23 April, 2020

The last few weeks have been extremely challenging for many covenants supporting UK defined benefit pension schemes.


For now, traditional covenant considerations for pension trustees are going to be second order. Business as usual needs to be considered later; the primary short-term focus has to be on ability to survive the crisis and emerge as a solvent going concern. The alternative is insolvency and entering into a PPF assessment period, which is not going to be good for member outcomes. 


First and foremost, trustees will want to know details of how Covid-19 is impacting on employers’ short-term profit and cash flow projections. Immediate liquidity is the prime consideration.


As part of this, schemes need to understand employers’ ability to access debt facilities. We’ve already seen examples of clients taking their debt facilities and drawing them into cash resources, so they’re available to use when necessary, rather than attempting to draw them down at a time when they might be less able to do so (or banks unwilling to allow).


Reduced or zero earnings


In many industries there will be reduced or zero earnings for a period of time and this may cause technical covenant breaches from a banking perspective.


In those circumstances, it’s important to understand what approaches are being made to lenders and what the attitudes of these lenders are - including whether there’s been any waivers or amendments of covenants, both in the short and longer term.


In light of the impact of Covid-19, many businesses are conserving cash via deferrals of rates, rent, tax payments or capital expenditure programmes. They’re also halting or reducing dividends, and deferring debt payments both mandatory and discretionary, and cutting costs from a staff perspective.


Some of this may be alleviated by government support, but timing of access to government funds may add to the cash flow pressure. Businesses may need to consider other liquidity resources and schemes themselves may need to defer contributions, or pay pension expenses out of scheme funds.


Winners and losers will emerge in the longer term – for stronger companies, there may be more opportunities for growth through acquisition or organic growth from an improved competitive position, while the weaker may be or restructured or acquired. There will also be questions to answer around the longer-term impact on the covenant arising from Covid-19 impacts on customers, the supply chain and internal business risks, including loss of key staff or reduced staff morale. But that’s tomorrow’s problem. The focus now is riding out the crisis and emerging solvent, able to rebuild back to pre-crisis levels.


If you would like to talk to someone about any of these issues, contact Darren Masters 07789 030429, or email Darren.masters@mercer.com

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