Brexithas heightened worries about pension deficits in the U.K., with capital levelsat banks and insurers set to suffer.
Theaggregate deficit at British firms increased by close to £90 billion in a singlemonth, according to figures from the Pension Protection Fund — topping £383billion at the end of June, up from £294 billion a month earlier. The PPF isBritain's publicly funded backstop for pensions.
Britainvoted to exit the European Union on June 23. Brexit risk pushed investors tosafe havens such as U.K. sovereign bonds — driving down yields that helpdetermine the value of pension assets — and led to volatility in equitymarkets. The Bank of England has saidit will probably further ease monetary policy in August, adding to the pressure.
In aJuly 7 report, RBC Capital Markets said U.K. pension funds will probably face"a reasonably long-lasting adverse impact on solvency" as the yielddrop prompted by Brexit impact their valuations.
Therisk that pension schemes pose to the financial health of companies, includingfinancial services firms, has increased, according to Raj Mody, head ofpensions at PricewaterhouseCoopers in London.
"Thecurrent volatility raises the alert levels for pension schemes," he saidin an interview. "It makes the challenges they are facing more acutelysignificant."
Companiesneed much more sophisticated assessments of their pension investments, Modysaid, in order to avoid running pension deficits for too long. Such deficitsoccur when the amount present in a firm's pension pot is less than the amountowed in payments to employees in retirement. Investors are increasingly lookingat pensions liabilities, he said.
Banksand insurers are set to take a hit to capital. RBC explains that, at forexample, the defined benefit pension plan is currently in surplus, and thatthere is a common equity Tier 1 deduction from shareholders' equity to accountfor this. But RBC expects that a more negative rate environment will feed intoCET1 calculations. It estimated that at June-end the bank had a £1.175 billiondeficit, on liabilities of £42.55 billion, which it believes will cost the bank50 basis points of capital. Lloyds had a CET1 ratio of 12.79% at the end ofMarch 2016, according to data from SNL Financial, an offering of S&P GlobalMarket Intelligence.
, at the end of thefirst half, faced an estimated defined pensions scheme deficit of £855 million,having ended 2015 with a £473 million surplus. Its liabilities grew to £32.60billion from £28.28 billion over that period. This should impact the CET1 ratioby 20 basis points in 2016, RBC said. Its ratio stood at 11.25% at the end ofMarch.
had an estimated pension liability of £40.52 billion at the end of June, accordingto the RBC report, about £2 billion less than its pension assets. But in orderto bring its pension pot above water it had to inject £4.2 billion into thefund in January 2016.
, meanwhile, saidBrexit had contributed to a ballooning of its pension deficit to €1.2 billionat the end of June from €740 million at the end of December 2015. Moody'sanalysts said this is credit negative for the bank because the larger deficitwill probably exceed the capital generated by earnings during the first half of2016, negatively impacting capital ratios. Its CET1 ratio was 11.2% at the endof March.
Theissue is affecting insurers too. Aviva Plc has a pension scheme that RBC estimates is 8%larger than its market cap, with £17.21 billion in liabilities at June-end. RBCsaid the reduction in yields related to Brexit might have pushed the fund intoa deficit of about £1 billion with a funding ratio of 95%. , despite asavvy interest rate hedge, might face a funding deficit of about £450 million,RBC said.
Andpension difficulties are not limited to the U.K. On July 26, its CET1 ratio had dropped to 11.5%at June-end from 12.0% in March, partly because of a spike in pensionliabilities. On a conference call July 28, BNP Paribas SA CFO Lars Machenil was grilled by analystsover his bank's capital exposure to pension deficits, although he said the"little impact" was not material enough to affect the bank's CET1ratio.
Anotherconcern is the way in which pension funds are managed, according to PwC's Mody.He said many pension trustees are acting as mere custodians and often do nothave the required skills to actively monitor their investments and respond tomarket trends in good time. Even at many companies that specialize in finance,pension schemes can be sleepy affairs that are not equipped to deal withextreme market volatility, according to Mody; many have "limitations totheir expertise" and few use information that is reliable enough.
"Evenif [the scheme is] well-funded now it could become badly-funded soon because ofthe way it is managed," he said. "Anything going on in the pensionscheme needs careful monitoring."