Monday, December 1, 2014

The Royal Airline Pension Shaft?

Steve Johnson of the Financial Times reports, Monarch Airlines pension fund reduced to a pauper:
The UK’s Pension Protection Fund is likely to take one of its largest financial hits to date from the Monarch Airlines pension fund.

The PPF, the government-mandated lifeboat for capsized corporate pension plans, agreed to accept the Monarch scheme in October as part of a deal to keep the company afloat, protecting 2,500 jobs.

Greybull Capital, a London-based turnround specialist, agreed to provide £125m of capital and liquidity facilities in exchange for a 90 per cent stake in Monarch, as long as it did not have to assume responsibility for the airline’s pension scheme.

However, John Ralfe, an independent pensions consultant, estimated the deal would cost the PPF £170m, more than a quarter of the £619m of claims it incurred on the 107 schemes it admitted in the year to March 2014.

“This size of hit would make Monarch [among the] half dozen or so largest hits” the PPF has taken since it was formed in 2005, Mr Ralfe said.

Monarch’s accounts show that, as of October 2013, its pension scheme had assets of £302m and liabilities of £500m on an FRS 17 accounting basis. Mr Ralfe calculated this deficit would since have risen to around £220m, although the cost to the PPF is likely to be nearer £200m, given that scheme members, who include comparatively well-paid pilots, will see their individual pensions capped.

The net cost to the PPF is further defrayed by a one-off £30m contribution from the Swiss-Italian Mantegazza family, the previous owners of Monarch, agreed as part of the sale.

The PPF also received a 10 per cent stake in Monarch but this holding, described as an “anti-embarrassment” protection, is not currently ascribed any value.

The fund said the Monarch scheme was still being assessed, but that a hit of around £170m was likely, which would be among the 10 largest it has suffered.

The PPF, which is funded by an annual levy on corporate defined benefit pension schemes, said it was likely to receive around £695m during the current financial year.
Alan Rubenstein, Chief Executive Officer of the Pension Protection Fund, shared these comments on the Monarch deal:
"We welcome that we, along with the Pensions Regulator, have been able to agree a deal with Monarch which meets our principles of restructuring and allows the company to continue trading. We have been in lengthy and detailed negotiations with the numerous interested stakeholders for some time to ensure that the interests of members and levy payers are protected.”

"It is very important to us that pensions liabilities are treated seriously and properly on any restructuring. We are pleased that those involved with the Monarch case understood this fundamental point.”

"Over the coming weeks we expect the pension scheme to enter the PPF assessment period and we will work with the scheme to take this forward and provide reassurance to members.”

“We wish Monarch every success going forward."
Greybull Capital got a good deal here. With the price of oil plunging, airline stocks are taking off as investors bet on a deflationary boom in some sectors. Not having to assume any responsibility on the airline's pension scheme is a huge weight off Greybull's shoulders but they still have to turn in profits in a very competitive industry.

In other airline news, the BBC reports that Lufthansa cancels 1,350 flights as pilots strike again:
German airline Lufthansa has cancelled 1,350 flights, as pilots prepare to go on strike after talks between the carrier and pilots collapsed in a row over retirement benefits.

The cancellations will affect more than 150,000 passengers, Lufthansa said.

The pilots' strike is the ninth since April. Flights affected include both short- and medium-haul flights from 12:00 (11:00 GMT) until 23:00.

Lufthansa's long-haul and cargo flights will also be affected on Tuesday.

Europe's largest airline asked for new talks with union officials and called the strike disproportionate.

The airline wants to phase out its early retirement scheme, something the pilots are strongly opposed to.

They are currently able to retire at the age of 55 and receive up to 60% of their pay until the standard retirement age of 65.

Lufthansa said it had made concessions in recent talks, including giving the pilots a 5% pay rise.

The strikes this year have knocked $160m (£102m) off the airline's operating profits.

The union said "despite all efforts for compromise proposals" by Lufthansa pilots during several rounds of negotiations since October, it had been unable to come to a satisfactory agreement with the company's management.
Suzanne Bishopric, Director of the United Nations Joint Staff Pension Fund, sent me the article above and asked: "Is the increasing frequency of strikes in Germany a sign of Euro Zone convergence?".

I replied that's "it's only the beginning." A lot of people in Germany are in for a rude awakening. Pensions for life starting at the age of 55 is simply wrong for a lot of reasons, chief among them is that it doesn't take into account that people are living longer and companies simply can't afford to take on more longevity risk. 

Finally, here in Canada, Kristine Owram of the Financial Post recently reported, Air Canada may opt out of government lifeline as pension surplus grows:
Only two years ago, Air Canada’s pension plan was a millstone that threatened to send it into bankruptcy court for the second time in a decade. But today it has become so healthy that the airline may opt out of an agreement with Ottawa that forbids investor payouts.

Air Canada reported a small pension surplus at the beginning of 2014, a dramatic turnaround from the $3.7-billion deficit a year earlier. And that surplus has continued to grow throughout the year despite lower interest rates, said chief financial officer Michael Rousseau.

“We’re pleased to report that our surplus has actually increased since the start of the year,” Mr. Rousseau said on a conference call Thursday following the release of the company’s third-quarter results. “Returns have been very solid despite the reduction in interest rates.”

In early 2013, when Air Canada’s pension was deep in the red, the airline signed an agreement with the federal government that gave it more time to cover the shortfall. In exchange, executive compensation was frozen at the rate of inflation and dividends and share buybacks were prohibited.

Mr. Rousseau said the airline will decide early next year whether it will opt out of that agreement now that its pension plan is back in the black, potentially opening the door for new treats for shareholders.

Air Canada’s shares jumped 5.39% to $9.38 Thursday after it reported record results that beat analysts’ expectations thanks in large part to strong performance from its discount carrier, Rouge.

“Rouge has been more successful than we expected and we’ve been very pleased with the rollout,” CEO Calin Rovinescu said, adding that more routes will be announced in the coming months.

Despite the strong third-quarter results, Air Canada cautioned that cost per available seat mile, or CASM — a measure of the airline’s operating cost per seat per mile flown — will fall only 2.5%-to-3.5% this year, less than previously forecast.

And the airline expects to add as much as 10% to its system capacity in 2015 as it continues to expand Rouge and introduce new Boeing 787 Dreamliners to its international fleet.

“The strong Q3 will certainly be well received, however the Q4 CASM guidance and 2015 capacity plans will get some attention,” RBC analyst Walter Spracklin said in a note to clients.

However, Mr. Spracklin pointed to Air Canada’s October load factor, which measures how full its planes are, as a positive sign. Last month’s load factor was 82.1%, an improvement from a year ago despite a 10% increase in capacity.

“The October numbers look very strong and this will temper the possible negative reaction to the 2015 capacity guidance as the demand environment clearly remains robust,” he said.

Air Canada’s adjusted net income came in at $457-million or $1.55 per share, a record for any quarter in the airline’s 77-year history. That beat the estimate of $1.45 and was a 25% improvement from a year ago. Operating margin improved by 1.8 points to 13.8% as operating revenue grew and costs fell.

The airline has been cutting costs through the acquisition of new, denser airplanes, with more seats and less legroom, plus the rollout of the budget-conscious Rouge.

Air Canada also announced Thursday that it will acquire two more high-density Boeing 777 aircraft, bringing its total 777 fleet to 25. It will also replace eight of its Embraer 190 aircraft with three Airbus A320s.
I flew Air Canada Rouge back in September when I visited the epicenter of the euro crisis and was hardly impressed (for direct flights to Athens from Montreal in the summer months, you're better off going with Air Transat if you can get your dates. It's cheaper and better than Rouge).

But leaving aside my criticism of Air Canada (don't get me started), there's no doubt that their pension plan has made a significant turnaround since the company was thrown a pension lifeline back in early 2013.

Since then, its pension has been flying high, aided by higher rates and solid investment gains. The pension staff at Air Canada has done an outstanding job managing assets and liabilities, doing a lot of the things that have helped HOOPP get overfunded. And the plunge in oil prices will also help bolster Air Canada (AC-B.TO) and other Canadian airlines like Transat (TRZ-B.TO) and Westjet (WJA.TO).

Of course, when it comes to pensions, interest rates matter most, and I foresee more trouble ahead at Canada's private DB plans. You can have the best investment staff doing all sorts of yield-enhancing strategies (like selling volatility which Air Canada's Pension does a lot) but if rates stay at historic low levels or worse still, keep dropping, these private DB plans will feel the pain, which is why I continue to call for enhancing the Canada Pension Plan for all Canadians.

Below,  Bloomberg's Kari Lundgren reports on Lufthansa pilots resuming their strike as they press to maintain their retirement benefits. She speaks to Mark Barton, Anna Edwards and Manus Cranny on "Countdown" (clip is from September but same issues still persist).

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