After Market Rout, Pension Pain Looms
Wall Street Journal
By DAVID REILLY
OCTOBER 29, 2008, 4:28 P.M. ET
Corporate pension plans dug themselves out of a deep hole between 2002 and 2007. Now, they're back in it.
That presents already rattled investors with yet another worry: Pension-plan shortfalls will likely result next year in hits to earnings, shareholders equity and possibly cash at a number of companies.
Given the prevalence of
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Given the complexity of pension accounting and the fact that companies generally measure their plans at year end, it's still too early to say exactly how the market downturn will affect specific companies. As Tuesday's rally showed, a lot can still happen to the market between now and Dec. 31.
But it's clear that trouble is brewing. At the end of 2007, companies in the S&P 500 had a combined pension-plan surplus of about $60 billion, according to David Zion, accounting analyst at Credit Suisse. The market selloff in the nine months to late September turned that into a combined deficit of about $75 billion, he estimated.
Then came the October market rout. That could result in a $314 billion deficit if more downbeat assumptions about market values, such as a 40% fall in stock prices for all of 2008, are plugged into Mr. Zion's S&P 500 pension-plan model. Even if markets rally a bit and stocks end down just 30%, companies could still face a deficit of about $186 billion.
Because companies record the value of their plans' surplus or deficit in shareholders equity, deficits cut into companies' book value, or net worth.
Drops in book value are especially harmful to financial companies, potentially limiting their use of borrowed money, or leverage. But they can also hurt nonfinancial companies, which sometimes have covenants in bond or loan agreements that prevent debt from rising too high as a percentage of equity. Lower equity can also inhibit future borrowing.
Mr. Zion estimated in his September report that Unisys Corp., for example, could face a $480 million hit to equity, which would be equal to 130% of book value. A possible $675 million hit at Qwest Communications would equal 120% of book value.
Deficits could also result in a cash call for some companies, based on federal rules that require funds to be pumped into plans when shortfalls pass certain thresholds.
How badly big pension deficits affect earnings depends on a host of estimates, because pension accounting rules spread out over a number of years the impact of changes in plans' funded status.
But there will be suffering. In a note this week, Bernstein Research lowered 2009 estimates for AT&T and Verizon based on expectations that increased pension and other retirement benefit costs could reduce earnings by 4.7% and 4.5%, respectively.
Merrill Lynch, meanwhile, estimated in a recent report that pension hits could cut expected 2009 earnings at General Motors by 79%, while leading to a 35% reduction at Con Edison and a 24% decline at New York Times Co.
The upending of the financial system could also force companies to rethink long-term return assumptions, which now average about 8%. That seems way too rosy given that over the past 10 years, the S&P 500 has actually lost about 12%, for an annual return of about negative 0.6%.
If companies start ratcheting down return assumptions, earnings hits will extend well beyond 2009. That could leave plans, and companies, with a lot more digging to do.
Write to David Reilly at email@example.com