Call to Order and Roll Call
The 5th meeting of the Interim Joint Committee on Appropriations and Revenue was held on Thursday, October 22, 2015, at 10:00 AM Central time, in the Community Financial Services Bank Center at Murray State University. Senator Christian McDaniel, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Christian McDaniel, Co-Chair; Representative Rick Rand, Co-Chair; Senators Ralph Alvarado, Danny Carroll, Chris Girdler, David P. Givens, Stan Humphries, Morgan McGarvey, Wil Schroder, Brandon Smith, Robin L. Webb, and Stephen West; Representatives Denver Butler, John Carney, Larry Clark, Ron Crimm, Jeffery Donohue, Myron Dossett, Joni L. Jenkins, Terry Mills, Steven Rudy, Arnold Simpson, Jim Stewart III, Susan Westrom, and Jill York.
Guests: Dr. Tim Todd, Interim Vice President for Academic Affairs and Provost, Jordan Smith, Director of Government Relations, Murray State University; Russ Salsman, Chief of Staff, Department for Local Government, Amy Barnes, Branch Manager, Coal Development Branch, Office of State Grants, Department for Local Government; Ryan Barrow, Executive Director, Office of Fiancial Management; Steve Rucker, Executive Director, Kentucky Network Communications Authority, Mike Hayden, Executive Advisor, Kentucky Network Communications Authority, John Hicks, Office of the State Budget Director, Dave Davis, General Manager, South Central Rural Telephone Cooperative, Tyler Campbell, Executive Director, Kentucky Telecom Association.
LRC Staff: Pam Thomas, Charlotte Quarles, and Jennifer Beeler.
Approval of the Minutes
Representative Rudy made a motion, seconded by Senator Carroll, to approve the minutes of the September 24, 2015 meeting. The motion carried.
Welcome from Murray State University
Dr. Tim Todd, Interim Vice President for Academic Affairs and Provost, and Jordan Smith, Director of Government Relations, Murray State University, welcomed the committee to Murray State University and gave a brief overview of the university.
Department for Local Government–Discussion of the flow of severance tax revenues
Amy Barnes, Branch Manager, Coal Development Branch, Office of State Grants and Russ Salsman, Chief of Staff, Department for Local Government gave a brief overview of severance tax revenues and their impact on the Commonwealth.
Amy Barnes explained the distribution of coal and non-coal mineral severance taxes to local governments. Distributions are made through two funds-the Local Government Economic Assistance Fund (LGEAF) and the Local Government Economic Development Fund (LGEDF).
Ms. Barnes provided a more detailed explanation of how mineral severance revenues are distributed. She explained that non-coal minerals on which severance taxes are paid include natural gas, limestone and oil. Fifty percent of the funds generated from non-coal minerals are deposited in the general fund. The remaining fifty percent is deposited in the LGEAF. From the amounts deposited in the LGEAF, distributions are made to producing counties based on actual tax collected in each county. Ten percent of each county allocation is then distributed to each municipality within the county based on population.
Ms. Barnes then discussed the distribution of the coal severance tax revenue. She noted that like the minerals tax revenues, tax receipts are split with fifty percent going to the general fund and fifty percent going to local governments. The amounts going to local governments are subject to several alternative allocations, deductions, and redistributions before the statutory distribution formula is applied.
Ms. Barnes provided a detailed explanation of how the distribution formula works, the categories in which expenditures can be made, and the various accounts within the LGEDF and LGEAF. She also reviewed specific allocations and appropriations from county coal severance funds made in budget bills.
Ms. Barnes supplemented her presentation with several charts, tables, graphs, and spreadsheets which are available with the meeting materials in the LRC Library.
In response to a question from Representative York, Ms. Barnes explained that with non-coal severance revenues, the amount that goes back to the county is determined based on gross revenue, then distributions are made in accordance with the statutory formula.
In response to a question from Representative Simpson, Ms. Barnes stated that in 2009, the annual coal severance tax revenues were $290.7 million, and in 2015 annual coal severance revenues were $179.2 million. Russ Salsman stated that line items from the budget within a county are prioritized by the county and are funded as the revenues become available for each priority. If there are not enough revenues, some of the line item projects may not get funded.
Discussion of the Commonwealth’s Credit Rating
Ryan Barrow, Executive Director, Office of Financial Management, Finance and Administration Cabinet, gave a brief overview of what a credit rating is, and which agencies provide credit ratings of the Commonwealth. He noted that credit rating agencies are independent entities that assign a grade based on the risk of default.
He listed the factors considered by the ratings agencies in establishing a credit rating, and noted specifically that adjusted net pension liabilities is one of the factors considered.
Mr. Barrow explained that none of the three top credit rating agencies rate Kentucky the same way. He noted that in June 2014, Moody’s revised Kentucky’s general obligation implied Aa2 rating outlook from negative to stable. In September 2015, Standard and Poor’s downgraded Kentucky’s general obligation implied rating from AA- with a negative outlook from A+ with a stable outlook primarily due to “chronic underfunding” of pensions.
Mr. Barrow concluded by noting that for the Commonwealth’s credit rating to improve there would need to be significant improvement in pension funding levels, a continued build-up and maintenance of reserves, and continued economic and revenue growth.
In response to a question from Senator Givens, Mr. Barrow stated that all three credit rating agencies provide a slightly more negative rating for Kentucky because Kentucky only issues lease appropriation debt rather than general obligation debt.
In response to a question from Chairman Rand, Mr. Barrow explained that the rating agencies typically consider adequate reserves to be at least five percent, however states can be above or below that number without impact depending on other factors.
In response to a question from Senator Givens relating to net tax-supported debt and what is included, Mr. Barrow explained that debt associated with projects that generate revenues to offset the debt expenditure are excluded from that debt balance.
In response to a question from Chairman Rand, Mr. Barrow stated that credit rating agencies do not pay a lot of attention to the methods used by state in calculating debt – they have their own methods for calculation, however they do pay attention to circumstances in which states deviate from their own policies relating to debt.
In response to a question from Senator Carroll relating to the impact on the Commonwealth’s credit rating if pension obligation debt had been issued, Mr. Barrow stated that pension bonds have at best a neutral assessment. Assessments are either negative or neutral depending on the structure of the bonds.
KentuckyWired
Steve Rucker, Executive Director, and Mike Hayden, Executive Advisor, Kentucky Network Communications Authority, Ryan Barrow, Executive Director, Office of Financial Management, and John Hicks, Office of the State Budget Director provided an overview of KentuckyWired and how the project will impact the Commonwealth.
Mr. Rucker explained that KentuckyWired is an open access, state-owned fiber network designed to provide “middle mile” broadband access throughout the state. The network will bring broadband closer to communities so that local providers can provide the “last mile” directly to the consumer’s premises. The network will serve approximately 1,100 government entities, and there will be a presence in every county. Mr. Rucker noted that KentuckyWired is not a local service provider (ISP).
Mike Hayden explained the reasons Kentucky is pursuing the KentuckyWired approach. He stated that historically governmental agencies have obtained broadband services through separate carrier arrangements with outside entities. The existing system provides limited high capacity fiber which translates to limited speed, and that Kentucky pays two to five times more for the service than what surrounding states pay for comparable services. Anchor tenants of the system will include 1,100 governmental entities.
Ryan Barrow explained why Kentucky chose to use a public-private partnership to finance the KentuckyWired project, and reviewed the various revenue streams.
Mr. Barrow stated that total project financing will be approximately $325 million. $270 million of that amount will be generated through bond sales and private equity investors, $30 million will come from state-issued bonds, and the remaining $23 million will come from federal grants and other federal funding sources.
Mr. Hayden stated that the open access network provided by KentuckyWired will be a unique opportunity for local public or private internet service providers to tap into the system and offer broadband to businesses and homes. Third party discussions and negotiations are underway with local service providers and power and utility companies regarding pole attachment agreements and use of their existing fiber in the KentuckyWired network.
Tyler Campbell, Executive Director, Kentucky Telecom Association and Dave Davis, General Manager, South Central Rural Telephone Cooperative and President of the Kentucky Telecom Association briefly discussed the local provider perspective on KentuckyWired noting several concerns the association has regarding the initiative.
In response to a question from Representative Clark relating to provision of a clearinghouse number for contractors interested in participating in the project, Mr. Rucker noted that the number listed on the KentuckyWired website can be used for job inquiries.
Senator Webb asked where she can obtain a copy of the P3 contract. Mr. Hayden responded that the contract can be accessed on the KentuckyWired website.
Senator McDaniel commented that the General Assembly spent a great deal of time discussing the KentuckyWired initiative during budget negotiations, and that the debt the Commonwealth would be required to issue was reduced substantially during that process. He expressed concern regarding the liability of the Commonwealth in the event of default on one of the conduit bonds issued on behalf of the private partners. Mr. Barrow explained that there are different types of default addressed in the contract with the private partner, but the Commonwealth is not responsible should the private partner default on payments.
Senator Givens encouraged Mr. Hayden, Mr. Barrow, and Mr. Rucker to not overbuild broadband capacity where adequate capacity is currently available through existing providers.
In response to a question from Senator Givens as to what predicated the rebidding of the Commonwealth’s current contract with AT&T to provide broadband for K-12 educational facilities, given that Kentucky was recently recognized as first in the nation for K-12 broadband access, Mr. Rucker stated that to obtain that status, an annual appropriation of $5 million was required for 173 locations and that there are well over 1,700 governmental locations with the same need for broadband growth. Therefore, under the current contract, significant additional appropriations would be required to get those entities to the same level. Mr. Rucker added that the FCC sets the broadband standards and those standards will increase in the next three years
In response to a question from Senator Givens, John Hicks stated that during the development of KentuckyWired and the bid process, there has been constant communication with the Department of Education and the FCC, the federal agency that administers the e-rate program to ensure that the receipt of federal e-rate matching funds will not be in jeopardy.
In a response to a question from Senator McGarvey, Mr. Barrow explained that Macquarie is an investor in the project and is also part of a consortium of companies that will design, build and operate the system.
Senator McGarvey asked whether it is possible within the next few years that the Commonwealth will be paying more for internet services than it would otherwise because of the commitment made under the agreement with Macquarie. Mr. Rucker responded that there is no contractual provision that would allow the price to increase other than by the CPI. The 1,100 governmental entities are consumers served by the KentuckyWired network. Mr. Hicks stated that the Commonwealth should not be paying more for service under this proposed model because we are currently paying 2 to 5 times more than our peers under our existing broadband contract.
Senator McGarvey expressed concern that by removing the 1,100 governmental entities from the service base, that local providers would no longer be able to afford to provide service to other households and businesses in very rural areas. In response, Mr. Rucker stated that the middle mile infrastructure will allow other ISPs to build in areas where they haven’t been before, resulting in more carriers and better pricing.
In response to a question from Senator McGarvey relating to ownership and control of the KentuckyWired network, Mr. Hicks responded that once the network is completed, it will be turned over the Commonwealth and the Commonwealth will be the owner.
In response to a question from Senator Schroder, Mr. Hayden stated that KentuckyWired will serve governmental entities and educational facilities. He explained that the Commonwealth Office of Technology (COT) has assured them that all governmental and educational facilities will be able to support the increased network capabilities.
Senator McDaniel noted that in the bond issuance documents for the $270 million conduit bonds, the 1,100 governmental users were specifically referenced, which includes the 173 K-12 school districts. He asked what will happen if KentuckyWired does not win the K-12 contract currently out for bids. Mr. Hicks responded that if that happens, then there will be an issue from the budget side in the ability of the Commonwealth to provide the resources for the full amount of the availability payment.
In response to a question from Chairman McDaniel regarding who is currently holding the bond funds for the KentuckyWired project, Mr. Barrow explained that the $270 million in bonds for this project are currently being held by a trustee, as with any Commonwealth transaction.
Senator McDaniel asked, with the movement of personnel from COT to KentuckyWired, how we know there are no internal conflicts or potential exposure relating to the K-12 solicitation and the fact that KentuckyWired will be one of the bidders. Mr. Rucker responded that he is the only person who moved from COT to KentuckyWired, and that he ceased participation in the drafting and development of the solicitation once the FCC determined that the same entity could not be both the applicant and provider of services. Prior to that determination, the services were to be provided through the Finance Cabinet. Once the determination was made, a separate entity was established.
With no further business before the committee, the meeting adjourned at 12:21 p.m.