SB 149-AIDEA: DIVIDEND TO STATE;INCOME;VALUATION  2:40:56 PM CHAIR COSTELLO announced the consideration of SB 149. She noted that this is the first hearing. 2:41:32 PM GENE THERRIAULT, Policy Director, Alaska Industrial Development and Export Authority (AIDEA), introduced himself. 2:41:51 PM At ease 2:42:26 PM CHAIR COSTELLO reconvened the meeting. MR. THERRIAULT directed attention to the word "excluding" on page 2, lines 3 and 21, of the bill to help explain the presentation. The exclusions were added by the legislature in recognition that certain things needed to be excluded from the determination of available net income in order to calculate the dividend AIDEA pays the state. Some new accounting rules are becoming problematic and AIDEA would like the legislature to consider adding things to the exclusion. He said Mr. Lamb will have examples of the new rules, the impact they are having on the dividend, and the proposed solution. He said the PowerPoint would cover the dividend: history (which he just summarized), goal, statutory language, and two accounting problems they are working to solve. He displayed a chart showing the AIDEA dividends that have been paid starting in FY1997 since AIDEA was capitalized with a little more than $300 million. Since then, AIDEA has repaid just under $380 million. The bill is intended to bring a little more predictability to that income stream going forward. He turned the discussion over to Mr. Lamb. 2:46:33 PM MICHAEL LAMB, Chief Financial Officer, Alaska Industrial Development and Export Authority (AIDEA), explained that the state receives an annual dividend based on AIDEA's operations and SB 149 seeks to make that dividend more stable and predictable. This has become an issue because accounting rules have changed since the statute was written. This matters because the dividend is based on the statutorily defined net income which is based on the financial audit. As the audit numbers change, the statutory net income number changes which changes the dividend. Three types of transactions affect the financial statements that affect the dividend. The first type are entries from "real transactions" that occurred. Examples are booking what was paid for an asset, revenue that is generated, payroll that is paid, taxes paid, and what cash was received and why. There isn't a problem with this type of transactions. The second type of transactions are entries from "estimates and allocations." Examples are booking depreciation and amortization expenses which recognizes and records that an asset used up some of its estimated useful life over the period of operations. There isn't a problem with this type of transactions. The third type of transactions are entries from "market value adjustments." These are entries related to transactions that did not happen, but the statute requires them to be recorded for the audit as though they did occur. [The statute requires compliance with GASB (Generally Accepted Auditing Standards) and GAAP (Generally Accepted Auditing Principles).] He clarified that market value adjustments have a purpose for an audit or to read a financial statement, but it's a policy decision as to whether they should be used to compute the dividend or excluded like other things. 2:50:34 PM MR. LAMB summarized the pertinent language in the existing Sec. 44.88.088 relating to the payment of the dividend: The authority shall adopt a policy for payment of a dividend to the state each year. The amount of which may not be less than 25 percent nor more than 50 percent of the net income for the base fiscal year. The meaning of "net income" is the change in net position, or the equivalent term under GAAP as set out in the audited financial statements of the authority for the base fiscal year, excluding amounts attributable to intergovernmental transfers, capital contributions, grants, or impairment losses on development projects financed under AS 44.88.172. 2:50:42 PM CHAIR COSTELLO asked why "market value adjustment" doesn't appear in the bill. MR. LAMB replied it's part of the proposed new language. He displayed a chart to illustrate how the dividend is calculated. It is based on the statutorily defined "net income," which comes from the audited financial statements that the board approves. Those board-approved audited statements must include applicable "market value" and/or "write-down/loss" entries. GAAP requires those entries and that all applicable GASB statements are implemented. SB 149 would modify the existing excluded language such that "net income" would not include any market value adjustments and/or state or federal write-down activity when calculating the dividend. 2:53:01 PM CHAIR COSTELLO asked how the dividend would have been affected if this change had been in statute in previous years. MR. LAMB said he would point that out later in the presentation. MR. THERRIAULT clarified that AIDEA will continue to follow all GAAP and GASB rules to get the audited financial statement. AIEDA is asking the legislature to back out market value adjustments only for the purpose of calculating the dividend. MR. LAMB added that the question is whether or not the components that now make up the audit are appropriate for the calculation of the dividend. 2:54:37 PM MR. LAMB restated the problems that arises when market value adjustments are factored into calculating the dividend. Entries that did not happen are booked as though they did. This causes AIDEA's net income to swing, which also causes the dividend to the state to swing. When the swings are material it makes a material difference in the size of the dividend. It's a problem for AIDEA when it has to pay a dividend based on cash it hasn't actually earned, and a problem for the state when AIDEA pays a dividend based on unrealized losses, not the cash it earned. He drew an analogy to an individual taxpayer who has to use market value adjustments in their tax return. The individual had W-2 earnings of $100,000, interest and dividend income of $7,500, and a permanent fund dividend of $1,500 for total income of $109,000. If the taxpayer's income calculation had to include hypothetical unrealized GASB 31, 68, 72, and 75 market value adjustments, the total income would be $169,000. That figure presumes the taxpayer sold the assets when in fact he did not. He noted that while the analogy shows more income than was actually earned, it could just as easily go the other direction. MR. LAMB displayed a chart showing 25 years of AIDEA's audited net income pre-GASB 31 market value adjusting entries. He noted that the year-to-year changes are not large. The next chart superimposes net income calculations after GASB 31 mark-to- market adjustments started in 1997. Including unrealized revenues and losses results in dramatic swings in net income from year to year. This causes the dividend to swing just as dramatically. He pointed to the number of times that AIEDA has paid a dividend based on unrealized income. For example, in 2010 the dividend was based on nearly $20 million in unrealized income. Assuming a 50 percent dividend, AIDEA would have paid $10 million more in dividends than it actually earned. The situation reversed in 2013 when AIDEA paid a dividend based on about $20 million in unrealized losses. The cost to the state was $10 million less in the dividend. 3:03:34 PM CHAIR COSTELLO asked how he would describe the public policy value of the bill. MR. LAMB said tying the dividend to the cash that AIDEA actually earned from its operations provides much more stability and predictability for both AIDEA and the state. SENATOR MEYER asked if it's safe to say that this change doesn't necessarily mean the state will get more of a dividend or less of a dividend. MR. LAMB said we could be better off in some instances and not in others. 3:08:44 PM MR. LAMB said the bill also seeks to fix the potential for a dividend penalty. When the value of a project has been determined to have been permanently reduced, GAAP requires an adjusting entry to be booked to reduce and/or remove some or all of the value of the asset or project from AIDEA's balance sheet. The resulting entry reduces net income, which either reduces the dividend or stacks the dividend AIDEA pays due to the adjusting entry reducing value. The dividend penalty for an adjusting entry could be 25 percent to 50 percent. He discussed a hypothetical example. If the state funded a project with $8.8 million and it were to go away, the $25.3 million in net income that the dividend would have been based on would be reduced by $8.8 million so the net income would be $16.5 million. The $8.8 million has no value and the dividend is reduced by 50 percent or $4.4 million. He displayed a visual to discuss the same example. AIDEA believes this should be fixed, he said. 3:14:27 PM He reviewed the new statutory language proposed in SB 149. The language on page 1, lines 10-11, would fix the first problem, and the language on page 2, lines 5-8, would fix the second problem. 3:16:06 PM MR. THERRIAU summarized that the bill adds to the excluded items, accommodates the new GASB rules, and ensures that projects that are written off won't drag the dividend down. The policy of the bill is to add predictability to the dividend. Referring to Senator Meyer's question, he said these changes will smooth the impact to the dividend. CHAIR COSTELLO asked what precipitated the bill. MR. LAMB said part of it was that the board wanted the ability to explain why the dividend had shrunk to the legislature. Also, as he became more familiar with the statutory language he realized it needed to be fixed. The third reason is that new GASB rules are coming and there is a compounding effect. 3:21:33 PM CHAIR COSTELLO held SB 149 in committee.