Dividend block – a post-Brexit vote reality?

Despite an upbeat trading statement, Carclo plc recently announced that they may not be able to pay their final dividend (a modest cash cost of £1.3 million) because of the increase of their IAS19 pension deficit since the Brexit vote due to a material fall in corporate bond yields.

This is despite having plenty of cash in the bank, and a market cap of around £100 million so what is going on?

How pension deficits impact available profits

All companies in the UK can only pay dividends out of ‘profits available for distribution’ (also known as ‘distributable reserves’) as shown in their ‘relevant accounts’.

Carclo’s relevant accounts are their 31 March 2016 accounts and they were expecting to pay their final dividend on 7 October 2016.

At 31 March 2016 distributable reserves in Carclo plc were around £7.9 million, so paying out £1.3 million as a dividend seems OK.  Before actually paying a dividend the directors also need to believe the company still has sufficient distributable reserves from which to pay the dividend.  The wrinkle here is that changes in pension scheme deficits directly impact distributable reserves, via changes to other comprehensive income. 

Falling bond yields increase deficits

Carclo has a defined benefit pension scheme, quite a big one compared to the size of the plc’s balance sheet.  At 31 March 2016 there was an accounting deficit of £23 million on a liability value of just a shade under £200 million.

So let’s consider what happened between 31 March 2016 and 31 August 2016:

• high quality corporate bond yields (the ones that are used to derive the discount rates for value pension liabilities in companies’ books) fell by around 1.4%pa
• long term price inflation expectations remained broadly unchanged

For a typical pension scheme, the liability value will have increased by around 20% to 25%.  For Carclo this means an increase of over £40 million in the liability value.  Over the same period assets will generally have increased in value as well and Carclo’s pension scheme assets might have increased in value by around £20 million.

So overall we have liability values up by £40 million and asset values up by £20 million meaning distributable reserves have taken a hit of around £20 million taking them from £8 million at 31 March 2016 to around -£12 million at 31 August 2016.

The result is that distributable reserves are now negative and hence the directors can no longer pay the final dividend due on 7 October – unless market conditions improve… quite a bit… in the next month…

Pension scheme risks can impact on companies’ finances

Is this just a one-off?

Given the recent falls in corporate bond yields it may be something finance directors and investors need to get used to.  Monitoring tools can help employers get to grips with the impact of their pension scheme on company finances.

Time for companies to really start measuring and controlling their pension scheme risks?

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