July 11
Pity the poor pension trustees and members
Carillion was in the news overnight for all the wrong reasons, as contract write downs turned investor sentiment sour, the shares now having falling more than 50% from their Friday close.
Matthew Vincent’s story for the FT (see here) led with questioning how professional investment managers had allowed Carillion’s over optimism to blind them to clear cut warning signs to sell out and move on to greener pastures. Pity the poor pension trustees however, with no such option, what now for them?
The pension obligations of Carillion are very material: spread across their five defined benefit schemes they total £3.3 billion at 30th June 2017 on an accounting basis, giving rise to a net pension deficit of almost £600 million. That compares to their latest market capitalisation at lunch today of just over £400 million.
The company is currently paying in some £50 million a year of deficit reduction contributions across all the schemes and a new valuation fell due at 31st December 2016. With a 15-month timeframe for agreement, this will be at a relatively early stage: no doubt if the trustees’ advisors have given any preliminary advice, they will be running back to their desks for the slide rules to redraw them.
As our latest research report on the Risk of Ruin for pension schemes shows (see here), covenant is key to a successfully outcome for scheme members. Insolvency of the sponsoring employer is the major risk for members not receiving their pension benefits in full and management of the cashflow crisis at Carillion to reset and restore their finances will be essential.
It is likely that the 31st December 2016 funding valuation will show a significant deficit given the covenant implications of the first half announcements. The year end accounting deficit was some £663 million net of tax and the shortfall to the cost of securing all benefits with an insurance company would have been much, much higher.
The Guardian’s article (see here) records the total provision to the balance sheet following contract review at some £845 million and that the cash costs of fixing even the bad contracts is estimated at £100 – 150 million, enough to wipe out a year’s profit at the upper end of Carillion’s revised expectations. In the short-term therefore, Carillion will be dealing with the balance sheet subsidence.
Material increases in cash contributions following this valuation are very unlikely to be available and as our Risk of Ruin report shows likely to come at a high cost to Carillion even where affordable, with limited reduction in the Risk of Ruin of their schemes. If anything the balance of current circumstances weights more to the potential for a request for employer contributions to be moderated in the near term, with a view to preserving the existence of a covenant for the long-term (though it should be that is not part of the current business plans as set out in the half-year results nor something which would be agreed lightly).
Net debt averaged some £695 million in the first half of 2017 and material actions are afoot to bring that down through various cost reduction and disposal programs. The trustees will want to ensure they balance the pay down of that debt (which may well be prior ranking to them and therefore in one sense beneficial to have paid down) with receipt of funds themselves, given they are effectively a debt on the business and that the Regulator expects them to treat the relationship accordingly.
The suspension of dividends for 2017 and a review of dividend policy, saving (up to) £80 million a year, is a necessary step given the balance sheet deterioration and analysts speculate that Carillion might need to raise upwards of £500 million in new equity through a rights issue to restore some financial solidity.
For now then the trustees are in something of a waiting game. The 31st December 2016 valuation will give opportunity to reflect the significant financial changes but what the cash implications will be given the likely constraints on the business is not yet clear. As our Risk of Ruin analysis indicates, contingent assets are a very effective way of reducing the Risk of Ruin where robust and properly constructed, but there will likely be little recourse for the Carillion trustees, even with a refinanced balance sheet, unless the business is acquired and merged with a larger entity as is being suggested as a potential recovery route which could open up that option.
It will be very interesting to see how the recapitalisation plays out, what route that takes and how the medium-term picture develops for the trustees as to the appropriate funding of the schemes. One thing we can be sure is the Regulator will be keeping a keen eye given the size of the numbers involved…

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