Sponsor Covenants under stress - Assessing sponsor covenants in current conditions Engaged Investor Forum Paul Thornton, Gazelle 21 May 2009 Registered in England No Authorised and regulated by The Financial Services Authority The information and views contained in this document are not intended to be a comprehensive study, nor to provide specific advice, and should not be relied upon nor treated as a substitute for specific advice concerning individual situations. Gazelle Corporate Finance Limited 41 Devonshire Street London W1G 7AJ United Kingdom Telephone: +44 (0) Facsimile: +44 (0)

2 Topics  The assessment of the “sponsor covenant”  Negotiating security for members with a changing corporate agenda  Recovery plans second time round  Opportunities for de-risking through buy-out

3 The basics of sponsor covenant assessment  The ability of the company to generate cash  Other claims on cash flow  Necessary capital expenditure  Financing costs  Investment plans  Maintaining dividends  The wider competitive environment  Corporate structure – where does the principal employer sit?

4 Typical events  sale of all or part of the sponsor’s businesses  financial restructuring within the group  restructuring of activities  payments to shareholders Impact on the covenant  may be increase in debt, location of debt, sale of assets Impact of any change in control  may be change in management, new counterparties, change in approach to DB scheme  may be limited future opportunities to negotiate with the sponsor Impact of corporate events on the covenant

5 Impact of the credit crunch on the employer and covenant  More difficulty in refinancing, including normal debt rollovers  Higher cost of debt  Knock-on effect of any credit-downgrade  The impact will depend on debt profile and exposure to financial markets

6 Impact of an economic slowdown on the employer and covenant  More difficult trading conditions  Reduced revenues or rate of growth of revenues  Slow payment by creditors  Delay to capital investment for future growth generation  Not all companies equally affected

7 How companies are responding Typical corporate responses:  Maintain liquidity, reduce reliance on bank credit, seek other sources of funding  Extend debt maturity profile and review debt/equity ratio  Reduce pay-outs to shareholders – dividends and buy-backs  Sell non-core businesses  Manage the credit rating Factors / concerns  Treasury management - alternative funding routes may not be available  Market increasingly sensitive to loan covenants  Dividend yield support for share price?  Risk of being seen as forced seller  Downgrades having magnified impact

8  Preserving the status quo  Improving the funding position  Improving downside / insolvency exposure  Risk sharing / transfer options Negotiating security for members – setting objectives

9 Recovery plans second time round  A closer look at prospects beyond the slowdown  More reliance on covenant assessment  Pension Regulator guidance – too soft or just right?  Negotiation tactics planned in advance

10  Funding assumptions are driven by investment strategy and level of covenant risk  Covenant risk is aggravated by investment risk and weak funding assumptions - can the sponsor cope with failure of the investments to meet the assumptions?  Investment risk should be reduced and funding assumptions strengthened where the covenant is weak  The strength of the sponsor covenant informs both investment and funding strategy Interaction of sponsor covenant, funding and investment risk Sponsor covenant risk Funding risk Investment risk

11 Buy-outs and Buy-ins – an opportunity for de-risking  Provider’s covenant should compare favourably with the sponsor’s  FSA solvency requirements - but appropriate levels and availability of further capital as yet untested  Financial Services Compensation Scheme underpinning – but could this survive systemic failure?  Backed up by continuing employer covenant in case of buy-in

12 Weighing up the insurance providers How exposed are they as a business?  Traditional insurers - more diversification of risks  New entrants - typically monoline but use additional tools to manage longevity risk  Foreign owned – how strong is “reputational” support? How much capital do they need… and how can they get it if needed?  Where is capital held within the wider group and what restrictions are there on moving it within the group?  Some providers can raise cash from the equity and bond markets…but at what cost?  Some providers are backed by private equity groups…what likelihood / commitment is there for additional capital?

Sponsor Covenants under stress - Assessing sponsor covenants in current conditions Engaged Investor Forum Paul Thornton, Gazelle 21 May 2009 Registered in England No Authorised and regulated by The Financial Services Authority The information and views contained in this document are not intended to be a comprehensive study, nor to provide specific advice, and should not be relied upon nor treated as a substitute for specific advice concerning individual situations. Gazelle Corporate Finance Limited 41 Devonshire Street London W1G 7AJ United Kingdom Telephone: +44 (0) Facsimile: +44 (0)