Laura Blows reveals a novel solution by Legal & General for companies to use property to partially fund a buyout

For the past few years, de-risking has been the key focus for companies managing their DB schemes, with a buyout - handing over responsibility of the DB scheme to an insurer - considered the ultimate de-risking solution.

It is little wonder that sponsors may want to wash their hands of their DB scheme, as final salary pension schemes’ funding (or lack thereof) has become a lot more prominent on a company’s balance sheet, thanks to the IAS19 accounting standard and its recent amendment to do away with the ‘corridor method’ of reporting expected gains and losses.

Another factor is the recent Court of Appeal ruling regarding The Pensions Regulator issuing Financial Support Directions (FSD) against Nortel and Lehmans following their insolvency, which found that complying with a FSD is an expense of insolvency, so must be paid before any distributions to unsecured creditors. This means that pension scheme liabilities is likely to be placed even higher up the distribution priority order in the event of insolvency.

But it is not just final salary pension schemes that are causing headaches for companies. In these current volatile market conditions, many companies that are long in commercial property are finding it hard to unlock the value locked up in these assets. However, Legal & General is offering a way for both of these issues to be solved: by giving companies the option to conduct a buyout and pay for part of it using property assets.

According to Legal & General’s head of pension buyouts Tom Ground: “This is an exciting prospect for companies as it means they can unlock the value embedded in their property and fix their pension scheme deficit, or even remove it, at the same time.”

This is not expected to add any more time to the buyout process, as both transactions are conducted simultaneously. To make sure things go smoothly Legal & General’s annuity business and property fund managers, Legal & General Property (LGP), work closely together to assess the company’s property assets and factor in the suitability of the property portfolio.

In order to complete a property transaction at the same time as a buyout, the company would need to have an investment grade credit rating and be prepared to enter into a lease term of at least 20 years which is annually index-linked. The property portfolio would need to be worth more than £25 million. So this type of deal would only be suitable for buyouts with a notional value of over £250 million, assuming the scheme is 10 per cent to 15 per cent under funded.

This solution does not only apply to portfolios that are owned outright, because Legal & General can now provide commercial property financing, which means that this proposition can be applied to a wider range of portfolios. Doing the refinancing and lease-back transactions together could allow companies to unlock a greater proportion of the embedded value in their property portfolios.
Ground says: “Property lease income is attractive as it is similar to an annuity cash flow. Legal & General are primarily interested in the cash flow and the property only as much as it is security on this cashflow. This means we are happy to do a property transaction where the property reverts back to the company at the end, so it’s like a lease. This way the company can help fund the pension deficit while retaining control of the property, and any uplift in value, at the end of the lease.”

Legal & General has not yet conducted simultaneously a buyout and a property financing arrangement; however it is uniquely placed, in terms of its property investment, property lending and buyout business, to be able to offer this solution to companies.

LGP has recently acquired for one of its clients Imperial College London and Berkeley First’s joint student property venture in Battersea for £116 million, in an industry-first deal that enables LGP to let the property to Imperial College London on a 45 year lease, with annual RPI-linked reviews, after which the freehold/ownership reverts back to the university. Separately, Legal & General has also recently completed one of the largest buyouts to date; conducting a bulk annuity contract with T&N Retirements Benefits Scheme in a deal worth £1.1 billion.

The natural next step is to deploy this expertise – in executing large, complex annuity transactions and in structuring property deals – in the same transaction. The benefits of this joint buyout/property transaction are clear, as Ground summarises: “This is a cost-effective way to unlock value embedded in property, fix property refinancing issues and solve a pension scheme’s deficit problems, while only dealing with one counterparty.”

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