Lloyds Bank pension scheme members are said to be unhappy that their defined benefit (DB) plan could have been saddled with 'toxic' assets after the company became one of the latest sponsor to transfer non-cash assets into its pension scheme. Are trustees really at risk of being duped into taking unwanted assets into funds? Pension Funds Insider investigates.

The LTU union recently released a newsletter in response to earlier reports that the bank, along with HSBC, has transferred £5bn in assets from its core business into its pension fund (£1bn directly and £4bn into a new partnership with the fund). Lloyds TSB required bailing out by the UK government in 2008 during the financial crisis and questions remain over the real value of some of the loans and investments it made before the crisis.

Data held by Pension Funds Online shows that Lloyds' DB scheme 'No.1' is invested in a variety of diverse assets, such as Mezzanine debt and infrastructure. Scheme members who have been reassured by plans to gain solid returns through diversification may not be so happy to know that the fund also holds the potentially 'toxic' non-cash contributions its sponsor has bestowed upon it.

And, judging by the reaction of the LTU, there are indeed many staff at the bank who doubt the value of these assets. The union said that "members of the Lloyds TSB No1 and No2 Pension Schemes have every right to know whether their pension funds have been saddled with these so called "toxic" assets, which potentially could be worth a lot less than the value placed on them by the bank."

The term 'toxic assets' can be misleading, however.

Despite being known as one of the causes of the financial crises, many asset-backed securities that plummeted in value in the wake of the financial crisis could still perform well in the long-term.

Even if a large number of 'toxic assets' are contained in the Lloyds transfer that could still make the exercise, which began back in December 2009, an innovative way to heal the pension fund. At their last valuation in 2009 the two schemes had a total deficit of £8.5bn.

As Lloyds' pension liabilities of £27bn match its current market cap, innovative thinking to solve the pension problem could well be beneficial to the group and UK taxpayers' long-term interest.

HSBC noted that in completing a similar asset transfer to its pension scheme, the bank would then be able to improve their Pillar 1 capital position and transfer some liquidity risk away from the bank to the scheme. These are both big advantages for banks grappling with a new regulatory environment.

The LTU says that Lloyds TSB is failing to put the members of the scheme at ease, however, by refusing to disclose what assets have been transferred to the pension scheme. For its part, the bank says this is because the transfers are yet to be formally disclosed to investors.

A Lloyds spokesman told Pension Funds Insider that "the Group takes a prudent approach to the long-term stability of its pension schemes. Any changes to the funding of these schemes have to be approved by independent trustees who have a legal obligation to look after the interests of the pension fund. Members' needs continue to be our top priority."

Clearly whether any 'toxic assets' in the transfer are to pay decent returns to the fund would depend on the wider economy recovering and whoever has taken up the loans that the Lloyds pension fund now may hold paying them back. That is surely something trustees would have been wary off, and in a way is no different to the more conventional assets held by the scheme.

Avoiding being caught out by an asset transfer

Jeremy Lee, director of investment consulting at Redington, has advised on a number of asset transfers and points out that trustees are generally in a good negotiating positions when a sponsor approaches them with a bundle of assets. That trustees enjoy "the backing of the Pensions Regulator" strengthens them, he told Pension Funds Insider.

Guidance from the Regulator in 2010 points out that should non-cash assets be packed as contingent assets for use in the event of a sponsor's insolvency, "the trustees will need to consider the value they are to place on the contingent asset or security for the purposes of making suitable changes to the recovery plan. For some, such as cash in a designated account, this will be straightforward but for others, such as property or a group company guarantee, careful consideration will be needed before allowing for the contingent asset in a scheme's funding strategy."

Lee agrees that "from a valuation perspective, you need an independent expert to come in and value assets. That is all the more important in exercises that involve intangible assets." 

Lee says this golden rule of using an independent valuator does appear to be widely followed and has always been practised in transactions he has been privy to.

The intangible element marks a new departure in asset transfers. Travel firm TUI made headlines earlier this year for gifting its pension schemes some of its best known travel brands, Thomson and First Choice as part of a recovery plan.
 
Marks & Spencer and Diageo broke ground before that by bestowing their pension schemes with the more tangible assets of property and whisky respectively.  

To get ideal value, Lee advises trustees to aim to secure over-collateralised asset packages.
 
He says: "That should provide the comfort that even if the value of the assets in the structure falls, there should still be enough in there to meet the cash schedule they have agreed with the sponsor."
 
The Lloyds transfer, like many of the others before it, creates a partnership for the pension fund in which £4bn of the transferred assets are placed. While as much as £1bn of non-cash assets may have been transferred to the scheme directly, this partnership is earmarked to only be drawn upon if the sponsor falls behind with future deficit recovery payments.
 
The creation of separate partnerships, while seemingly being an economical way to guarantee a commitment to a fund, adds great complexity to the transfer exercises.
 
Lee admits that often "it will take a good set of trustees several months, if not a year, to fully understand what is going on." He adds that there is always the danger that "trustees will be wary of them just because they are so complicated."
 
Legal matters and tax issues in particular should be clear of any loose ends before trustees decide to proceed.

Lee sees the development of non-cash asset transfers to schemes continuing "as long as there is pressure on cash for companies there will be a demand for innovative structures."
 
He adds "I imagine though that they will remain large transactions as the amount of time and effort you have to put into doing them doesn't really justify doing them for a small amount of money."
 
Lee adds he knows of at least another two big exercises in the pipeline.

There are no magic solutions to pension deficits, but just maybe innovating with non-cash transfers will come a close second. While the current scepticism as to the value of bank assets is raising questions at Lloyds, few pensioners are likely to care what assets went into providing their DB pension if it arrives as promised.

First published: 18.10.2011

dbillingham@wilmington.co.uk