More debt won’t solve BA’s pensions headache

July 17, 2009

Issuing a bond or taking out a bank loan to support a pension fund deficit is not a solution to a problem. It is simply a way of funding one future liability with another. At best it defers the problem; at worst it can magnify it.

So when British Airways <BAY.L> gets a big pat on the back for borrowing 300 million pounds and securing the facilities to borrow another 330 million pounds, in spite of having net debts of 2.5 billion pounds at the end of June, this just underlines the nastiness of the financial state it is in .

The financial crisis is a sort of perfect storm for BA. Premium air travel, especially over the north Atlantic where it makes much of its money, is plummeting. Global business class fares fell by 23.6 percent in May according to the International Air Transport Association. Meanwhile, the slump in the prices of most financial assets have ballooned its pension fund deficit. BA is undertaking a triennial review of its pension funds and the word on the street is that the deficit may be in excess of 3 billion pounds. That compares with a market capitalisation of just 1.4 billion pounds.

In its latest annual report, BA wryly observed: “If the financial markets deteriorate further, our pension deficit may increase, impacting balance sheet liabilities, which may in turn affect our ability to raise additional funds.”

The fund-raising does at least lay this fear to rest. Moreover, the additional 600 million pounds gives the airline total headroom of 2 billion pounds which should see it through the downturn –  though a further cash call cannot be ruled out.

The use of convertible debt allows BA to achieve some value for the high volatility of its own stock. The 300 million pound issue converts into shares at a premium of between 30 percent and 38 percent, increasing the shares outstanding by just 15 percent to 20 percent assuming full conversion. A straight share issue would have involved much greater dilution.

And lastly, the fact that the pension trustees released 300 million pounds of “rainy day money” has led some conclude to that BA’s pension problems may not be as deep as feared. But this may be a misreading. Rather, the trustees may have concluded that the guarantees are a drop in the ocean in the context of the deficit. The bigger priority therefore is to avoid doing anything that risks bankrupting BA.

This brings us back to the underlying point. BA may have staved off a financial crisis. But it will not solve its problems by issuing more debt. To do that it will have to cut its costs and find a way to bring its pensions deficit under control.

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