As FT Alphaville noted last week, the percentage of British Airways’ shares on loan has been climbing, making it the short-sellers’ favourite airline.
One theory behind the rise is that the carrier’s pension deficit will not make for happy reading when its trustees publish the results of their triennial revaluation sometime in September. The trustees last valued it at £1.74bn in September 2008, but it’s widely-expected to have jumped to over £3bn in 2009.
It’s a point picked up by airline analyst Geoff van Klaveren, formerly of Exane BNP Paribas and now at Deutsche Bank, in his initiation of BA coverage:
The threat of industrial action by cabin crew in the autumn, the publication of the latest actuarial pension deficit at the end of September, and the continued delay of the Iberia deal are potentially negative catalysts for the stock.
Indeed, the interesting thing about that pension review is that it took place at the end of March — when equities were at their lowest point this year. The fund is still about 60 per cent invested in stocks, according to Van Klaveren’s estimates, and thus highly susceptible to market highs and lows.
In theory then, the timing of the revaluation should place the deficit at something like £3.6bn, he says.
The saving grace of the deficit, however, will be the pension trustees’ ability to toy with the discount rate — a measure used to value pension funds’ liabilites, according to Van Klaveren (for a full discussion of pensions accounting see here, here, or here). The discount rate is usually based on high-quality corporate or government bond yields. A lower discount rate tends to increase pension liabilities, and a higher one tends to decrease them.
We’re not sure how much flexibility the trustees actually have on the discount rate. Traditionally UK pension trustees use gilt yields, which were relatively low in March, right before the Bank of England began quantititative easing. Nevertheless, Van Klaveren says:
In reality the pension actuaries will take into account the facts that the European equity markets have risen more than 25% since 31 March 2009. They will do this by taking a more aggressive discount rate on the liabilities. For example, a 50bp increase in the discount rate would reduce our theoretical deficit to GBP2.4bn, and a 100bp increase in the discount rate would reduce the theoretical deficit to GBP1.2bn. The deficit is therefore highly sensitive to the discount rate.
The idea then is that while BA’s 2009 pension deficit will probably be higher than in 2008, it won’t be as high as it would have been without that increased discount rate.
If the market can see through any possible tampering with the discount rate, however, those short-sellers may yet avoid a BA burn.
Related links:
British Airways’ cash conundrum - FT Alphaville
British Airway’s pension puff - FT Alphaville
Sums that risk BA landing in a pensions hole - FT
