Carillion highlights the many problems of credit crunch era pension financing

This morning’s news brings us back to a problem which has dogged the credit crunch era. The advent of first official interest-rate cuts and then central bank balance sheet expansion was designed to pull economic demand from the future to the present. This poses an issue for pensions as it does for all long-term savings contracts as they rely on the future. The issue has become clearest when we look at a consequence of the widespread monetary easing which was reflected in a question on Thursday to ECB ( European Central Bank) President Mario Draghi which mentioned “10 Trillion” dollars of negative yielding bonds. If you start doing any sort of maths you find that the negative yields imply you will be getting less back in the future than you pay in now and that is before you factor in the impact of inflation. Who invests to make a loss?

Putting it another way here are the real yields as of today from Germany. Not what economics 101 would predict for am economy in a boom is it?

Just for clarity some of the nominal yields are negative as shown in the chart but even when they go positive they are negative if we allow for inflation prospects and estimate a real yield.


This reflects the conceptual issue as we note that its business model was to take advantage of the era of monetary easing. Take a look at this from the House of Commons Briefing Paper.

Over the eight years from December 2009 to January 2018, the total owed by Carillion in loans increased from £242 million to an estimated £1.3 billion – more than five times the value at the beginning of the decade.

So it was able to borrow on a large-scale as we note an effect of these times which is often forgotten. Not only did it become cheaper to borrow for many purposes but there was an availability of credit meaning that Carillion could borrow ever more as well as cheaply. As an aside the banks would no doubt have been happy to make some business lending but as I reported many years ago now about Japan you don’t always get the sort of business lending you want as we note what it did with it.

In the eight years from 2009 to 2016, Carillion paid out £554 million in dividends, almost as much as the cash it made from operations. In the five years from 2012 to 2016, Carillion paid out £217 million more in dividends than it generated in cash from its operations.

Now let us skip to the pensions situation.

Carillion has 13 UK defined benefit pension schemes with 27,000 members. In January 2018, the trustees estimated that the schemes’ Pension Protection Fund (PPF) deficit (the shortfall compared to what is needed to pay PPF compensation levels) was up to £900 million

So shareholders got dividends and we know the directors were well paid and were able to think of the future. From the Financial Times.

Allowing clawback conditions to be changed a year ago, striking out corporate failure as a reason to take back bonuses.

Yet they were somewhat more forgetful about the futures of others.

When did this start?

Rather concerningly the problems were long-standing. From Josephine Cumbo in the Financial Times.

In written evidence to the Committee, Robin Ellison, chair of Carillion pension scheme trustees, said the trustees had tried to agree higher funding contributions from the company in 2008, 2011 and 2013.

Even worse there are higher estimates of the problem emerging from the woodwork.

In his letter to the committee, Mr Ellison revealed that the funding shortfall for five of the six Carillion pension funds he chairs widened from £508m in 2013 to around £990m in 2016 when measured on a “technical provisions” basis. This is the measure used to set contributions from the employer every three years. However, the “buyout” deficit, or the measure used by the Pension Protection Fund to value a creditor claim for the pension debt, is nearer £2bn according to Mr Ellison.

This brings us to the subject of the regulator as we wonder what it has been doing over the past decade?

On Monday, the Work and Pensions Select Committee published new evidence claiming that the Pension Regulator (TPR) was alerted to problems with the company’s main pension plans as long ago as in 2008, when the scheme’s trustees and the company were locked in a funding dispute.

We seem to be back to the issue of who regulates the regulators as this looks like the behaviour of yet another paper tiger.

What is a pensions deficit?

In theory this is easy as it is simply an expected future shortfall. The problem is that more than a few variables are unknowable such as investment returns, inflation and interest-rates and yields in the future. The modern era started in 1997 with the Minimum Funding Requirement which had an impact on the markets I was working in/on at the time. From HM Parliament.

it appears to have created some extra demand in the long end of the gilts market, which may have contributed to the depression of yields.

This led to the view that one of the aims of the MFR was to support the Gilt market. Then another issue arose which has continued which is the use of yields to value pensions as only a year later there was a big change for dividend yields in pension funds.

the dividend yield is no longer a reliable measure of “value” for UK equities – this is partly due to the abolition of tax credits on UK dividends in the July 1997 Budget, which
has changed companies’ behaviour over profit distribution, and partly because investors are willing to value shares on future long-term expectations, despite the
absence of dividends or profits

More recently we have seen corporate bond yields used for pension deficits but this has brought its own problems as central banks have intervened here. Firstly by making them more attractive by cutting interest-rates then reinforcing it via balance sheet expansion via bond buying. Then explicitly by actually buying corporate bonds as the Bank of England did in August 2016 and less obviously via the ongoing ECB programme as UK companies do issue Euro denominated bonds.

The irony of all this is that if you had bought long-dated UK Gilts two decades ago you would have done really rather well especially if you sold to the “Sledgehammer” buying of the Bank of England as it sent the market to all time highs with its panic inspired move.

What about direct contribution pensions?

These are simply ones where you put money in ( and if lucky your employer does as well) and it is invested and you make or loss depending on how the investments do. This is different to the schemes above where the employer promises a return based on your salary or earnings. According to the Financial Times just over a week ago the costs here are not quite what we are told.

The total cost of investing in popular funds, including those run by Janus Henderson, BlackRock and Vanguard, is up to four times higher than first thought, FTfm can reveal today. The Mifid II trading rules, which came into force this month, have forced asset managers to disclose hidden charges.

Some care is needed as platform charges are not caused by the fund management group but there are charges which are far from transparent.


There is much here to consider. The concept of investing for the future is simple and yet the credit crunch era has made it more complicated. For example there was a time ( and no doubt regulatory rules still suggest it) that the safest investment was a government inflation or indexed linked bond. No we see a time when in the UK and Germany you are pretty much guaranteeing yourself a loss in real terms if you hold them to maturity. If we look at conventional bonds they yield so little there is no fat on the bone as real yields are hard to come by.

Ironically this will have benefited some as if you had been holding bonds over the ,long-term then you are quids ( Dollars, Euros,Yen) in as we have been in a bull market. More recently equities have joined that party but here is the rub. In my opinion central baking easing has helped drive this too as current investors/pensioners benefit from borrowing from future returns. The claimed “wealth effects” must make it harder to make money going forwards as we note that like in Japan zombie companies which is what we are increasingly looking at with Carillion were indeed propped up.

Meanwhile I would suggested that especially if we consider their student debt burden millennials are unlikely to be able to buy a home and invest in a pension simply by giving up takeaway coffee and avocado toast.

Also I am pleased to report that the spirit of Sir Humphrey Appleby is alive and kicking at the UK Pensions Regulator.

The Regulator said: “It is too early to comment on whether with different information we could or would have taken action in the past or whether we will take action in the future, based on any new information that comes to light.” ( h/t @JosephineCumbo )



Whatever happened to yield and the investors and savers who relied on it?

Today I wish to look at a concept of investing and indeed saving which has seen quite a few changes in the credit crunch era. This has been brought to my mind by this piece of news this morning from the Financial Times about Lloyds Banking Group.

In a boost to investors, the bank revealed a full-year dividend payment of 2.25p per share, up from 0.75p per share last time, amounting to a total payout of £1.6bn. It also unveiled a special dividend payment of 0.5p, amounting to £400m.

This yield boost as seen the share price rise some 5 pence to 68 pence and at such a level it represents a yield of 4% for this year and 3.3% after that. Of course looking forwards using a dividend to calculate a yield has the issue that it is by no means guaranteed. Indeed one might be wondering already if Lloyds can afford it going forwards with numbers like these.

Pre-tax profits fell to £1.6bn for 2015, from £1.8bn the previous year, dragged down by the PPI provision in the fourth quarter.

A lot of it depends on whether you believe that the new extra Payments Protection Insurance write-downs are sufficient as this has been a road where we have heard from the bank Europe many times.

It’s the final countdown
The final countdown

There are also the issues of the banking sector itself which has had a troubled 2016 already. It was only on Tuesday when I discussed HSBC which may struggle to maintain its dividend and Standard Chartered which axed its final dividend payment. This of course follows on from Royal Bank of Scotland which announced yet more problems a few weeks ago. Still someone seems able to plan for his own higher dividend.

However, António Horta-Osório,Lloyds chief executive, has received a 6 per cent salary increase this year taking it to £1,125,000, in his first pay rise since joining the bank in 2011. He is to be granted a deferred bonus of 723,977 shares, which was worth £450,314 at Wednesday’s closing price of 62.2p.

The Guardian are more bullish on his pay deal claiming it is £8.5 million but they do not break it down.

If we look back I recall that many of the bank shares were considered to be “dividend” stocks and that Lloyds yielded 7% for a while. Of course that then hit trouble as share prices collapsed and dividends were axed. More recently one might have considered oil companies to be providers of a safe dividend which remains us we need to be very careful about the concept of a safe haven.

However let me move on by quoting the UK FTSE 100 dividend yield which was 4.09% at the end of January according to the London Stock Exchange.

What about savers?

Back in September of  2010 Bank of England Deputy Governor Charlie Bean.told us this on Channel 4 News.

At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.

The current Bank of England data series starts just after then in January 2011 when it records the ordinary deposit savings rate as 1.3% as opposed to the January 2016 rate of 0.47%. So savers may ask Mr.Bean or rather Professor Sir Charles Bean how good his Forward Guidance was? Also how long they will be expected to do this?

Savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit.

The Bank of England has stopped publicising the value of senior executive pension pots – I wonder why! – so let me do the maths and point out that the 2014 annual accounts imply a value of £4.5 million for our knighted professor. Accordingly it will be quite some time or more likely never that he has to eat into his own capital a bit.

In the counterfactual world of Mr.Bean everyone is better off as QE saved the economy and prevented their savings being eaten by the dragon Smaug from the Hobbit or such like.

What about bond yields?

It was only yesterday that I pointed out the issue of the fast disappearing bond yield in the UK.

The heat is on here as the UK ten-year Gilt yield has fallen to 1.37% this morning…….. The five-year yield has dipped to 0.71% which if maintained will lead to cheaper fixed-rate mortgages.

So there is little yield to be found there and whilst it ebbs and flows the trend appears to still be downwards. There was a time that people would laugh at forecasts of the ten-year US Treasury Note yield going below 1% but its drop after a rise in official short-term rates has quieted that. Especially if we note that Germany has one of 0.16% and Japan has seen its dip into negative territory again. Indeed the German bond yield universe has this problem according to @fwred.

Frankfurt, we got a problem. New record high 45% of Bund universe trading below ECB’s depo rate, not QE eligible.

That’s below -0.3% as opposed to 0%. Of course this leads to trouble elsewhere as investors look to markets which do at least have a positive yield.


These have particular trouble as longer dated bond yields are used and they have plunged in yield as described above. If we look for the impact then according to Sharing Pensions pre credit crunch a basic ( no indexation in fact no add-ons) would have provided a yield of 7.9% for a 65-year-old and now provides 5.6% which is quite a cut. Frankly if Gilt yields remain where they are then we can expect further falls. A reason why they have not fallen further is that annuity providers have invested elsewhere but this too comes with problems. This lead Legal & General to announce this earlier this month.

Of our LGR annuity bond portfolio 0.7% (£266m) is in sub-investment grade Oil & Gas and 0.1% (£38m) in sub-investment grade Basic Resources.

I do not want to scare monger as L&G can cover that but it does at least beg a question of where the race for yield is going?

The whole concept of long-term saving hits all sorts of problems with low and negative yields. Places which use present value calculations will watch it head towards infinity or perhaps more accurately become undefined. It was only Monday that I pointed out a consequence in Japan.

The Bank of Japan’s negative interest rate decision has started affecting the life insurance market, with sales of some products such as whole-life insurance policies being suspended following the announcement.

Buy To Let

For foreign readers this is the UK term for buying a property and renting it out. This provides quite a “yield” these days although much of what is considered a yield is in fact a capital gain or asset price rise. From Your Move.

Taking into account both rental income and capital growth, the average landlord in England and Wales has seen total returns of 12.0% over the twelve months to January…..In absolute terms this means that the average landlord in England and Wales has seen a return of £21,988 over the last twelve months, before any deductions such as property maintenance and mortgage payments.

The gross rental yield is estimated at 4.9%.


What we have seen in the credit crunch era is a reduction in the interest-rate or yield on what were traditional savings products which were considered to be relatively safe. First we saw official interest-rate cuts hitting deposit savings rates in a trend which continues although 0% has been something of a Rubicon in many places so far anyway. Then we saw QE style pressures push bond yields and long-term interest-rates lower as failure in one area did not lead to a rethink but an Agent Smith style “More…..More” instead. Along the way we see that products such as whole of life insurance and annuities have been hit hard.

Such financial repression pushes investors and savers into riskier investments such as equities and in the UK in particular property both to own and rent out. The catch is in the riskier bit especially as policy after policy emerges to boost house prices which means for new buyers the risk continues to rise. The situation gets more highly charged.

You may wonder why I have left the concept of a real yield to the end but it has been deliberate as you see it is so misunderstood and has been so volatile I am not sure that we know what it means going forwards. Let me give you an example from the UK Debt Management Office from this week.

The United Kingdom Debt Management Office (DMO) announces that the syndicated offering of £2.75 billion nominal of 0⅛% Index-linked Treasury Gilt 2065 has been priced at £163.728 per £100 nominal, equating to a real gross redemption yield of -0.8905%.

So if inflation shoots up the UK taxpayer cannot lose? Oh hang on…….

Oh and those who believe that the Consumer Price Index is a more accurate guide to inflation than the Retail Price Index have just given up a gap that is currently of the order of 1% per annum.