DebtFreeGuru.com's - Tip of the Week - Monday, October 4, 2004
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Companies Sitting on Pension Time Bombs
United
Airlines' struggles have put a new focus on a pension guaranty system that
is near collapse. Reform could take a huge chunk out of the bottom line on
big offenders.
By Michael Brush
(As seen on MSN.Com)
Thanks
to robust stock returns since the lows of mid-2002, a serious problem
weighing on many companies has simply vanished from public debate: Their
massively underfunded pension plans.
Over
the past two years, pension portfolios inside companies have risen sharply
along with the market, sweeping under the rug concerns about looming
retirement-plan shortfalls.
But
severe turbulence in the airline sector may soon change all that, moving
the menace of bankrupt pension plans squarely back into the spotlight.
If
so, many of your stock holdings could be at risk as companies are forced
to shore up pension plans. We’ll get to potential problem companies in a
moment, and the best ways to spot them. But first, a little background on
what’s brewing.
The
domino effect
To
find the culprit that could bring things to a head near term, look no
further than bankrupt UAL Corp. (UALAQ,
news,
msgs),
the parent of United Airlines. As part of its recent flight into
bankruptcy, the troubled airline decided to hoard cash by
“temporarily” suspending contributions to its pension plans.
But
here’s the rub. Many corporate-debt analysts -- like those at
CreditSights, an independent credit research group -- think the move looks
like the first step in a scenario that will see United Airlines walk away
from its pension obligations altogether at some point. United Airlines
suggested as much in court filings last week.
United
Airlines workers won’t spend their golden years in the poorhouse if this
happens. They would still get most, if not all, of their pensions --
because those pensions are guaranteed by our country’s Pension Benefit
Guaranty Corp. (PBGC). That’s a government body funded by premiums from
companies that operate defined-benefit pension plans. (As a quick
refresher: Defined-benefit plans are the ones where workers get a pension
based on how long they worked for a company and how much they got paid.
These workers don’t make direct contributions, unlike people in defined-contribution
plans, such as 401(k) plans.)
However,
if United Airlines bails on its pension obligations and leaves the PBGC to
clean up the mess, that could set off a chain reaction at other airlines
-- most likely Delta Air Lines (DAL,
news,
msgs)
and US Airways Group (UAIR,
news,
msgs),
for starters. They, too, would plead that they need to bail from their
pension obligations to stay competitive, says Glenn Reynolds, chief
executive of CreditSights, “because they will have an inherent
cost-structure disadvantage.”
The
link to your stock portfolio
But
how could the mess hit stocks in your portfolio that have nothing to do
with the airline industry? To find the nexus, look no further than the
PBGC itself -- and the heap of problems it faces.
Thanks
in part to a sharp decline in the number of defined-benefits plans (from
112,000 in the mid-1980s to just over 31,000 today), the PBGC now collects
much less in premiums. That’s one reason it’s at risk of bankruptcy
itself -- or rather, of the need to go to the government for a taxpayer
bailout if it hits the wall, which looks more and more likely.
Look
at the bill PBGC would get stuck with if United Airlines bailed on its
pension obligations. The airline has contributed just $50 million in
premiums to PBGC. But PBGC says it would be saddled with claims worth $6.4
billion. This kind of mismatch provides a powerful incentive for
companies like United Airlines to walk away from their pension
obligations. It’s a good deal -- for them, at least.
Even
before United Airlines went into bankruptcy, problems were mounting at
PBGC. It had an $11.2 billion deficit at the end of 2003. Now, it’s
potentially exposed to bills for as much as $85 billion from possible
pension-plan terminations -- about $23 billion from the airline sector
alone. In total, private defined-benefit plans had a massive $400 billion
gap between assets and liabilities as of the end of 2003, suggesting
bigger headaches down the road. “PBGC is basically going to go bankrupt
if you look at it from a purely actuarial basis, because it can’t handle
the influx of bankrupt pension plans,” says Roger King, a senior analyst
at CreditSights.
Before
that begins to play out, you can bet PBGC will make lots of noise in
“Right
now, PBGC doesn’t tend to go out and pound the table a lot,” says
Reynolds. “But if they get activist, there could be hell to pay for some
of these companies out there. If Congress takes steps to make sure the
gaps are filled, it could affect any of the most exposed companies because
they will be asked to accelerate their payments to their pension funds.”
Already
PBGC executive director Bradley Belt is laying the groundwork for reform.
In a recent speech, he called for changes that would toughen rules and
raise premiums for companies that are at high risk of running into trouble
with their pension plans. That could lower profits, and maybe stock
prices.
Who
will get hit?
To
be sure, the government gave deadbeat companies a reprieve of sorts in
April. That’s when Congress agreed to increase the interest rate used to
discount future pension obligations back to the present. That makes them
look smaller, right now -- even if it doesn’t reduce the bill further
down the road.
“So
now, when you are determining your funding requirement, your pension plan
is going to look healthier,” says David Zion, an accounting expert with
Credit Suisse First Boston. “I viewed it as a bit of a gift.”
Outside
of the airline group, predicts Zion, some of the biggest amounts will be
forked over next year by Ford Motor (F,
news,
msgs),
$1.3 billion; Exxon Mobil (XOM,
news,
msgs),
$1 billion; Hewlett-Packard (HPQ,
news,
msgs),
$472 million; ChevronTexaco (CVX,
news,
msgs),
$450 million; and Altria Group (MO,
news,
msgs),
$392 million.
But
things could get worse if airlines run from their pension obligations and
threaten to put PBGC on the path to bankruptcy, setting off a crackdown on
deadbeat corporations by
Are
investors worried? Sean Reidy, co-manager of the Olstein Financial
Alert Fund (OFALX),
says his fund group backs out unfunded pension obligations when valuing
companies as standard practice. “But we are probably a lot more
conservative than most people.”
Zachary
Shannon, an analyst with Camelback Research Alliance, which tracks
earnings-quality issues and unfunded pension burdens for clients, agrees
that investors seem a lot less concerned about pension issues than they
were a year or two ago. “We think it is still really relevant though,”
he says.
How
to spot trouble
For
a simple way to spot companies most likely to run into trouble, investors
should look for at least two types of weaknesses, according to experts
such as Zion and Shannon:
-
Companies that have the biggest proportion of unfunded pension obligations compared to market capitalization. Unfunded pension obligations at Delta Air Lines, for example, are 8.7 times the size of its market cap. (Another way is to compare the obligations to net assets.)
-
Companies that get the biggest chunk of their net income (excluding unusual items) from assumed returns on their pension investments. Oddly, companies are allowed to include returns on pension investments in their net income -- even though they owe the money to retirees, and those returns are based on assumed rates of return of 8% to 12% that are far bigger than real market returns in many years. “Income from pension plans should be backed out to get a real net income number,” says
We
asked
|
The
20 most underfunded pension plans |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
Source:
Camelback Research
|
20
companies with largest percentage of income from assumed returns on
pension funds |
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
Source:
Camelback Research Alliance
*Reported
pension income minus assumed corporate tax rate of 35%
**Income
excluding unusual items
***For
companies reporting losses, the loss would be lower by this percentage,
without pension income
DebtFreeGuru.com - Tip of the Week - Monday, October 4, 2004
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