01/17/2006 08:00 AM House STATE AFFAIRS
| Audio | Topic |
|---|---|
| Start | |
| HB278 | |
| HB273 | |
| Adjourn |
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 23 | TELECONFERENCED | |
| += | HB 278 | TELECONFERENCED | |
| += | HB 273 | TELECONFERENCED | |
ALASKA STATE LEGISLATURE
HOUSE STATE AFFAIRS STANDING COMMITTEE
January 17, 2006
8:04 a.m.
MEMBERS PRESENT
Representative Paul Seaton, Chair
Representative Carl Gatto, Vice Chair
Representative Jim Elkins
Representative Bob Lynn
Representative Berta Gardner
Representative Max Gruenberg
MEMBERS ABSENT
Representative Jay Ramras
OTHER MEMBERS PRESENT
Representative Mike Hawker
COMMITTEE CALENDAR
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."
- HEARD AND HELD
HOUSE BILL NO. 273
"An Act relating to the dividends of individuals claiming
allowable absences; and providing for an effective date."
- HEARD AND HELD
HOUSE BILL NO. 23
"An Act relating to construction of a legislative hall."
- BILL HEARING CANCELED
PREVIOUS COMMITTEE ACTION
BILL: HB 278
SHORT TITLE: RETIREMENT SYSTEM BONDS
SPONSOR(S): REPRESENTATIVE(S) HAWKER
04/19/05 (H) READ THE FIRST TIME - REFERRALS
04/19/05 (H) STA, FIN
01/12/06 (H) STA AT 8:00 AM CAPITOL 106
01/12/06 (H) Heard & Held
01/12/06 (H) MINUTE(STA)
01/17/06 (H) STA AT 8:00 AM CAPITOL 106
BILL: HB 273
SHORT TITLE: PFD: DELAY PAYMENT FOR ALLOWABLE ABSENCES
SPONSOR(S): REPRESENTATIVE(S) WEYHRAUCH
04/18/05 (H) READ THE FIRST TIME - REFERRALS
04/18/05 (H) STA, FIN
05/05/05 (H) STA AT 8:00 AM CAPITOL 106
05/05/05 (H) Heard & Held
05/05/05 (H) MINUTE(STA)
01/12/06 (H) STA AT 8:00 AM CAPITOL 106
01/12/06 (H) Scheduled But Not Heard
01/17/06 (H) STA AT 8:00 AM CAPITOL 106
WITNESS REGISTER
CAROL SAMUELS, Vice President
Seattle Northwest Securities
Portland, Oregon
POSITION STATEMENT: Described the use of the Pension Obligation
Bond (POB).
GARY BADER, Chief Investment Officer
Treasury Division
Department of Revenue
Juneau, Alaska
POSITION STATEMENT: Provided information on Pension Obligation
Bonds.
TOM BOUTIN, Deputy Commissioner
Treasure Division
Department of Revenue
Juneau, Alaska
POSITION STATEMENT: Testified regarding Pension Obligation
Bonds.
DEVEN MITCHELL, Executive Director
Alaska Municipal Bond Bank Authority
and Debt Manager for the State of Alaska
Juneau, Alaska
POSITION STATEMENT: Answered questions regarding the use of
bonds in Alaska communities.
JEFFREY SINZ, Chief Fiscal Officer
Municipality of Anchorage
Anchorage, Alaska
POSITION STATEMENT: Testified in support of HB 278.
TERRY HARVEY, Staff
to Representative Bruce Weyhrauch
Alaska State Legislature
POSITION STATEMENT: Presented HB 273 on behalf of Representative
Weyhrauch, sponsor.
ACTION NARRATIVE
CHAIR PAUL SEATON called the House State Affairs Standing
Committee meeting to order at 8:04:47 AM. Representatives
Gatto, Elkins, Gardner, and Seaton were present at the call to
order. Representatives Lynn and Gruenberg arrived as the
meeting was in progress.
HB 278-RETIREMENT SYSTEM BONDS
8:05:27 AM
CHAIR SEATON announced that the first order of business was
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."
CHAIR SEATON said the meeting will focus on the Pension
Obligation Bond (POB) because using POBs is one of the methods
that is being considered in addressing the under-funded Public
Employees' Retirement System (PERS) and the Teachers' Retirement
System (TRS).
8:07:04 AM
CAROL SAMUELS, Vice President, Seattle Northwest Securities,
Oregon, said POBs offer a potential tool that can be very
flexible and useful to local and state jurisdictions. Seattle
Northwest Securities has been involved in over $3 billion of
"these types of obligations" in Oregon. Referring to her
presentation, Ms. Samuels defined a POB as a replacement
obligation for a jurisdiction's already existing obligation to
the pension system. She continued as follows:
It can help defray some of the costs that are already
on the books. Pension systems essentially measure
assets on one hand, in other words, the securities
they own in their portfolio, against a calculation of
future liabilities over the long term, which they
translate into present value dollars, or dollars that
are meaningful today. They compare the two of them,
and if liabilities are greater than assets, again,
measured on a present value basis, then you have an
unfunded actuarial accrued liability, which ...
everybody abbreviates ... to UAAL or UAL. This is not
an uncommon problem. In fact it's rare to find a
pension system, either in the private sector or in the
public sector, that does not have a significant
unfunded liability. [This is] largely because
investment returns in the early years of this decade
lagged expectations.
8:10:15 AM
MS. SAMUELS further explained:
In Alaska, repayment of this debt - this UAAL - is
amortized just like any other bond or loan that you
might have on your mortgage, for example. It's
amortized over a fixed period and it's built into
existing payroll rates. So, a fairly significant
component of payroll rates is devoted to repaying the
debt. The debt is amortized in Alaska at an interest
rate of 8.25 percent. Now, I often get questions
about the differences in percents - why is it one
percent of payroll and another percent that isn't
equal to 8.25 - and it's important to keep in mind
that they're different. One is a percent of payroll,
so you take a given payroll of a jurisdiction, you
figure out the dollars that are necessary to repay the
debt at an interest rate of 8.25 percent, and then you
divide by the payroll of the jurisdiction to get the
payroll rate. So they're both percentage terms, but
they're measuring different things.
Therefore, the retirement system is essentially the
banker, and when I say it's a replacement obligation
to issue a pension obligation bond, that's exactly
why. There is an obligation; it is an unconditional
obligation of the jurisdiction. They have to repay
it, and it's being amortized at 8.25 percent. Many
jurisdictions have looked to the marketplace to see
whether or not they can get a better deal. Again,
it's not a new obligation, it's not like borrowing
money to build a new sewer system where you have to
come up with additional revenue. If this works as you
hope it will, this should lower your overall costs
because you will only enter into this if you believe
you can save money on an obligation you have already.
Moving to page three, being more specific to your
situation, why might this be something you'd want to
consider granting authority to jurisdictions to
pursue? Well, according to the most recently released
valuation, which is from 2004, PERS rates...are
expected to rise to 32 percent of payroll, beginning
in 2011, and they don't go down again until 2029.
Paying a third of your payroll in pension costs is
obviously a pretty significant bite for jurisdictions
to take on, and they're not paying anywhere close to
that right now, so you can expect that over time the
amount of money that's devoted to paying pension and
related healthcare costs is going to eat up their
ability to do the other things that citizens expect,
from cities, boroughs, school districts...
TRS rates are even expected to go higher. They are
expected to go to 50 percent of payroll in 2011, and
they will continue increasing to 56 percent by 2028
before they then decline. So it's a long way to go
with pretty extreme rates relative to what we've seen
elsewhere. Properly structured pension bonds - and I
underscore properly structured, there are lots of ways
to structure these that would not be, in our opinion,
prudent for a jurisdiction - can be an effective tool
to bring these payroll rates down immediately, and
more importantly, to produce long term savings for
these jurisdictions. In Oregon, as I mentioned, we've
been pretty heavily involved in assisting
jurisdictions with obligations of this type. In fact,
jurisdictions overall have sold more than $5 billion,
and we project that, at the rates of return that the
Oregon actuary uses, which is 8 percent (not 8.25),
that savings are going to be over $1.3 billion, or
close to 25 percent of the total.
8:14:37 AM
REPRESENTATIVE GARDNER asked what the normal life of a pension
bond is, regarding PERS and TRS.
8:15:00 AM
MS. SAMUELS said she recommends a structure that matches the
amortization period of the loan Alaska is receiving from the
system. She added that it is tempting to lengthen that period
to reduce costs, but it is not financially prudent because it is
borrowing against the borrowing.
8:16:30 AM
CHAIR SEATON said the present dollar value of the pension
obligation system is based on a schedule of payments over the
next 20 years, and those scheduled payments have to take place.
He asked if the POBs have anything to do with the structured
payment schedule or only with the present dollar value.
8:17:35 AM
MS. SAMUELS said she thinks her presentation will answer his
question. She said there may not be a direct match between what
the debt service is and the annual saving, because in many
cases, these are not like typical bonds with guaranteed
payments. She said payments are based on rates of returns that
are earned on the bond proceeds, how quickly the payroll grows,
and on other demographic variables. She added that it is very
complicated, and needs to be considered carefully before moving
ahead. It is not as predictable as refinancing a mortgage, she
noted.
REPRESENTATIVE GRUENBERG asked if there was a way to make it
more predictable.
8:19:25 AM
MS. SAMUELS said, "Not exactly," and requested that she continue
her presentation. Referring to page 4 of her presentation, she
said:
PERS is basically twice the size as TRS, in terms of
the asset base. The number of covered employees is
70,000, versus approximately 21,000. The average
employer rates that are currently being paid, and
these are in contrast to the ones I cited
earlier...are approximately 16.8 percent and 21
percent. Please note the footnote: these are
collared rates, meaning they are, in a way,
artificially reduced in order to keep within a 5
percent band. The actuary actually calculated that
for PERS the rate should have been about 25.6 percent,
where as for TRS it should have been closer to 39
percent. So you can already see the steady
increase...and the longer you take to pay it
back...the more interest accrues. It's like you're
not making a payment, so the debt just keeps
increasing, which is one of the reasons that rates are
projected to rise so high. Funded ratios for PERS and
TRS are approximately 72 percent and 64 percent, and
when you translate the debt, the shortfall in 2004 in
present value terms is approximately $5.7 billion
combined.
MS. SAMUELS continued, referring to page 5:
Obviously saving somewhere between 20 and 25 percent
of your debt sounds pretty good, and reducing payroll
rates sounds even better...but the thing that people
need to understand and be comfortable with is
that...this is basically...an arbitrage play. Now
usually when you use the words "arbitrage play," you
say that in sort of a whisper with a giggle because
it's illegal under federal tax laws. The reason that
we say it proudly in this case, is because federal tax
law does not rule over this type of issue. Why?
Because you would have to sell these bonds on a
taxable basis. In other words, unlike a bond issue
that Juneau might sell for a new sewer facility, the
interest on which would be tax-exempt under federal
tax law...these bonds would have to be sold on a
taxable basis. Interest earned on the bonds is
subject to federal tax. The reason the federal
government makes these taxable, which makes the
interest rate higher (right now we're projecting an
interest rate for an obligation of this type to be 5.5
to 6.0 percent), is they reserve the tax exempt
privilege for capital projects. This is considered to
be an operating project.
The good news of the federal government not being
involved in this is they have absolutely nothing to
say about whether or not you earn arbitrage.
Arbitrage is borrowing at one rate and turning around
and re-investing at another. That is essentially the
main issue when it comes to pension bonds. Can you
borrow at, say, 6 percent..., and turn around and
invest it at the PERS system at 8.25? If that's the
case, that 2.25 percent difference, that's what we
call the arbitrage, allows municipalities to reduce
their overall cost of the pension system...
In this example, the breakeven is your rate of
borrowing. In other words, if you borrow at 6
percent, as long as you earn more than 6 percent, you
will end up costing your jurisdictions less than if
they continue to make their loan repayments to the
PERS system. On the other hand, and if you earn 8.25
percent, you will meet the savings that I am going to
show you later in the presentation. If you earn
somewhere between 6 and 8.25, you will still save
money, but you won't save as much. If you earn more
than 8.25 percent, which historically the system has,
you'll save even more than I'm going to show you, but
then, of course, if you earn less than 6 percent, you
will end up costing your jurisdictions more.
So, the real question that a municipal official needs
to ask themselves before going ahead and entering into
a POB, is do I believe over the next 22 years, in this
case, that I can earn more than my current borrowing
rate which is somewhere between 5.5 and 6.0 percent.
If you think that that's a good bet, and again we use
the word bet because that is what it is, it is a
guestimate, it's a gamble, but in this case it could
work very heavily to your advantage. If you think
that that's a good gamble, then it's something that
you should do.
Of course, you are kind of gambling either way,
because if you don't make this choice, and you
could've earned a higher rate of return on these
proceeds, you could put your jurisdiction in worse
shape by not pursuing a POB.
8:26:00 AM
Moving on to page 6, we have a snapshot of rates of
return, since 1992, in the pension system. As you can
see, in most periods it's in excess of 8.25 percent.
I do not have statistics that date back as far as I do
in Oregon, but under the theory that the Oregon
investment system is equivalent to the Alaska
investment system, I can tell you that Oregon has
statistics that over the past 50 years, they have
earned more than 10 percent return. That doesn't mean
they're going to earn 10 percent return every year; it
doesn't mean they're going to earn 8 percent every
year, which is the benchmark for the Oregon system.
There are going to be some years where you have a
1994, or worse, you have a 2001. But if, on average,
the system earns more than 8.25 percent, you're ahead
of the game.
8:27:10 AM
CHAIR SEATON asked if the 2004-2005 numbers are available.
8:27:24 AM
MS. SAMUELS answered no, and that other testifiers will have
that. Referring to page 7, she said 133 jurisdictions in
Oregon, including the state, have used POBs. In Oregon they use
a full-phasing credit obligation, which means "you can borrow
funds and repay them on an unconditional basis without receiving
a vote." School districts and counties use that technique, she
said. She said the state chose to go to the voters to change
the constitution to allow the process, which ended up being
easily passed. It was a general obligation bond, and for public
perception reasons, Oregon chose to say that property taxes
could not be used to repay that debt, she noted. Oregon has
never levied a property tax, she added. Alaska could do it that
way.
8:29:38 AM
REPRESENTATIVE GRUENBERG said Alaska's constitution prohibits
general obligation bonds, so "all we can do is moral obligation
bonds."
8:29:42 AM
MS. SAMUELS said Alaska could pursue a constitutional amendment,
because the interest cost will be lower with a general
obligation bond than with a moral obligation bond. She said the
state would need to consider how long that authority change
would take, because interest rates may go up during that time.
The interest rate for a moral obligation bond would probably be
half a percentage point higher, she surmised, and over a 22-year
period that can really add up. She continued:
The key lesson we learned in Oregon is that it is
important to make sure you protect the borrowing side,
and you create a security structure that is saleable,
but it's probably more important that you figure out
the housekeeping issues...of what happens to the
proceeds when they're delivered to the system. If the
system were about to receive about $5 billion that
they weren't counting on, you'd want to make sure that
that money was protected, and that those jurisdictions
that had actually borrowed the funds, would end up
getting the credit for the amount they borrowed. The
process in Oregon is that there is a lump sum account
- and this is built into statute - that had a little
black box around it. The jurisdiction that funded
that black box is the only jurisdiction that gets the
credit for the funds that are in there. It is kind of
like a prepayment account. As money accumulated
through interest earnings, those funds are used to buy
down the payroll rate. So in the TRS example, if you
had a 50 percent payroll rate and you created a lump
sum account, funds would be drawn out of that account
on an annual basis and used to reduce that 50 percent
to something lower than that - say, 20 or 30 percent.
If the fund earns greater interest, over time, then
the 8.25 percent (which is assumed), then the payroll
rate buy-down will be even more significant...if it
earns less the payroll rate buy-down will be lower
than what's estimated. That gets back to the
question...about the predictability. There are
savings, but they may not come in your...standard
savings report where you're going to save $1 million a
year. You may save $2 million one year and $500,000
the next. It really depends on what happens to that
account.
8:33:26 AM
CHAIR SEATON referred to Table 6, and asked if payments are
strictly amortized, so that the employer is not seeing an
increase in the percent of payroll for retirement during low
return years.
8:34:27 AM
MS. SAMUELS said if there was "a series of [low] periods that
look like 2001, 2002, and 2003, you could see a situation where
payroll rates were higher than what would otherwise be the
case." Referring to page 9, which shows the rates of return
that affected Oregon, she said that because things "snapped
back" after 2003, actual earnings were over 60 percent,
translating to a 19 percent return. She said Alaska needs to
try and predict future rates, and then do a "gut check."
8:36:22 AM
CHAIR SEATON said that in spite of the snapping back, table 6
shows figures well below 5 percent in 2003.
8:36:42 AM
MS. SAMUELS said she doesn't know where that 2003 figure came
from, and she is skeptical because the system in Oregon earned
about 26 percent that year. She said the comparable months
might be different. Referring to page 9, she said that the
rates of return for 2002 have been well in excess of the
borrowing rate. Page 10 refers to the legislative process to
begin to use POBs. She said she is often asked if the
obligation can be paid off, and she said probably not, because
the system assumes an 8.25 percent return, and if there is a
period when it doesn't earn close to that, the employer will
need to provide the cash. If the fund earns double digits, for
example, it must benefit the jurisdiction only. These are
housekeeping issues, she said. Arbitrage risk remains the same.
She noted that the structure of the financing is important; it
is not appropriate to use unrealistic assumptions about rates of
returns. New Jersey did that, she stated. She said she would
not go into a borrowing at an interest rate of over 7 percent,
which is why the window for Alaska is narrow. Long-term
interest rates are expected to go up, and they are between 5.5
and 6.0 now. She doesn't think it is prudent to re-amortize
over a longer period of time or back weight it by taking all of
the savings up front. New Jersey and Illinois tried to balance
their budgets in that manner. She referred to page 11 and said
that statutes and administrative rules must be made to make sure
the money is handled properly.
8:41:21 AM
MS. SAMUELS said the bonds are not likely to be subject to early
redemption. The bonds are taxable and sold predominately
overseas to international banks, and Alaska's competition would
not be with other municipalities. If there is a redemption
provision it will cost half a percent, and she said that is too
high of a price to pay at the current low interest rates. "Once
you go down this road, your chances of getting back out of it
are pretty minimal," she warned.
MS. SAMUELS stated that rating agencies would know that Alaska
has a shortfall, and in their opinion translating that shortfall
into a bond is no different, in fact it might be a plus because
Alaska is doing all it can to bring down its cost structure.
She added it is less flexible to use a bond issue than to
continue to use PERS as a banker.
8:43:38 AM
CHAIR SEATON said Alaska's contribution rates are only going up
5 percent per year, "even though actuarially we should be at the
25 and 38 percent...and structurally we have just limited the
payments. Under the bond system...are we going to be paying at
an actuary rate or would we soft-structure it the same way so
that our payments...accrue slowly at first." He ask if it would
immediately increase the employers' payments per year.
8:44:31 AM
MS. SAMUELS said yes, a 5 percent collar is essentially the
meaning of a soft liability. She said it is taking advantage of
the softness of the obligation, but by doing that, the costs
will be significantly steeper down the road. Secondly, she
said, bonds are fixed, with a promise to repay a certain amount
of principle every year at a certain interest rate. There are
variable-rate structures, but it would still be a fixed
obligation, she noted. "The hardness of the structure means
you're taking care of your business now," and not waiting for
payroll growth. The bond is a more conservative financial
structure because, "you're making your payment as you owe them."
8:46:53 AM
REPRESENTATIVE GRUENBERG questioned if markets would look at
Alaska differently than Oregon because the state is so dependent
on the volatile oil resource for its revenues.
8:47:28 AM
MS. SAMUELS said Oregon can offer a different security structure
to the market. Alaska has a strong reputation in the bond
market, she noted, but a moral obligation pledge is worth a lot
less to investors. Alaska needs to evaluate "meaningful"
access, and she guessed that Alaska is well positioned under any
circumstance to enter the market. Some small cities may not be
able to enter the market. She said that getting an obligation
approved by the voters that would allow the state to not have it
subject to the appropriation process would grant much broader
and less expensive access to all municipalities in the state.
She continued:
Approaching the [Alaskan] voters is pretty tough hill
to get over. Our sense is that there are ways in ...
Point 2 to expand access with additional security
structures, such as the intercept. The intercept is
pretty important, and in our opinion HB 278, if you
pursue that, should be expanded to include things like
allowing an intercept for schools. ... Since schools
get such a wide proportion of their funding from the
state, effectively you've got a state credit, and that
is exactly the way we did it in Oregon. In Oregon
school districts ... get about 70 percent of their
operating cash from the state; they entered into an
intercept agreement with the state, whereby the state
paid the debt service directly, right off the top of
their appropriation, and they ended up with a credit
rating that was just one small notch below the state's
rating .... We would recommend that you pursue
something similar in Alaska to the extent there's a
way to get there under your current constraints.
8:51:19 AM
MS. SAMUELS said allowing bond reserves to be set up and
accessing bond insurance is important. Referring to HB 278, she
said the one significant issue she suggests is that the nature
of the obligation between the local entities and the Bond Bank
needs to be further defined. She said it wasn't clear that HB
278 granted authority for the Bond Bank to sell bonds for this
purpose, and the bill does not grant clear authority to the
local governments to sell bonds to the Bond Bank for this
purpose, she warned. She said the bill should be expanded to
contain an intercept agreement for schools. This could help
expand the amount of dollars for schools. She said the bill
should have additional flexibility, so that jurisdictions can
pool together outside of the Bond Bank and have their own
authority.
8:53:42 AM
MS. SAMUELS gave an example of the City and Borough of Juneau.
Juneau owes about $75 million to the PERS system. Assuming
bonds were sold in March and the borrowing rate would be
[indecipherable], which is about .25 percent too high, and the
fund earned 8.25 percent, Juneau's total savings would be over
$23 million, which is an annual savings of $1 million per year -
real money for a community the size of Juneau. She said another
way to look at it is a 20 percent savings, and she noted that
Oregon has a minimum requirement of saving 3 percent, so by that
definition, "this is a terrific refinancing."
8:55:23 AM
REPRESENTATIVE GATTO indicated that it sounds bad to say we are
going to solve money problems by borrowing money. He said that
in the late 1800s, there was the gay '90s, and that was followed
by the great depression. We are fighting a major war, he said,
and he asked if we could "find ourselves in such a hole that we
get sued by the bond holders" and lose Alaska's permanent fund.
8:57:26 AM
MS. SAMUELS agreed that the state would be borrowing, but she
said the state has already borrowed that money and would just be
changing its banker. "This is a debt you have already," she
said. She said POBs are a bad choice if there is an economic
depression. She noted that Oregon has a 56-year history of
investment returns, and it is over 10 percent through boom and
bust cycles. Alaska has an actuary to give an estimate of
returns, and the 8.25 percent is not the upper end, she said, it
is supposed to be the average. It is not a guarantee, she said,
but it could also turn out badly if Alaska doesn't do a POB.
9:00:06 AM
REPRESENTATIVE GRUENBERG said if these are moral obligation
bonds, then the permanent fund would be protected.
9:00:59 AM
MS. SAMUELS said she does not know about the laws restricting
the use of the permanent fund, but generically a moral
obligation is one in which investors have only a moral promise
to make payments.
9:02:18 AM
CHAIR SEATON asked if POBs were issued on an amortized repayment
schedule, would the individual municipalities issuing these
bonds see the employee wage base percentages jump to the
actuarial listed amounts. He noted the 5 percent collar now,
and wants to know if that would change.
9:04:15 AM
MS. SAMUELS said that is a housekeeping issue that needs some
attention. She added that there needs to be a structure that
memorialize how the rate reductions would be applied against
payroll rates. She doesn't think that has been set up, but it
could be done in the legislation or by administrative rule.
9:05:40 AM
CHAIR SEATON said the PERS and TRS actuarial rates are 25 and 38
percent, and "we're paying 14 percent because of the soft cap."
There is a collar of 5 percent, and he asked if that collar
would go away with a POB.
9:06:30 AM
MS. SAMUELS said it depends on how the system structures it, and
it is her understanding that the 5 percent collar is going away
anyway. She indicated that the following would work best:
Let's assume that PERS calculates that based upon your
$20 million payment, you're going to get an 8 percent
reduction in your payroll from now until 2028 when the
debt is retired. That's at the assumed rate of 8.25
percent. ... If the system itself projects that the
rate is going to go from this year's 16.77 to next
year at 21.77, you would still get that 8 percent
[reduction], it would just be against a higher number.
9:07:50 AM
CHAIR SEATON said an Alaska Retirement Management Board (ARMB)
presentation said a payroll reduction would be around 2.6 to
3.1. He asked if the 8 percent was a guess.
9:08:18 AM
MS. SAMUELS said she was pulling that number out of the air, but
she could probably calculate what the payroll rate reduction
would be.
9:08:37 AM
CHAIR SEATON said that would be helpful.
9:08:48 AM
MS. SAMUELS said:
Part of what makes a large rate reduction is if you
are making a payment in advance of when it's
recognized in the rates. So, if you pay the full
amount of your unfunded liabilities when you're only
being charged for, say, 60 percent of it - which is
basically what's happening now [because] they're not
building into your rates exactly what you owe - you're
going to get a bigger rate reduction if it's fully
recognized. ... There are quite a few municipalities
in Oregon who are paying nothing on PERS .... I would
not be surprised to see a pretty significant reduction
in rates because you are paying before it's recognized
in your rate structure.
CHAIR SEATON requested estimates from Ms. Samuels.
9:10:59 AM
GARY BADER, Chief Investment Officer, Treasury Division,
Department of Revenue (DOR), said DOR is staff to the Alaska
Retirement Management Board (ARMB). He noted that the board was
established in October and recently heard its first presentation
on POBs. He said the board learned that without POBs the [PERS
and TRS] system is significantly underfunded and future
contributions will be the way to cover those balances. POBs
lever the contribution risk - if the fund achieves greater than
the actuarial discount rate, the contributors to the fund
benefit, if it does not, they are at a disadvantage. He said
the leverage cuts two ways. If such bonds had been issued five
years ago, the total returns to the system would be less than
the cost of issuing the bonds. "We would be disappointed with
the experience," he said, and if the bonds had been issued three
years ago, we all would have been happy with the outcome. He
added that POBs impose a market timing decision on the ARMB.
"While it may make sense to invest all the assets immediately,
politics may require some sort of dollar averaging," he said.
"Imagine if we had invested all of the proceeds in mid-2000,
just about the peak of the stock market, today we would be very
dissatisfied with the results." The real test is what happens
over the life of the bonds, he noted.
9:14:29 AM
MR. BADER said several asset categories that the pension funds
invest in are not accessible immediately, like real estate. If
an infusion of $1-2 billion were available to the ARMB
immediately, it is doubtful that they could immediately adopt
the same asset allocations that they have now, and may need to
look more at public markets to invest the funds, he stated. He
told the committee that the state financial advisor, Chester
Johnson, recommended that "the bond rating agencies take a
harder look at general obligation bonds...and consider that a
hard liability, versus a promise to have to increase the
contribution rate as a soft liability." Regarding the cost of
issuing POBs, Mr. Johnson told him it depends on the amount of
bonds that are issued, but estimated that one to two percent -
or $10-20 million - of that which was underwritten might be used
up. He said ARMB heard four presentations on POBs and explored
the concept, but they did not come to any conclusions, and so
have no position on HB 278. Regarding page 6 of Ms. Samuels
report regarding investment returns, the FY04 rate of return was
14.7 percent, and in FY05, it was 8.95 percent for PERS.
9:17:24 AM
CHAIR SEATON asked if the asset allocation of the Alaska State
Pension Investment Board (ASPIB) was 60 percent in equities and
40 percent in bonds, and what that means regarding the POBs.
9:19:17 AM
MR. BADER said, "It's likely if you sell taxable bonds at 6
percent and you invest it in bonds, trying to mimic the Lehman
[Brothers Aggregate Index], you would get close to the same
return, and so it would be hard to make a case for that just on
the basis of looking at returns. However, when the board does
its asset allocation, it looks not only at investment returns,
but looks at the variability of returns and how they match with
other investments. For example, in 2002, when the stock market
peaked, equity returns...fell a lot. At the same time interest
rates were coming down, so fixed income returns were kind of
helping the portfolio, and keeping it from suffering the ten,
fifteen, twenty percent losses in equity returns. So a
portfolio is structured to try and have investments where some
are doing well and others are not in favor. That would be one
of the arguments for keeping an investment in bonds." He said
selling a POB and put it all in equities would be an even
riskier proposition than the way the board currently invests its
funds. He added that he can't give an answer.
9:21:19 AM
CHAIR SEATON said he would like the board to carefully address
that.
9:23:15 AM
MR. BADER said, "If you sell a bond today for 6 percent, and the
market happens to be 6 percent, well we look at that and say,
'What's the point?'" If interest rates go down, you will make
money on the investment. It isn't a given that you break even
or lose money.
9:23:53 AM
CHAIR SEATON said the POBs would probably not be redeemable, "so
is the difference than that the bonds that you might be buying,
you could...I guess you could resell them."
9:24:29 AM
MR. BADER said, "We do resell the bonds, and if interest rates
go down, we sell them at a profit."
9:24:37 AM
CHAIR SEATON asked about the structure of POBs and if they are
re-sellable.
9:24:55 AM
MR. BADER said the comments from the state financial advisor
indicate that the premium would be too high to make POBs
callable.
9:25:10 AM
REPRESENTATIVE GRUENBERG said he is confused, and the only
reason he heard on why POBs are taxable is because they are not
for capital construction projects. He said he would like
something in writing analyzing what kinds of bonds are taxable
and what are not. He also wants to know how they can be
structured to be tax-free.
9:26:54 AM
TOM BOUTIN, Deputy Commissioner, Treasure Division, Department
of Revenue, said the department generally opposes POBs, so far.
He noted that six to eight banking firms have made presentations
to the department, and Mr. Boutin said he has read reports on
the topic. He told the committee that he has been involved in
Alaska public finance for about 20 years, and he sits on a
number of boards that issue state debt. He said real estate
investments can make sense, but "issuing long term taxable bonds
in the hope to invest in a higher yield is not something that
the Department of Revenue would recommend to state government."
He said that HB 278 brings up unanswered questions. If a lease
structure is contemplated for HB 278, then he said he would
worry about extending the state moral obligation to lease debt.
He said that has implications for ongoing debt, and he added
that there is about $1.3 billion of state moral obligation debt
now. If the state moral obligation is not explicitly tacked on
the POBs, he said, there is a significant chance that a large
amount of this kind of debt would still be counted in a moral
obligation way.
9:30:33 AM
MR. BOUTIN said the state has a finite limit to a moral
obligation debt at the current rating levels, and HB 278 could
use up that debt capacity. He added that most Alaska
municipalities are too small to use the Bond Bank, and so the HB
278 structure would not be available to them.
9:31:37 AM
CHAIR SEATON asked Mr. Boutin to explain further about the size
of communities and their access to the Bond Bank.
9:32:01 AM
MR. BOUTIN answered that a number of Alaska municipalities are
rated the same as, or higher than, the state moral obligation
credit rating, so it doesn't make sense for them to use the Bond
Bank. Anchorage used the Bond Bank last year for replacing the
roof on their performing arts center. It made sense because in
that case part of the ticket receipts were used to make the debt
service for the roof. But if Anchorage went out and did that
structure on its own, the credit quality of having a ticket
surcharge wouldn't be a very good credit structure, he said.
When Anchorage came to the Bond Bank then all of the money,
including school foundation money, was pledged with a senior
lien to the Bond Bank. But typically, Anchorage won't come to
the Bond Bank. Juneau doesn't normally come to the Bond Bank,
but did so a year or two ago for hospital revenue bonds, because
health care bonds are well liked now. The Northwest Arctic
Borough is 25 percent of the Bond Bank's portfolio, he noted, so
"there's a typical community that gains an advantage from the
Bond Bank." That borough doesn't have a credit rating, doesn't
have property taxes, and so has used the Bond Bank more than
other communities.
9:35:20 AM
CHAIR SEATON said he thought Mr. Boutin said some smaller
communities don't have access to the Bond Bank.
9:35:41 AM
MR. BOUTIN said absolutely. He said Ms. Samuels mentioned
Hyder, and he said he would be skeptical if Hyder could come to
the Bond Bank and access the credit markets. "Likewise,
Hydaburg would be on the edge." He said communities that are
too small and don't have predictable revenue normally would not
have access to the Bond Bank. He said Kaktovik did a small deal
through the Bond Bank, but that was an anomaly.
9:36:59 AM
CHAIR SEATON said there were 155 different PERS employers around
the state and the legislature is trying to figure out if POBs
could be useful. He asked if Mr. Boutin was saying that the 30
smallest employers could not use POBs.
9:37:51 AM
MR. BOUTIN said that would have to be assessed community by
community, but it's a safe bet that there is a significant
number of municipalities that could not access the credit
markets through the Bond Bank under HB 278.
9:38:28 AM
CHAIR SEATON said he wants an estimation of the employers that
could not participate, and if there is a structural change that
could fix that, because the attempt is to design this for
everyone.
9:39:18 AM
REPRESENTATIVE GATTO asked if Oregon has an AA credit rating.
9:39:27 AM
MR. BOUTIN said he did not know. He said Alaska's general
obligation rating is AA with all three credit rating agencies.
The moral obligation rating is usually a full notch below, so he
expects an A rating for that.
9:40:15 AM
REPRESENTATIVE GATTO asked if the state's credit rating will
change by taking on the debt.
9:40:30 AM
MR. BOUTIN said he does not know what the moral obligation debt
capacity is, but it is far less than $6 billion. He said Alaska
depends upon a volatile single source of income, unlike Oregon,
and that is a concern of the credit raters. He said he didn't
think Oregon would be switching to a defined contribution plan,
but Alaska will be on July 1.
9:42:10 AM
REPRESENTATIVE GRUENBERG said he would like the same answers for
TRS. He asked if Rural Education Attendance [Areas] (REAA)
would have the same problems because they have no tax base.
9:42:45 AM
MR. BOUTIN said he doesn't know what structure would allow a
REAA to issue debt.
9:43:15 AM
CHAIR SEATON asked if the school districts have the ability to
issue debt.
9:43:26 AM
MR. BOUTIN said many municipalities issue school debt now to
build schools.
9:44:00 AM
REPRESENTATIVE GRUENBERG said it is the municipality that issues
debt, not the schools. He noted that Alaska differs from other
states in its dependency on the federal government.
9:44:21 AM
REPRESENTATIVE GARDNER asked about the state already having $1.3
billion in outstanding moral obligation.
9:44:48 AM
MR. BOUTIN said that is debt for the Alaska Student Loan
Corporation, the Alaska Municipal Bond Bank Authority ("Bond
Bank"), the Alaska Energy Authority, and perhaps for the Alaska
Industrial Development and Export Authority. State moral
obligation is a device used across the country as a credit
enhancement. "It's language of art that you stick in the
enabling legislation for an authority, and then you repeat it in
the bond documents that state that there will be a reserve fund,
and if that reserve fund is used to pay debt service, then the
executive director or commissioner is pledged to go to the
legislature and ask that the reserve fund be replenished." He
said if a state failed to meet that moral obligation, even to
the extent of not replenishing the reserve fund, then it would
not have access to the debt markets.
9:47:28 AM
CHAIR SEATON asked about a limit on the moral obligation.
9:47:39 AM
MR. BOUTIN said there is a limit, and it is less than $6
billion, but the state hasn't tried to test the limit.
9:49:04 AM
REPRESENTATIVE GRUENBERG said he is interested in pursuing
whether a constitutional amendment would be needed for POBs to
be used. He said general obligation bonds are easier to sell
and carry a lower interest.
9:49:47 AM
MR. BOUTIN said under most circumstances that's correct.
9:50:00 AM
REPRESENTATIVE GRUENBERG noted that Mr. Boutin said that two
other entities would benefit by having the ability to issue
general obligation bonds, including the student loan program.
9:50:26 AM
REPRESENTATIVE SEATON said a constitutional amendment is not
part of the bill.
9:51:20 AM
MR. BOUTIN declared that market timing of POBs is key, and the
state wouldn't issue POBs if it knew interest rates were about
to go down.
9:53:35 AM
REPRESENTATIVE GRUENBERG asked if timing is the issue with the
issuance of any bond.
9:53:51 AM
MR. BOUTIN answered no, a state debt is for a particular product
or a particular need, so "it's not timing for the market, you're
accessing the credit markets as cost effectively as you can to
make those student loans or to build that school or that road,
and so, no, it's only in this case where you're trying to do
arbitrage that it's a market timing issue."
9:54:31 AM
DEVEN MITCHELL, Executive Director, Alaska Municipal Bond Bank
Authority, and Debt Manager for the State of Alaska, said he
could discuss the annual report or answer questions. Referring
to the question of why POBs can't be taxed, he said that without
a project the federal tax code requires that it be taxed. The
state could possibly access a tax-exempt market if it had
another project that it was going to pay cash for and instead
used tax-exempt bonds and used that cash for "this
contribution."
9:56:23 AM
CHAIR SEATON said, "That would be a substitute for POBs. You
would take state money that we were going to put into whatever
project...we were going to put cash in, and we would infuse that
cash into the system. But we wouldn't be issuing bonds for that
case; that would be an alternative. Is that correct?"
9:56:38 AM
MR. MITCHELL said that's correct. He said the intercept
provision is already in statute, "and that when the Bond Bank
makes loans there is a contract that is entered into with that
municipality that provides the Bond Bank - not to take money
from the municipality, but to take it from the state before it
gets to the municipality - and that is the intercept provision
that helps garner the ratings the Bond Bank achieves in addition
to the moral obligation."
MR. MITCHELL said the ability of municipalities to issue bonds
is already defined. After speaking with attorneys, he said,
"some appropriation-backed bond would be possible, meaning that
it would be a subject-to-appropriation pledge of a local
jurisdiction," which is a fairly weak pledge. He noted that in
this case there is no building that might be taken, so the only
penalty might be the loss of market access, which would not be a
big threat to a small community. Mr. Mitchell said the Bond
Bank has to have sufficient ability to encourage the repayment
of the loan, and "there has not been a case of default in this
program." There have been about 34 communities in Alaska that
"have accessed the Bond Bank - and one authority - and in all of
those cases, but the authority, we have the ability to intercept
state aid, which is a huge hammer to that community." He said
some small communities have an infrastructure and other assets
like taxes and federal timber receipts, "and so you have a
mechanism for gathering that money for the repayment of your
obligation, where there really just isn't any ability to provide
that type of security in a large number of smaller communities
in the state of Alaska."
10:00:24 AM
CHAIR SEATON asked, "But with the intercept, you've been able to
finesse that lack of credit?"
10:00:43 AM
MR. MITCHELL answered that in some incidences that's correct.
He said those communities were also pledging a general
obligation of that community. He added that there was "a lot of
hand-wringing" regarding the Kaktovik loan, because it is a very
small community and doesn't have a lot of financial resources.
But he said the community found the project important enough
that it was willing to make a commitment with a general
obligation pledge "where they have put up their full faith and
credit of the community taxing authority," which he said carries
more weight than a local legislative body saying it is willing
to promise to pay annually. The intercept provision has
limitations, for example, without a school district "it wouldn't
be sufficient to cover debt service." He added that with the
foundation formula there's another set of issues to address.
10:02:21 AM
CHAIR SEATON asked if the five communities that have dissolved
have been involved with the Bond Bank.
10:02:49 AM
MR. MITCHELL answered no.
CHAIR SEATON asked him to provide information on the communities
with PERS liabilities that may not have the credit worthiness to
access the Bond Bank, and how that might be remedied.
MR. MITCHELL said it would be difficult. He will provide a list
of communities that "might" or "definitely will" be able to.
REPRESENTATIVE GARDNER asked the down side of borrowing money to
help fix the unfunded liability. She called it a "shell game of
taking money from existing capital projects and applying that
against the unfunded liability and then getting bonds for the
capital projects, which would have a lower interest rate and
would be tax-exempt."
10:04:47 AM
MR. MITCHELL said that is a theoretical possibility, but it
would be very difficult to implement, because the United States
Treasury has an interest in limiting tax-exempt bond authority.
He continued, "If there were maybe one large project that
otherwise was going to be-or one large group of projects-that
could otherwise have been funded with general obligation debt or
some other mechanism that the state had available...there are
other credit ramifications."
MR. MITCHELL said, as the debt manager, he has been discussing
the state's ability to access capital markets that would be paid
from the general fund, but "we've been operating on a little bit
of thin ice." He noted that Alaska's revenue forecast is a
"dire picture in the mid to long term" because its expenditures
are not going to match revenues. "We're going to have a
shortfall," he stated. The state has been reluctant to borrow a
lot of long-term obligations prior to a fiscal fix, he said. He
stated that it isn't just the issue before the committee, but
the state as a whole. "I don't think that there would be a good
alternative is the bottom line at this point." he said. He
agreed that it is theoretically possible but it's not without
other costs.
10:07:50 AM
REPRESENTATIVE GRUENBERG asked about the state paying back over
time and cutting out the middleman entirely, "rather than going
through this whole POB thing."
10:08:29 AM
MR. MITCHELL said that's one of the options.
10:08:44 AM
CHAIR SEATON clarified that the debt is structured to be paid
off by the employers that have the debt. The mechanism to pay
that debt is from individual contributions based on each
employee's wage base. Those are "the contributions that go up
to the 25 and 38 percent-depending on the figures. The problem
is that when a third of the salary base is charged for PERS, and
in TRS, almost 50 percent of the salary wage base must be
charged, it's a large burden on the employers." The POB would
be an attempt to pay off that debt up front, "so that we do not
collect that from the individual employers or the teachers'
salary, and so that we lower that amount and then the funds that
are available to those communities, those employers, or the
school district could be used for other things." He said there
could be other mechanisms for paying off that debt besides a
percentage of employee wage base, and POBs are one mechanism.
10:11:15 AM
The committee took an at-ease from 10:11 a.m. to 10:12 a.m.
10:12:29 AM
JEFFREY SINZ, Chief Fiscal Officer, Municipality of Anchorage,
asked if the committee had copies of his previous presentation
entitled, "Pension Obligation Bonds: One Employer's
Perspective." He said pension obligation debt is an important
tool, and there are very few tools available. "We have not made
any decision about the appropriateness of their use at this
point, but we strongly advocate for the preservation of pension
obligation debt as one tool that may become appropriate at some
point in the future."
MR. SINZ noted three basic issues to be overcome before
considering using POBs: access to the market place for small
communities; access to financial expertise during decision-
making, and; uncertainty and unanswered questions. He put forth
the following questions: What does the system do if it receives
a large inflow of cash from an employer? Who issues the debt?
How is it invested? What happens if investments are highly
successful or not? How are rates adjusted?
10:17:01 AM
MR. SINZ said the challenge is the large unfunded accrued
actuarial liability, and one answer is SB 141, "which is really
a long term change," and the effects would be seen sometime in
the future. He said rapidly increasing employer contribution
rates are limited by the five percent statutory limitation.
"The opportunity that seems to exist here is the opportunity to
substitute pension obligation debt for all or a portion of the
unfunded liability." He said he used analysis from Merrill
Lynch for a statewide perspective and from Seattle Northwest
Securities for specific information for Anchorage. Statewide
PERS unfunded actuarial liability, as of June 2004, was $3.41
billion, and by substituting pension obligation debt for that
liability, "it is possible to generate a significant savings.
The assumption Merrill Lynch used was that the entire unfunded
liability would be substituted with POBs." The cost of debt
would be 5.8 percent, "and PERS would earn the actuarially 8.25
percent rate on those monies, and by doing this the future value
of payments made by all of the employers participating in the
system would be reduced by $2.5 billion," which would be
realized over a 25-year period of the debt. He said the present
value of that savings is $1.2 billion.
10:19:55 AM
MR. SINZ said, "The effective reduction for participating
employers is 3.85 percent in the effective contribution rate we
would be paying." He noted that both normal and past service
cost rates are now being paid to the PERS in the form of an
employer contribution. "With a pension obligation debt
alternative, we would be paying the normal cost rate to PERS,
but we would be paying a debt service payment rather than that
past service contribution." Looking only at Anchorage as a
specific employer, its share of the current liability is $462
million. Using data from Seattle Northwest Securities, "we can
come up with a different set of savings assumptions. The future
value of savings they calculate-the potential future savings-is
$212.9 million for Anchorage with a present value of $113
million." He said that analysis assumed a cost of debt of 6
percent.
10:22:19 AM
CHAIR SEATON said Seattle Northwest Securities spoke of an 8
percent reduction. He asked about going from 28 percent to 25
percent.
10:23:08 AM
MR. SINZ said over a 25-year period there will be an annual
savings of about $6 million a year, which grows over the life of
the debt because of growth in the assumed payroll.
10:23:50 AM
CHAIR SEATON asked if he looked at "this being an amortized,
hard number...instead of increasing at the 5 percent per year in
the year that this is issued, you would then immediately jump to
the 25 percent...individual rate for those 25 years, instead of
having the soft increase of 5 percent."
10:24:19 AM
MR. SINZ said the analysis used the assumption of selling bonds
soon - within the next year.
10:24:37 AM
CHAIR SEATON said the state has been providing money to offset
the increases in the system. If the municipality would issue
bonds for this debt, "my understanding from the testimony is,"
that the contribution rate would immediately jump from 14.7
percent to 25 percent. "You would immediately jump to a hard
number basically equal to 25 percent of employee salary, and
that would stay fixed for the entire length of the debt since it
can't be recalled." Chair Seaton asked if that has been a
consideration that Mr. Sinz looked at in his analysis.
10:26:11 AM
MR. SINZ said it was not. He said his analysis does not factor
in debt-design structural issues. He said there are many things
that would need to be considered before a decision was made.
10:26:37 AM
CHAIR SEATON stated his concern that municipalities would not
like an increase in this amount, and POBs will cause a dramatic
increase in the contributions of employers for the short term.
He asked Mr. Sinz to look into that.
10:27:40 AM
REPRESENTATIVE GARDNER said the shift from the collared rate of
increase is not really before the committee; it is an
authorization to explore the POB option, and then each employer
can make the decision to participate.
10:28:07 AM
CHAIR SEATON said "the biggest cry we have heard from
municipalities is the increasing rate." Authorizing a structure
that will dramatically increase these contribution rates is a
critical factor to consider, he point out.
10:29:40 AM
REPRESENTATIVE GARDNER said the bill will authorize the tool
"should they choose to use it."
10:29:53 AM
MR. SINZ added that such an increase is not an unavoidable
consequence of POBs; there are ways to mitigate that effect. He
said HB 278 in its current form is not a perfect solution, nor
is it a decision to issue POBs in itself, but it is a step in
the right direction. He stated his support of the bill.
10:31:25 AM
CHAIR SEATON announced that HB 278 was heard and held.
HB 273-PFD: DELAY PAYMENT FOR ALLOWABLE ABSENCES
10:32:12 AM
CHAIR SEATON announced that the last order of business was HOUSE
BILL NO. 273, "An Act relating to the dividends of individuals
claiming allowable absences; and providing for an effective
date."
10:32:22 AM
TERRY HARVEY, Staff to Representative Bruce Weyhrauch, Alaska
State Legislature, introduced HB 273 on behalf of Representative
Weyhrauch, sponsor. He said HB 273 is timely because of the
latest statistics from the Permanent Fund Dividend division.
The bill will require the state to hold dividends of any person
who is out of the state with an allowable absence until that
person returns to the state.
10:33:46 AM
CHAIR SEATON said there is an update in the committee packet
regarding the amount of money that is leaving Alaska. He said
the committee will take up HB 273 on Thursday in more detail.
ADJOURNMENT
There being no further business before the committee, the House
State Affairs Standing Committee meeting was adjourned at
10:34:44 AM.
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