John Ralfe is an independent pension consultant.
BT watchers were left gobsmacked last week by the revelation that Indian billionaire Sunil Bharti Mittal is buying a 24.5 per cent stake in BT Group from Patrick Drahi’s Altice.
Speaking to reporters, Mittal said:
I’ve been watching BT for long, long years, it’s a company which has a glorious past, has national status, has this tremendous amount of physical infrastructure in the UK.
Unfortunately, one holdover from BT’s “glorious past” is its huge pension scheme. With over 250,000 members, it’s a reminder of just how many people the group used to employ.
Unlike other European telcos, BT’s pensions were not left with taxpayers at privatisation in 1984. Its underlying IAS19 pension liabilities at March 2024 were £40bn: the largest of any UK company, and roughly three-times its £13.5bn market cap. With £35bn of pension assets, it has a £4.9bn deficit, up from £1.1bn in 2022.
BT’s latest actuarial valuation — June 2023 — showed a £3.7bn deficit, and fixed annual deficit contributions at £780mn until 2030, £670mn in 2031, and £180mn from 2032 to 2034.
According to BT, this would mean “job done” — fully-funded by 2034 — but we should be a bit sceptical.
“Fully-funded” is a moving target — as a pension scheme approaches 100 per cent, a tighter discount rate is applied, increasing the value of liabilities. Plus, the Regulator has also just introduced a new “Long Term Objective” for mature schemes like BT’s (where over three-quarters of members are already pensioners), requiring liabilities to be measured assuming a low-risk asset allocation, so “low dependency” on the sponsor.
On this basis, BT estimated its June 2023 assets would cover 80 per cent of liabilities. Applying this to March 2024 gives a deficit of £7bn to £8bn. It will have to keep shovelling in money to pay this down — either diverted from operating cash flow or adding to the £19.4bn of net debt and leases.
BT seems keen on pension fiddles. Deficit payments include £80mn a year secured on EE shares in what BT calls an “Asset Backed Facility”. This is recognised as a £1.2bn asset in the BT pension scheme accounts, but not in BT’s consolidated accounts.
Such a security is certainly good for pension scheme members, but bad for bondholders. BT’s medium-term note covenants don’t prevent securities being shifted to the pension scheme, and the rating agencies don’t seem to have spotted this structural subordination.
Another fiddle: in 2018, BT put £2bn of BT bonds in its pension scheme. Routing this through a Scottish Limited Partnership — always a red flag — avoided breaking the rules on pension schemes lending to their sponsors. Those bonds have a final maturity of 2042, pushing the “fully funded” date well beyond 2034.
BT’s asset/liability matching is still very risky. Some 60 per cent of its assets are in liability-matching assets, but 40 per cent — £13bn, almost the same value as market cap — are in what BT calls “growth assets”: equities, PE, property, hedge funds, infrastructure and non-core credit.
BT’s analysis says a 15 per cent fall in the value of “growth assets” — which it optimistically calls a “1-in-20 year event” — would increase its deficit by £1.7bn. In economic terms, holding £13bn of “growth assets” is the same as BT borrowing £13bn, and then buying those assets directly — not exactly what you’d expect a telco business to be doing. Almost all of the £13bn growth assets are unquoted, and BT’s auditors, rightly, flag the valuation of those as one of their five key audit matters.
The good news is that BT didn’t suffer liquidity problems with the “Leveraged LDI crisis” of October 2022. The bad news is that its leveraged swaps are still a hidden risk for shareholders, because BT chooses not to disclose them in its consolidated accounts.
The BT pension scheme accounts show £50bn of interest rate swaps, a large chunk of the non-inter-bank market. Some of these swaps are “covered” exchanging, say fixed payments on underlying bonds for index-linked receipts, but some are “naked” — effectively off balance sheet borrowing.
BT’s accounts do show a £4.9bn “negative cash” pension asset, on “financial derivative contracts” (collateral cash paid to swap counterparties) again huge versus its market cap.
Despite the huffing and puffing after the 2022 gilt crisis, not much has changed in accounting or regulation for Leveraged Liability Driven Investing. The IASB still doesn’t require companies to disclose LLDI leverage in their accounts, which it should do immediately. The Pensions Regulator now requires schemes to fully report their LLDI positions, but it isn’t clear how it will use the information.
Many people still don’t distinguish between LDI (just a fancy name for simply matching pension assets and liabilities) and Leveraged LDI, borrowing to continue betting on “growth assets”. Or, like the Bank of England, they assume LLDI is a natural state of affairs, rather than a choice by pension schemes and companies, and consultants are still pushing LLDI.
I wrote for Alphaville in 2022 that BT has a pensions albatross hanging around its neck, which certainly hasn’t changed since then. But in the last couple of years, higher real interest rates have transformed the pension position of virtually all UK companies, and BT’s relative position is now worse.
Among the 40 or so FTSE 100 companies with DB pensions, only three, in addition to BT, are in deficit — and their deficits are all trivial versus their individual market cap. AstraZeneca, for example, has a £200bn market cap and a deficit of $230mn — barely a rounding error.
All the pension measures we could use — liabilities, deficit, asset/liability mismatch, hidden leverage — are all huge in relation to BT’s valuation, and will act as a drag for many more years.
Let’s hope Mr Mittal doesn’t come to experience buyer’s remorse.
