Monday, September 17, 2018

Legislative provisions viewed as harmful to public pensions left out of U.S. tax reform package

Graphic: iStock/Duncan_Andison

By Allen Jones, TEXPERS Communications Manager

The U.S. House Ways and Means Committee's new tax reform package of legislation does not contain provisions that would have imposed what TEXPERS and other retirement groups viewed to be unnecessary and unfunded federal mandates harmful to local and state public pensions.

First and foremost, the package does not include public pension proposals that our organization has been actively opposing,” says Paul Brown, president of TEXPERS. “However, it does include language on governmental plan 'pickups,' specifically that ‘a contribution shall not fail to be treated as picked up by an employing unit merely because the employee may make an irrevocable election between the application of two alternative benefit formulas involving the same or different levels of employee contributions.' TEXPERS along with our national and state coalitions will continue to monitor and keep our members informed in regards to this important issue.”

Brown says he is appreciative of TEXPERS members who contacted their elected representatives to express their concerns about the proposals.

Last week, House Republicans introduced tax reform legislation aimed at expanding 2017's Tax Cuts and Jobs Act. Although the primary purpose of the package is to make tax cuts for individuals and small business owners permanent, legislative proposals made earlier during the summer included retirement provisions.

The Public Employee Pension Transparency Act (House Bill 6290), introduced by California Republican Rep. Devin Nunes June 28, would have amended the Internal Revenue Code of 1986 for reporting and disclosure by state and local public employee retirement pension plans. TEXPERS' executive director, Max Patterson, and the association's president, Paul Brown, expressed their opposition to the proposed act in joint letters written in July to House Speaker Paul Ryan (R-Wisconsin) as well as to Ways and Means Committee Chairman Kevin Brady (R-Texas) and the committee's ranking member, Rep. Richard Neal (D-Massachusetts).

TEXPERS' leadership stressed that the proposed act conflicts with existing governmental accounting standards and would eliminate the tax-exempt bonding authority of state and local governments.

"Consider the fact that every state and many localities have recently made modifications to pension financing, benefits structures, or both and none required federal intervention," wrote Patterson and Brown. Click here to read TEXPERS' previous blog post about PEPTA and here to read TEXPERS' letter to Congressman Brady.

TEXPERS wasn't alone in opposing PEPTA. Twenty national organizations sent letters of opposition to all members of the U.S. House of Representatives opposing the legislation.
There is more good news. The tax reform package also doesn't include an extension of the Unrelated Business Income Tax to governmental plans or the "Rotherficiation" of contributions to all defined-contribution plans, which could potentially threaten the current tax treatment of governmental employee contributions to their defined-benefit plans.

According to Forbes’ synopsis of the proposed tax reform bill, it consists of three bills:

Click the links to open pdf documents offering more details of each legislation.

About the Author:
Allen Jones handles the print and online media needs of the Texas Association of Public Employees Retirement Systems. Before joining TEXPERS in 2017, he worked as a freelance journalist covering the Houston area for a daily newspaper; served as a publications manager for Hibu, an international corporation; and spent nearly 10 years working for Houston Community Newspapers, a group of community publications. He has a bachelor’s degree in journalism and communications.

So, you received a Public Information Act Request. 

Now What?

Photo: iStock/jat306

By Joe Gimenez, TEXPERS Guest Contributor

Have you heard about the Texas Monitor? It’s an online nonprofit news site whose reporters often use the TexasPublic Information Act to investigate governmental organizations of every type. The PIA is every journalist’s best friend – it requires every government entity to turn over any report, email, or data they generate to conduct business.  In Houston, the Texas Monitor's information requests led to indictment of a press secretary for failure to turn over public records. In another case, the Texas Supreme Court jumped into a fray, causing open government activists to go on the war path for even broader powers.

Is an investigative journalist, armed with a PIA request, headed your way? Quite possibly. The Texas Public Information Act allows for the full or partial disclosure of previously unreleased information and documents controlled by state and local governmental entities.

In San Antonio, an investigative reporter used Public Information Act requests to gain pension fund travel records and public safety department records. The San Antonio journalist’s news piece was TV media sensationalism at its worst – any Texas pension fund whose trustees do a due diligence trip or attend an educational conference could have been similarly smeared. Nonetheless the story is there, inspiring pension-fund haters with baseless conjecture about San Antonio heading down troubled paths. Totally false.

In San Diego, open government intervenors have used public records requests to ferret out pension disability benefits. They think disability claims are fraught with fraud. Texas has similar watchdog groups and they follow their California brethren. It’s only a matter of time before your pension system will earn its Public Information Act request, warranted or not.

The problem is that pension funds are difficult for most journalists to understand, and their stories sometimes become filled with inaccuracies, innuendo and false impressions. Before you know it, a false narrative about your system is the only thing that people in your city will think about you. Gold-plated benefits. Travel abuse. Disability fraud. Spiked pensions.

So what should you do when that public information request comes in?

As San Antonio Trustee Jim Smith recently told a TEXPERS Summer Educational Forum audience, first seek professional assistance. Media relations professionals can help begin framing the story from the first bit of data requested. Reporters need context; they should never be expected to become pension fund operations experts. Only you or your media advisor can help them with that. If you do it yourself, be sure to try to attain some objectivity to the situation. An outside advisor can help with their third party perspective. On the other hand, be sure any advisor you hire understands pension funds as well as you do. Your first response to the journalist should strive not to compel a reporter to continue digging.

Another possibility is that the journalist expands their dig to other governmental agencies which touch on the pension fund. Or, after their first request for information, they send in a second request for all emails related to the first request. That may look worse in the news report than the original issue.

Some investigative reporters also like to employ ambush tactics. They submit their public information request, find something and then they confront you at the next board meeting, camera in your face. It’s happened, time and again. What to do?

Again, a media professional will know what you’re up against and can help minimize the possible damage. Ask them to serve as your spokesperson and designate them as the single point of contact. If you decided to have a spokesperson from the pension fund be sure they are media trained. And since ambushes happen, it’s a good idea to provide media training for all your board members and executive staff. It may cost a bit, but it is professional training that can serve this and other situations.

In addition, work up contingency plans. Create draft communications for your members, vendors, investment professionals and elected officials – anyone who comes in contact with the pension fund. You might not know the direction the final news report might take, but have two or three responses in mind pending which direction it does take.

You or your media professional should encourage the reporter to see that they are on the heels of a non-story, that what appears to be scintillating stuff is actually part of the mundane world of pensions. You all might not be able to convince the reporters to kill the story, but you should work toward minimizing the negative and outlandish.

Finally, take these information requests very seriously from the first moment you receive it. Think about seeking help before they ever arrive if you know of a situation which might someday be ripe for media attention. The most costly thing to do is doing nothing until the request hits. Then you will pay exorbitant amounts in the damage done to the reputation of your pension fund. You may not be able to dig out.  

About the Author:
Joe Gimenez is public relations professional who specializes in pension fund communications. He has assisted TEXPERS and several Texas pension funds in crisis situations and public affairs.

PRB Study of Asset Pooling Delayed 

Due to Staff Member's Resignation

By Joe Gimenez, TEXPERS Guest Contributor

The Pension Review Board’s Actuarial Committee postponed the agency’s three-year effort to study the feasibility of asset pooling for smaller pension systems. Anumeha Kumar, the PRB’s executive director, told the committee at its Sept. 13 meeting in Austin that the resignation of a staff member would further delay the project.
Kumar had told the PRB in March that staff would begin its research of a recommendation in the agency’s 2014 Study of the Financial Health of Texas Public Retirement Systems. The recommendation noted that “Smaller systems may not have the advantage of the economies of scale available to larger retirement systems, thus smaller systems may have greater challenges in keeping their expenses low and achieving higher investment returns.”
This concern was on full display at the Sept. 13 meeting. During a review of a system, PRB Chairman Josh McGee asked several detailed questions about investment consultants’ fees compared to the assets of funds they managed. The system’s consultant responded by listing several services his firm provides smaller funds. The exchange did not seem to satisfy PRB committee members.
The 2014 PRB report noted that pooling existing pension fund assets might be problematic. While new systems might enroll in the Texas Municipal Retirement System and the Texas County and District Retirement System, merging existing systems into them “may present several significant potential legal and other issues, including how to maintain equivalence of benefits between old and new members, and how to address the existing liabilities of the merging systems.”
The PRB's executive director, Kumar, did not indicate a timetable for hiring a new staff member to study the recommendation.

About the Author:
Joe Gimenez is a public relations professional who specializes in pension fund communications. He has assisted TEXPERS and several Texas pension funds in crisis situations and public affairs.

Tuesday, August 21, 2018

Energy midstream undergoing transformative shift

Report provided by Salient Capital Advisors LLC

When it comes to crude oil and natural gas, boring is better… except when talking about the notable changes occurring within the midstream industry today. Then, we can say that “exciting” is a good thing.  Energy midstream is currently undergoing a transformative shift between two mutually-exclusive models. 

Graphic: Bloomberg, Salient Capital Advisors LLC, July 2018. For illustrative purposes only. Click image to enlarge.

On the one hand, there is the traditional, high-yielding Master Limited Partnerships (MLPs) with a General Partner (GP) that serially issue equity to fund growth projects. In return for a higher-yield, MLPs have expected to have ready access to capital whenever it was needed. On the other hand, there is the new model, in which midstream companies have prioritized a simplified corporate structure, reduced cost of capital, and self-funding of equity needs.

One of the primary ways in which these changes are being expressed is through the corporate structure. In short, MLPs are complicated. MLPs can be prone to misalignment of incentives between investors and management, and cash payments to GPs through Incentive Distribution Rights (IDRs) can place a large cost of capital burden on the MLP. The new midstream model, in contrast, is about better shareholder alignment and reduced cost of capital.

Click image to enlarge.
To achieve these goals, many MLPs are consolidating, simplifying, or converting into a C-Corp structure. Not including the potential for Initial Public Offerings (IPOs) or buyouts, the graphic included here shows just how much these potential changes could affect the makeup of the marketplace over the next several years.

Why should our friends and partners at TEXPERS care about these changes? One reason why these changes are so significant is because they are partly designed to increase the appeal of midstream to a broader investor base, namely, institutions. Eyeing midstream companies’ simplified structures and greater visibility into their future growth potential, institutions have been making up an increasing source of outstanding midstream ownership.  Only a few years ago institutions owned roughly 30% of the space. Today that figure is about 50%, and we believe that trend will only continue, according to recent PricewaterhouseCoopers LLP and Wells Fargo Securities LLC partnership reports.

Another reason we feel these changes are so important is the increasing capital needs of energy midstream. In a recent report, the Interstate Natural Gas Association of America (INGAA) has illustrated the need for $55B-$70B in midstream infrastructure spending every year for the next 20 years. This level of potential spending is substantial, and, in our view, midstream companies will need healthy balance sheets and large institutional partners to fund the necessary growth projects.  We believe that those companies that adopt the new model are a better fit for the future of the industry and have the potential to thrive in this environment.

The final reason why these changes are so important is that, in our view, they improve the investment outlook for the space. As suggested above, we believe there will likely be some winners and losers over the next few years as the transition to the new model progresses, but, as evidenced by a positive macroeconomic backdrop and quarter-over-quarter earnings beats, the future appears bright for those who can navigate their way through.  

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Salient or TEXPERS. 

China’s quest for artificial intelligence

By Daniel J. Graña, a guest columnist

China is rapidly making a name for itself in the AI space. The buzz around this new digital frontier has been growing over the past year, and the government is working with the country’s tech industry, from start-ups to established firms, to promote AI research and infrastructure.

During a recent visit to China, we were surprised but enthusiastic to meet so many innovative, hardware technology companies focused on AI-enhanced tools. The offerings included machine vision — a rapidly growing branch of AI that aims to give machines sight comparable to our own. We were also shown industrial automation, voice recognition devices, and mobile chipsets designed to better tackle machine-learning tasks. China’s tech sector benefits from a pool of Western-educated engineers and local graduates, along with a wealth of government assistance. 

Eyeing high-income status

Spurred by concern that China imports $200 billion in semiconductor chips, President Xi Jinping’s government views the development of the tech industry as a key ingredient in moving the country from middle-income to high-income status. The trade rift with the United States, with its possible implication of lost access to high-end U.S. technology, is deemed a national security threat.

China has put in place a robust plan for state funds and localization targets. At this stage, there is a gap between the proposals and action. While success isn’t guaranteed, the medium-term targets include some chip makers and telecommunications companies in the United States, South Korea, and Japan.

Embracing surveillance and facial recognition

There is a multitude of possible AI applications, but the companies we met with are concentrating on two end markets: surveillance and autonomous vehicles. A systems integrator, a maker of optical-related products, and a startup that focuses on facial recognition are among companies that have carved a niche in this space. Given the lack of concern about privacy in the country, Chinese companies are likely to be global leaders in AI-enhanced surveillance and facial recognition technologies going forward.

China currently regulates traditional and social media, including television and online posts. Surveillance technology backed by AI promises to cement the government’s ability to control and influence every aspect of society and the activities of its more than one billion people.

The autonomous vehicles race

Nowhere is the enthusiasm for self-driving vehicles more apparent than in China, the world’s largest car market. Domestic companies are working with overseas vehicle makers to develop a platform for autonomous vehicles for the Chinese market. Pedigreed venture capital firms are investing in Chinese robotics companies. 

With China’s demand for cars showing no signs of slowing down, it is likely the country will be among the first to make the transition from traditional automobiles to autonomous forms of transport.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Putnam Investments or TEXPERS.  

About the Author:
Daniel J. Graña is the portfolio manager of Putnam Emerging Markets Equity Fund. He also manages an institutional portfolio of Asian ex-Japan equities. Previously at Putnam, he was an analyst in the Equity Research group, covering emerging markets with a focus on the financial and consumer goods sectors, from 1999 to 2002. Graña joined Putnam in 1999 and has been in the investment industry since 1993.

Private credit EBITDA add backs – what do they mean and why should investors care?

By Linda Chaffin, guest columnist

A common question among investors, credit managers and consultants is: “Where are we in the credit cycle?” While credit markets will ebb and flow, most believe we are presently at the more competitive end of the spectrum. And in a competitive market, pressure on financing structures and documentation can be expected. In my view, a key challenge is a current shift in the magnitude and type of EBITDA add backs that are being used to justify higher debt levels and valuations.

EBITDA (earnings before interest, tax, depreciation, and amortization) is a proxy for cash flow to service debt and used to value a company by applying a multiple, such as 8x EBITDA. Since this metric is a key driver for company valuation and financing capacity, it is not surprising that investment bankers and company owners seek to maximize EBITDA.

From a credit perspective, EBITDA addbacks are not a new concept. It gets tricky when borrowers propose more subjective add backs that are intended to justify debt issuance that is not prudent. 

The types of EBITDA adjustments may include:

EBITDA Adjustment Type
Transaction Related
Seen in most financings, these common adjustments are for one-time deal-related costs, sponsor management fees, non-cash or non-recurring compensation and severance costs
Potential Cost Savings

Add backs for anticipated savings such as modified compensation, reduced rents and headcount reductions are more complex. To evaluate these, a quality of earnings report can be obtained to analyze the proposed adjustments. These can be allowed as an EBITDA add back with proper review and documentation

Later in a credit cycle, borrowers may propose addbacks that are extrapolations of recent performance. For example, a borrower may propose annualized credit based on a short period of recent performance (three-month EBITDA multiplied by four to calculate an annual rate). In these cases, it’s best to look to the borrower’s history of achieving projected outcomes as well as considering seasonal impacts
Maturity Credits

In certain industries, a borrower may request adjustments for future expected performance. For example, if new offices have been opened in a medical practice, the borrower may seek credit for a mature patient load. Quantifying and approving these adjustments requires significant work
Incremental Expenses
Corporate carveouts and family-owned businesses may need to build in costs for additions to staff, systems, and facilities

For any lender, getting to an accurate EBITDA amount is important for making appropriate credit decisions as well as setting financial covenants, specifically, the maximum permitted leverage ratio (funded debt / EBITDA). For lower middle-market companies, a miss of the leverage covenant is often the triggering event bringing borrowers and lenders to the table for discussion. In most cases, getting to the table earlier helps to preserve value.

Unjustified addbacks can hide the true level of leverage so astute lenders should know how to analyze and challenge EBITDA adjustments line by line to ensure they understand the borrower’s ability to service debt. To gauge portfolio risk, it is important for investors to understand a private credit manager’s philosophy around and process for evaluating EBITDA add backs.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of NXT Capital' or TEXPERS. 

About the Author:
Linda Chaffin oversees NXT Capital’s investor relations activities and fundraising efforts. She is actively involved in raising third-party funds and developing and maintaining investor relationships across the institutional LP community, including insurance companies, public and corporate pension plans, foundations, endowments and consultants. Chaffin brings more than 20 years of investor relations, fundraising, private equity, corporate finance and M&A investment banking experience to NXT. Before joining NXT Capital in 2017, she was senior vice president for Pathway Capital Management where she was responsible for raising new capital and developing and maintaining investor relationships for both private equity and private debt strategies. Prior to joining Pathway, Chaffin was vice president of Finance and Investor Relations at Marwit Capital where she led the firm’s fundraising efforts. Before joining Marwit Capital, she served as a senior vice president in GE Capital’s Beverly Hills office and held numerous roles within J.P. Morgan’s M&A, Asset-Backed Securities and Healthcare groups in New York. She began her career with various corporate finance roles at Huntington National Bank and Stern Stewart. Chaffin earned a bachelor's degree in Business Administration from The Ohio University and a master's degree in business administration from The University of Chicago Booth School of Business.