SENATE BILL NO. 270 "An Act relating to the dividend paid to the state by the Alaska Housing Finance Corporation; and providing for an effective date." BRYAN BUTCHER, DIRECTOR, GOVERNMENT AFFAIRS AND PUBLIC RELATIONS, ALASKA HOUSING FINANCE CORPORATION, DEPARTMENT OF REVENUE, explained that sponsor statement. SPONSOR STATEMENT  Senate Bill 270 will modify the Alaska Housing Finance Corporation's transfer plan statutes to reflect federal changes in generally accepted accounting principles. House Bill 256 passed in 2003 that set in statute a transfer plan for AHFC to pay an annual dividend to the state of Alaska. The yearly dividend would be lesser of $103 million or 75 percent of the Corporation's net income for the previously completed fiscal year minus bond repayments for state capital projects. In 2006, Senate Bill 236 passed that made the first adjustments to the transfer plan. This bill changed the definition of "net income" to "adjusted change in net assets", which reflected federal changes to generally accepted accounting principles. SB 270 will make another modification due to federal changes in generally accepted accounting principles. It will add to the definition of "adjusted change in net assets" to include "temporary market value adjustments to assets and liabilities made during the base fiscal year". This change will allow for a true dollar figure for the Corporation's dividend to be calculated from rather than inaccurately high or low numbers based on how interest rate swaps are now considered. Co-Chair Stedman asked for an explanation of the interest rate swap. JOE DUBLER, DIRECTOR OF FINANCE, ALASKA HOUSING FINANCE CORPORATION, explained that an interest rate swap is a derivative financial instrument where the corporation enters into a contract with a counter party where they are paid a fixed rate in exchange for a variable rate. The variable rate is based on an index. This allows for the selling of variable rate bonds to hedge the change of interest rates over the 30 year time period bonds are typically sold. The Alaska Housing Finance Corporation has lowered the costs of funds by entering these interest swaps. Mr. Butcher remarked that SB 270 is a simple bill. Co-Chair Stedman inquired if there have been any problems collecting on the swaps. Mr. Dubler responded that currently the swaps are marked to market every quarter for financial statement presentation. If the swap out was closed today than it would require a payment to the counter party. Senator Olson asked who would want an interest rate switch in light of the low interest rates on the world market. Mr. Dubler answered that these swaps were entered into in 2001 through 2006 when the corporation saw the majority of the mortgage activity was from home buyers. The mortgage market started offering very sophisticated loan products to all borrowers that caused the Alaska Housing Finance Corporation concern. The corporation decided to take on the risk themselves because they had the expertise to take on these types of transactions and pass the benefit to the borrowers in the form of a lower interest rate. Most for-profit corporations enter into some sort of interest rate hedge. 9:49:27 AM Co-Chair Stedman remarked that many parties were caught by surprise by the derivative market. Mr. Butcher remarked that the corporation had three swaps with Lehman Brothers, but when Lehman Brothers went bankrupt, the corporation wrote them a check to purchase out of the position. The three swaps were rebid and several million dollars were made in the transaction. 9:50:38 AM Co-Chair Stedman reported a zero fiscal note from the Department of Revenue. Senator Thomas asked if this was being made during base fiscal year or on an annual basis. Mr. Butcher responded that the adjustments are made annually. This makes an adjustment from the financial statements to what was originally agreed to in the transfer plan. Accounts have made a lot of changes over the years that have affected the agreement with the legislature over what the dividend would be on an annual basis. The general accounting principals have been modified to require the corporation to include changes in the market value of certain interest rate swaps. This was not part of the original deal with the legislature. SB 270 asks to back this modification out. Senator Thomas inquired if it would be broader with the changes. Mr. Butcher explained there was another motivation from 1997 that required the corporation to bring booking marketable debts securities to market. The change was immaterial to the corporation's financial statements. The swap situation could have large swings in value from quarter to quarter and the corporation did not want a $10 million net increase in one year affecting the dividend, then maybe a $10 million decrease for the following year also affecting the dividend. 9:53:53 AM Co-Chair Stedman questioned the corporation's intention of going forward with derivatives. Mr. Butcher responded that they would not be entering into any more in the near future. The corporation's debt issuance for this calendar year will consist mainly of some federal bonds through 2010. Co-Chair Stedman questioned the reason for not doing it anymore. Mr. Butcher replied that the interest rate swaps entered to date have been swaps that change a variable rate debt into a fixed rate obligation of the corporation. The variable rate debt market in the world has had some issues with liquidity in the past year and a half. There have been a lot of bond holders putting the bonds back into the corporation and they have had to come up with the cash to pay off their position. The variable rate interest rate today is almost non-existent due to the shortage of liquidity. Co-Chair Stedman asked if these are standardized or non- standardized contracts. Mr. Butcher remarked that the general terms are standardized, but each firm has their own way of doing business. Co-Chair Stedman asked Mr. Butcher to explain the difference between a standardized and non- standardized contract. 9:57:04 AM Mr. Butcher explained that the liquidity facilities are an agreement where the provider supplies liquidity for a variable rate debt obligation. Bond holders have the right every seven days to put the bonds back into the corporation; therefore the corporation must have the money to pay those bonds off. Since the corporation does not usually have that large a sum of money available an agreement is entered into with a bank to provide liquidity in case a bond holder wants their money. There are then further agreements between the corporation and the bank. 9:59:22 AM Co-Chair Stedman understood the standardization, but the transparency was not as apparent as many thought hence the world financial situation. The state of Alaska did not get hit as bad as many areas in the country, but comfort levels are still not high. SB270 was HEARD and HELD in Committee for further consideration.