John Ralfe is an unbiased pension guide.
There has been loads of digital ink spent on final month’s “LDI meltdown”, however little exploring the impression on particular corporations. But BT has now provided some perception into the way it coped with current extraordinary occasions.
The UK telecoms firm printed its half-year outcomes and its June pension scheme accounts final week, and so they bear shut studying. BT isn’t simply any outdated firm — it has the biggest IAS19 accounting pension liabilities of any UK firm, calculated utilizing a AA company bond fee — and has been within the pensions highlight for twenty years.
So what occurred to BT?
The excellent news is that the a lot larger AA company bond yields from March to September shrank BT’s IAS19 liabilities by 1 / 4 from £54.3bn to £40.6bn. And as a result of it has hedged all of its curiosity and inflation publicity fairly effectively via matching bonds and long-dated rate of interest swaps, belongings fell by the same quantity — £53.5bn to £39bn — leaving the IAS19 deficit just about unchanged at £1.6bn.
Crucially, regardless that BT’s pension scheme has a whopping £50bn of rate of interest swaps with maturities over 40 years, it had no liquidity or collateral issues. BT’s actuarial deficit — calculated on a more durable foundation than IAS19 — which fixes deficit contributions, remained at about £4bn at September, which it plans to repay by 2030. The subsequent three-year actuarial valuation is at June 2023.
BT’s curiosity and inflation hedges have definitely carried out what they had been designed to do, however this doesn’t imply shareholders can cease worrying about pensions.
Although 60 per cent of pension belongings had been in matching bonds, money and “secure income”, 40 per cent of belongings at June 2022 (about £19bn) had been in what BT describes as “equity-like assets” — public shares, personal fairness, property, hedge funds, infrastructure and “non-core credit”.
The £19bn in “equity-like assets” is way bigger than BT’s £12bn market capitalisation. BT is on the hook for all pension deficits, so in financial phrases, holding £19bn of “equity-like assets” in its pension scheme is an identical to BT borrowing £19bn long run, after which shopping for these belongings immediately.
Quoting the adage, “BT looks likes a badly-run hedge fund which just happens to own a phone network”. BT’s market cap is subsequently delicate to actions within the worth of “equity-like” pension belongings — as a matter of arithmetic, a ten per cent fall of their worth hits BT’s market cap by about 10 per cent after tax.
About £15bn of those belongings are unquoted, and BT’s auditors checklist “the valuation of unquoted plan assets” as their first “key audit matter”. Much of BT’s £50bn guide of rate of interest swaps are leveraged swaps — successfully borrowing — permitting it to proceed betting on equities, and run an enormous asset and legal responsibility mismatch.
We all know from company finance 101 — the Modigliani-Miller theorem — that growing leverage via borrowing doesn’t create any first-order worth for shareholders. Only the tax break on debt curiosity funds creates shareholder worth. Equally, leverage within the pension fund via leveraged swaps doesn’t create first-order worth for shareholders. And there isn’t any tax break for pension fund leverage.
Because pension fund leverage reduces the corporate’s capability to borrow, and debt creates shareholder worth via the tax break on curiosity funds, pension fund leverage isn’t impartial, however destroys shareholder worth.
Although BT plans to repay its £4bn actuarial deficit by 2030, in observe, being “100 per cent funded” is a shifting goal for any pension scheme. As they grow to be higher funded a tighter low cost fee applies, growing the current worth of liabilities.
New UK guidelines on funding and funding technique may also require mature schemes to have a “Long Term Objective”, utilizing a good low cost fee, including a number of billion to BT’s deficit.
BT was privatised with nice fanfare in 1984, and in contrast to different privatised European telcos, pensions weren’t left with taxpayers. But during the last twenty years BT has suffered a long-term “double squeeze” — its market cap has shrunk, whereas decrease actual rates of interest have elevated pension liabilities. Furthermore, it has £20bn of debt and lease liabilities, and a credit standing of simply BBB.
Now with a market cap of simply £12bn, and £40bn of pension liabilities, BT is a small enterprise supporting an enormous pension scheme. BT continues attempting to reinvent itself for the twenty first century, however like Samuel Coleridge’s Ancient Mariner, it has a really twentieth century pension albatross hanging round its neck.
Source: www.ft.com