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Do SMEs have defined benefit pension problems?
5 July 2012
It is not only large plcs that have defined benefit ("DB") pension schemes, there are a lot of SMEs that have them as well. It is also the case that lenders are remaining wary when it comes to funding employers with DB benefit pension schemes, as opposed to defined contribution ("DC") schemes, regardless of whether they are large or small companies.
Clearly the issues associated with DB pension schemes can be complex however just because they are potentially complex is no justification, in isolation, for adopting a negative approach to lending decisions for employers with such schemes.
DB pension schemes associated with SMEs tend to be comparatively small and, to date, scheme volatility has tended to be low. This has therefore not been a major issue for SME employers which include smaller businesses, in some cases with turnover below £3m. However, the recent downward shift in investment returns has caused some scheme deficits to increase significantly at a time when corporate liquidity, particularly in the SME market, is constrained.
Some commentators on the sector have suggested that there are perhaps 300 of these smaller DB schemes where, as a consequence of increasing scheme deficits, there is a seriously increased risk of corporate failure purely as a result of the employer being unable to service the obligations to their DB pension schemes.
However, every business faces risks in all aspects of its operations, which are assessed by a funder when making a lending decision and there is no reason why obligations to pension schemes should be treated any differently. Any funder that is prepared to get "under the skin" of these issues will, I believe, find potential lending opportunities. A detailed enquiry with the employer will often reveal that the scheme obligations are being appropriately addressed and that the employer and scheme trustees are working together to mitigate risk. This can improve the employer covenant and hence mitigate the long term cost of the pension scheme to the employer with the result that the scheme presents no greater risk than other day to day commercial factors.
A good example of this is a recent case where we were able to assist a SME corporate employer in securing a 60% reduction in scheme contributions as a result of robust pragmatic negotiations with the trustees of the scheme. This also enabled the company's bankers to obtain a clearer understanding of the pension position which enabled it to support additional facilities for the company to fund the introduction of new products and the expansion of the company's customer base.
If a lender has concerns about extending a facility or making a new advance where there is a DB pension scheme, there is no reason why an assessment of the obligations to the scheme, the relationship between the employer and the trustees, and the long term management of the scheme risks, should not form part of an external review prior to lending, rather than just seeing the scheme as an immovable obstacle to providing funding.
Wherever a problem is associated with pension scheme obligations, it is appropriate to obtain expert advice as finding solutions can be complex but the problem is often not insurmountable and mutually satisfactory outcomes for the stakeholders can be achieved. However, the fundamental point for bank relationship managers/directors is that they must make themselves aware of and understand the nature of any pension scheme operated by their customers and the business risks that may be associated with it.
Given the uncertainty that exists in dealing with pensions related matters, we would always be pleased to provide an assessment of the issues for the respective stakeholders and funders.
If you or any of your clients are affected by the issues highlighted above, please do not hesitate to contact Gerald Smith on 0121 710 1680 or by email using the online form below.