SPOTLIGHT SHINES ON SPONSOR BALANCE SHEETS

Pension scheme deficits on corporate balance sheets are facing increased scrutiny by creditor banks and ratings agencies. This scrutiny stems from a mixture of ongoing economic malaise, tighter capital regulations, bank deleveraging and rising pension deficits.  The impact has been severe, for example, with some banks writing clauses into loan agreements forbidding firms from acquiring subsidiaries with DB schemes.  Bank refinancing of corporate sponsor loans and scheme contribution schedules have also been negatively affected.

A few recent cases highlight the depth of this issue:

Trinity Mirror

– Sponsor contributions cut from £33mio to £10mio for next 3 years in order to secure new £110mio debt facility with banks
– Cut comes despite pension scheme deficit rising from £161mio to £230mio last year (liabilities total £1.7bio, funding level 86%)
– The background to this decision was weak corporate results (40% drop in profit to £74mio in 2011)
– The Pensions Regulator is currently investigating

Read more:  The Guardian / Financial News / Professional Pensions / Journalism

Premier Foods

– Sponsor deferring £94mio of contributions to 2014 as part of £1.2bio refinancing of loans
– Scheme deficit fell from £321mio to £282mio last year on an IAS 19 basis
– Deficit helped by moving final salary benefits to career average, switching indexation from RPI to CPI and DC arrangements
– The Pensions Regulator is in contact with trustees

Read more: Professional Pensions

Engineering Firms
   
– Two unnamed firms become the first to be bankrupted by banks refusing to refinance loans
– Size of DB scheme liabilities an over-riding factor in banks’ decision
– Pension Protection Fund is now running the schemes

Read more: Pensions Week

Tesco

– Pre-emptive action taken by well-funded sponsor to reduce pension scheme liabilities
– Full pensionable age raised to 67, indexation on new contributions switched to CPI from RPI
– Follows Tesco’s first profit warning in 20 years, knocking almost $5bio off market value
– Corporate profits remain healthy at £3.7bio in 2011, analysts mark down 2012 forecasts

Read more: The Guardian / Financial Times

These examples show the growing ‘new’ pressure on corporate sponsor balance sheets which carry losses from DB scheme deficits.  I say ‘new’ because the pressure has been there for a while – think of the BT downgrade in 2010 where S+P cited the pension deficit contributions – but was less noticeable before the banks had realised the full extent of the pressure on their capital and funding positions and the consequent tightening up of their lending criteria. As a result, sponsors now have to weigh up support for their DB scheme(s) against not only business investment decisions but also against upcoming loan refinancing needs. To make matters worse, stress on the sponsor can also lead to quite rapid and direct stress on the scheme itself with previously agreed contribution schedules being subject to downwards pressure of deferment at the behest of a bank’s loan department, even with a relatively strong sponsor covenant in place.

In this context, it has never been more vital for sponsors and Trustees to work together with a clear vision and set of objectives for the pension scheme.  It is essential to evolve recovery plan strategies from ‘Set and Forget’ to ‘Anticipate and (Re-)Calibrate’ to ensure that any improvements in markets and funding levels are taken advantage of.

Most important is to have an actionable gameplan.  This plan should: highlight the biggest risks within the scheme and establish a clear risk budget; contain clear goals and objectives to reach full-funding; promote strong governance; set realistic triggers to de-risk (or indeed re-risk).

The ability to de-risk is not available to all schemes.  It requires regular updates on market movements/funding level, swift decisions from trustees and a robust risk management framework within which these decisions are made.  Once the framework is in place it can be used both to manage current scheme risks and also to find opportunities for dynamic de-risking when conditions are favourable.

To show what can happen when a scheme is in a position of strength, here’s a quote from AkzoNobel’s latest annual report:

    “In January 2012, we concluded the triennial actuarial funding review of the ICI Pension Fund. We expect to have top-up payments over the remaining six years of the recovery plan that are £198  million lower in total than the sum of the current schedule. In 2012 and 2013, they will be £62 million per annum lower, in 2014 to 2016 £19 million per annum lower and in 2017 £16 million lower. In addition, we have agreed to terminate an assetbacked guarantee in favor of the pension fund, releasing an asset on our balance sheet on order to fund further de-risking activities and thereby reduce future demands on our cash flows.”

[Please note that all opinions expressed in this blog are the author’s own and do not constitute investment advice.  Click here for full disclaimer]

Author: David Bennett

David was Redington’s Head of Investment Consulting from 2013-2018 and was recently promoted to the Executive Board. He also Chairs Redington’s Investment Strategy Committee. David is the lead consultant to a range of full advisory clients and also works on ad hoc projects for Trustee and Sponsor-side clients, as well as having oversight responsibility for some clients. His clients include: Fenner, Anglian Water, EDF, Smiths Group, Heathrow, Xerox and Taylor Wimpey. As Chair of our Investment Strategy Committee, David is very familiar with all of the strategies in which the Fund is invested. David joined Redington after twenty-four years at Goldman Sachs, where he had a number of roles. Most recently, David worked in Goldman Sachs’s Pensions and Insurance Strategy Group, where he advised UK pension funds and insurance companies. He was also a Trustee of the Goldman Sachs Defined Benefit pension fund. David has an actuarial background from his time as a trainee actuary at Commercial Union, and studied Mathematics at Cambridge University.