Legislature(1999 - 2000)
05/14/1999 03:10 PM Senate FIN
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
CS FOR HOUSE BILL NO. 156(FIN)
"An Act relating to investments by the Alaska
Permanent Fund Corporation; and providing for an
effective date."
This was the second hearing for this bill in the Senate
Finance Committee.
Co-Chair John Torgerson noted that there was some
disagreement he had with the Alaska Permanent Fund
Corporation dealing with the amount of money the
corporation may borrow for real estate purposes. Under the
current language, he explained, there is no limit. He told
the Committee he had asked the corporation to propose an
amount appropriate as a limit.
Another concern of Co-Chair John Torgerson's related to
Section 1 of the committee substitute ".the corporation
may, either directly or through an entity in which the
investment is made, borrow money." He proposed an amendment
(Amendment #1) that deletes "either directly or" and said
the corporation agreed to that change.
Co-Chair John Torgerson referred to discussions about the
management of real estate owned by the corporation. His
proposed amendment adds a new subsection (C) that requires
properties to be professionally managed.
Co-Chair John Torgerson said he had also raised the issue
of allowing the Legislative Budget and Audit Committee to
review and approve real estate transactions rather than
simply review and comment. However, he was assured during
previous testimony that to make this change would give the
legislature too large of a role in the investments of the
fund.
The final concern Co-Chair John Torgerson had with the bill
related to the "five-percent float" and whether or not it
should only exclude equities.
Amendment #1: This amendment deletes, "either directly or"
following "may" on page 1 line 7 of the committee
substitute. The language then reads, "With respect to real
property investments of the fund, the corporation may,
through an entity in which the investment is made, borrow
money if the borrowing is without recourse to the
corporation and the fund." The amendment also adds a new
subsection to Section 2 of the committee substitute that
requires real estate management firms to be "professionally
managed." Senator Sean Parnell moved for adoption. Senator
Al Adams objected to hear the corporation's position on the
amendment.
JIM KELLY, Director of Communications, Alaska Permanent
Fund Corporation, Department of Revenue testified that the
amendment is acceptable to the corporation. He added that
the first part of the amendment also addresses Co-Chair
John Torgerson's concern with the borrowing limits. He
offered Peter Naoroz to explain "non-recourse" and how the
comfort level of the legislature can be maintained.
Senator Al Adams withdrew his objection and without
objection, Amendment #1 was ADOPTED.
PETER NAOROZ, Manager of Real Estate Investments, Alaska
Permanent Fund Corporation, Department of Revenue
testified. He related how, two years ago, Mr. Kelly asked
his office to review the existing statutes governing the
corporation's flexibility, and come up with ways to
increase the fund's return and to reduce risk. The
resulting review, he told the Committee, showed
opportunities to reduce operating and administrative costs.
Peter Naoroz used as an example a real estate investment in
Washington D.C. called Tyson's Corner; a mall that also
includes an office building and surrounding land. He
relayed that when the corporation went to refinance this
property, the lender requested the corporation to address
the statute that prohibits the corporation from borrowing
money or to guarantee from the principal of the fund, the
obligations of others. He said that it was thought that
because the corporation held this investment in partnership
with other investors, the state was in effect guaranteeing
the other investors' obligations. As a result, he said, the
corporation had to undergo a long process of forming a
legal opinion on the interpretation of the statute and then
convince the lender that the loan could be extended. He
identified this situation as an area where changing the
statute could show a cost saving to the State because of
the delay in procuring the loan and the extra cost to
obtain the legal opinion. He viewed this as a housekeeping
matter.
Peter Naoroz then explained how the fund is currently
governed by the "Prudent Investor Standard", and because of
this, the corporation looks at borrowing caps, loan-to-
values, its obligations to those it borrows from as well as
entities the corporation invests in. He said the
corporation then compares these factors to the existing
"rent roll" i.e. the existing assets of the entity, and
tries to match them. The corporation also looks at several
factors, he continued, for sources to address risk
mitigation. In this manner the corporation is able to
secure financing on portfolios of assets, according to
Peter Naoroz.
Peter Naoroz felt the request for a cap on a particular
investment is appropriate and should be considered,
However, he thought that when the corporation is attempting
to secure financing on a pool of assets, the amount could
potentially be much larger, he cautioned. He noted a number
of office investments in Atlanta, Washington D.C., New
Jersey and San Diego that are unleveraged, where the
portfolio is approximately $400 million. He stressed that
in today's marketplace, the finance on this pool is very
attractive compared to any single asset financing
opportunity. Therefore, he said, pooling of assets gives
the corporation more flexibility and additional buying
power, as well as reducing the costs and enhancing returns.
Peter Naoroz stated that the corporation is currently
addressing the loan cap internally on a case-by-case basis.
He wanted the Committee to consider allowing this practice
to continue.
Jim Kelly asked Peter Naoroz to give an example of the
Permanent Fund's risk to borrowing on a $400 million
portfolio. Peter Naoroz replied that in this situation, the
corporation would approach the marketplace and request the
best terms to borrow approximately $200 million. He noted
that the corporation's current portfolio of this amount has
between 8 1/2 and 9-percent current return and has
appreciated in value since its purchase. Using this data,
he predicted that the returns on the investment would be
deposited into the principal of the fund and could be
borrowed against. He stated that the assets in the
portfolio would be the only collateral, i.e. there would be
no obligation on the part of the permanent fund and the
$200 million that was borrowed would be a return of
principal. This is a good thing he stressed, because the
corporation can then redeploy its cash or principal. He
told the Committee that when he is asked to rebalance the
total portfolio, the ability to aggregate the assets and
place financing on them is a good tool.
Co-chair Torgerson asked for the definition of "real
property" versus real estate. Jim Kelly answered "real
property" is defined in statute as real estate that is
improved by completed and substantially rented buildings.
Co-chair Torgerson wanted a comparison to "raw land." Jim
Kelly responded that raw land is not allowable for
permanent fund investment purposes. However, he noted
proposed language that will allow raw land in some cases,
such as the property adjacent to Tyson's Corner. The
committee substitute will allow the corporation to invest
in vacant property that is adjacent to property in which
the corporation already has a vested interest in, thus
adding to the portfolio. He noted this is the only instance
where investment in raw land is allowed.
Peter Naoroz added to the definition of real property
saying it is the corporation's direct investments, whether
in entities or not. The other assets considered real
estate, he continued, are mortgages-both whole loans and
securities mortgages for commercial mortgage backed
securities, and investments in the stock of real estate
operating companies and real estate investment trusts.
Co-Chair John Torgerson asked if the Prudent Investment
Standards are in statute or simply practiced internally.
Jim Kelly responded that the standards are contained in
statue under AS 37.13.120.
Co-Chair John Torgerson referred to page seven of the
committee substitute discussing the "five-percent float."
He said he would leave it up to the Committee to decide
whether or not they wanted to limit the investments allowed
using five-percent of the total assets of the fund.
Jim Kelly recounted when the Permanent Fund was first
established and that it was given a conservative "legal
list" that did not include real estate or stocks. Over
time, he said, the legislature has given the corporation
authority to make those investments. He stated that it has
become more apparent in the investment world that risk is
not a matter of one individual asset, but rather how the
total portfolio is constructed. In the rules set for
pension funds, he noted, it was determined that risk should
be determined on a total portfolio basis. Therefore he
emphasized, very risky assets, such as international
investments can be held if they are included in a portfolio
that also contains domestic stock to result in a portfolio
with less risk. This applies to alternative investments as
well, and the corporation can purchase them under the
basket clause, he said.
Jim Kelly advised that to construct a portfolio that has
good risk management, the mix of investments should have
good correlation with each other. He pointed out that the
basket clause would increase the flexibility of the
corporation by allowing it to either increase the
allocation at an asset allocation level or at a security
level. He referred to a statement made by Michael O'Leary
describing how fixed income investments have evolved over
time.
Jim Kelly spoke of investment opportunities that have
arisen that were not on the "five percent float" list, such
as asset-backed securities that are considered not risky.
He speculated that similar opportunities would come up in
the next several years and said that the fund's trustees
want an opportunity to invest in both fixed-income and
equities, knowing that equities return more money. This
bill, he said, has a provision to allow those investments.
Jim Kelly stated that with the asset allocation currently
in statute, the fund's rate of return on investment would
be 7.75 percent. If the asset allocation increases five-
percent in equity, he predicted the fund would earn an
expected medium return of 7.94 percent. If the corporation
is allowed an asset allocation of fifty-eight percent in
equities, which would be two percent below the maximum, he
predicted a return of 8.13 percent rate of return. Changes
to the asset allocation, he qualified, would reduce the
amount of return.
Co-Chair John Torgerson calculated a rate of return
increase of 19 points for each five percent allocation to
equities.
Senator Gary Wilken understood that there were two separate
issues addressed in the bill. The first, he surmised, was
the original intent of the bill to expand the corporation's
portfolio into different markets, such as real estate. The
second issue dealt with the fifty-five percent provision,
he noted. Therefore, he concluded that there were really
two questions the Committee must decide on, either
independently or together. He expressed he was comfortable
supporting both items. He commented that he did not think
the corporation request of five percent of the total assets
to use in other investments was unreasonable. He believed
that the fund managers would remain conservative in the
investment strategy of the overall fund.
Senator Loren Leman echoed Senator Gary Wilken's comments
in support of the bill.
Senator Gary Wilken offered a motion to report from
Committee, SCS CS HB 156(FIN). Without objection, it was
REPORTED from Committee with individual recommendations and
the House fiscal note for the Department of Revenue,
Revenue Operations in the amount of $3,154.6.
The committee took a brief at ease.
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