PENSION FLOP CAPITAL PARTNERS

Last year, when the Pension Benefit Guaranty Corporation (PBGC) announced it would bail out the pension plan of bankrupt supermarket chain Penn Traffic Company, the PBGC gave details on the pension's projected shortfall and how the pension guarantor would fund this liability. The PBGC, based in Washington DC, also gave helpful details to Penn Traffic pensioners on how to locate information about where their retirement funds would now be coming from.

Not mentioned in the press release, but of great interest to anyone who invests in distressed companies, is the fact that the PBGC also took a 23.2 percent equity stake in Penn Traffic as part of the pension liability assumption, according to records PEI obtained from the PBGC in a Freedom of Information Act request.

Over the years, the PBGC has been awarded equity stakes – sometimes of significant size – in numerous busted companies. But the process behind these participations, and the PBGC's strategy in exiting these positions, is somewhat of a mystery to the outside world. “We don't want people to follow where we invest,” explains William FitzGerald, a disclosure officer with the PBGC. “The government doesn't want to be the investment wedge for the economy.”

The PBGC was created in 1974 by the federal government to promote the growth of defined-benefit pension plans. (Private equity GPs should be thankful for this, as these plans have become the capital backbone of the industry.) When a company is about to have trouble funding its pension plan, the PBGC can step in to guarantee the continued payout of funds to pensioners. The corporation is not supported by taxes. Instead, an important source of funding for the PBGC has been insurance premiums paid by member pension plans. The corporation also supports its activities via investment proceeds.

Unfortunately, the PBGC's financial condition currently is in poor shape thanks to the generally weak state of pension funds in the US (which is of course part of a global phenomenon). Pension plan terminations have spiked considerably, and the PBGC has warned that as it faces the prospect of bailing out more plans, its base of premium-paying insured participants is falling. Last year, the federal corporation took in just $1.5 billion in insurance premiums but had to pay out $4 billion to bail out pension plans.

The one bright spot for the PBGC is its investment income, which brought in $3.9 billion last year. As of last September, the corporation had roughly $33 billion in “received assets from terminated plans”, according to the 2005 annual report. The PBGC estimates that about 25 percent of this is in the form of equity.

On a case-by-case basis, the PBGC will end up with a stake in a bankrupt company that has turned its pension plan over to the federal guarantor. For example, when United Airlines dumped its pension plan on the PBGC last year in the largest corporate pension default in US history, the guarantor ended up with more than 11 million common shares of the airline. Information provided by the PBGC did not specify what percentage stake this gives it in United. However the reorganised airline company currently has 98 million shares outstanding and a market cap of $3 billion.

The PBGC also has significant stakes in Aloha Airlines, Fansteel, Polaroid, US Airways, Singer, Atlas Minerals, Uniroyal, TWA and Smith Corona, among other smaller stakes. Information provided in the FOIA request goes back to the early 1990s.

FitzGerald says he has no “cut and dried answer” on the PBGC's policy for exiting equity positions acquired during bankruptcy. “It depends on circumstances. We have equity managers and we pay them lots of money for advice about this.”

The PBGC's core mission is not to maximise its own gains, but to maximise the financial health of the companies whose pension liabilities have been assumed. With large equity stakes in many of its major “clients”, however, it can be said that there is an alignment of interests. FitzGerald notes, too, that the PBGC is meant to exist “in perpetuity, and that's a long time”.

As pressure mounts on this federal programme, it seems its long-term financial health will increasingly depend on the post-bankruptcy performance of its received equity. One hopes that the feds are getting good advice in this regard.