrade.

The scandal at the agency came to light in July after the state auditor flagged officials to a missing audit. Gregory Campbell, the agency’s former controller, and John Duff, the agency’s current chief operating officer who was Campbell’s supervisor, were arrested Aug. 8 on allegations they provided false information to potential bond investors.

Criminal Charges

Campbell, 52, is charged with forgery, securities fraud, racketeering and conspiracy, according to a criminal complaint filed Aug. 7 in New Mexico state court in Santa Fe. Duff, 70, is charged as an accessory to securities fraud and racketeering as well as with conspiracy.

According to the complaint, Campbell admitted he forged the agency’s 2011 audit report by copying and pasting the letterhead and signatures from the 2010 audit report. The phony audit was part of the official statement for a $24.3 million bond issue in March. Campbell is also accused of, with the knowledge and permission of Duff, “cooking the books” by concealing a loss of $40 million in agency revenue in 2010 and 2011, according to the complaint.

David Freedman, a lawyer for Duff, didn’t return a call for comment on the allegations. Campbell doesn’t have a lawyer, according to S.U. Mahesh, a spokesman for the New Mexico Regulation and Licensing Department, which brought the complaint. A call to a number listed for Campbell in Albuquerque wasn’t returned. No arraignment has been scheduled yet, Mahesh said.

Earlier Scandal

The scandal isn’t the first to embroil the NMFA. In 2008, it was at the center of an investigation into whether Beverly Hills, California, financial adviser CDR Financial Products won business from the agency after making contributions to Richardson’s political committees. The Justice Department didn’t file criminal charges against Richardson after the year-long probe by a federal grand jury, which prompted the Democrat to withdraw from consideration to be President Barack Obama’s commerce secretary.

‘Muted Reaction’

So far, the current scandal is eliciting “muted reaction” in the market, said Josh Gonze, portfolio manager at Thornburg Investment Management in Santa Fe, which oversees $7 billion in municipal bonds. Investors are demanding 0.30 to 0.40 percentage point of additional yield for NMFA bonds. The debt typically traded at 0.30 percentage point more than top-rated bond and now it’s trading at 0.60 to 0.70 percentage point more, he said.

“It’s one of those issues where there’s uncertainty regarding how seriously to take this,” Gonze said.

The finance authority suspended loans above $5 million earlier this month, allowing it to use $25 million in cash on hand to continue to help towns buy fire equipment and finance other small projects, Zavelle said. Still, those projects will have to be weighed carefully or “it is quite possible we could be out of money in four months,” he said.

Among more than $294 million in larger projects on the agency’s radar that were put on hold was a $27 million project to build infrastructure for a 500-lot home development that had already been stalled for a decade in Albuquerque. Michael Riordan, the director for municipal development, said the city sought out private financing and was surprised to get an offer with terms similar to what they could get from the finance authority.

Moving Forward

Smaller cities don’t expect to be so lucky. Dan Dible, the city manager of Gallup in the western part of the state, said his city is moving forward with refunding two bond issues of more than $20 million each that it had hoped to refinance through the NMFA. While the city won’t get as good of a rate, it can’t afford to wait, he said.

“We know we won’t do as well,” Dible said. “We don’t want to wait out NMFA because we have no idea how long it is going to take and this market is so good we are going to go after it now.”

In Las Vegas, New Mexico, a city of 14,000 northeast of Santa Fe, city manager Timothy Dodge said it may have no choice but to pay a higher interest rate to reconstruct a leaking dam. Though construction is at least six months out, the city is weighing other options, including working directly with private banks. That will likely mean higher interest rates than going through the finance authority, he said.

“The finance authority has always been an asset to local government here in New Mexico,” Dodge said. “It is going to impact the state.”

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