The banks with the tightest loan to deposit ratios are China Merchants
Bank, Bank of Communications, and China Minsheng, so this move will be
more negative for them.

The investor group, which includes Berkshire Partners, Advent International and Bain Capital will pay $10.80 per American Depositary Share, a 9.6% premium to Thursday’s closing price.

Yesterday’s results demonstrated continued underlying progression in the turnaround story, particularly in Global Service. But the market reacted very negatively to the “substantial concerns” of the Pension Regulator, which has yet to approve the pension funding agreement made between BT and the Pension trustees. This flagged uncertainty over the potential cash drain of deficit contributions. Investors should look through this issue, however, as there is unlikely to be any change to deficit contributions until after the next triennial valuation. As you were then. The stock is now in bargain territory.

If the regulator chooses to interfere, it would first encourage the trustees to think again. We suspect the trustees are unlikely to change their stance, or if they did, they would be unlikely to gain concessions from BT. The company position is clear – management already believes the trustee’s valuation is £6bn too conservative. BT will fight this issue if it needs to. If the regulator wishes to argue the case, it could seek to appoint independent trustees. To do so the case would have to be heard by the Determination Panel (3 people), who must then issue a Determination Notice of their recommendations. This can be appealed to the Pension Regulator Tribunal and further appeals can be held up to the Court of Appeal. BT highlights that similar procedures are still ongoing relating to 2005 valuations, making any resolution to this issue unlikely until well after the next triennial valuation.

The cash contributions to the pension deficit of £525m in December 2010 and 2011 are fixed and will not change. Any uncertainty relates to payments after 2011, whereby the regulator could dispute both the cash contributions and the time span over which BT funds the deficit. By this time the next triennial valuation will come into play, and the world should be a different place to the Armageddon scenario presented to the trustees at December 2008. Nonetheless, if things do not improve over the next few years, BT could face the prospect of larger contributions over a shorter period.

On our analysis BT’s FCF before pensions should rise from £1.7bn to £2bn by 2013. We model dividend related cash payouts of £500m to £600m. This leaves room for well over £1bn of annual pension payments without removing the cash dividend cover. Furthermore, any finalised arrangement would likely be reached after 3 contributory payments had already been made, contributing to a reduction in the deficit, and the impact of any time scale reduction should be reduced; going from, say, 14 years to 10 years, rather than from 17 years to 10 years.