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COVID and covenant: six months on

COVID and covenant: six months on

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Six months after the UK first went into lockdown, COVID-19 continues to dominate life and the economy in the UK.   Compared to the previous quarter, economic output fell by 20% from April to June, – the biggest quarterly fall on record.

There are signs of recovery.  Following the re-opening of ‘non-essential’ retail from 15 June, retail spending is back to pre-pandemic levels, though patterns have changed dramatically.  Food retail in the three months to August 2020 was up 4% on the previous year, but spending in non-food stores was down 10%.  Online sales have increased to 25% of all retail sales, at the expense of bricks-and-mortar retail.  Suburban high streets are getting busier, while city centres remain quiet.

Other industries face severe problems. Demand in the travel and tourism industries remains low; VisitBritain forecasts a 73% fall in visits from overseas and a 49% fall in domestic tourism spending this year, compared with 2019.  77% of eligible jobs in the accommodation and food services sector had been furloughed by the end of July.  Hospitality received a short-term boost from the ‘Eat Out to Help Out’ scheme in August but local restrictions affecting around a sixth of the population and the nationwide ‘Rule of Six’ continue to depress demand.  Restaurant closures and job cuts are increasing as the furlough scheme comes to an end.  (This trend is unlikely to be stemmed by the replacement Job Support Scheme announced on 24 September 2020, due to its cost to employers.)  The increase in home working has reduced demand for office services, such as stationery and maintenance.  The arts and entertainment sector is all but shut down and experiencing an existential crisis.

Crises in particular sectors may not directly lead to DB pension risk.  For example, the live arts sector is highly dependent on freelancing and short contracts and DB pension schemes are uncommon.  (Some older arts organisations with more stable workforces, such as the major orchestras, do carry significant historic DB liabilities.)  On the other hand, the problems in the travel sector impact, both directly and indirectly, many large companies with sizeable DB schemes.  Airlines not taking delivery of aeroplanes is causing problems throughout the aerospace sector and its supply chains.

Looking more widely, employers across the board are incurring increased costs as they have had to adapt, and continue to adapt, their working environments and practices to make them ‘COVID secure’.  Businesses of all types remain vulnerable to disruption and unplanned costs from the direct and indirect impact of COVID infection on their workforces.  One confirmed case in a school can result in dozens of children sent home for two weeks and parents unable to work.  Increased costs and reduced profitability will extend into 2021 across a wide range of sectors.

Covenants are also being impacted by increased debt.  As at 20 September 2020, over 66,000 small and medium-sized businesses (up to £45 million turnover) had between them accessed over £15 billion of loans under the Coronavirus Business Interruption Loan Scheme.  Larger businesses had received £3.8 billion through the Coronavirus Large Business Interruption Loan Scheme.  As at 23 September 2020, the Bank of England held £16.4 billion of commercial paper issued by corporates under the Covid Corporate Financing Facility.  (These schemes combined were smaller than the Bounce Back Loan Scheme, under which a total of £38 billion had been lent to over one million small businesses.)  £27.5 billion of VAT liabilities were deferred by businesses of all sizes in the period from March to June.

On 24 September 2020 the Chancellor announced some measures to ease repayment of this debt.  Deferred VAT was originally due for payment in March 2021, but businesses will be given the option to spread payments over 2021-22.  The government intends to allow lenders to extend the term of a Coronavirus Business Interruption Loan from six to ten years.

And then there is Brexit.  On 31 December 2020 the UK will finally leave the European Single Market and Customs Union, as the transition period comes to an end.  Whether or not some form of trade agreement is reached before then, there will be new trade frictions and increased costs for both importers and exporters.  The question is how much disruption, friction and cost there will be.  The forthcoming US election adds to global economic uncertainty.

With no end to the pandemic in sight and further ripples or waves of infection likely to sweep across the country for the foreseeable future, it is vital that trustees look afresh at their covenant.  It is becoming increasingly clear that the covenant effects of the pandemic are very sector-specific.  The same will be true of the changes that will follow the end of the Brexit transition period.  If your funding strategy depends on continuing employer support, trustees and employers should agree monitoring frameworks on at least a six-monthly basis so that both sides understand the covenant risks and what is being done to address them.

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