It was reported at the weekend that the FTSE 100 engineering company, GKN plc, was considering issuing bonds of up to £250 million in order to help finance its UK pension deficit. This follows the publication of GKN plc’s full year results for 2016 which revealed a deficit in respect of its UK pension schemes of £1.2 billion (with corresponding assets of £2.3 billion and liabilities of £3.5 billion). At the current time it is expected that some £73 million will be paid into GKN plc’s UK pension schemes during 2017 consisting of £43 million in respect of deficit contributions and the future accrual of benefits and £30 million from its asset backed funding arrangement. We understand that the proposal to raise debt to fund the pension scheme deficits forms part of GKN plc’s negotiations with the pension schemes trustees in respect of the funding valuations which are being carried out as at 5 April 2016 and 31 December 2016.
GKN plc has been working long and hard to manage its pension scheme deficits, with the use of an asset backed funding arrangement (established in April 2010), pensioner buy-out and buy-in exercises and the use of sale proceeds to address the deficit (via the sale of its stake in Westland in 2004). However, GKN plc’s deficit continues to hit the headlines causing concern amongst its shareholders and reportedly preventing it from carrying out transactions or achieving a break-up of the business. However, the chief executive of GKN plc, which has a market capitalisation of approximately £6.3 billion, recently called for calm, warning that if companies were rushed into funding their pension scheme deficits too quickly it could damage the UK’s economy.
By funding the pension schemes’ deficits via the issue of bonds GKN plc is essentially swapping one form of debt for another. Whether the deal is attractive will depend on the terms available in the market. Currently GKN plc’s unsecured borrowings include a £350 million 6 ¾% bond maturing in 2019 and £450 million 5 ⅜% bond maturing in 2022. Corporate bond yields are currently at all-time lows making the issue of bonds potentially attractive. However, GKN plc will need to balance this cost against the cost of servicing their pension liability on both an accounting and funding basis.
A further consideration for GKN plc is whether it would prefer its debt to be held by bond holders or by the pension schemes trustees. Whilst pension scheme trustees are instructed by the Pensions Regulator to act like any other unsecured creditor they may have the ability to be more flexible in certain circumstances.
Finally, it should be noted that as these discussions form part of the funding valuation negotiations there is likely to be considerable focus on the cash contributions payable into the pension schemes. By raising debt in this manner it may be possible for GKN plc to pay off some of its funding deficit immediately and maintain its current level of cash contributions into the pension schemes.
A debt is still a debt, whether it is held by the bond holders or the pension scheme trustees. Which form of debt GKN plc prefers, will be determined by a combination of the above factors.