MINUTES  SENATE FINANCE COMMITTEE  April 28, 2000  9:10 AM TAPES SFC-00 # 106, Side A & Side B CALL TO ORDER Co-Chair John Torgerson convened the meeting at approximately 9:10 A.M. PRESENT Co-Chair John Torgerson, Co-Chair Sean Parnell, Senator Pete Kelly, Senator Randy Phillips, Senator Gary Wilken, Senator Green, Senator Leman, Senator Donley, Senator Adams. Also Attending: REPRESENTATIVE ELDON MULDER; DALE ANDERSON, Staff, Representative Eldon Mulder. Attending via Teleconference: DANIEL FAUSKE, Chief Executive Officer/Executive Director, Alaska Housing Finance Corporation (AHFC), Department of Revenue, Anchorage; STEVE CANTOR, Financial Advisor, Alaska Housing Finance Corporation (AHFC), Department of Revenue, Anchorage; DEVEN MITCHELL, Debt Manager, Treasury Division, Department of Revenue, Seward; SCOTT JANKE, City Manager, Seward. SUMMARY INFORMATION HB 281-BONDS: PUBLIC SCHOOLS/UNIV/HARBORS HB 281 was HELD in Committee for further consideration. HB 287-APPROPRIATIONS: SCHOOLS/UNIV./HARBORS HB 287 was HELD in Committee for further consideration. HOUSE BILL NO. 281 "An Act providing for the issuance of general obligation bonds in the amount of $665,000,000 for the purposes of paying the cost of design, construction, and renovation of public elementary and secondary schools, renovation of state buildings, capital improvements at the University of Alaska, and capital improvements to state harbors; and providing for an effective date." HOUSE BILL NO. 287 "An Act making and amending capital appropriations and reappropriations and capitalizing funds; and providing for an effective date." Co-Chair Torgerson commented that separating the two proposed bills would be difficult given the continuity of the subject matter. He noted that testimony would be received on both bills at the same time, reiterating that the issues were closely related. Co-Chair Torgerson pointed out that legal opinions received from two former Attorney Generals, Avrum Gross and Charlie Cole, regarding the use of monies generated from the sale of tobacco, have indicated that would not be in violation of the dedicated fund. REPRESENTATIVE ELDON MULDER agreed that the two issues were inter-related. He noted that HB 281 was the authorization for the project and that HB 287 was the request for the actual appropriation. HB 281 proposes a structure be created to administer the tobacco securitization acting as an insurance policy. Representative Mulder pointed out that the Master Settlement Agreement (MSA) with Phillip Morris and the other tobacco companies was driven by consumption of tobacco. He used an example of three plaintiffs in Florida who were awarded $5.9 million dollars for actual damages not including the punitive repercussions. Representative Mulder stated that those types of cases could force the price of tobacco to rise and consumption to decline over time. He believed that the trends could affect the settlement agreements. For the State of Alaska, that would mean declining return on the Master Settlement Agreement. Securitization is based on selling an asset to a third party, in this case Alaska Housing Finance Corporation (AHFC) and then in exchange, receive a present day value for that asset. In turn, bonds would be sold in the market place based on revenue projections related to the Master Settlement Agreement. The Bond Council advised the Legislature that there are a relatively "finite" number of bonds, which can be sold in that fashion. They could be volatile. Currently, there exists $14 million dollars worth of bonds in the market place. Representative Mulder asserted that the State of Alaska would be available to experience all of the upside from such a bond sale. He affirmed that the bonds would be discounted and were projected to be paid off within a thirty-year period. Co-Chair Mulder added that if the resulting revenue stream remains constant, the bonds would be paid off in a shorter period, possibly twenty years or less. If that happens, Alaska would receive revenue back. Co-Chair Mulder informed members that the proposed mechanism would be an insurance policy to assure that the revenue stream is maintained as outlined in the Master Settlement Agreement. He cited that bondholders would assume risk for a reduced revenue stream. Co-Chair Mulder referenced a list of proposals from around the State as outlined in HB 281, including the University of Alaska-Southeast campus, Pedro Bay School and Norvic High School. He clarified that there are approximately $185 million dollars worth of major maintenance projects related to schools around the State and new construction, $80 million for University upgrades and new construction projects, and approximately $36 million dollars related to ports and harbors, for a total package $350 million dollars. Co-Chair Parnell addressed the probable criticism that the Legislature's approach could expect to receive in taking the tobacco settlement revenue stream used through the State's general fund, pulling those funds from the State's use. He requested that Representative Mulder respond to that assessment. Representative Mulder agreed that the Smoking Cessation Program has been a controversial subject. He noted that following the Master Settlement Agreement (MSA), the State did include $1.4 million for tobacco cessation programs. He noted that as long as the MSA funds have been generated, the State has established benchmarks for that program. He referenced language in HB 281, Page 3, which indicates segregating $1.4 million dollars of the revenue stream from the funds for deposit into the general fund earmarked for cessation programs. Co-Chair Parnell stated that he was more concerned with the $22 million dollar hole in general fund revenue which would traditionally be applied to Medicaid for the tobacco cessation programs. He advised that the Legislature would be selling the right to that asset and then moving it to AHFC. Representative Mulder countered that the bonding system is based on revenue in and payments out. If the Legislature chooses this approach, the Master Settlement Agreement monies would continue to be paid to the State while the bonds were being paid off, thus, providing present day cash. Using a General Obligation (GO) bonding mechanism, it would go into the general fund and the State would then pay for those Medicaid programs. Using that bonding method, the current revenue stream would be received and then making the same payment out. Co-Chair Parnell pointed out that it would be the same general fund money. Senator Wilken pointed out that to date, no state had yet undertaken bonding. He referred to Page 8, the "Tobacco Settlement Payment Securitization, March 2000,." [Copy on File]. Senator Wilken added figures from various lines indicating the revenue stream for a total amount of $762.5 million dollars. He then referred to Page 13, the Net Bond Proceeds column for a total of $268 million dollars. He inquired if that indicated that the State would be surrendering their rights to a revenue stream of $762 million. DANIEL FAUSKE, (Testified via Teleconference), Chief Executive Officer/Executive Director, Alaska Housing Finance Corporation (AHFC), Department of Revenue, Anchorage, explained that the discount rates used are located in the middle of Page 13, 6.29%, 6.88% and that 5.4 and 5.8 were factored into the spread and out to 2008. Senator Wilken referenced Table 13, and asked if the State would normally pay 5.236% interest for the capital bond projects. He stated that in the proposed case, the cost would be 6.299%. Essentially, the State will be paying a 1% premium of the cost of the capital given the uncertainty of the revenue stream. He questioned if that was a valid assessment. Mr. Fauske responded that was only partially correct, as that scenario allows for a shorter maturity on the one side having the interest rate difference of 5.6% versus a 12.7% average life on the bonds. He referred to the second line of the "Sample Bond Issue," chart, which identifies the more specific Planned Principal Average Life. He noted that there would be a discount to allow for additional costs given the nature of the revenue streams related to these bonds. Senator Wilken questioned what the actual premium would be on the payment for the uncertainty of the tobacco revenue stream to the bondholder. Mr. Fauske replied it would be approximately 40 basis points in the current market. Senator Wilken translated that to ½ percent, plus or minus 10 points. Mr. Fauske replied that was a fair assessment. Senator Wilken asked the probability of the $15 billion dollars being "eaten up". Representative Mulder replied that there had been testimony from Solomon, Smith, and Barney regarding that issue. Under their testimony, advice was provided. DALE ANDERSON, Staff, Representative Eldon Mulder, pointed out that within member's packets some of that correspondence had been included. Senator Wilken asked if there were other comments on the possibility of the pool "drying up" without a "rush to judgement". STEVE CANTOR, (Testified via Teleconference), Financial Advisor, Alaska Housing Finance Corporation (AHFC), Department of Revenue, Anchorage, responded that would be an issue in moving forward in the "tobacco world". It is difficult to predict an outcome. Most of the industry experts believe that the tobacco companies will be able to honor their obligations regardless of what happens during litigation. Senator Wilken asked if Mr. Cantor had a sense if the $15 billion dollars could possibly dry up within the next twelve months. Mr. Cantor replied that those were different securities than what the State or AHFC is accustomed to selling. It would be a different security and transaction. He stressed that there is a limited marketplace for that type of security. It is difficult to predict the marketplace, however, he noted that there was an advantage to moving quickly and taking advantage of the current market. Senator Wilken asked about the corporate structure and how the tobacco companies would establish subsidiaries and relinquish their obligation to the MSA. Mr. Cantor stated that most tobacco companies would be able to handle their obligation. The manner, in which the transaction is structured, the revenues to all the parties to the agreement are on the basis of how many cigarettes are shipped domestically across the country. As long as the companies are still producing, they will be liable. There are various designations of how much each company will pay. Bond Council has issued extensive opinions as to what happens when anyone of those manufacturers declares bankruptcy. By and large, most analysts have agreed that the where-with-all exists to pay the agreement, and in the condition of bankruptcy, the agreement remains a vital obligation. Senator Wilken voiced concern with the charts-base payments. He suggested that given the structure of the MSA, the cost of the flat line could be inflated. Representative Mulder referenced the document - "Types of Debt Instruments" which outlines the true cost of doing the issuance of the programs. DEVEN MITCHELL, (Testified via Teleconference), Debt Manager, Treasury Division, Department of Revenue, Seward, explained that the contemplated structure required to achieve the target issuance amount which would net $269 million dollars is called "turbo". The way, in which it works, the nominal debt service schedule, would have a minimum annual amount, required by the bond and would reach out forty years. That will provide a projected revenue stream which would be obligated to extend the funds received over the nominal debt service up to that particular project line, and then applying that sum toward debt retainment. That number would provide additional security to the bondholders, as they would be more assured of being repaid. The proposed mechanism would allow the interest rate to decrease somewhat. Representative Mulder advised that graph was not accurate. The graph indicates base payments in paying back the bonds, while the full structure anticipates receiving the revenues and applying them against the base payments. He believed that would provide an advantage in receiving the full amount of money, however, the issuance would not be based off that participation. Co-Chair Torgerson asked Mr. Mitchell if he had seen the graph provided by J.P. Morgan. Mr. Mitchell stated he had not. He noted that depending on to whom one spoke, the response would vary regarding the revenue stream. There are perimeters within which it lies. How elastic the smoking demand will be is not yet known. The base-line structure bond issuance could be more comparable to the deals which have already come to market with the City of New York. The Department had checked that structure early on in the process and decided that it would provide less security to investors and that it would ultimately yield a lower issuance amount. That option was discarded. Mr. Fauske advised that Mr. Mitchell look at Page 13 of the handout. He pointed out that under the strategic contributions, the capital appreciation bond was listed. Mr. Mitchell interjected what the bond structure had captured. He pointed out the present value of that increase was included in the $269 million dollars. He added that those were bonds in which interest was paid, so that at maturity, both the principal and accrued interest would be paid off. He noted that was the structure used from the income stream ranging from 2008 - 2017. Senator Wilken explained that he wanted to fully grasp what was being proposed. He understood that there are three costs which need considering at this time. · The first would be the future costs of the general fund hole which would need filling during future legislatures. · The second cost would be that the State would need to pay a premium for the revenue flow, established at ½ percent. · The third cost would be giving up the right to an increased revenue flow. Senator Leman asked how the right would be given up for the increased revenue flow. Representative Mulder countered that the State would not be giving up the opportunity to get the increased revenue stream. If the revenue stream remains the way it currently is with the MSA, it will become a fully applied structure. It is anticipated that the bonds will be paid off in an expedited fashion. He reminded members that all projected costs are assuming that the State of Alaska will receive the projected revenue stream. If the State does not receive that amount, it will then be based on a flat fee. He advised that was the reason it was a conservative issuance. Senator Leman asked if it could become a future obligation. Representative Mulder stated that it would not. Senator Leman inquired the differences in the numbers originally submitted by the Senate. Representative Mulder emphasized that it will cost more than anticipated. The current list includes a more accurate reflection of anticipated costs. Senator P. Kelly asked the benefit to the State if the bonds were paid off early. Representative Mulder replied that the State would get the MSA funds back. Senator Wilken questioned the spread which amounts to an additional payment. He noted that if they were paid back by the projected date of 2018, the revenue stream shown on Page 8 would come back to the State of Alaska. Representative Mulder agreed. Senator P. Kelly asked the reason to adopt the proposed plan. Representative Mulder advised that the graph illustrates how the State could get the money back. However, on the other hand, if it does not pay off, then the bondholders would take the risk. For that insurance policy, the State pays ½ percent. Senator P. Kelly mentioned that one of the plans proposed by the Senate would be to invest the money into a Capital Budget Reserve (CBR) account so as to produce a revenue stream. He believed that plan would have similar advantages to the plan proposed by Representative Mulder. SCOTT JANKE, (Testified via Teleconference), City Manager, Seward, noted that he had been listening with interest to the discussion. Tape: SFC - 00 #106, Side B 9:57 A.M. Mr. Janke stated that he was in favor of the revenue bond from a practical standpoint as a City. In a revenue bond scenario, the dollars would be available earlier. In the case of Seward, the identified project would be the East Harbor expansion and would generate U.S. Army Corp matching money. Mr. Fauske indicated that the goal of AHFC was to provide the best professional service possible. He emphasized that the proposed legislation was a good idea and a prudent way for the State to capture revenue that bears some uncertainty. He mentioned a concern of AHFC is their ability to have representative projects within the scope of the overall bond portfolio. Co-Chair Torgerson asked the price tag associated with that idea. Mr. Fauske replied it would amount to about $5 million dollars, which represents 1% of the overall bonding package. He stressed that it would be a small price to pay for AHFC maintaining their own facilities. Co-Chair Torgerson agreed that appeared fair. Mr. Cantor recognized that it was a difficult decision for the Legislature to determine how to spend the tobacco revenues. Each state is facing the same position across the country. He commented that the proposed legislation set forth by Representative Mulder was good for the State. Mr. Cantor added that AHFC should be the financing entity to maintain all the projects and requested that AHFC's capital needs be included in the bill. Co-Chair Torgerson noted that HB 281 and HB 287 would HELD in Committee for further consideration. ADJOURNED Senator Torgerson recessed the meeting at 10:02 A.M.