GENERAL SUBJECT(S): OVERVIEW PRESENTATION GENERAL OBLIGATION BONDS by SALOMON SMITH BARNEY The following overview was taken in log note format. Tapes and handouts will be on file with the House Finance Committee through the 21st Legislative Session, contact 465-2156. After the 21st Legislative Session they will be available through the Legislative Library at 465- 3808. Time Meeting Convened: 9:15 a.m. Tape(s): HFC 00 - 90, Side 1 HFC 00 - 90, Side 2 PRESENT: X Co-Chair Therriault X Co-Chair Mulder X Vice Chair Bunde absent Senator Parnell absent Representative Austerman absent Senator Torgerson X Representative J. Davies absent Senator Al Adams X Representative G. Davis absent Senator Donley X Representative Foster absent Senator Green X Representative Grussendorf absent Senator P. Kelly X Representative Moses absent Senator Leman X Representative Phillips absent Senator Phillips X Representative Williams absent Senator Wilken ALSO PRESENT: TIMOTHY RATTIGAN, DIRECTOR, PUBLIC FINANCE DEPARTMENT; SALOMON SMITH BARNEY; GEORGE W. LEUNG, DIRECTOR, PUBLIC FINANCE DEPARTMENT, SALOMON SMITH BARNEY; MIKE DALESSI, VICE PRESIDENT- INVESTMENTS, BRANCH MANAGER, SALOMON SMITH BARNEY. LOG SPEAKER DISCUSSION TAPE HFC 00 - 90 SIDE 1 000 CO-CHAIR MULDER Co-Chair Mulder convened the Joint House and Senate Finance Committee meeting at 9:15 A.M. He noted that the purpose of the meeting is to provide an overview on bond financing by Salomon Smith & Barney. 100 TIMOTHY RATTIGAN, DIRECTOR, PUBLIC FINANCE DEPARTMENT, SALOMON SMITH BARNEY, SEATTLE Introduced other members present representing Salomon Smith Barney- Mike Dalessi, Vice President, Branch Manager, Juneau & George Leung, Director, Public Finance Department, New York. A handout was distributed. [Copy on File]. 247 MR. RATTIGAN Provided a brief overview of the handout. He noted that the presentation would include: 1. Bond Market Overview 2. General Obligation Bonds 3. Tobacco Securitization 364 MR. RATTIGAN Page 1 illustrates the overview of the municipal bond market. Page 2 represents the historical municipal market interest rates. Page 3 provides indicative interest rates for the State of Alaska bonds. Mr. Rattigan pointed out that when short-term rates are increased, that keeps long term rates in check. 462 MR. RATTIGAN Page 5 explains the investment grade rating categories. That area lists the types of debt instruments and compares them between Moody's, Standard & Poor's and Fitch. It is designed to rank within a consistent framework, the relative repayment risk of each debt issuer. 581 MR. RATTIGAN Noted that Page 6 indicates the investment grade rating categories. State of Alaska's General Obligation bonds have been rated Aa2/AA(prior)/double A and its limited obligations and certificates of participation are rated A1/A+/NR. A majority of state general obligations are rated prime grade or high grade. Only three states have ratings in the medium grade category. 677 GEORGE LEUNG, DIRECTOR, PUBLIC FINANCE DEPARTMENT, SALOMON SMITH BARNEY, NEW YORK Introduced Section 2-General Obligation Bonds, and how these standards affect the State of Alaska's rating. He stated that the general obligation bonds are the strongest form or repayment and generally lowest borrowing cost. The full faith and credit of an issuer secure them. The issuer pledges to repay general obligation debt without limitation. 780 MR. RATTIGAN Added that there is recognition of how the permanent fund rating has been used. At this time, he noted that it is not a negative but that there is recognition that this is declining revenue as the oil market is declining. The permanent fund dividend is recognized as a possible use to supplement those funds. 847 VICE CHAIR BUNDE Asked the number of states that have the double A rating. 876 MR. LEUNG Replied that having the Permanent Fund available is important to the State's rating. However, there are concerns with the nature of that timing. 926 MR. RATTIGAN Explained that Mr. Leung would address the State's rating status. 949 MR. LEUNG Referenced Page 9. He spoke to the spectrum of security and noted that the State's general obligation bonds are frequent financing vehicles for the state. Forty states currently have outstanding GO bonds. Ten states that do not issue GO bonds generally issue other types of bonds and or lease obligations. State GO bonds are the highest rated class of bonds and generally the most secure debt offered in the municipal bond market. 1001 MR. LEUNG Page 10 - rating analysis factors for GO Bonds. Page 11 & 12 provide detail of the key factors for rating. 1085 REPRESENTATIVE WILLIAMS Spoke to page 11 and the administrative factor of tax breaks-economic base, financial analysis, debt analysis, administrative factors. 1102 MR. LEUNG Explained that these are general factors that apply to all issues. 1130 REPRESENTATIVE WILLIAMS Interjected the idea of a statewide income tax. 1143 MR. LEUNG Spoke about the sophistication of mitigating the dependency on one revenue source. 1172 REPRESENTATIVE PHILLIPS Commented on the economic base factors. She noted the income level decline. She asked if there was an analysis on that factor. 1202 MR. LEUNG Explained that a rating provides a judgement and balancing of concerns. The rating agency is fully aware of that concern. 1226 REPRESENTATIVE PHILLIPS Inquired if Alaska would be able to receive that information and requested that information be made available. 1248 VICE CHAIR BUNDE Inquired at what point in time would debt be less conservatively managed. 1300 MR. LEUNG Explained that the Prudhoe curve is what the rating agency has used to determine the analysis. At current time, the debt can be addressed by the State. He believed that policy and discussion with the rating agency should move forward. The rating agency will look at the rate of debt and they will then allow 3-5% of that budget which provides a benchmark to be used to insure the stability of finances. 1408 MR. RATTIGAN Interjected that the rating agency rule of thumb should concur with that number. The Prudhoe curve has been extended. Other considerations are how the constitutional budget reserve is being used. That consideration is not as dependent on the curve as it use to be. Other possible revenue stability was discussed. He spoke to what the rating analysis of 3-5% would include. In Alaska, that number includes $1 million dollars of federal aid; the analysis does not include those monies. 1518 REPRESENTATIVE G. DAVIS Asked if a consideration had been made why choices are made. 1547 MR. RATTIGAN Noted that the rating agencies have opened up their process more lately than they have in the past 20 years. He commented that there is more dialogue now. 1617 REPRESENTATIVE J. DAVIES Spoke to other investments that the rating agency should consider. He noted that production decline has slowed significantly the past several years. Representative J. Davies pointed out that the tax rates in the handout were listed in the administrative portions. He proposed the idea of a state income tax. He questioned if under a diversified base, would that concept be placed under a stable income. 1688 MR. LEUNG Referenced Pages 13-15- the tax debt comparison with other states. He pointed out that these numbers do not reflect the debt reimbursed to state schools. 1728 CO-CHAIR MULDER Inquired if other states incur debt for their statewide school system. 1738 MR. LEUNG Responded "increasingly so" to allow the cheapest and lowest cost of borrowing. He stated that this cost is reflected in the resource development fiscal increase on the state level. Local governments are under tax cap limitations and consequently, the state ends up supplementing local source funds. 1794 MR. RATTIGAN Some states have issued their own bonds and then distribute them to the school districts. He explained the variety of mechanisms used to fund education from state to state. 1822 MR. LEUNG Page 16-Tobacco Master Settlement Agreement (MSA), an emerging class of bonds backs by tobacco settlements. Currently, there are six states actively considering this move. The settlement funds are shared in only two states- California and New York. The MSA is an agreement between settling tobacco companies and 46 states, including Alaska. The settling companies have agreed to make payments to the states in perpetuity, based on domestic cigarette consumption. The State of Alaska is entitled to receive 0.3414187% of the base payments under the MSA. 1911 CO-CHAIR MULDER Asked what the bonds are going toward. 1918 MR. LEUNG Replied that in New York, the bond are being used for schools, hospitals, and health care. 1935 REPRESENTATIVE J. DAVIES Asked about Georgia. 1941 MR. LEUNG Replied that Georgia is considering the uses as are a number of other states. 1956 REPRESENTATIVE PHILLIPS Commented on the new court ruling regarding that settlement. 1966 MR. LEUNG Acknowledged that the issues are enormous. One of the factors is litigation. He referenced a case worth a tremendous amount against the tobacco companies implemented by individuals. Additionally, there are class action suits. All these risks are very significant. 2020 MR. LEUNG Added that the settlements are between states as a class and that currently lawsuits are winding their ways through the courts. He noted that essentially, the tobacco companies have committed consumer fraud. 2061 MR. RATTIGAN Noted that factoring in of such analysis, are all-affordable under these scenarios. He stressed that tobacco remains a very profitable industry. The Florida case brings up an issue of class action. If appealed, a bond could be posted. For the tobacco to post a bond, they might have to declare bankruptcy. The payments from the tobacco industry to each of the states are treated as an operating cost by that industry. At this time, the money to the states continues to flow. 2150 CO-CHAIR MULDER Clarified that tobacco money received through the MSA is treated as an operating expense. He believed that the likelihood of continued payment was high. 2168 MR. LEUNG Agreed. He added that the payments would probably be continued in the event of bankruptcy. 2184 MR. LEUNG Interjected that this risk is not based on one tobacco company. There are essentially four companies that make the tobacco market. The risk would be tied to the weakest company. The attorney general noted that the risk was not on one company going bankrupt, but rather the volume of cigarette smoking and drop in consumption. 2242 MR. RATTIGAN Interjected that the tobacco bonds are rated higher than any corporate risk. You would be buying someone's ability to continue to want and need to buy cigarettes. TAPE CHANGE HFC 00 - 90, SIDE 2. 000 MR. RATTIGAN Spoke to the volume of consumption. He questioned if that should be considered a revenue stream or a risk to diversify. There are additional revenues expected to flow. Alaska is anticipating using the additional revenue to pay back bonding faster. 107 CO-CHAIR MULDER Asked if members understood the escrow agent. 126 MR. LEUNG Referenced Page 26 - structured credit or Securitization, which lists the structure at issuance and ongoing debt service for the State. The credit risk is separate from the repayment of the bonds. 217 MR. RATTIGAN Stated that Alaska Housing Finance Corporation (AHFC) is the State agency, which is set up to issue and provide that service. That is because it is "insulated" should something happen. 276 VICE CHAIR BUNDE Inquired which escrow services would be charged. 312 MR. RATTIGAN Explained that escrow is set up to guarantee that the money is distributed to each state. What each state does with their money is left up to that state. A Securitization mechanism helps track the money. Those fees are not prohibitively expensive and this is not unlike the escrow established in other state accounts. 393 VICE CHAIR BUNDE Asked if Alaska had the option of using escrow. 415 MR. RATTIGAN Replied that escrow is used to track the tobacco companies. Those companies make a lump payment to the Tobacco Fund and it is then distributed to each state. Separate accounting occurs to pay the debt service first, which is the state discretion. 485 VICE CHAIR BUNDE Asked if the state could use the money over a long period of time or use right away. He asked what that would cost. 534 MR. RATTIGAN Page 27, the difference is quite small. The only cost is the issuance of the bonds. The present values of the stream and is coming back as bond proceeds at that time. Present value factoring is the listing of Securitization. That number is around 1% of the total bonds issued - $2.5 million dollars. 633 REPRESENTATIVE PHILLIPS Asked if anyone anticipates that the tobacco industry may not be around much longer. 669 MR. LEUNG Acknowledged that is a concern. He referenced Page 21, WEFA forecast a 58% decline in total US consumption of cigarette over the next 43 years. He emphasized that the tobacco industry is still a profitable industry. 765 CO-CHAIR MULDER Asked if the MSA was more driven by consumption. 783 REPRESENTATIVE PHILLIPS Questioned the length of time that the bonds are being held. 797 MR. RATTIGAN Interjected that the elasticity of the industry is being studied. He reiterated that tobacco is still a profitable industry. In relationship to the WEFA study, there are still 200 billion cigarettes sold each year. 852 REPRESENTATIVE J. DAVIES Pointed out that was U.S. consumption only. He noted that there are a lot of other countries with high tobacco consumption. 875 MR. RATTIGAN Agreed. The international consumption does not factor into the MSA. The Attorney General has said that if anyone manufactures cigarettes outside of the MSA agreements within the United State, the Department of Law will take it up. 953 MR. LEUNG Spoke of the force used to sign on and agree to the MSA, which has worked to compel non-participating manufacture to join. A non-participating manufacture would be required to pay an extra amount, which would economically compel them to join. 1020 REPRESENTATIVE J. DAVIES Referenced Page 26 and asked about the residual bond. 1038 MR. LEUNG The residual bond is the issue of debt service coverage. There is a level of excess revenues needed to service that bond. 1089 MR. RATTIGAN Stated the bond service payments are set aside to repay the bonds, which could come back as a credit positive. The rating analyst can take into consideration tobacco revenues and the risk could be sold off. He noted that non of the tobacco revenues are factored. 1177 REPRESENTATIVE PHILLIPS Observed that in America, our government has placed a debt to a whole industry. 1208 VICE CHAIR BUNDE Observed that was the price for doing business with addicts. He pointed out the number of cigarette sold. He noted that income was guaranteed and "shaky". 1261 MR. RATTIGAN Commented that above the threshold the income stream will be volatile. Rating analyst have pointed out that the anticipated volatility will create movement. 1302 MR. LEUNG Commented that it would be consume the financial factors. This is an uncertain revenue stream. Rating analyst want to understand how the state will use the monies and the implications that has to the fiscal balance. The revenue is declining over time and building an operating deficit. He questioned how the revenues were being used and future budgetary balances. 1373 CO-CHAIR MULDER Referenced Page 27, the real cost of Securitization in the present value of $500 million. 1418 MR. RATTIGAN Agreed that the debt service payments must be scheduled and the present value basis stays small. He stated that the analysis would be the same for any bonds. Present value is much different. It is important to consider concepts when determining how much is actually available to spend. He spoke to capitalizing some of the interest. He pointed out that the net number is about $250-$260 million dollars which could be used for capital projects. 1527 CO-CHAIR MULDER 1545 MR. RATTIGAN Stated that the projects could become more expensive over time to build and that should be factored in. This is just a cash flow analysis. 1574 CO-CHAIR MULDER ADJOURNMENT The meeting adjourned at 10:30 A.M. JOINT HOUSE/SENATE FINANCE COMMITTEES MARCH 30, 2000 9:15 A.M. HFC & SFC 9 3/30/00 am