CS FOR HOUSE BILL NO. 13(FIN) "An Act relating to prepayments of accrued actuarial liabilities of government retirement systems; relating to the Alaska Municipal Bond Bank Authority, the Alaska Housing Finance Corporation, and the state bond committee; establishing the Alaska Pension Obligation Bond Corporation; permitting the Alaska Municipal Bond Bank Authority or a subsidiary of the authority, a subsidiary of the Alaska Housing Finance Corporation, the state bond committee, and the Alaska Pension Obligation Bond Corporation to assist state and municipal governmental employers by issuing bonds, notes, commercial paper, or other obligations 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; authorizing a governmental employer to issue obligations to prepay all or a portion of the governmental employer's shares of the unfunded accrued actuarial liabilities of retirement systems and to enter into a lease or other contractual agreement with a trustee, the Alaska Municipal Bond Bank Authority or a subsidiary of the authority, a subsidiary of the Alaska Housing Finance Corporation, the state bond committee, or the Alaska Pension Obligation Bond Corporation in connection with the issuance of obligations for that purpose, and relating to those obligations; relating to revision of the employer contribution rate in connection with financed prepayment of unfunded accrued actuarial liabilities of government retirement systems; and providing for an effective date." REPRESENTATIVE MIKE HAWKER, SPONSOR, related that HB 13 would authorize the state to engage in pension financing transactions in order to fully fund the state's pension liabilities. 9:50:09 AM BRIAN ANDREWS, DEPUTY COMMISSIONER, TREASURY DIVISION, DEPARTMENT OF REVENUE, reviewed a past presentation on Pension Obligation Bonds (POB's) which covered reasons to issue the bonds, what risks are involved, the potential saving that may be achieved, and why POB's are taxable debt, not tax-exempt debt. Mr. Andrews pointed out that the mechanics of a POB transaction are relatively simple. A POB transaction tries to accomplish the replacement of an existing debt obligation with another form of debt which has a lower cost. The concept is the same as refinancing a home mortgage at a lower interest rate. The 2006 actuarial report points out that the state has an $8.6 billion unfunded liability (debt) that it owes to the state pension plan. It carries a cost of 8.25 percent. Two weeks ago pricing from three major investment banking institutions was obtained. A POB transaction deal could be done for 5.25 percent, a savings that over 25 years on a billion dollars represents $23 million a year or $323 million over 25 years discounted at 5 percent. Mr. Andrews reported that the debt markets currently are exhibiting a lot of instability. He voiced confidence, though, that a transaction could be accomplished between 5.25 percent and 5.75 percent. The interest rate environment is the lowest it has been in the past 40 years. In fact, the ten year treasury at about 3.7 percent has only been lower 3.9 percent of the time in the past 20 years. The secret to a POB transaction is to do it at the lowest possible cost. Mr. Andrews explained that if the proceeds of a POB transaction are invested with an earnings rate greater than the cost, it is a good deal. Over the past 16 years, in only 2 years, 2001 and 2002, the issuance of a POB transaction would have proven to be a poor decision. This is a 25 year transaction, so it will not be known if it was a good or bad deal until the POB is paid off. 9:53:25 AM Mr. Andrews addressed the political and market risks. He turned to the PERS Case Study savings matrix on page 27 from his previous handout entitled, "Pension Obligation Bonds, February 8, 2008". He pointed out the annual contribution rate of 35 percent in PERS - an average of all participants. He showed how the various bond transactions affect contribution rates and savings. He explained that the matrix is unique because it also shows the impact of cash on the contribution rate. The point is that cash is the best asset to use. He added that a 5.25 percent cost of debt was used and the matrix was based on a level percent of pay. Mr. Andrews pointed out the conclusions on page 31. As long as more can be earned than the cost of the POB, it is a better move. It is a very favorable interest rate environment. Risks associated with POB issuance are quantifiable and statistically justified by the rewards. Doing nothing is not a viable option. 9:57:23 AM Senator Dyson stated his understanding about pension obligation bonds. He requested information about how the market uses taxable and non-taxable bonds. He wondered if bonds should be issued for construction projects, rather than for debts. Mr. Andrews spoke of IRS rules which prevent the use of an earnings arbitrage. He explained how they are marketed at a higher rate. He talked about tax exempt strategies which have higher risk. The capital projects amounts are not sufficient enough to do a $2 billion-plus deal. Senator Dyson said that investors and managers of the funds are attracted to tax exempt bonds. He suggested bonding capital projects to pay down PERS/TRS liability. Mr. Andrews explained that the state cannot take money and use it for unfunded liability and qualify for a tax free exemption. Co-Chair Stedman added that the state already has the ability to issue bonds for capital projects. He gave an example. He requested comments on that possibility. Mr. Andrews explained that it is fine as long as there is not a physical connection. If the capital projects are bonded, which frees up money in the budget, then that money can be used to pay down the unfunded liability. Co-Chair Stedman said it is a policy decision. 10:03:42 AM Representative Hawker added that as large and diverse as the state is, there is a role for both tax exempt debt for specific projects and for debt specifically targeted for reduction of the pension liability. He pointed out that a balanced program, which is currently in place, is the best. Co-Chair Stedman requested information about how the bonds are rated and issued. Mr. Andrews explained that that state currently has an AA rating - a neutral rating. An increase to AA1 was requested recently. POV's are appropriation bonds and the ratings are one notch below other state ratings - AA minus. Co-Chair Stedman asked about expectations of the issuance of $1 billion at today's market at AA minus - an estimate in dollars. He mentioned the $3.6 billion in savings and a desire to push the state's rating higher and thereby reducing the pension debt somewhat. 10:08:51 AM Senator Dyson asked what an appropriate level of debt for the state to carry is. Mr. Andrews commented that Alaska is very unique compared to other states. Tools rating agencies use to measure other states don't apply to Alaska because of its dependence on oil for revenue. POB transaction does not impact the state's rating. He said the state has an additional capacity for general obligation debt of about $1.5 billion. AT EASE: 10:11:23 AM RECONVENE: 10:12:08 AM Senator Dyson said he is interested in what the prudent level of debt the state can carry is, knowing that the $40 billion is off limits. Co-Chair Hoffman thought the committee should be interested in the answer. Representative Hawker referred to hangouts from the previous meeting: Pension Obligation Bonds and Other Post-Employment Benefits by Roger Davis and published by Orrick, and "Time May Be Ripe For A POB Revival" by Standard & Poor (copies on file.) He maintained, in the context of the bill, the rating agencies do not view POB's as adding to state debt. Structuring a method to pay off debt can enhance the state's rating. Co-Chair Stedman referred to a cash flow analysis sheet from February 15. He requested additional columns be added to show the payments assumed under SB 125. Senator Thomas said he is surprised at the adjustment that has to be made over the 25-year time period for the net present value of savings. Mr. Andrews noted that reflects money's time value. 10:16:35 AM JEFF URBINA, VICE PRESIDENT, WACHOVIA SECURITIES, SEATTLE, reported that Wachovia Securities was the number one ranked underwriter for municipal bonds in Alaska for 2007. He shared the history of his company's involvement with pension obligation bonds. He reported that there are only a few tools to use to address an unfunded pension liability. It is difficult to compare Alaska to other states. Most POB programs focus on a three-legged stool approach: programmatic evaluation, actuarial assumption analysis, and an evaluation of actuarial investment pool earnings. This approach frames a solution to unfunded pension liabilities. Most solutions include POB's. Mr. Urbina summarized that he feels that Alaska would be successful using POB's. 10:20:32 AM CAROL SAMUELS, SENIOR VICE PRESIDENT, SEATTLE NORTHWEST SECURITIES, OREGON, shared Oregon's experience with bond issuance. Oregon's system is about four times the size of Alaska. At the end of 2002, there was an estimate of the unfunded liability totaling $17 billion. The state provided legislative changes in 2003, which reduced unfunded liability by about 50 percent. Voters approved the issuance of $2 billion in state bonds. In addition, local governments issued $3 billion in bonds. The results have been very positive. The rate of return was at 8 percent. It was estimated that savings would be about 25 percent or $1.4 billion. The highest rate of return was over 20 percent. She related the advantages of the long-term successes of the bonds. She emphasized that it is important to structure the financing carefully and have an understanding as to how bond proceeds will be invested. Co-Chair Stedman referred to a handout from the Seattle Northwest Securities company (copy on file.) 10:25:44 AM ADAM STOLL, VICE PRESIDENT, GOLDMAN SACHS, referred to a presentation in the members' packets. He related that POB's are a very common tool used by governments. Since 2003 there have been over $30 billion in POB's issuances. Last month a Standard & Poor report said POB's have been popular with issuers and successful for sponsors. He mentioned the current low interest rate environment and its advantages to Alaska. Mr. Stoll referred to page 2 of the handout which depicts three examples of past POB's: Oregon, Illinois, New Jersey. He noted that the interest costs of the three plans vary greatly. He explained the advantage of an investment rate of return on POV's issued with a low interest cost. Senator Thomas noticed an extreme amount of activity in 2002-2005, as depicted on page 1. Mr. Stoll said that was due to unfunded liabilities increasing greatly during those years because of low returns. 10:28:59 AM GREG SUNDBERG, MANAGING DIRECTOR, MERRILL LYNCH, reported that his company has worked on this legislation with a variety of people in Alaska for the past four years. He thought the legislation was a good tool and he spoke in favor of the bill. He offered to answer questions. Representative Hawker summarized that the legislation is a prudent measure for the state to undertake. Co-Chair Stedman suggested working with the Department of Revenue to expand the cash flow analysis. Representative Hawker agreed.