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As debt refinancing costs rise, Trustees should ensure they have a plan

Whenever a high street favourite like Wilko collapses, it’s a stark reminder of the need for robust corporate and pensions governance.

Pensions trustees always need to be on the front foot and particularly now given the unstable nature of the macroeconomic environment. While it’s true that many companies are currently enjoying record pension scheme surpluses, many other schemes, Wilko included, are facing significant pension deficits and weaker covenants. As the cost of debt refinancing climbs, those problems will only intensify.

Insolvencies and interest rates on the rise

The numbers tell a sobering story. The latest ONS insolvency stats show that 225 compulsory liquidations were recorded in September 2023, up 19% compared to a year ago. Meanwhile, the Bank of England recently warned in a blog that rising interest payments, relative to corporate earnings, are making it increasingly hard for some medium and large companies to repay their debts.

It would be understandable if businesses felt they were being assailed on all sides. Not only are they facing further pressure over debt maturity and escalating interest risks, but they’re also having to deal with cash-flow pressures, due to increased operating costs pushed up by inflation.

No one should underestimate the scale of the debt maturity challenge coming down the line in the UK over the next couple of years, when borrowers will have to refinance their existing debts.

What does this mean for DB pension schemes sponsors?

DB pension scheme sponsors are very much in the line of fire here, set to encounter significant refinancing pressures over the next one to three years. The impact will be even harsher for companies with limited liquidity headroom or operating at a loss. They are likely to find the process of securing funding an uphill struggle, with the terms offered ending up as less favourable compared to when the original financing was secured.

This situation will potentially push sponsors to seek deficit repair contributions (DRCs) deferrals, given that they will be required to refinance significant facilities at far higher rates than when they were first issued.

At the same time, trustees may also experience shifts in lender demands during the refinancing process, pushing the scheme into even further difficulty and resulting in lower recovery in a downside scenario.

Trustees need to be fully prepared for potential refinancing

What should pension scheme trustees be doing to lay the ground for future challenges?

Top priorities include:

  • Understanding and monitoring the debt structure of corporates;
  • Ensuring that trustees are informed of any forecast or actual breach in covenant on a timely basis; and
  • putting a water-tight contingency plan in place.

Trustees should request key information about the latest trading dynamics and how these might dovetail with any upcoming refinancing requirements for the company. Likewise, they should possess a clear picture of the downside support structure the scheme has in place, the potential value that could be recovered and what can be done to strengthen that support.

The scheme’s position should be considered as part of any refinancing discussion, with trustees involved in those talks at the earliest possible stage. Trustees and other third-party advisers should always be at the table when loss-making companies are making financial decisions which could impact member outcomes, particularly when their pension schemes are also facing a deficit.

Schemes could, of course, still be at risk when the restructuring comes. Trustees can help ensure that appropriate governance measures are followed, even if, ultimately, they are unable to save a struggling business.