SENATE BILL NO. 97 "An Act relating to pension obligation bonds." 1:39:24 PM SENATOR ANNA MACKINNON, SPONSOR, explained that the bill took the current statutory $5 billion pension bonding authority and reduced the amount to $2.5 billion. In addition, the legislation required the administration to submit a proposal to the Legislative Budget and Audit Committee (LBA) within 45 days of issuing any pension obligation bonds (POBs). She noted that the procedure was the same as any RPL (request per legislature). She pointed out that the process included the legislature in the process and allowed for time to respond if necessary. She believed the administration supported the legislation. She recounted that in the prior year when the administration proposed the POB plan, her constituents requested the bill and questioned whether any amount of the authorization should be spent on POBs due to the inherent risks. She thought that the administration had proposed a very conservative approach to POB's. She detailed that unlike other cities or states, the administration's plan "did not take all of the benefits upfront." Other states that had defaults with POB's "took all of the benefits when they were most at risk." The state's approach deferred the smaller payments until the end of the loan proposition. She reiterated that the administration's approach was conservative. She informed the committee that if the state had issued POB's in 2007 the results would have been positive. Had the Walker administration issued POB's last year positive gains were also anticipated. She qualified that the "positive influences" needed 20 to 30 years to come to fruition which prompted her to introduce SB 97. She believed that the legislation did not tie the hands of the administration, invited engagement with the legislature, and added a layer of transparency to the process. She offered to review the sectional analysis. 1:43:16 PM LAURA CRAMER, STAFF, SENATOR ANNA MACKINNON, read the sectional analysis: *Section 1: Requires a subsidiary created under the Alaska Housing Finance Corporation to submit a proposal to the Legislative Budget and Audit (LB&A) Committee prior to borrowing money and issuing bonds for the purpose of financing or facilitating financing of a governmental employer's share of unfunded accrued actuarial liability of retirement systems *Section 2: Creates a new subsection outlining the process for submitting a proposal to the LB&A Committee *Section 3: Requires the State Bond Committee to submit a proposal to the LB&A Committee prior to issuance and sales of bonds for the purpose of financing or facilitating financing of a governmental employer's share of unfunded accrued actuarial liability of retirement systems, including the costs of issuance and administration *Section 4: Creates a new subsection outlining the process for submitting a proposal to the LB&A Committee *Section 5: Amends the pension obligation bond limit from $5,000,000,000 to $2,500,000,000 *Section 6: Requires the Pension Obligation Bond Corporation to submit a proposal to the LB&A Committee prior to issuance and sales of bonds for the purpose of financing or facilitating financing of a governmental employer's share of unfunded accrued actuarial liability of retirement systems, including the costs of issuance and administration *Section 7: Creates a new subsection outlining the process for submitting a proposal to the LB&A Committee *Section 8: Requires the Alaska Municipal Bond Bank Authority to submit a proposal to the LB&A Committee prior to issuance of bonds, notes, commercial paper, or other obligations for the purpose of assisting employers to prepay all or a portion of their share of unfunded accrued actuarial liabilities of retirement systems in an effort to reduce their costs *Section 9: Requires a subsidiary created under the Alaska Municipal Bond Bank Authority to submit a proposal to the LB&A Committee prior to borrowing money and issuing bonds for the purpose of financing or facilitating financing of a governmental employer's share of unfunded accrued actuarial liability of retirement systems *Section 10: Creates a new subsection outlining the process for submitting a proposal to the LB&A Committee *Section 11: Conforming language for the powers of a subsidiary corporation created under the Alaska Municipal Bond Bank Authority *Section 13: Conforming language for the issuance of bonds and notes by the Alaska Municipal Bond Bank Authority 1:45:06 PM Vice-Chair Gara recalled that in 2007 he was supportive of investing in POB's. He noted the unpredictable nature of the stock market. He wondered why the current investment climate with rising interest rates was a good time to invest in POB's. Senator MacKinnon explained that in 2007 the state was facing a $10 billion to $12 billion pension liability of which, the $5 billion figure was roughly 50 percent of the liability but did not factor in the unfunded liability for healthcare costs. When the legislature issued a cap of $5 billion it was less than 50 percent yet still considered a significant amount. Currently, the state's unfunded liability was $6.1 billion. The $2.5 billion number was less of a ratio but still reduced the liability and was close to the amount the administration deemed reasonable to sell in the market at one time. The unfunded liability was only as accurate as the performance of the assumptions of the rate of the return. She clarified that the $$6.1 billion figure was as reliable as the credit rating agencies reports that contained the numbers and were based on assumptions that the state's actuaries calculated. She reminded the committee that the legislature contributed $3 billion in FY 15 in order to reduce the debt load. Co-Chair Foster noted Representative Pruitt had joined the meeting. Vice-Chair Gara commented that he understood the risk and ascertained that in hind sight, he wished the state issued the POB's in 2007. He asked why POB"s were authorized in the past but never issued. Senator MacKinnon confirmed that POB's were issued in 2007 but no proposal was ever issued until the current governor believed that the market was "timed right." She related that the public opposed the bond issue because of the risk and the proposal was "met with resistance." 1:50:22 PM Representative Grenn cited the sponsor statement and read the following: Credit rating agencies continue to monitor our activities and the policy measures we pass to improve our financial foundation. Representative Grenn inquired whether lowering the bonding authority contributed to improving the state's fiscal foundation or was a "prudent" change to protect our credit rating. Senator MacKinnon believed that lowering the authority would be positively viewed by the market and the agencies. Representative Ortiz asked about any potential downsides of the action. Senator MacKinnon responded that she did not see any. She indicated that she always attempted to balance both sides of the issue with any legislation. She acknowledged that many thought POB's were too risky and should be avoided. She agreed that the bonds required 30 years of returns to work and were risky. She thought the legislation was a compromise and was a "nod" to the credit rating agencies that sent the message that the state was not relying on debt to solve the problem. She added that utilizing debt might be a component but not the entire approach. Representative Ortiz asked what the negatives were of taking the liability down to zero. Senator MacKinnon pondered whether the legislature could "sustain a legislative override" for a governor's veto. She had confidence that both legislative bodies endorsed a reasonable approach to alert credit agencies that they took the state's financial situation seriously by not totally relying on debt to solve the problem. She mentioned the $3 billion pension liability payment as proof. 1:54:15 PM Co-Chair Seaton mentioned the idea of taking the unfunded liability to zero. He wondered at what point the state was required to pay post-retirement pension adjustments the state was required to pay to the retired employees. Senator MacKinnon reported that when the state hit 100 percent [no liability] the retirees could ask for additional benefits. When the $3 billion payment was made in FY 15 the legislature's goal was to achieve 80 percent funding of the state's liability and was the point debt could be repaid with "positive investment returns." She had voted with many of her colleagues in favor of much of the money paying for the Teaching Retirement System (TRS) instead of Public Employees' Retirement System (PERS). She delineated that the TRS debt was entirely the state's debt but PERS was shared with the municipalities at a 60 percent to 40 percent split. The House and Senate came together to pay the state's 100 percent debt and attempted to achieve an overall 80 percent ratio. She cautioned against achieving a 90 percent ratio because if the state over-contributed than retirees could ask for more. She believed in being cognizant of how much the state could fund the liability. She thought that the state's estimated unfunded liability was understated due to the current rate of return. Co-Chair Seaton recapped that Senator MacKinnon discussed that the state owned 100 percent of the TRS liability and only 60 percent of the PERS. He queried whether the state would be better off funding its 100 percent liability versus the PERS system. He indicated that if the state funded PERS at 100 percent liability, the state would pay the municipalities' retirement reimbursement and end up paying for their debt. He asked whether she objected directing POB's to the TRS system. 1:58:47 PM Senator MacKinnon responded that the bill was in the committee's possession and she would trust the judgement of the committee. She detailed that when the state established the 22 and 12 percent ceilings on municipal contributions the numbers were a compromise. The municipalities asked the state of Alaska to help fund the liabilities. The state chose to help by extending the years on the debt and thereby lowering the payments. She did not think the state should turn away from the municipalities struggle with meeting the payment obligations and avoid burdening the local communities further by not providing more than 60 percent. She advocated working together in the best financial interest of all and not exclude helping the municipalities. She hoped that the administration would talk with the legislature regarding the municipalities when considering POB's. She remembered that the legislature directed the administration to deposit much of the $3 billion to TRS but still wanted to make a deposit into the PERS system to help local communities and the state. She remarked that the cap set at 22 percent meant that the state was paying the portion above 22 percent. Representative Pruitt questioned the role of LBA in the bill. He noted that ultimately the administration could make its own decisions regarding RPL's. He asked whether the sponsor considered granting LBA the ability to ultimately veto an issuance of POB's. Senator MacKinnon responded that last year the administration had responded to concerns raised by the House and Senate Finance Committees regarding the proposed POB plan. She revealed that any issues raised against POB's could cause "the buyers to increase the cost of debt through risk." "The minute the legislature starts talking in a negative way the administration had to include the documentation in the bond packets." She concluded that LBA was the appropriate place to decide on the issuance because if the administration decided to proceed regardless, all that was needed to stop the process was for the legislature to write a letter and the credit rating would increase. She relayed that the Senate Finance Committee had written a letter without prior knowledge of the consequences. She felt that the administration was sensitive to the issue and the reaction of the legislature. In addition, the state's debt manager was required to relay any issues to the purchaser of the bonds. Representative Pruitt acknowledged that the administration had consulted with the legislature over whether to proceed with the POB's. He surmised that Senator MacKinnon was comfortable with LBA's role due to the increased costs of bonding signaled by any resistance from the legislature. Senator MacKinnon replied in the affirmative. She discerned that even a dialog raising concerns about POB's in the LBA committee process could trigger a rate increase based on borrower's discomfort. She felt comfortable with the language but deferred to the committee. 2:07:20 PM Representative Guttenberg reminded members to refer to Mayor Navarre's comments on the debt liability and its origins in previous testimony. [Mayor Mike Navarre, Kenai Peninsula Borough, Presentation to the House Finance Committee on March 28, 2017] He surmised that last year when the governor announced the POB issuance and received strong opposition resulting in his decision not to proceed indicated that the "process did work." He thought that the LBA provision in the bill in favor or against held "significant" sway over whether to proceed or not. He felt that the state already had a system that appeared to work. He wondered why the process needed to change. Senator MacKinnon relayed that the debt to bonding authority ratio was presently a significantly larger portion of potential indebtedness that carried great risk. The bill offered a similar ratio as the situation in 2007. She qualified that the state was underestimating the liability but did not think the ratio should be above 50 percent especially without approval of the legislature. She revealed that the administration was supportive of the lower authority. She maintained that SB 97 was a positive move for the states bond rating and offered a positive ratio. She believed that the LBA provisions created a formal process to include the legislature in the decision. Representative Guttenberg was wondering what the state was trying to fix. He reiterated his belief that the system worked last fall. He suggested that merely not using the $5 billion authority was an asset and had a value. He felt that the authority and its best use was "a tool in the state's coffer." He believed that the administration's acceptance of the lower bonding authority was its "standard answer" for "making do" with less. 2:13:58 PM Representative Thompson was sensitive to the issues regarding the local contribution. He spoke to his experience as the previous mayor of Fairbanks. He recapped that when he was mayor the city had requested its PERS balance from the state actuarial. He reported that the city was told it had an excess of $35 million and three years later the state claimed the city owed $130 million. He noted that the 22 percent cap was imposed in response to the situation. Senator MacKinnon replied that the bill did not alter the contribution rate. She countered that credit rating agencies were aware that Alaska could utilize its unissued debt and further indebt the state. The situation jeopardized the state's bond rating. She commented that the by reducing the bonding authority the legislation put the state in the right direction. She advocated taking the state's pension obligation "very seriously." She spoke to the current fiscal crisis and funding the $2.8 billion budget deficit as a priority and considered the $6.1 billion pension obligation and future indebtedness as a "background issue" that needed to be addressed. Representative Pruitt referenced the discussion regarding the credit rating. He wondered whether lowering the bonding authority thereby lowered "the potential opportunity for debt" and the ratio. DEVEN MITCHELL, EXECUTIVE DIRECTOR, ALASKA MUNICIPAL BOND BANK AUTHORITY, DEPARTMENT OF REVENUE, replied that he agreed with Senator MacKinnon that an outstanding authorization impacted credit. He relayed that in the current situation, the authority was for a liability the state already had "and was a little different." He recounted that last fall the $2.3 billion to $3.3 billion POB's issuance proposal received ratings in line with current ratings except for Standard and Poor's decrease of a "notch" from AA+ to AA flat. He likened predicting the credit rating agencies was similar "to reading tea leaves." He understood the legislature's point of view. He offered that as an "issuer of debt" he perceived that "greater flexibility resulted in better execution" of debt but recognized the need for a balanced approach. He concluded that "at the end of the day he could not think of any objection to reducing the current authorization." Representative Guttenberg clarified that bonds were prohibited from any other type of use besides pension obligations. Mr. Mitchell responded in the affirmative. He qualified that when the initial authorization was established the legislation included a "couple" of different types of authorization based on the financial situation at the time that would not be utilized in the "current construct of the retirement system." He noted that one provision granted the municipalities use of the bond bank to cover the unfunded liability. He revealed that the option was not viable because the bonding would only benefit the state and not the municipality. He informed the committee that the current PERS actuarially assumed contribution rate was over 26 percent, the municipalities paid 22 percent and the state paid the remainder. He added that funding the debt service was based on a commitment by the legislature and the administration; no collateral or taxing pledge was committed to the debt service. The state's commitment to the debt service was a "lesser pledge" than what was typical in "other instances." Representative Guttenberg asked whether the POB credit rating "stood alone or was built into the state's credit rating as a whole." Mr. Mitchell answered that the POB credit rating relied on the state's credit rating and was one notch under the state's overall credit rating. He elucidated that the legislation required a credit rating of at least AA minus. Representative Guttenberg clarified that the $3 billion payment was a cash infusion and not a bond issue. Mr. Mitchell responded that he was correct. 2:25:52 PM Vice-Chair Gara mentioned the provision that a bond issuance was predicated on consent by LBA within 45 days. He wondered whether the time lag would have "a potential or material imperial" on the issuance. Mr. Mitchell answered in the negative. He related that last year the state engaged in 79 meetings with institutional investors in order to sell the bonds and the day before the pricing and commitment the state reneged on the sale. He revealed that as a result the banking community would only purchase future POB's from the state with some type of formal approval from the legislature. He indicated that the LBA provisions formalized the current "ad hoc process." He determined that there was "a lack of clarity" on how to obtain the appropriate approval from the legislature that the bill provided. Co-Chair Seaton asked Mr. Mitchell to explain the difference between soft and hard obligations for unfunded liability payments. Mr. Mitchell explained that the state could choose not to fund the annual actuarially determined funding requirements without "negative ramification." When debt was issued making it a hard liability, missing payments resulted in consequences such as rating downgrades and lost access to the capital markets. He ascertained that recently "an evolution of pension liability was underway" and was elevated in the considerations of the credit rating agencies. He detailed that a failure to pay POB liability resulted in a similar rating downgrade as a debt service payment. Co-Chair Seaton had expressed concerns about the pension adjustments when the liability was paid at 105 percent. He wondered whether the state was statutorily or contractually obligated to pay the post-retirement pension obligations in addition to cost-of-living increases. Mr. Mitchell deferred the question to the Division of Retirement and Benefits. He thought that the payments only applied to Tier 1 retirees. 2:31:09 PM Co-Chair Seaton referenced the state's split obligations between PRS and TRS. He questioned whether the state could issue POB's to the percentage of liability where the municipality would not need to pay its contribution at 22 percent. He wondered whether the 18 percent obligation would apply or could POB's be structured in a way to maintain the 22 percent split. Mr. Mitchell answered that the 22 percent was statutorily set in SB 125 (Pers/Trs Contribut'ns;Unfunded Liability) [CHAPTER 13 SLA 08 - 04/08/2008] and did not fluctuate. He learned last fall that the way the actuarial math worked, any significant cash payment into PERS over $500 million diminished the percentage of payroll requirement in the short term. He discovered that the 22 percent was a "hard payment requirement" set in statute. Last year's $3.3 billion POB transaction proposal would have funded TRS at 90 percent and the portion that the state paid would have been refinanced if the bonds were issued. Co-Chair Seaton asked whether there was any downside to limiting the pension liability to 85 percent through use of POB's. He wanted to avoid any situation where the state was overfunded. Mr. Mitchell responded that the administration was looking at funding the liability at 90 percent. He observed that "if the state was borrowing at one rate and expected to reinvest at a higher rate than the larger the issue the greater the potential benefit." He deduced that for TRS the 85 percent limit "could restrict the potential of an issuance" but seemed satisfactory for PERS. 2:36:21 PM Representative Guttenberg asked if the state reached 105 percent what the state's liability to increase benefits was. Mr. Mitchell deferred the question to the Division of Retirement and Benefits. Representative Guttenberg referenced other state's lower credit rating and reported that the states were still able to borrow money. He wondered whether a credit rating could be disregarded and money could be borrowed at a reasonable rate. Mr. Mitchell answered that California had experienced a volatile and tumultuous period with its credit rating. He commented that borrowing depended on the type of credit and market conditions that determined how expensive the credit rating differential was. He observed that there was a lot of anxiety with the market and rating agencies regarding Alaska due to the budget situation. Co-Chair Foster OPEND Public Testimony. 2:40:18 PM Co-Chair Foster CLOSED Public Testimony. SB 97 was HEARD and HELD in committee for further consideration.