BT: A blacker pension hole
BT seems to me to have been a bit disingenuous this morning in the way it has presented its first quarter results.
The impression it creates is of steady-as-she goes in its retail and wholesale broadband and telephony businesses. And that the troubled global services divisions - which provides services to big institutions - is now looking sick rather than a basket case.
Which is presumably why its share price bounced an impressive 11% this morning.
So it comes as something of a surprise to discover, buried in a note some way into the press release, that at the end of June its net liabilities exceeded its net assets by a substantial £3.2bn.
Now I can't remember the last time that a putative blue chip like BT, a semi-utility that's supposed to generate buckets of cash, had a net deficit on its balance sheet.
This is a non-trivial occurrence.
Intriguingly, BT insists that:
"this does not affect the distributable reserves and dividend paying capacity of BT group plc, the parent company".
Which is a bit odd - in that some might argue that the prudent course would be to strengthen the balance sheet by conserving cash and abandoning the dividend (which was slashed 59% only 10 weeks ago).
So what's created this hole?
Well the deficit before tax in its pension fund has doubled from £4bn to £8bn in just three months.
And, under legislation passed by this government, this is an unavoidable debt.
To put this £8bn chasm in its pension-scheme into an appropriate context, the entire market value of the company is less than £10bn.
The cause of the huge increase in this debt is not a collapse in the value of the pension scheme's assets. In fact these have risen 3.8% to £30.4bn.
What's ballooned are the liabilities, from £33.1bn to £38.3bn.
And some will say that BT has been hoist on its own petard - in that pensions analysts such as John Ralfe have been arguing that for months the company has been understating the size of its pension liabilities through the so-called discount rate it uses.
Explaining this is a bit complicated, so please bear with me.
The way that any pension fund values its liabilities is to evaluate the numbers of people in its scheme and how long the current and future pensioners are likely to live.
Then it adds together the payments it is likely to have to make to those current and future pensioners over the many decades till the last pensioner is dead.
And then the fund calculates the present-day value of all those payments, in order to ascertain the value of the assets it should be holding today such that it can be confident of paying out all those pensions over all those years.
Now this is the tricky bit.
Under accounting rules, what's known as IAS 19, a pension fund "discounts" those future payments - or puts them into today's money - at the prevailing rate of interest on high quality corporate bonds.
Perhaps the best way to think of this is that the fund is assuming that its assets - its investments - will increase in value at the rate of interest paid by big sound companies for borrowing from investors.
And the important point to grasp is that the higher the yield on corporate bonds (or the higher the rate of interest that companies have to pay to borrow) the lower the current value of a pension fund's liabilities.
So BT's pension fund looks in much better shape when big companies are paying much more to borrow.
Here comes the paradox.
Because of the credit crunch, this corporate bond yield surged to a record 7.72% last October. And the yield increased simply because investors took fright and didn't want to lend to companies.
So the credit crunch - which has been doing so much damage to the health of businesses - created the illusion that weak pension funds, like BT's, were in better shape than was actually the case.
The point is that corporate bond yields were temporarily inflated and distorted by panic in the markets: that 7.72 rate of return wasn't remotely a return that any fund should have expected to earn over the decades to come; it was an unrealistic discount rate.
Now as economies have started to show signs of recovery, investors have become less reluctant to lend to companies.
So the yield on corporate bonds - and the relevant yield for BT is AA-rated corporate bonds - has fallen.
Since March, the yield on AA corporate bonds has fallen from 6.85% to 6.2%.
Hey presto: the economic outlook looks less bleak; the price of credit for companies has fallen; but the value of pension fund liabilities at BT has gone through the roof.
What's worse, the pension regulator thinks that BT is still not using prudent enough assumptions in measuring its pension-fund hole.
It doesn't like the use of the AA corporate bond yield to measure liabilities and - as part of the rigorous three-yearly actuarial evaluation that all schemes have to go through - the regulator has asked an outside expert to advise on what a sounder discount rate would be.
Ralfe believes the deficit on more sensible conservative assumptions would be about £11bn, more than BT's stock-market value.
And if BT were forced to value its pension liabilities on the basis of the yield on gilts - which is how schemes are valued when companies want to get shot of them to an outside insurer - well then the deficit would be well over £20bn.
Which is broadly a way of saying that BT's managers under the chief executive Ian Livingston are not any longer working first and foremost for the company's shareholders, but that their more important and burdensome obligation is to the pension fund.
As a start, BT in May agreed with the regulator that it would put £525m each year into the scheme for the next three years - consuming half of all the cash generated by the business.
What it's now negotiating is the contributions for succeeding years. And there is little reason to believe that these substantial payments will fall for almost as far as the eye can see.
Arguably, in an economic sense, BT's current and future pensioners own this totemic business.