SENATE FINANCE COMMITTEE February 4, 2016 9:05 a.m. 9:05:25 AM CALL TO ORDER Co-Chair Kelly called the Senate Finance Committee meeting to order at 9:05 a.m. MEMBERS PRESENT Senator Anna MacKinnon, Co-Chair Senator Pete Kelly, Co-Chair Senator Peter Micciche, Vice-Chair Senator Click Bishop Senator Mike Dunleavy Senator Lyman Hoffman Senator Donny Olson MEMBERS ABSENT None ALSO PRESENT Deven Mitchell, Executive Director, Alaska Municipal Bond Bank Authority, Department of Revenue. SUMMARY ^PRESENTATION: STATE DEBT and CREDIT RATING 9:06:11 AM DEVEN MITCHELL, EXECUTIVE DIRECTOR, ALASKA MUNICIPAL BOND BANK AUTHORITY, DEPARTMENT OF REVENUE, discussed the presentation, "Targeted State Debt Summary and Credit Review" (copy on file). He shared that there were a couple of mistakes within the presentation. Co-Chair Kelly encouraged members to hold their questions until an appropriate time. Mr. Mitchell looked at slide 1, "State Debt Obligation Process": All Forms of State Debt are Authorized First by the Legislature For limited obligations following this authorization the authorized issuer implements Senator Dunleavy wondered if the debt obligation was open- ended, or were there separate obligations. He specifically queried the number of acts passed by the legislature, which opened the ability to bond. Mr. Mitchell replied that the authorization was in effect until the implementation. Senator Dunleavy surmised that that there could be concurrent obligations. Mr. Mitchell agreed. Senator Dunleavy gathered that corporations could also be granted authorization. Mr. Mitchell agreed. Mr. Mitchell continued to discuss slide 1: General obligation bonds must also be approved by a majority of voters All State Debt must be structured and authorized by the State Bond Committee Includes general obligation bonds, subject to appropriation issues, and revenue bonds The State Bond Committee determines method and timing of debt issues to meet the authorized projects cash flow needs Committee must hold a publicly noticed public meeting and approve a Resolution authorizing the sale of the obligations Disclosure document, rating agency presentation, investor presentation, and other legal documents must be prepared Bonds are sold and a closing is conducted where the final documents are signed and funds are transferred. The School Debt Reimbursement Program is administered by the Department of Education and Early Development Must be general obligation of local government, at least 10 year and level debt service 9:14:49 AM Senator Bishop noted the GO bond sale in early 2000s, at a time of a small capital budget. He remarked that the bond sales were executed in 2004, but was not utilized until 2008. He stressed that contracts should be project and bid ready, in order to immediately take advantage of the money from the bond sales. He noted that assets must be kept at a high level, to maintain a high value. Co-Chair MacKinnon queried the members of the Alaska State Bond Committee. Mr. Mitchell replied that the committee was established by statute. The members consisted of the commissioners of the Department of Revenue (DOR), Department of Commerce, Community and Economic Development (DCCED), and Department of Administration (DOA); or their designees. He stated that there were three designees, which were deputy commissioners of the departments. Co-Chair MacKinnon surmised that the administration was driving the committee with how to move forward with debt. She noted that the school debt program was recently suspended, with the hope to incur additional debt. She looked at page 5 of the Debt Report (copy on file). She noted that the reimbursable figure to the municipalities was $895 million, but queried the outstanding school debt. Mr. Mitchell replied that the school debt was approximately $60 million to $65 million, which was authorized prior to the January 1, 2015 deadline. Co-Chair MacKinnon appreciated the control of the school debt. She surmised that there was unissued debt of $271 million in the general obligation bonds in the affordability analysis from January 2016. Mr. Mitchell replied in the affirmative. Co-Chair MacKinnon wondered if there was other debt that was not on the balance sheet, which would impact the state credit rating. Mr. Mitchell replied that a slide would address that issue. 9:19:48 AM Mr. Mitchell highlighted slide 2, "State Debt Obligations Outstanding." The slide showed the state's payments from GF. He noted that there were two errors in the slide, which should be zero: Knik Arm Crossing and Pension Obligation Bonds. He continued to discuss the slide: General Obligation* Par Amount: $753,800,000 Final Maturity: 2020 -2038 Average Annual Debt Service: $60,000,000 Total Debt Service to Maturity: $800,000,000 Subject to Appropriation (COP/Lease Revenue) Par Amount: $310,600,000 Final Maturity: 2016 -2033 Average Annual Debt Service: $25,000,000 Total Debt Service to Maturity: $410,000,000 Knik Arm Crossing (subject to appropriation) Par Amount: $300,000,000 Final Maturity: 2037 or 2038 Average Annual Debt Service: EST. $25,000,000 Total Debt Service to Maturity: $500 million Pension Obligation Bonds (subject to appropriation) Par Amount: $5,000,000,000 School Debt Reimbursement ** Par Amount: $895,400,000 Final Maturity: 2034 Average Annual Debt Service: $95,000,000 Total Debt Service to Maturity: $1,100,000,000 Other State Reimbursements (Capital Projects) Par Amount: $35,800,000 Final Maturity: 2031 Average Annual Debt Service: $4,500,000 Total Debt Service to Maturity: $50,600,000 Vice-Chair Micciche queried the municipal share of the school debt reimbursement. 9:22:57 AM AT EASE 9:23:30 AM RECONVENED 9:23:38 AM Mr. Mitchell shared that the total outstanding state debt was $898 million. The community share was approximately $400 million. Vice-Chair Micciche queried the potential increased risk to the state with the $400 million. Mr. Mitchell replied that there had been a proration in support of the program in the past. He furthered that the program had been modified over time. He stressed that the communities would have a difficult time funding. Vice-Chair Micciche surmised that the state had ultimate responsibility for the school debt. Mr. Mitchell responded that the state had an agreement to fund a portion of the debt service, so there was no additional commitment. Co-Chair MacKinnon noted that Anchorage carried 50 percent of the school debt. She remarked that it made a difference whether the debt was carried at a higher than the current interest rate. She noted that, under the previous administration, Anchorage carried a higher percentage debt load. She understood that Anchorage was encouraged to refinance their debt, so the state's debt service would be lower. She announced that Anchorage did not refinance. She wondered whether the administration would consider reducing the payments from the state. She queried a proposed statute, which would work in the state's best interest. She understood that there was a cost to the communities to refinance debt. Co-Chair Kelly asked for a restatement. Co-Chair MacKinnon restated her question. She compared the debt refinancing to refinancing a mortgage. 9:30:53 AM Co-Chair Kelly wondered if the loans could be refinanced at a lower rate by the communities. Mr. Mitchell replied that issuing bonds required a ten-year par call. At the tenth year, refinancing was available. He stressed that refinancing was not available before than ten-year mark, unless there was advanced refunding under the tax code during the life of the bond issue. He remarked that advanced refunding allowed for the money to be put in an escrow account that paid the interest expense on the callable bonds. At the sixth year, the bonds become callable, so there was a defeasement. 9:35:11 AM Senator Bishop noted that the state only carried 70 percent, and the community percentage never showed on the state balance sheet. Mr. Mitchell agreed. Co-Chair MacKinnon looked at the asterisk on the General Obligation portion of the slide. She shared that she had received an email that stated that the administration was ready to move forward with issuing debt of $271 million. She queried the number of consideration by the administration. Mr. Mitchell replied that the state had a $155 million bond anticipation note that would mature on March 18, 2016. He explained that the administration was looking to issue a bond of $151 million of GO bonds in early March to refinance the bond anticipation note. Co-Chair MacKinnon understood that there was a cash call due. Mr. Mitchell agreed. Co-Chair MacKinnon did not know the cash call, but assumed it was for the transportation package. She queried the reasoning for one-year bonds, with available assets. Mr. Mitchell replied that the bond were used, because they were authorized by the legislature and the voters in 2012. He furthered that bond notes had been issued annually since 2013. He announced that there had not been the level of spending that was initially projected. Co-Chair MacKinnon wondered if there was $151 million cash flow for bonds. She shared that some of the bond packages only funded design. She questioned the utilization of debt for projects that may not come to fruition. 9:40:24 AM AT EASE 9:41:25 AM RECONVENED 9:42:17 AM Co-Chair Kelly offered a prayer for a sick staffer in the building. Mr. Mitchell shared that the $151 million was to refinance the 2015 bond anticipation notes. The project expenditures that had been made to date were approximately $130 million. He stated that the forecast had historically included DOT and DCCED, which fully utilized the $180 million generated by the prior sales in the fiscal year. He remarked that the bond anticipation note program there was no anticipation of issuing additional obligations, until all the current funds were expended. The accounting system was currently inefficient, so the issuing of new bonds would require extra work from the administration. There was a hope to minimize the "footprint." He shared that, historically the state had earned more from the money held than were paid in interest expense; because of the short position. There was a net interest cost in the first year of approximately 9 basis point; second year was almost 10 basis points; and the third year was 15 basis points. The payments were extraordinarily low rates, which was reinvested in the short-term pool in the Treasury Division. He stressed that issuing $200 million of long-dated debt would earn the state 40 basis points, but there would be negative carry on the construction fund. He stressed that the money in the bank should only be there out of necessity. Co-Chair MacKinnon felt that the rating agency would see that this was normal business procedure, and no new debt. Rather the debt was reforming in a way that was most efficient for the state. Mr. Mitchell agreed. 9:45:52 AM Mr. Mitchell looked at slide 3, "General Obligation bonds Current Financings": Recent Activity: To date, $182 million of the State's 2012 GO bond authorization ($453.2 million) has been funded through Bond Anticipation Notes (BANs) in 2013, 2014, and 2015 Average interest rate on Bans has been just over 1/10 of a percent The State has amortized $19.3 million to date 2015 BAN repaid 2014 BAN with no new money Cash flow on projects has been slower than projected Co-Chair MacKinnon noted that any debt that the state does not incur should be considered a good thing. She felt that the administration was using debt in a proper manner. Mr. Mitchell discussed slide 4, "State Debt Obligations Authorized But Unissued": Known/anticipated Bond Issues March 2016 -Approximately $150 million of general obligation bonds to refinance 2015 Bond Anticipation Note Next six months -Up to $150 million of Bond Anticipation Notes to fund projects authorized by the 2012 Transportation Act Next six months -Refinance the balance of the Matanuska Susitna Borough Goose Creek Correctional Facility Lease Revenue Bonds for savings. The general fund pays 100 percent of the debt service on these bonds. 9:50:18 AM Co-Chair MacKinnon queried the reasoning for 20 year mark for the Knik Arm Crossing. Mr. Mitchell replied that the 20 year mark was in the fiscal note. Co-Chair MacKinnon wondered whether the bond committee would make that determination. Mr. Mitchell replied that the State Bond Committee would make that determination. He furthered that the legislature had the power to change the law. Co-Chair MacKinnon encouraged the State Bond Committee to consider the current situation and issue the length of term of the debt that benefits the state in the most advantageous way. Mr. Mitchell continued to discuss slide 4. He remarked that there was an authorization for up to $5 billion of pension obligation bonds. He remarked that the administration chose to ensure that the legislature agreed that it was a reasonable choice. He remarked that a portion of the bonds for Goose Creek had been refinanced in the previous year. He stressed that there was no interest in the "belly" of the curve, so the state chose to do the longer dated maturities with a sale of 8.5 percent, which exceeded the targets by two. He remarked that the state may try to refinance a portion of the debt, with the hope that the borough would undertake a portion of that debt. 9:54:14 AM Vice-Chair Micciche wondered if there was a list of outstanding debt that may be different in statute to bring down the cost; and addressed unissued debt. Mr. Mitchell replied that the state's debt program was efficient and conservative. He stressed that, per availability, people were efficient within the programs. He noted that there could be an adjustment to the school debt reimbursement program, so the state did not rely on sub entities to issue debt in an advantageous fashion. Rather, the state issue the debt itself. He noted that the Knik Arm Crossing was subject to appropriation, subordinate lien, and toll revenue structure. He hoped to use toll revenue to pay the bonds to the extent that they were sufficient. He stressed that there would be an issue in using GO bonds to the state, because there was federal highway money in the project which outlined limitations in how to use toll revenues. He stated that the structure may seem less efficient that the GO bonds, the structure made sense. He remarked that there were some prisoners outside the state, who wanted to move back to Alaska. He stressed that it was difficult to get voters to approve a prison project, so the legislature was required to make the decision for the discreet stand-alone project, Goose Creek. He stressed that it may have a lesser credit quality, but made sense overall. 9:57:10 AM Mr. Mitchell addressed slide 5, "Pension Obligation Bond Strategy." He felt that there are different ways to consider pension obligation bonds. He stated that pension obligation bonds were beneficial at a lower interest, enhancing the probability for success. He shared that the bonds were currently at 5 percent interest rate. He stressed that the pre-funded pension system, which relied on earnings, informed the decision to drive down the interest rate. He stressed that the unfunded liability was at an actuarial rate at 8 percent. He stressed that refinancing the unfunded liability may lower the interest rate to 5 percent. Senator Dunleavy wondered if Mr. Mitchell would take on similar financing for his home. Mr. Mitchell replied that he was not a sophisticated investor, so he would be reluctant to make that move individually. Senator Dunleavy noted that there had been some wildly "off the mark predictions and assessments made by experts." 10:02:05 AM Mr. Mitchell continued to discuss slide 5: Known/anticipated Bond Issues March 2016 -Approximately $150 million of general obligation bonds to refinance 2015 Bond Anticipation Note Next six months -Up to $150 million of Bond Anticipation Notes to fund projects authorized by the 2012 Transportation Act Next six months -Refinance the balance of the Matanuska Susitna Borough Goose Creek Correctional Facility Lease Revenue Bonds for savings. The general fund pays 100 percent of the debt service on these bonds Mr. Mitchell highlighted slide 6, "State of Alaska -Debt Capacity." The slide showed the metrics of the debt capacity. Co-Chair MacKinnon wondered whether the analysis was based on FY 15 actuals, FY 16 new revenue dollars, or projected revenues for FY 17. Mr. Mitchell replied that the slide was based on the Fall Revenue Sources book for FY 16 and throughout. He shared that the book included a table titled, "State Appropriatable Revenue." He remarked that there were categories of money in the state which was known as "restricted." He remarked that the money was not "restricted." The legislature could spend the money, but chose to put it into savings, because that was the historic action of the legislature. Co-Chair Kelly handed the gavel to Co-Chair MacKinnon. Mr. Mitchell looked at slide 7, "Rating Agency Views -State of Alaska": Moody: Aaa (Negative) Rapid reserve depletion and absence of diversifying tax revenues or imposing significant expenditure reductions would be consistent with a lower rating Standard and Poor's: AA+ (Negative) Alaska has sufficient financial resources to stabilize general fund operations/ uncommonly large reserves cannot overcome the current trajectory of fiscal condition/ modest debt burden, untapped potential sources of tax revenue Fitch Ratings: AAA (Stable) Very large reserves providing multiple-times coverage of debt obligation; downgrade if sustained revenue decline is not addressed 10:07:15 AM Co-Chair MacKinnon wondered if other rating agencies looked at the closed pension plan as a positive rating to the state. Mr. Mitchell replied in the affirmative. Co-Chair MacKinnon stressed that the positive financial perspective was due to the understanding of the liability and hoping to eliminate that liability. Mr. Mitchell agreed. Mr. Mitchell discussed slide 8, "State of Alaska -Historic Ratings and Issue Timeline; ANS West Coast Spot Price": February 11, 2014: Rating Agency Update December 16, 2014: Moody's revises Alaska outlook to negative after oil price plunge, affirms Aaa GO Rating December 18, 2014: S and P no action, warns that Alaska must reduce deficit to keep AAA rating February 3, 2015: Rating Agency Update March 10, 2015: Sold Series 2015A GO Bond anticipation Notes, $155.2 mm March 24, 2015: Refinanced $100.6 mm of 2009A GO Bonds for 7.5 percent in PV savings April 2, 2015: Refinanced $101.9 mm of 2008 Goose Creek Bonds for 8.56 percent in PV savings April 13 2015: Teleconferenced to update Moody's, Fitch, and S and P on Legislative Session June 26, 2015: Update Call with Fitch July 9, 2015: Update Call with Moody's August 7, 2015: Meeting with S and P August 18, 2015: S and P revised the outlook to negative from stable affirmed AAA GO Bond Rating October 21, 2015: Fall 2015 Fiscal and Credit Update to Rating Agencies January 6, 2016: S and P lowered its rating to AA+ from AAA on GO Bond Ratings (outlook negative) Mr. Mitchell highlighted slide 10, "Alaska's Current Budget Challenges are Unprecedented, But the State's Large Reserves Provide Time for Developing and Implementing Sound, Structural Budget Reforms": Budget realities have appropriately prompted wide reaching discussions on spending priorities, tax and revenue policies, use of reserves and distribution of Permanent Fund dividends Abundant reserve levels provide the opportunity for Alaskans to take a deliberate and comprehensive approach to restructuring the State's public finances There have been NO suggestions that existing obligations should in any way be compromised. The state has always acted in ways that provide positive assurances to bondholders. Mr. Mitchell addressed slide 11, "Overview of Moody's State GO Rating Methodology and Criteria": Moody's outlines four broad rating factors and 10 sub- factors in its fundamental analytical framework for rating U.S. States, each with an assigned weighting Economy, 20 percent weight Governance, 30 percent weight Finances, 30 percent weight Debt, 20 percent weight Each of these factors is evaluated using various sub- factors scored on a scale from 1 (Aaa) to 9(Baa and Below) Each sub-factor's value is multiplied by its assigned weight and then summed to produce a weighted average score, which is translated to the grid-indicated rating The grid-indicated rating is then adjusted up or down for applied notching considerations Mr. Mitchell highlighted slide 12, "State of Alaska Moody's GO Scorecard." He remarked that Moody attempted to "fit everyone in the same box", which was difficult with Alaska, because the state was unusual. Mr. Mitchell explained that the scores were based on a set of criteria that may not relate directly to Alaska. He remarked that economy, governance, finance, and debt were the weighted categories. 10:11:02 AM Mr. Mitchell looked at slide 13, "Overview of S and P State GO Rating Methodology and Criteria": S and P outlines five key rating factors in its analytical framework for rating U.S. States Government framework Financial management Economy Budgetary performance Debt and liability profile Each of these factors is evaluated using various metrics scored on a scale from 1 (strongest) to 4 (weakest) Each metric may have several indicators that are scored on the same scale and averaged Ultimately, the scores for the five factors are averaged with equal weight to arrive at an overall score which is translated to an indicative credit level Mr. Mitchell addressed slide 14, "State of Alaska S and P GO Scorecard." Mr. Mitchell looked at slide 15, "Overview of Fitch State GO Rating Methodology and Criteria": Fitch outlines four key rating factors in its U.S. State Government Tax-Supported Rating Criteria Debt and Other Long-term Liabilities Economy Finances Management and Administration Fitch does not use a numerical scoring system; instead, for each rating factor an entity may be classified as "Above Average," "Average," or "Below Average" based on a number of different attributes Fitch does not detail how a final rating is derived based on how an entity rates in each category Overall, Fitch's ratings for states' GO debt falls within the two highest rating categories of AAA or AA, with a few outliers Fitch's methodology is more of a traditional rating approach and allows the rating analysts greater discretion in assigning relative weights to each factor depending on issuer specifics Co-Chair MacKinnon shared that S and P had a concept of economy, governance, finance, and debt. She encouraged state to develop a state scorecard, based on combination of the three rating agencies. She wanted to show Alaskans why the criteria would be important for the senate to examine. She stressed that the rating agencies were examining the unemployment rate; standard income; and other factors in their rating outcome. Vice-Chair Micciche looked at slide 12, and asked for more information about why the state did not use a binding consensus revenue estimating process. Mr. Mitchell responded that Alaska did not always fit into the exact requirements accurately. He stressed that revenue was classified in a different way in Alaska and outside of volatility. He stated that UGF may be considered volatile, but was backfilled with CBR and other reserves. He noted that there was more money deposited into the CBT than what was withdrawn. Vice-Chair Micciche noted that revenue forecasts were issued twice a year. He felt that there was a common practice of overestimating the price of oil. He wondered if the pool was too small in the evaluations of probable price atmosphere. Mr. Mitchell replied that it was not a binding forecast. He felt that the legislature's involvement with the drafting of the revenue forecast book could be a positive step. Co-Chair MacKinnon handed the gavel to Co-Chair Kelly. 10:17:33 AM Senator Dunleavy surmised that the rating agencies did not set the rates. Mr. Mitchell replied in the affirmative. Senator Dunleavy wondered if the rates were negotiable. Mr. Mitchell misunderstood the question. He stressed that the rating agencies set the credit rating. Senator Dunleavy wondered if the interest on the final debt would be negotiable between the state and the debt issuing institution. Mr. Mitchell replied that the state sold debt, and was given a credit rating on the debt. The rating was incorporated into a document, and the investors made a decision on credit quality. He stressed that there were various other variables, like the lack of income tax. Co-Chair MacKinnon queried the current debt capacity. Mr. Mitchell replied that the established metrics were considered "best practices." He shared that Puerto Rico had an extreme debt. He furthered that one must analyze the issue of taking on more debt that would result in a negative credit rating. 10:22:01 AM Co-Chair Kelly queried the bond capacity. Mr. Mitchell responded that, for purposes of the fall forecast and the debt affordability analysis, the bond capacity would be approximately $175 million to $225 million. Co-Chair MacKinnon looked at page 3 of the "Alaska Public Debt" (copy on file). She noted that the potential impact of the Knik Arm Crossing bonds resulted in the "state exceeding the target debt limit for the category of borrowing for the next ten years." She stressed that the committee had zero bond debt capacity based on what was already authorized. Mr. Mitchell agreed. He furthered that he had handicapped the Knik Arm Crossing, but felt that there would be more information soon about that project. Vice-Chair Micciche wondered why the committee would care about the credit rating. Mr. Mitchell responded that the state sold some bonds through the Alaska Municipal Bond Bank. He stated that a lower rating would result in more expensive bonds. He stressed the importance of keeping the costs low to ensure a higher credit score. Vice-Chair Micciche queried the most important components of the fiscal gap that required progress in order to enhance the rating. Mr. Mitchell replied that there must be an understanding of the true credit rating in the state. Vice-Chair Micciche wondered if a negative rating would be used as a tool to control increasing debt. Mr. Mitchell did not understand the question. 10:28:30 AM Vice-Chair Micciche remarked that a positive rating may make debt look attractive. He wondered if the negative rating may force responsible management without the use of debt. Mr. Mitchell replied that he would focus on debt. Senator Bishop wondered how the state used the Grant Anticipation Revenue Vehicles (GARVEE) Bonds, and how they were paid. Mr. Mitchell responded that GARVEE bonds were issued in 2003. He explained that, in some states, a GARVEE bond could be a revenue pledge with a motor fuel tax back, which anticipated using federal highway funds in the future to pay for the obligations with the state match requirement. He shared that Alaska could not pledge any revenue, so the state used a general obligation bond. The general obligation bond was repaid in the Accelerated Transportation Act. He stated that the investment earnings on the proceeds were used as the state's match, so the UGH outlay was ultimately zero. The federal funds were used to pay all of the debt service on those obligations. Senator Bishop noted that there was a difference between spending for services and spending for investments. He stressed that the state should have a strong economy in order to preserve the workforce. He shared that the AKLNG project required the most skilled workers. He encouraged the committee to continue to fund construction projects. 10:32:46 AM Senator Dunleavy wondered if the current rating agencies were rating bonds in the 2007 and 2008 recession. Mr. Mitchell replied in the affirmative. Senator Dunleavy commented the country had exceeded $18 trillion debt. He shared that the United States citizens paid nearly $3 trillion in taxes to "bail out those outfits." He suggested that people research Puerto Rico, because some were fleeing Puerto Rico en masse. He felt that optimism was a positive thing, but should not override historic realities. He felt that the country had not worked out the toxic debt. He stressed that someone always paid for the decisions. Co-Chair Kelly discussed the following week's schedule. Co-Chair MacKinnon stated that the Medicaid bills were still in subcommittee. ADJOURNMENT 10:36:41 AM The meeting was adjourned at 10:36 a.m.