Legislature(2005 - 2006)HOUSE FINANCE 519

03/08/2006 01:30 PM FINANCE

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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Heard & Held
Heard & Held
Moved Out of Committee
+ Bills Previously Heard/Scheduled TELECONFERENCED
HOUSE BILL NO. 278                                                                                                            
     An  Act  relating  to the  Alaska  Municipal  Bond  Bank                                                                   
     Authority;  permitting the  Alaska  Municipal Bond  Bank                                                                   
     Authority  or a subsidiary  of the  authority to  assist                                                                   
     state  and municipal governmental  employers by  issuing                                                                   
     bonds  and   other  commercial   paper  to   enable  the                                                                   
     governmental  employers to  prepay all  or a portion  of                                                                   
     the  governmental  employers'  shares  of  the  unfunded                                                                   
     accrued actuarial liabilities  of retirement systems and                                                                   
     authorizing governmental  employers to contract with and                                                                   
     to  issue  bonds,  notes,  or commercial  paper  to  the                                                                   
     authority  or   its  subsidiary  corporation   for  that                                                                   
     purpose; and providing for an effective date.                                                                              
REPRESENTATIVE MIKE  HAWKER, SPONSOR, stated that  one of the                                                                   
biggest issues  facing the  State of  Alaska is the  unfunded                                                                   
pension liability.   It has become  a growing issue  the last                                                                   
several years; last year, a determination  was made on how to                                                                   
best address  it.  HB  278 recommends  a way to  address that                                                                   
Representative  Hawker stated  there is  a $6 billion  dollar                                                                   
deficit.  He knew that the State  could not come up with that                                                                   
amount of money, however, the  amount could be amortized over                                                                   
time.  The issue  before the Committee is how  to pay it off,                                                                   
understanding the compound growth rate of 8%.                                                                                   
HB 278  provides a tool within  the financial market  to help                                                                   
pay off  the obligation with the  least possible cost  to tax                                                                   
payers.  The idea is to borrow  from an entity, asking a less                                                                   
amount of interest and the difference  would be a net savings                                                                   
over time for the State.                                                                                                        
1:50:59 PM                                                                                                                    
Representative Hawker  suggested a possible savings  close to                                                                   
$1.5 billion  dollars over the time  of the loan if  the debt                                                                   
is bonded out.   He reiterated that this savings  would be to                                                                   
the taxpayers of the State of Alaska.                                                                                           
Representative Hawker  acknowledged that borrowing  the funds                                                                   
would create a  profound constitutional change  and that such                                                                   
a mechanism was available within the international markets.                                                                     
The  bill  was  brought  forward  because  it  addresses  the                                                                   
capital  market;  municipalities   would  like  to  have  the                                                                   
consideration of  that option and the statutory  authority to                                                                   
pursue  it.   He  noted that  the Municipality  of  Anchorage                                                                   
supports the concept.  The Alaska  Municipal League (AML) has                                                                   
passed  a resolution  indicating  that  they  would like  the                                                                   
statutory authority  to consider the option.   The bill would                                                                   
provide  statutory  authority  to  municipalities  to  pursue                                                                   
pension obligation bond transactions.                                                                                           
1:55:08 PM                                                                                                                    
Representative  Hawker stressed the  simplicity of  the bill.                                                                   
The   most  complicated   aspect   of  the   legislation   is                                                                   
understanding  what  pension  obligation  bonds are  and  the                                                                   
associated benefits  and risks.    He recommended  that staff                                                                   
and  legislators   carefully  read  the  back   up  materials                                                                   
regarding  the   transactions.    Two  firms   interested  in                                                                   
pursuing  the  transactions  are  on  line  for  testimony  &                                                                   
1:58:31 PM                                                                                                                    
Representative  Hawker  said pension  bonds  would be  better                                                                   
than the  alternatives to solving  the pension  fund concern.                                                                   
Most municipalities do not have  the ability to write a check                                                                   
to  solve their  pension fund  issues.   The annual  required                                                                   
payment into the  Teacher Retirement System (TRS)  amounts to                                                                   
50% of  the teacher's gross pay.   A pension  bond obligation                                                                   
would allow the  State to reduce their  matching requirement.                                                                   
The local  taxpayers end up paying  most of the cost  for the                                                                   
local school districts.                                                                                                         
Representative  Hawker   summarized  significant   points  of                                                                   
   · Too risky - risk that the State would not be able to                                                                       
     invest at 8% and borrow at  5%.  The spread between what                                                                   
     can  be borrowed  and  what can  be  invested is  called                                                                   
     arbitrage.     Arbitrage  has been  illegal since  1986.                                                                   
     There is  a specifically  allowed federal provision  for                                                                   
     pension   obligations.     Representative   Hawker   was                                                                   
     comfortable  that investors  would be  able to  continue                                                                   
     the 8% profit on investments.                                                                                              
   · The mechanism of the bill is to grant the authority to                                                                     
     the   Alaska  Municipal   Bond  Bank   to  execute   the                                                                   
     transactions on  behalf of the municipalities,  in order                                                                   
     to  facilitate  reaching  all  capital  markets  in  the                                                                   
     country.   The risk  becomes obligated  to the  State if                                                                   
     that authority  faults.  There is a moral  obligation to                                                                   
     the State, if the municipality defaults.                                                                                   
   · Some say that Wall Street would "frown on the benefit"                                                                     
     of  issuing  obligation  to  the  municipalities.    The                                                                   
     current pension obligation  is a moral obligation to the                                                                   
     State of Alaska.                                                                                                           
   · There is fear that the municipalities would not "pay                                                                       
     up".  Representative Hawker did not agree.                                                                                 
Representative  Hawker urged  support for  HB 278,  believing                                                                   
that  capital markets  are extremely  self-governing and  the                                                                   
investors  would not take  a high  risk with those  accounts,                                                                   
given the high degree of self-regulation.                                                                                       
2:09:46 PM                                                                                                                    
Representative Hawker  urged that the fiscal  note be changed                                                                   
to indeterminate.                                                                                                               
2:11:04 PM                                                                                                                    
Co-Chair   Meyer  pointed  out   that  representatives   from                                                                   
Northwest Securities  Corporation were present  to testify on                                                                   
Representative  Hawker advised that  several firms  had taken                                                                   
an  interest  in  the  State  of Alaska.    No  one  firm  is                                                                   
authorizing   a  transaction,   only  providing   educational                                                                   
2:12:26 PM                                                                                                                    
Representative  Kelly noted support  for the legislation  and                                                                   
asked if Fairbanks had indicated support for the option.                                                                        
2:13:39 PM                                                                                                                    
Representative Hawker replied  that the bill does not address                                                                   
specific concerns.                                                                                                              
2:14:28 PM                                                                                                                    
CAROL  SAMUELS,  (TESTIFIED  VIA  TELECONFERENCE),  NORTHWEST                                                                   
SECURITIES  CORPORATION,  SEATTLE   WASHINGTON,  provided  an                                                                   
overview of a power point presentation  included in the file.                                                                   
(Copy on File).  She testified in favor of the bill.                                                                            
2:16:46 PM                                                                                                                    
Ms. Samuels referred  to Page 1, the pension  obligation bond                                                                   
description.  A  pension obligation bond is  a financing used                                                                   
to  defray  unfunded pension  costs.    It is  a  replacement                                                                   
financing rather  than a new obligation.   Many jurisdictions                                                                   
have used  pension obligation  bonds to refinance  the system                                                                   
loans at rates lower than the amortization rate.                                                                                
Ms.  Samuels  referred  to Page  2,  addressing  why  pension                                                                   
obligation bonds might be useful in Alaska.                                                                                     
   ·     According to the recently released 2004 valuation,                                                                     
         assuming above average growth  in population, Public                                                                   
         Employees Retirement  System  (PERS)  rates rise  to                                                                   
         32% of payroll beginning in 2011  and do not decline                                                                   
         until 2029 and the Teachers Retirement  System (TRS)                                                                   
         rates rise to  50% of payroll  in 2011  and continue                                                                   
        increasing to 56% by 2028 before declining.                                                                             
   ·     Pension obligation bonds can be an effective tool                                                                      
         for immediately reducing payroll rates and                                                                             
         producing long-term savings for jurisdiction.                                                                          
   ·     In Oregon, jurisdictions are projected to save over                                                                    
         $1.3 billion dollars from use of that technique.                                                                       
Ms. Samuels  continued,  Page 3 provides  a graph  indicating                                                                   
the  Alaska Pension  system, asset  base, covered  employees,                                                                   
*average  employer  rate,  funded   ratio  and  the  Unfunded                                                                   
Accrued Actuarial Liability (UAAL) as of 2003 valuation.                                                                        
2:23:11 PM                                                                                                                    
Page 4  provides a  graph of  the bonding  used as a  popular                                                                   
tool.  Many jurisdictions throughout  the country have chosen                                                                   
to finance their PERS liability with bonds.  In Oregon:                                                                         
   · A total of 133 school districts, cities, counties and                                                                      
     the State have issued $5.4 billion dollars of pension                                                                      
   · Savings projected at $1.3 billion overall, assuming an                                                                     
     8% rate of return.                                                                                                         
   · Original statutory authority provided to local                                                                             
     governments and school districts in 2001 for issuance                                                                      
     of "full faith and credit obligations".                                                                                    
   · School districts also granted authority to enter into                                                                      
     an intercept agreement with the State, whereby,                                                                            
     operating funds were additionally pledged.  The                                                                            
     approach resulted in "State" credit rating.                                                                                
   · State constitutional amendment approved by voters in                                                                       
     2003 authorizing the State to issue General Obligation                                                                     
     (GO) bonds for its share of the liability.  Voter                                                                          
     approval margin was 55.25%.                                                                                                
2:25:05 PM                                                                                                                    
Page 5  highlights the  arbitrage issue.   Issuing  a pension                                                                   
bond is  not like refinancing  a mortgage.  The  success from                                                                   
borrowing depends on the market  returning more than the cost                                                                   
of the bond.                                                                                                                    
2:27:47 PM                                                                                                                    
Ms. Samuels  continued,  Page 6 indicates  the Alaska  Public                                                                   
Retirement System (PERS) history  of investment results.  She                                                                   
pointed  out that  in  Oregon,  PERS has  a  long history  of                                                                   
strong investment performance:                                                                                                  
   ·     10 year average: 12.38%                                                                                                
   ·     15 year average: 12.69%                                                                                                
   ·     56 year average: 10.84%                                                                                                
2:29:44 PM                                                                                                                    
Page 9 demonstrates  the Alaska PERS system-wide  refinancing                                                                   
analysis.   A  refinancing  of the  $3.4  billion PERS  could                                                                   
result  in  net present  value  savings  of over  $1  billion                                                                   
2:31:40 PM                                                                                                                    
Page 10  examines the  savings available  in refinancing  the                                                                   
Teachers  Retirement  System  (TRS).   She  estimated  a  $37                                                                   
million dollar  savings, which might be redirected  back into                                                                   
the classroom.                                                                                                                  
2:32:15 PM                                                                                                                    
Page 11 summarizes the lessons learned over the past.                                                                           
   1.   Payment to PERS does not guarantee UAAL will be paid                                                                    
        off in full.                                                                                                            
   2.   What happens if UAAL is subsequently reduced or                                                                         
        increased - reduction and lump sum  payment would put                                                                   
        jurisdiction  in  surplus.     Funds  would   not  be                                                                   
        returned to jurisdiction,  but surplus would  be used                                                                   
        to reduce payroll rates further.                                                                                        
   3.   Structure of the financing matters - inappropriate                                                                      
        to  use  unrealistic   assumptions  about   rates  of                                                                   
        return; amortization structure of  bonds should match                                                                   
        amortization of  UAAL that the  PERS system  uses; it                                                                   
        is not  prudent  to  have  back  weighted  structures                                                                   
       where all savings are produced in early years.                                                                           
2:34:04 PM                                                                                                                    
Ms. Samuels noted  several examples of debt  financing, which                                                                   
had been accomplished in inappropriate  ways.  She noted that                                                                   
8% was used  as a reasonable  rate of return, whereas  9% was                                                                   
not appropriate in their opinion.                                                                                               
2:34:58 PM                                                                                                                    
Page 12 continues outlining the  "house keeping" issues.  She                                                                   
noted that  regulations would  need to  be drafted  to ensure                                                                   
that funds were accounted for  and payroll rates were reduced                                                                   
in a rational manner.  She opined  that work would need to be                                                                   
done on the system to ensure funds were protected.                                                                              
2:38:19 PM                                                                                                                    
Ms. Samuels  noted Page 13 summarizes  the intent of  HB 278.                                                                   
The  bill  authorizes  access  to  capital  markets  for  the                                                                   
purpose  of  financing  pension  liabilities.    It  provides                                                                   
express  authorization  for  all types  of  jurisdictions  to                                                                   
issue  obligations for  that purpose  either individually  or                                                                   
thorough another entity.  It also  provides authorization for                                                                   
individual  jurisdictions to  pool together  through a  state                                                                   
entity  such as  Bond  Bank to  achieve  economics of  scale.                                                                   
Additionally,  it will  allow for credit  support to  enhance                                                                   
access  to the  market such  as, intercept  of funding,  bond                                                                   
reserves and bond insurance.                                                                                                    
2:38:59 PM                                                                                                                    
Vice Chair  Stoltze questioned  the number  of agencies  that                                                                   
sell this type  of bond.  Ms. Samuels replied  that there are                                                                   
multiple  firms  eager  to  help   with  selling  the  bonds.                                                                   
Representative Hawker added that  any capital market would be                                                                   
available to pursue such a transaction.                                                                                         
2:39:54 PM                                                                                                                    
Representative  Kelly  referred  to  the  mechanism  used  to                                                                   
determine  a  credit  rating,  inquiring  if  that  would  be                                                                   
available  and/or useful.   Representative  Hawker  commented                                                                   
that was  being researched and  there would be  a forthcoming                                                                   
Representative  Kelly  followed  up with  queries  about  the                                                                   
taxation   structure  of   bonds.     Representative   Hawker                                                                   
responded that in  a 1986 federal statutory  change, in order                                                                   
to take advantage of arbitrage,  the bonds become executed on                                                                   
a taxable basis.                                                                                                                
ERIC WHALEY,  (TESTIFIED VIA  TELECONFERENCE), MERRIL  LYNCH,                                                                   
noted  questions that  many municipalities  raised  regarding                                                                   
how the legislation  would impact either the  municipality or                                                                   
the State's  bond  rating.  Mr.  Whaley pointed  out that  an                                                                   
unfunded liability  already exists.   One unfunded  liability                                                                   
would be replaced by another.                                                                                                   
A question was asked if the risk  was not positive over a 20-                                                                   
30 year time period, would the  State have been better off if                                                                   
the pension  bond had not been  issued.  Mr.  Whaley provided                                                                   
historical  examples  since 1926  of  when portfolios  had  a                                                                   
return  less than  the  bond rates  and  the  only time  that                                                                   
happened  was   just  before   the  Great  Depression.     He                                                                   
acknowledged risk, commenting it is minimal.                                                                                    
Mr. Whaley offered to answer questions of the Committee.                                                                        
2:45:04 PM                                                                                                                    
KEVIN RITCHIE,  EXECUTIVE DIRECTOR,  ALASKA MUNICIPAL  LEAGUE                                                                   
(AML), JUNEAU,  testified in favor  of the legislation.   AML                                                                   
supports  the   State  to  allow  employers   the  option  of                                                                   
refinancing  the PERS  & TRS  debt  to avoid  the 8.25%  rate                                                                   
imposed  by the system.   He  emphasized that  it would  be a                                                                   
tool for only some  municipalities; it is not a  fix for all.                                                                   
He  added that  the relationship  between the  State and  the                                                                   
schools are important.                                                                                                          
2:46:58 PM                                                                                                                    
Mr.  Ritchie pointed  out that  the municipalities  currently                                                                   
are asking,  given the funding  provided last year  to reduce                                                                   
the 5%  increase, questioning what  that meant for  the long-                                                                   
term health  of the  system.   He maintained  that these  are                                                                   
important policy questions that must be addressed.                                                                              
Representative   Kelly   referred  to   previous   discussion                                                                   
regarding  the  refinancing  a  portion  of the  fund.    Mr.                                                                   
Ritchie deferred to the finance  specialists to better answer                                                                   
that question.                                                                                                                  
2:48:30 PM                                                                                                                    
Mr.  Ritchie reiterated  that the  municipalities do  support                                                                   
the legislation.                                                                                                                
2:48:58 PM                                                                                                                    
Representative  Hawker concurred  that the legislation  would                                                                   
be  more  beneficial  if  it   refinanced  the  entire  fund,                                                                   
however,  knew   that  some   municipalities  might   not  be                                                                   
comfortable with  that risk.   It would  be best to  let them                                                                   
each decide.                                                                                                                    
2:49:53 PM                                                                                                                    
Vice Chair Stoltze  asked  if  each municipality's  level  of                                                                   
debt   would    affect   their   ability    to   participate.                                                                   
Representative Hawker    responded        that        indeed,                                                                   
municipalities  would have  to consider  their own debt  load                                                                   
and  rating  circumstances.    It  represents  a  substantial                                                                   
obligation and noted that each  circumstance would need to be                                                                   
considered on an individual basis.                                                                                              
Vice Chair Stoltze  thought    that    net-caps    for    the                                                                   
municipalities  could  be  considered and  wondered  if  that                                                                   
potential exists.                                                                                                               
Representative  Hawker acknowledged  that  caps could  affect                                                                   
the  municipality's   ability  to  participate   or  prohibit                                                                   
financing options.                                                                                                              
2:51:56 PM                                                                                                                    
Representative Kerttula  asked  how a  municipality could  go                                                                   
about obtaining authorization  for financing.  Representative                                                                   
Hawker responded,  it would happen  through the  same process                                                                   
used   for   current  financial   obligations   incurred   by                                                                   
municipalities.   He referred  to AS 29, regarding  authority                                                                   
of  municipal  debt  and  outlined   the  methods  to  obtain                                                                   
authorization for municipal debt.                                                                                               
2:53:35 PM                                                                                                                    
CARL  ROSE,  ALASKA  ASSOCIATION  OF  ALASKA  SCHOOL  BOARDS,                                                                   
JUNEAU, noted  that on  February 12,   2006, Ms. Samuels  had                                                                   
addressed  their   Board.    He  advised  that   the  numbers                                                                   
impressing  him was  the projected  50% anticipated  increase                                                                   
rate in  payroll by  2011; increasing again  to 56%  by 2028.                                                                   
AASB supports  the option for municipalities  to refinance to                                                                   
reduce  the   high  rates  affecting   payroll.     He  noted                                                                   
appreciation for all the work done on the bill.                                                                                 
2:56:17 PM                                                                                                                    
BILL BYORK, PRESIDENT, NATIONAL  EDUCATION ASSOCIATION (NEA),                                                                   
ALASKA, expressed  the organization's  desire to  explore the                                                                   
proposed  refinancing options.   It  is a  critical tool  for                                                                   
addressing the State's unfunded  liability and that HB 278 is                                                                   
2:57:30 PM                                                                                                                    
Representative  Hawker  summarized,   noting  that  both  the                                                                   
financial  and educational  communities  view the  bill as  a                                                                   
viable  tool   but  not  supported  by   the  Administration.                                                                   
Amendments  will  be forthcoming  to  address  concerns.   He                                                                   
disagreed that the risks outweigh the benefit.                                                                                  
Co-Chair Meyer stated  that the Administration  could testify                                                                   
when the  bill incorporated  the amendments,  making  it more                                                                   
2:58:55 PM                                                                                                                    
HB 278 was HELD in Committee for further consideration.                                                                         
3:00:22 PM                                                                                                                    

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