SENATE BILL NO. 121 "An Act establishing the State of Alaska Capital Corporation; authorizing the issuance of bonds by the State of Alaska Capital Corporation to finance capital improvements in the state; and providing for an effective date." SENATE BILL NO. 122 "An Act establishing the Alaska capital income account within the Alaska permanent fund; relating to deposits into the account; relating to certain transfers regarding the Amerada Hess settlement to offset the effects of inflation on the Alaska permanent fund; and providing for an effective date." This was the first hearing for these bills in the Senate Finance Committee. CHERYL FRASCA, Director, Office of Management and Budget, Office of the Governor, informed the Committee that these bills contain the Governor's proposal pertaining to funding provided by the lawsuit that the State brought in the 1970s against oil companies over the valuation of the State's royalty oil and gas. The case was eventually settled in the mid 1990's. During the 15-year appeal process, the oil companies asked the federal courts to move the case outside of Alaska. The argument was that because all Alaskans are potential jurors, they would be biased because they would potentially benefit from the proceeds going into the Permanent Fund. The federal court asked the Alaska Legislature to attempt to resolve this issue. Ms. Frasca continued that two separate Legislative pieces, one under the Governor Steve Cowper Administration and one under the Governor Walter Hickel Administration, were passed to address the concern. One prevented the interest earnings from the Amerada Hess settlement from counting toward the calculation of the Permanent Fund Dividend (PFD). That effort served to remove the potential bias, and the lawsuit was ultimately settled out of Court. Ms. Frasca stated that the money from the settlement was deposited into the Permanent Fund, and its balance, as of the end of FY 2004, amounted to approximately $424,000,000. The proposal contained in SB 122-AMERADA HESS INCOME; CAPITAL INCOME ACCT. would establish an income account and the proposal in SB 121-STATE OF AK CAPITAL CORP.; BONDS would establish a corporation through which $30,000,000 in annual earnings would be leveraged to issue bonds to fund State capital projects. The capital projects that would be funded by the Capital Corporation bond revenue were included as such in the capital budget the Murkowski Administration presented in December 2004. Ms. Frasca noted that Deven Mitchell with the Department of Revenue would be presenting information pertinent to SB 121, regarding the Capital Corporation structure. 3:04:48 PM DEVEN MITCHELL, Debt Manager, Treasury Division, Department of Revenue, expressed that tremendous work has been conducted in regards to the structure of the Alaska Capital Corporation; specifically in consideration that it's structure should not impact the State's credit rating. The process would first involve the establishment of the Alaska Capital Income Account, as specified in SB 122, as a subaccount of the Permanent Fund Earnings Reserve Account (ERA). "The money doesn't flow to the general fund and therefore it can be construed as being self-supporting and not included in the State's net tax supported debt. This is a very important feature of the proposal." Mr. Mitchell stated that, "money in the Alaska Capital Income Account would then be available for annual appropriation for any legitimate purpose including to the State of Alaska Capital Corporation". The Alaska Capital Corporation would be a new public corporation created in the Department of Revenue. The Corporation's Board would include the State Bond Committee supported by existing Department of Revenue staff. "The Corporation would be able to enter into operating leases that would provide for the annual transfer of money from the Capital Income Account to the Corporation, subject to annual appropriation." The bond structure being proposed is a flexible amortization-type of bond issuance, often referred to as a "turbo" structure. It would require interest only payments for up to a 40-year schedule with a final balloon payment at the end. This structure would also allow for "a paying down of principal in the short years as you had principal available". It would allow for volatility in the market. The historical realized return of the Permanent Fund over the past twenty years has been 8.94 percent; the current realized return assumption is 7.04 percent. Were a 7.04 percent return realized, approximately $29,800,0000 a year would be generated by the settlement funds. That "anticipated revenue stream" could be leveraged over 17 years to obtain the $340 million in capital projects being proposed. Mr. Mitchell qualified however, that it would be unrealistic to anticipate "a flat 7.04 percent return a year". Returns have fluctuated from a low of 1.15 percent to "double-digit percents in other years"; thus the need to address the volatility issue. The proposed turbo structure concept has been deemed acceptable by the State's credit agencies. It has also been discussed with underwriters, and while the various underwriters "have different ideas on how the actual implementation of the program might occur, there seems to be a consensus that there are means of dealing with the revenue stream, the volatile revenue stream, insuring a high probability of ability to pay". He noted that "one important credit feature" of this proposal is that the Corporation would have "a moral obligation on a reserve fund". A "moral obligation is that there would be a reserve requirement…" Mr. Mitchell stated that one component of the tax code "is the maximum annual service, and, if there is ever a draw on that reserve fund, then the Board is charged with requesting replenishment from the Legislature". The State currently has approximately $1.1 billion in outstanding bonds that have such a moral obligation associated with them. This in effect would establish "a floor" in regards to the bond issuance. He explained how the State's investment grade credit rating could be affected were bonds sold without such a floor. 3:11:05 PM Ms. Frasca informed the Committee that further information could be found in the Office of Management and Budget background paper titled "Use of the Amerada Hess Settlement to Fund Capital Projects" [copy on file] included in Members' packets. The schematics of the two proposals are located on page seven and eight. 3:11:30 PM Senator Dyson asked whether it would be possible "to issue too many bonds and overload the system". Mr. Mitchell responded that regardless of whether the question pertained to the State's overall bonding or specifically to this proposal, the answer would be "yes". To that point, the Department of Revenue "has a strong desire to maintain the State's" AA credit rating. In order to maintain that credit rating "outside analysts" are utilized to review the State's action on a continual basis. While some states' debt management department might be able to develop "a debt capacity based on projected revenues for the next twenty years", such action would be impossible in Alaska as the State's primary source of revenue is extremely volatile. This is the reason for requiring large reserves in such funds as the Constitutional Budget Reserve. Therefore, in response to the question as to whether there would be a limitation on the State's ability to leverage, this proposal would be recognized as being sustainable. It could survive a very negative earnings scenario or cash flow scenario. On a broader scope, it would provide the State money that would not impact the State's credit rating. 3:13:40 PM Co-Chair Wilken voiced being "surprised" that on the 111th day of the Legislative Session, even though it has been discussed by Legislators and the Administration, the status of this legislation is as it was on the first day of the Session. While he has no issue with utilizing Amerada Hess earnings, he does have a problem with "the complicated system" being proposed. He would support using Amerada Hess earnings for the debt retirement account as it would provide approximately $30,000,000 to support this year's $140,000,000 debt to fund schools, harbors, and other needs. That action would be "perfectly defensible". Co-Chair Wilken deemed the activities associated with the Alaska Corporation Income Account and the Capital Corporation, as depicted on the aforementioned schematics, as being "unnecessary". A simpler solution would be to move the money from the Amerada Hess Fund into the Debt Retirement Fund. Co-Chair Wilken shared his objection to some of the projects proposed to be funded in this manner, because doing so would amount to committing "15-year money" to fund three-year projects. While he voiced support for the array of projects, funding them in this manner would not be considered "good fiscal management". Other funding sources are available. 3:16:16 PM Co-Chair Wilken continued that he could not support the establishment of a new bureaucracy through which to fund capital projects, as it would not be necessary. The Amerada Hess money could be deposited into an account that is currently utilized to fund bonds. 3:16:57 PM Ms. Frasca appreciated Co-Chair Wilken's comments. She reminded that the Administration had provided its budget proposal in December 2004 and that work on it had begun as early as October 2004. The options through which to fund the infrastructure were uncertain at that time. She recognized that "shifting" the Amerada Hess funding to the Debt Retirement Fund was an option; however, that Fund would be utilized to fund prior years' obligations. The desire with this legislation was to finance and develop future infrastructure needs. "We share the same goals in terms of where we want to go, and the question is how best to finance it." At the time the budget was being developed, this was considered the best option as it met the criteria and did not jeopardize the State's credit rating. It is still considered "a good mechanism". 3:18:16 PM Co-Chair Green stated that the question is how to best balance the funds that are available. There is a "different feel to this year's budget" than in previous years, because, other than Department of Transportation and Public Facilities transportation and federally funded projects, the amount of capital budget projects was held to a minimum. There are numerous funds out there and efforts should be exerted to reach a balance in utilizing the funds that are available. Co-Chair Green voiced appreciation for the information that has been provided. Senator Stedman voiced that he holds a similar position to that of Co-Chair Wilken. The bills were HELD in Committee. 3:20:00 PM