STATEOF COLORADO DEPARTMENT OF THE TREASURY Walker R. Stapleton Jonathan J. Forbes State Treasurer Deputy Treasurer House and Senate Leadership: ‘The State of Colorado s contemplating issuing pension obligation bonds (“POBs") to help lower PERA’s unfunded pension liability as it relates to the State and potentially the School Division of PERA. The aggregate ansaction size of POBs contemplated could exceed, ty several multiples, ny prior State issuance. Furthermore, this potential financing could potentially represent the Jargest municipal transaction inthe country in CY2015. Such a high profile issuance will create several structural challenges which the State must overcome in order to ensure a successful transaction. Although te State is willing to dedicate the resources necessary to ensure a successful OB transaction, thereare several variables that exist which the State currently has no control ‘There are two basic requirements of a POB financing to make it successful: (1) the borrowing cost of the POBs must be below PERA’s 7.50% actuarial rate; and (2) the investment ofthe proceeds of the POBs by PERA must meet or exceed the 7.50% actuarial rate. The fist ofthese requirements is pethaps the simplest to understand and perhaps the easiest to implement. Ifrates the State could ‘borrow at in the bond market are lower than the actuarial rate of return set by the pension system, the State has created a financing structure that creates savings. A POB financing takes a soft liability ofthe State and converts it toa hard liability which isthe debt service on the POBs. The second basic requirement ofa successful POB financing isthe investment of proceeds where it is ‘more ciffcult to predict financial performance. In addition to the difficulty of predicting investment performance ofthe POB proceeds, once the proceeds ofthe POBs are transferred to ERA, the State loses sontrol of how the proceeds from the bond issuance are invested, ‘This loss of control over how bond money is invested is of serious concem tothe State as PERA’s portfolio earned about 5% last year. To date, PERA has not wanted to have the State involved in the investment of the FOB proceeds. The only assurances thatthe State has been given thus far is that PERA has the capability to invest the proceeds quickly based on its current split between fixed 1come (~25%) and equity (~75%) investments. Investing POB proceeds “quickly” exposes the State tothe risk that equity markets areata peak and are due fora correction. The State would prefer to see PERA meke equity market investments using a more methodied, dollar cost averaging approach, perhaps not achieving ull equity market investment (75% of POB proceeds) ‘over the course of 2-3 years. The negative carry associated with this slower collar cost averaging pprosch is negligible and persists only fora short period of time relative to dumping 75% of the POB proceeds in the equity markets on day one and hoping we are not at a peak. The chart below details a history ofthe S&P500. ‘Sav of Colorado Temuners Offre ToseHistory SBP 500 “TTLL ULL ETE ‘As can be seen in the graph above, the S&P 500 is at historical highs. Although it sone ofthe best times to be accessing the taxable municipal xed rate market, it is perhaps one ofthe most ‘uncertain times to be going “all-in” on an equity investment. Again, the State would prefer to see a Siow, methodical, dollar os averaging approach when it comes to the investment of FOB proceeds into the equity markets. Additionally, the Treasurer's Office believes itis inthe best interest ofthe State to esablish some sort of reporting mechanism between PERA and the State With respect to how the proceeds from the POB issuance will be invested, The Treasurer's office understands thet the revenues being secuitzed inthis transaction are for PERA members and employees. However, the State will main “on the hook” fr this transaction fom «financial and credit standpoint should various elements ofthe financing not perform as expected. ‘The Treasurer's office remains committed to lowering PERA’s unfunded liability. Pension obligation bonds represent one “too!” out of many that can be implemented successfully ifthe transaction contemplated has both discipline and structural boundaries. Unfortunate, POBs alone ‘will not fix all the financial concerns associated with PERA. In addition toa POB state, Colorado needs to underake wider structural reforms which will address PERA’s unfunded liability and put Colorado's retirement system on the path toward solvency. ‘This letter is written in the spit of collaboration so tha all parties can move forward in securing a ‘successful POB financing both forthe well being of PERA and Colorado's econome future. All the best, oo Valker Stapleton Treasurer of Colorado ‘Suef Colona Tesure's Oe Tort