Governor's Plan To Borrow Against State Lottery

A couple days ago Gov. Schwarzenegger proposed to close the state's $15.2 billion budget gap by borrowing against the state lottery. The proposal aims to generate $5.1 billion for the fiscal year that begins July 1 by selling bonds backed by future lottery earnings.

To make the plan work, the lottery would be expanded and modernized to generate more sales.

Democrats blasted the plan as a gimmick that stands little chance of success in the face of likely opposition from casino-owning Indian tribes, who compete for the gambling dollar.

In an attempt to mold public opinion on the lottery proposal, the Schwarzenegger administration has written and distributed a memo about the plan.

The memo outlines the lottery proposal and, in the administration's own words, "why we expect no challenges to this plan."

MEMO: Facts on Lottery Plan
FROM: Fred Klass, Chief Operating Officer, California Department of Finance
TO: Interested Parties
DATE: 5/15/08

Below is a description of the Lottery plan contained in the 2008-09 May Revise. It discusses 1) what “modernization” means, 2) what “securitization” is and our reasoning for the estimates we have provided, and 3) why we expect no challenges to this plan.

1) Modernizing
When you have an entity like California’s Lottery that is locked, by statute, into using pre-1984 technology, modernization is simple.

Right now, the Lottery has only two types of games: you can either buy a paper ticket for a drawing-type game (Mega Millions, etc.) or buy a paper ticket and scratch it (Scratchers). Modernizing it would mean flexibility in the types of games offered, using today’s technology. However, it specifically does not mean slot machines or video lottery terminals (no machines of Class II or Class III gambling).
Modernizing would also mean greater flexibility to increase the size of lottery payouts.

Some facts:
Currently, California’s Lottery performance ranks 28th in the nation among 42 states with lotteries – and it’s the absolute worst among the 10 largest states in terms of per capita sales and a number of other measures.

It has been bringing in about $3.3 billion in gross revenue per year. And, according to Lamont Financial Services, the Department of Finance’s outside financial advisors, it could improve its per capita number by more than 200 percent over the next decade.

There is already support in the Legislature for modernizing the Lottery, with a bill, SB 1679 (Florez) already introduced.

2) Securitizing
Through securitization, we would sell the rights to a portion of the future revenue stream from the Lottery for cash upfront. This would be a very attractive deal for investors even if we did not modernize our Lottery.

Several states, including Florida, Oregon, and West Virginia, already securitize their future lottery revenues through bond sales.

Our advisors, Lamont Financial Services, used a conservative model and some basic assumptions to determine that California could raise $15 billion over the next three years by securitizing future Lottery revenues after modernization legislation has been passed. (*Their report is attached.)

Other financial advisory firms would tell you that California could accomplish this securitization. In fact, if yo wanted to talk to a financial advisor yourself, here are a couple of names and numbers of advisors familiar with lotteries and securitization, including our own:

Tom Dunphy, Lamont Financial Services Corp, (925) 937-4958.
Markus Pressdee, Credit Suisse, (212) 325-3080

Also, last year, state Treasurer Bill Lockyer suggested securitization of future Lottery revenues, saying the state could attractive funding in that manner. The Treasurer’s office consulted three firms – Banc of America Securities LLC, JPMorgan, and Merrill Lynch & Co. – in getting estimates, though those firms did not look at the added benefit of modernization.

3) No Challenges
We expect no legal or other challenges to the state’s ability to modernize our Lottery and securitize a portion of its future revenues, for a number of reasons:
There is already support for this in the Legislature.

Securitization is a well-established method of financing. Other states and countries already do the same thing.

Modernization would not compete with the types of gaming offered by Indian-run casinos.

The state would maintain management control and oversight of the Lottery.
Education would continue to receive its current share of revenues plus the additional protections provided by the Governor’s Revenue Stabilization Fund.