STATE OF COLORADO DEPARTMENT OF THE TREASURY Walker R. Stapleton State Treasurer Jonathan J. Forbes Deputy Treasurer House and Senate Leadership: The State of Colorado is contemplating issuing pension obligation bonds to help lower unfunded pension liability as it relates to the State and potentially the School Division of PERA. The aggregate transaction size of POBs contemplated could exceed, by several multiples, any prior State issuance. Furthermore, this potential ?nancing could potentially represent the largest municipal transaction in the country in CY2015. Such a high pro?le issuance will create several structural challenges which the State must overcome in order to ensure a successful transaction. Although the State is willing to dedicate the resources necessary to ensure a successful POB transaction, there are several variables that exist which the State currently has no control over. There are two basic requirements of a POB ?nancing to make it successful: (1) the borrowing cost of the POBs must be below 7.50% actuarial rate; and (2) the investment of the proceeds of the POBs by PERA must meet or exceed the 7.50% actuarial rate. The ?rst of these requirements is perhaps the simplest to understand and perhaps the easiest to implement. If rates 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 ?nancing structure that creates savings. A POB ?nancing takes a soft liability of the State and converts it to a hard liability which is the debt service on the POBs. The second basic requirement of a successful POB ?nancing is the investment of proceeds where it is more dif?cult to predict ?nancial performance. In addition to the dif?culty of predicting investment performance of the PCB proceeds, once the proceeds of the POBs are transferred to PERA, the State loses control of how the proceeds from the bond issuance are invested. This loss of control over how bond money is invested is of serious concern to the State as portfolio earned about 5% last year. To date, PERA has not wanted to have the State involved in the investment of the PCB proceeds. The only assurances that the State has been given thus far is that PERA has the capability to invest the proceeds quickly based on its current split between ?xed income and equity investments. Investing POB proceeds ?quickly? exposes the State to the risk that equity markets are at a peak and are due for a correction. The State would prefer to see PERA make equity market investments using a more methodical, dollar cost averaging approach, perhaps not achieving full equity market investment (75% of PCB proceeds) over the course of 2-3 years. The negative carry associated with this slower dollar cost averaging approach is negligible and persists only for a short period of time relative to dumping 75% of the PCB proceeds in the equity markets on day one and hoping we are not at a peak. The chart below details a history of the State of Colorado Treasurer?s Of?ce Page 1 2,500 History of 500 2,000 - 1,500 1,000 1' SLID- As can be seen in the graph above, the 500 is at historical highs. Although it is one of the best times to be accessing the taxable municipal ?xed rate market, it is perhaps one of the most uncertain times to be going ?all-in? on an equity investment. Again, the State would prefer to see a slow, methodical, dollar cost averaging approach when it comes to the investment of POB proceeds into the equity markets. Additionally, the Treasurer?s Of?ce believes it is in the best interest of the State to establish 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 of?ce understands that the revenues being securitized in this transaction are for PERA members and employees. However, the State will remain ?on the hook? for this transaction from a ?nancial and credit standpoint should various elements of the ?nancing not perform as expected. The Treasurer?s of?ce remains committed to lowering unfunded liability. Pension obligation bonds represent one ?tool? out of many that can be implemented successfully if the transaction contemplated has both discipline and structural boundaries. Unfortunately, POBs alone will not ?x all the ?nancial concerns associated with PERA. In addition to a POB strategy, Colorado needs to undertake wider structural reforms which will address unfunded liability and put Colorado?s retirement system on the path toward solvency. This letter is written in the spirit of collaboration so that all parties can move forward in securing a successful POB ?nancing both for the well being of PERA and Colorado?s economic future. All the best, alker Stapleton Treasurer of Colorado State of Colorado Treasurer?s Of?ce Page 2