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Pensions Drinking Themselves Silly?
Norma
Cohen of the FT reports, Unusual
spirit to solve pension ills:
In what is surely one of the
more unusual approaches to a pensions shortfall, Diageo, the drinks
group, has offered up a veritable lake of its whisky as collateral for
the growing
shortfall in its benefits scheme.
Under the deal’s terms,
the scheme’s trustees will form a partnership with Diageo that will own
up to £430m of maturing whisky that will be transferred in by the
company over time. As the batches mature each year, Diageo will have an
option to buy £25m of the whisky, with the trust using proceeds to
fund the pension scheme. The company said the deal was cash-flow
neutral.
Diageo said it was not doing
the deal because it could not afford to pay. It has an A credit rating
and £1.2bn of free cash flow. Instead, it wanted to do this deal
because “it allows us to use free cash flow to return cash to
shareholders”.The deal has not yet
been approved by the Pensions Regulator.
Diageo is not the only
company to use operating assets rather than cash to try to plug the
hole in its pension scheme. A combination of the stock market crash,
low bond yields (which increase liabilities) and longer lives for
retirees has pushed a string of other companies into similar schemes,
which will allow them to improve scheme funding while saving cash.
J
Sainsbury, Marks and Spencer and Whitbread have announced similar
schemes and pensions advisers said several other companies were working
on transactions that will be unveiled over the next few months.
But what makes the Diageo deal different from
these others is the nature of the collateral. In the other cases, the
collateral is cash-generative property. If the employer were to become
insolvent, the properties revert to the pension scheme and can be sold
vacant. Britain has an army of professionals with expertise in valuing
these assets.
But the value of the Diageo collateral depends, in
large part, on the brand that attaches to each of the whiskies in its
pool, according to Stuart Whitwell, joint managing director of
Intangible Business, which specialises in valuing brands and other
obscure assets.
“Lots of products would have no value without the
brand,” Mr Whitwell said. He added that his firm was in talks with
several companies, including one in the FTSE 100, which are looking at
using some of the intangible value of their products to use as
collateral.
“Take vodka. Without the brand, it is just a commodity,” Mr
Whitwell said.
Diageo said it was not transferring ownership of
the brands to the trust. Mr Whitwell said that it was likely that if
Diageo went bankrupt, which is highly unlikely, the whisky brands would
remain with the company and be sold for the benefit of creditors, not
the pension scheme. The scheme would then be left owning immature,
unbranded whisky.
It is not impossible
to establish a value for a commodity that has been shorn of its brand;
indeed, such valuations happen all the time. It is just that, in these
cases, some objective market value must be established and, inevitably,
this is a lower value than that which would attach to the branded
product. Specialists know this as “managed distress value”.
But
even if Diageo is using goods with some intangible value as collateral,
the broad outlines of its deal are very familiar. Pensions advisers
said they were increasingly attractive to companies, particularly those
saddled with legacy liabilities and which are much smaller than they
once were.
Earlier this year, GKN, the engineer, created a
similar vehicle to hold a £331m collateral pool for its pension scheme.
The vehicle receives rental income from several properties owned by
the company, as well as cash coming from company trademarks.
David
Robbins, pensions partner at Deloitte, noted that ITV recently gave
comfort to trustees of its scheme by placing ownership of a subsidiary,
SDN, into a structure similar to that used by Sainsbury, Diageo and
the others.
Deloitte also recently advised an employer on a deal
in which a similar structure became entitled to some of the cash flow
from the company’s book of receivables.
Mr Robbins said that
Deloitte is advising on several deals that involve assets that have
intangible value such as brands, patents and trade marks. “These are
very pervasive deals,” Mr Robbins said, noting that they were time
consuming to complete. “They affect your relationships with banks, your
accounting, everything.”
For banks, the creation of these
structures affects the value that they could extract from the company in
the event of bankruptcy. The assets that are in the new partnerships
would be claimed by the pension schemes rather than the creditors.
Usually, pension schemes are last in the creditors’ queue when companies
go bust.
Marc Hommel, pensions partner at PwC, said that some
companies were attracted to the arrangement because of tight credit
markets. “Cash is in short supply,” Mr Hommel said.
“The company may
decide ‘We need cash to pay our dividends and invest in the business’.”
It
is not just cash-strapped companies that are looking to set
cash-producing collateral aside for their pension schemes. “If an
employer wants a scheme to follow an investment strategy with a high
concentration in risk assets, then the trustee might seek a charge on
assets,” he said.
Also, Mr Hommel added, employers may feel that
market values are unusually depressed at present.
As time passes,
they could find themselves with schemes that are in surplus and there
is no legal mechanism to extract surplus for the benefit of
shareholders. Indeed, he said, that was the reason that some
collateralised arrangements had been set up in the first place.
This
story reminds me of when YRC Worldwide Inc. negotiated with the
Teamsters union and its pension fund representatives to postpone cash
payments into the plan and
replace them with real estate collateral when the company was
desperately trying to conserve cash.
I think this is another
bad idea and I'd be surprised if the Pensions Regulator approves the
deal. Valuing the cash generation of a brand spirits is tough in the
best of times, and the scheme's trustees could end up getting royally
screwed if Diageo goes bankrupt, leaving taxpayers to foot the bill to
make up for any shortfall.
If pensions want to drink
themselves silly, I suggest they focus on the liquidity tsunami driving risks assets higher. Forget Dubai, forget Greece, forget
European sovereign debt woes and bank stress tests, forget the
"imminent" collapse of China, forget perma bears like Bob Prechter
warning you of the
Dow plunging to 1,000, forget all of the doom & gloom.
There
is only one way we're going to get out of this mess. Pension reform,
which is going on around the world, and more policies geared at
reflating risk assets and introducing some inflation in the economic
system. This means expect more stimulus, more quantitative easing (if
needed), more volatility, but there is simply no other way to get out
of this mess. We need pension reform, rising assets, and rising bond
yields (to lower the present value of pension liabilities).
Finally,
please take the time to carefully read Tony & Rob Boeckh's
latest investment letter, Asset
Allocation Thoughts (click here
to download). It's a must read letter which analyzes macro themes impacting asset
allocation decisions. I wish pension funds used more common sense and
less quantitative algorithms in structuring their asset allocation
decisions. Oh well, if all else fails, pensions can continue drinking
themselves silly, after all, taxpayers will be left holding the bag.
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Someone with a better memory might be able to recall the mutinies the Royal Navy suffered in the 19th century when the whisky rations were watered down by penny-pinching admirals and (Navy equivalents to) quartermaster generals.
On the other hand, getting paid your pension in monthly whisky rations is a sound deflationary policy, considering the local and relative purchasing power of alcohol on the workforce of young working age men during hard times. The old coots do better off the more diabetic they are.
All Ponzi schemes work in an up market - as long as we can pretend equities are 1% more valuable every month (without the equal amount of inflation) a monkey can make a pension plan work. Pensions need to be properly funded from the first day of employment. The average public sector employee contributes 10K a year to his/her pension split between themselves and the employer (that would be you) so after 20-years 200K have been stocked away. Then they retire and over the next 20 years get over 2mil in pension. Doesn't work - you can hope for the FED to make these plans whole but the entire problem is that the private sector employee and retiree ends up paying 1.8 mil for every public sector retiree while at the same time not enjoying the fruits of his own labor.
When it all goes KABLOOEE... the pensioners will have a least a couple of good belts before they put their guns to their heads..... With all the Greek bashing here, surprised we haven't seen any references to sex with sheep... my such civility on ZH!
You are all about history when it supports the bull case. So:
Thought experiment - can you name me a time in history when there was asset price inflation while real estate values were falling?
I can name only one: France, 1790s, when seized church lands were used to back new fiat currency. Land prices fell because clergy insiders got wind of the scheme and sold their holdings, driving down prices, while food prices went up six-fold in the aftermath. I don't think anyone in government with a sense of history wants to repeat that experiment.
However, when Bernanke admits the obvious - that three years of reflation efforts have been an epic failure - my theory is that he'll try a variant of this approach, where a nonconvertible, domestic-only fiat currency will be backed by the MBSs on the Fed's books.
My contention is that the only way to 'get out of this mess' is for real wages to rise across the board.
"My contention is that the only way to 'get out of this mess' is for real wages to rise across the board."
Good luck, this is years, maybe decades away. As for real estate, you had the biggest bubble in history, helped by the securitization bubble and GSE bubble. Housing will stabilize once employment picks up convincingly, but that doesn't mean prices are heading back up. Still lots of overhang and people have become wiser, buying smaller houses they can actually afford.
Which is why I think the Japan scenario is the best possible outcome.
And, oh, no, real estate wasn't the biggest bubble in history. The only way this could be true is if you refer to total dollar volume. The size of the housing bubble depends on the affordability measure you use, but we basically went from home prices averaging 3x family income to 5x. It wasn't actually a real estate bubble; real estate prices were just a side effect of a credit bubble.
If you look at a few of them in a historical context, bubbles tend to be roughly a factor of 20x price appreciation. Examples:
- Gold, 1974-1980: $35/oz to $800/oz, roughly 23x
- Nasdaq, 1989-2000: 300 - 5100, roughly 17x
- Nikkei 225, 1971 - 1989 (I start this from 1971 because that was the year it broke and held 2000): 2000 - 38000, roughly 19x.
- Going way back, the South Seas company bubble was 20x almost to the penny.
The Shanghai Composite is the largest bubble I can find in all of recorded history.
Leo
As a pension fund specialist, you know that the biggest problem for funds is an underinvestment in good quality long duration assets. Compared to the terrible yield in bonds and the lack of longer dated higher yielding assets, whiskey is not a bad investment. Add this to the fact that the workers at Diageo probably feel like they understand whiskey more than hedge funds or mortgage bonds, and I don't see much downside. Whiskey is a tax free investment and the worst case scenario is a default of Diageo leading to a loss of the brand. Even then, it would be a complex process to lose the right to label the whiskey. My feeling is, whatever happens to the global economy, there will still be strong demand for the hard stuff...
Thanks for the article Leo. I guess I sympathise with you on the issue of brand values going into a pension scheme but also sympathise with others who point out that the whisky does have a value and may well be more reliable than fiat money at this time.
I have also been reading about the occupational pension chnages proposed for the UK as I have one it is important to me and I found the thoughts of the notayesmanseconomics web blog interesting as ever,
"Now one needs to be careful with words here as I have seen a lot of misguided writing on this subject as the indices which the government is changing set minimum levels for private sector pensions so it is not forcing them to change as they have the option of exceeding them. However as these schemes in general have large deficits they are increasingly likely to offer only the minimum level of inflation protection. Should this happen then as I have suggested above if you believe RPI will in general exceed CPI, then this change means that this government is effectively proposing to allow pension schemes to reduce the value of members’ accrued benefits and not just future ones. This has very serious implications, as such changes have never been permitted before."
The full analysis is on http://notayesmanseconomics.wordpress.com
Is the latest micro-rally in the US equity markets an advance bet on QE.v2.0, or a consequence of a rebounding euro and again-declining dollar - the price of oil suggests to me the latter.
If QE 2.0 is coming, isn't it March 2009 all over again? I would assume this time however, the stimulative effect will be half of what it was, or worse, but nonetheless, on an annoucement would you not expect equities to begin a 25%+ run for a time, headed into November? A declining dollar, and a rising Euro?
Ned,
Excellent points but I am not convinced we need QE 2.0 just yet. Also, Europe is mired with its own problems, so any bounce in the Euro will be muted...it won't go back to 1.50 any time soon.
Leo, check out this story which is very big in the UK. I'm sure it's worth an article. The move from RPI to CPI could be massive for UK schemes and easily cut their liabilities immediately by 10%
http://www.guardian.co.uk/money/2010/jul/09/pension-changes-to-cut-final-salary-payouts
and here is what the minister said http://www.publications.parliament.uk/pa/cm201011/cmhansrd/cm100708/wmstext/100708m0001.htm#10070869000014
Thanks, will ask around and look into this.
..but we haven't had QE2.0..because that would make a bina fide basis for civil disobedience. We have accounting gimmicks instead. Pensons Reform cannot happen if the current financial architecture is to be maintained: The stock market is being mysteriously buoyed, who knows if the same is true for earnings. Employment is still abysmal, house equity is still a burden, interbank credit is dry... the economy would grow if there confidence, but now everyone is convinced its a trick, we're spectators. The Dollar is walking a tightrope - we're watching to see it fall over the edge. This isn't just about Risk inflation - we're watching the collapse of an empire.
Leo, Leo, Leo! A Trustee needs to think of a worst-case scenario. When TSHTF, and everything has gone to zero, even unbranded Maturing Whisky Spirit will have a liquidation value to someone. As a Trustee, I would take some of it, curl up in the corner, and toast my good fortunes to have made this deal.
Leo, I've criticized a couple of your past articles. Liked this one. Well done. For what it's worth.
Liked your comment above too.
Am I the only one bothered by the fact that we're on the verge of turning into a barter economy?
One does not even have to do numerical analysis to figure out that this must be a bad deal for the pensions. The usual suspect gang of thievery facilitators, including the appraisers, are circling around it like buzzards around a carcass. Why should the shareholders get paid a dividend when the company that they own has a contractual liability to make a payment into its pension fund. And why are the trustees SO STUPID that they can't figure out that the owners are essentially stripping out the company right out from underneath them?
Then again, I'd rather have a bottle in front of me than a frontal lobotomy.
fat finger....
Leo, You say:
This means expect more stimulus, more quantitative easing, there is simply no other way to get out of this mess.
That is not true Leo. There is another door we could choose. We could slow this pony down. We could put things on a more credible path. We could do something right for a change.
Suck it up Leo. We are not going to go down that road. Congress has no stomach, the people do not want it and your boy Ben Bernanke is not going to do QE2. If he does it will be lights out for every one of your customers with 24 months. Your door leads straight to hell.
+1000. We're the alcoholic who knows we have to stop drinking. But we're gonna try it just one more time. Eventually, it stops working. Frequently, that last bender is the one that kills you.
The article says:
"We need pension reform, rising assets, and rising bond yields (to lower the present value of pension liabilities)."
Great sentiment. I need the body of a 25 year old man. But QE and stimulus are just as likely to fix my sagging belly as they are to generate real asset value increases or real bond yield increases. Inflated assets and high interest rates during inflation aren't real value. They are just destructive redistribution--"hell" as you put it. It's over. The can cannot be kicked further down the road.
Today, every road leads to pain--a lot of it. The path that is most likely to preserve some liberty, wealth, and the social order is to accept the deflation that is here and let it run it's course. The Weimar approach ends with randomly selected people hanging from lampposts. Although some will be politicians (and many would applaud that), a lot of good, normal people will share their fate. It's not clear that any notion of limited government would survive Weimar.
I'd settle for the body of a 25-year-old woman.
Or 2 or 3 ....
Spoken like a hedge fund manager losing his shirt as he desperately tries to short this market. Listen to me carefully: the power elite will do everything it takes to avoid debt deflation. If this means QE 2.0, including outright purchasing of stocks, they will do it. The banksters control the Fed and they'll do whatever it takes to reflate risk assets and bring inflation back in the system. Unfortunately, this might also mean they are preparing for war with Iran, hoping a supply shock will boost prices. Who knows? All I know is that deflation is simply not an option for the financial oligarchs. It doesn't mean they'll succeed, but it means they'll fight it tooth and nail.
Unfortunately, I agree with you. Whilst deflation may overwhelm the PTB efforts to reflate the market, they will do ANYTHING to prevent this outcome. It is simple, the largest debtors are governments and banks, and if their debts increased in real terms, the game is over.
"Spoken like a hedge fund manager losing his shirt as he desperately tries to short this market"
Wake up Leo... The SPY today is about where it was in 1998, unless you adjust for inflation in that case it is down at least 50%..... over those twelve years you lose half your money/buying power whether you are long or short the major averages.
The SPY is down 400% against many of the metals and other basic necessities over the past decade..... ZERO return Leo, short away if you like you "hedgies".... or go long, it really does not matter, its all a zero sum game unless you are the booky. Its a fucking casino, nothing more.
+Agreed. Still not sure why you dislike Gold...
Gold will not do well because risk premiums are falling, inflation expectations remain low, and the run-up was overdone.
"Gold will not do well".... Have you looked at gold versus the stock market since you quit wetting the bed Leo? Gold is up about 400%.
Agreed, but going forward will this still be the case? I highly doubt it.
But you think stocks will keep going up.
We agree that the ruling class will try to avoid further deflation at all costs. I think we may not agree on whether it is the right course. I also think we may disagree about whether QE 1.0 was productive in that regard and whether QE 2.0 has any chance of success. Eventually, reality will bite hard. And I think "eventually" is here soon.
Frankly, I think all our rulers care about is next November. If QE 2.0 can keep the current bunch in power, they will do it regardless of consequences after Nov.
On your personal note: not a hedge fund manager and not short anything. I've learned I'm just not sophisticated enough to ride that wave and make money.
Breaker,
My apologies, and yes we agree, all politicians care about is next Nov., but I am not so quick to dismiss QE 1.0....may be a lot more stimulus in the financial system than we think.
A very good friend of mine (best-man kind of friend) is a big-time Democrat in CA. Spends a lot of time in Sacto and is heavily involved in the current budget issues.
The good news from him is CA will probably not have to choose between laying off 140,000 plus employees or defaulting next October (after that, who knows).
The bad news: he has been watching the stimulus money go by and is aghast that it's only effect in CA is to extend the employment and benefits of public employee union members. As far as he can tell, virtually none of it has gotten to the private sector. He's still a Keynesian. He contributes a lot of money to dems and voted for Obama, Barbara Boxer and Diane Feinstein. But his take today is that the current bunch blew it big time. They spent a trillion dollars for stimulus in all the wrong places for political reasons and have no bullets left to shoot.
And he puts his money where his mouth is. He has spent the last 3-4 months rearranging his finances to be more deflation proof.
This time I agree with you.
Yes! That is the road they will take for obvious reasons, but it is not necessarily the right road.
BTW: My Greek friends told me that your Greek words you called me, were really nasty. (I forgive you. Your Greek Passion I guess)
My Greek friend told me that Greeks enjoy discussing politics and economics at nauseum. And that they enjoy beating their women.
Hye ek? If so, don't pick on the Greeks! Save it for...
Your Greek friend is an idiot and the only thing he is spanking is his monkey.
i'd rather have my pension backed by johnnie walker black than some fiat paper or muni bonds.