The UK Hits creditor's Rights

A shocking ruling in the UK will, no doubt, reprice risk for credit investors.

(Telegraph) -- Members of bankrupt pension schemes have been handed a near-blanket guarantee by a radical court ruling that pushes them right up the creditor hierarchy but has been branded "catastrophic" for banks and companies.

In a fundamental shake-up of the corporate debt structure, pension trustees will be able to demand a lump-sum payment from administrators of a failed business ahead of all lenders bar those backed by property assets. Even the administrators will be lower in the pecking order.

 Before the ruling, pension claims ranked beneath the riskiest unsecured loans, potentially robbing workers of their retirement income.

In a packed courtroom at the High Court on Friday, Mr Justice Briggs ruled in favour of The Pensions Regulator in its bid to recover funds from Lehman Brothers and Canadian telecoms firm Nortel for the 43,000 members of the insolvent companies' pension schemes.

The administrators of Nortel and Lehman, which went bust with UK pension deficits of £2.1bn and £148m respectively, were contesting the regulator's decision to issue a "Financial Support Direction" (FSD) requiring them to strike an agreement with the pension trustees before disbursing funds to creditors.

Under the current rules, if no agreement is struck the regulator imposes a "Contribution Notice" (CN) demanding the administrator make a payment to the trustees. In a ground-breaking judgment, Mr Justice Briggs ruled that the CN would qualify as an "administration expense" – meaning it must be paid above all but "fixed asset" creditors, even before the administrators take their fees.

 The implications of this on credit investors is potentially huge.  If pension schemes essentially become priority claims (administrative claims) the recovery rate for secured and unsecured creditors will obviously fall.  Given this, the debt of companies with large unfunded pensions should trade wider (in spread terms) as recovery rates are diminished.  This is akin to the Sons of Gwalia debacle in Australia (which was finally reversed - info here:  SoG Reversal or a summary here: Bracewell on SoG) which impacted credit spreads in Australia.


Keep your eye on this one, it could be a big deal (if it sticks, it is a big deal).  This is why pension obligations must be considered when evaluating a company's creditworthiness.

Pensions - Mind the Gap

On the wire today (WSJ):

Many of America's largest pension funds are sticking to expectations of fat returns on their investments even after a decade of paltry gains, which could leave U.S. retirement plans facing an even deeper funding hole and taxpayers on the hook for huge additional contributions.

The median expected investment return for more than 100 U.S. public pension plans surveyed by the National Association of State Retirement Administrators remains 8%, the same level as in 2001, the association says.

The country's 15 biggest public pension systems have an average expected return of 7.8%, and only a handful recently have changed or are reconsidering those return assumptions, according to a survey of those funds by The Wall Street Journal.

Corporate pension plans in many cases have been cutting expectations more quickly than public plans, but often they were starting from more-optimistic assumptions. Pension plans at companies in the Standard & Poor's 500 stock index have trimmed expected returns by one-half of a percentage point over the past five years, but their average return assumption is also 8%, according to the Analyst's Accounting Observer, a research firm.

Pension funds at companies in the S&P 500 faced a $260 billion shortfall at the end of 2009, according to Standard & Poor's. Estimates of the fund deficits faced by state and local governments range from $500 billion to $1 trillion.

While I completely disagree with the prospects of earning 8.5% longer term (isn't the "new normal" lower?) this is not new (or at least should not be).  Some analysts - myself included - have been looking at pension funding status and return assumptions for years.  This is just another example of why you do your homework when analyzing companies.  Keep in mind that corporations use a corporate bond yield discount rate which is going to hurt.

Full story here:  WSJ article on pensions 9-18-10