Oil and Gas

US companies using debt to cover pension shortfalls

April 5 (IFR) - Faced with ballooning deficits in their pension funds, US companies are increasingly turning to the bond market to help plug the gap, taking advantage of super-low borrowing costs.

The 100 biggest US pension funds had a combined deficit of $326.8bn last year, pushing up charges to earnings to an all-time high of $38.3bn, according to consulting firm Milliman.

That figure is expected to rise to as much as $54bn in 2012, Milliman said.

To address their pension liabilities, companies are set to make record contributions into pension funds this year -- and many are turning to the debt capital markets to raise the cash.

“We have already seen a number of companies access the debt markets in recent months to finance their pension needs,” said Andrew Karp, head of investment-grade debt syndicate at Bank of America Merrill Lynch.

“It’s definitely something that we have identified as a potential use of proceeds this year,” he said.

Low interest rates are driving the surge in pension fund deficits.

As Treasury yields drop, so too does the percentage at which the funds can discount future liabilities when calculating their size on a net present-value basis.

The discount rate fell to a historic year-end low in 2011 at 4.80%. That rate was around 6.5% in 2008.

Barring a spectacular turnaround in equity markets, there isn’t much likelihood of the problem easing, as the Fed will otherwise stick to its low-rates policy through the end of 2014.

“Given the record-low discount rates, we estimate that 2012 pension expense will increase $16 billion, resulting in a record $54 billion charge to corporate earnings,” said John Ehrhardt, author of the Milliman report.

Several big corporate names have already turned to the bond market in recent months.

Raytheon issued $575m in 1.4% three-year and $425m in 4.7% 30-year bonds to fund increased contributions to their pension schemes.

CSX Corp issued $300m in 4.4% 30.5-year notes, while the Kroger Company sold $450m in 2.2% five-year bonds.


According to the US Census Bureau, the percentage of the population 65 years or older will jump from 12.4% in 2000 to 20.7% by 2050.

That suggests the overall problem of underfunded pensions can only get worse, unless corporations start to address the shortfalls now.

At the moment many corporates have record levels of cash on hand. But for those who want to conserve their liquidity or don’t have the cash to spare, record-low interest rates may convince them to use new bond issues to top up their pension funds.

“Our dialogue with corporate sponsors of pension plans is unusually active for this time of year, which is normally fairly quiet since most companies defer pension funding decisions to the fourth quarter,” Caitlin Long, from Morgan Stanley’s corporate strategies group, told IFR.

Normally companies issue bonds with five-year maturities for contribution money, but with funding levels at historic lows, companies are considering longer-dated deals.

“Most companies view pension deficits as roughly equal to five-year debt maturities, so funding pensions with proceeds of 10s and 30s terms out the obligation,” Long said.

Last year’s record 9.3% growth in liabilities versus 2010 overwhelmed the 5.9% investment return for the 100 biggest corporate pension funds, which had expected a 7.8% average return, the report said.

The shortfall came despite the fact that the corporate owners of those funds pumped $55.1bn of cash into them in 2011 -- and record levels of contributions are expected this year.

Ford and Exxon-Mobil expect that their 2012 pension contributions will be approximately $3.8bn and $2.9bn, respectively.

In addition, the study found, eight companies expect their 2012 contributions to be at least $1bn -- Boeing, Caterpillar, GE, Honeywell, Lockheed-Martin, Pepsi, Raytheon and Verizon.

The high numbers expected this year are also partly down to companies deferring some contributions until this year.

Last year’s contributions from General Motors, UPS and Pepsi, for example, decreased from 2010 by $2.1bn, $1.8bn, and $1.2bn respectively, Milliman reported.

One reason for deferring was the hope that the government will amend the Pension Protection Act of 2006 to allow for lower pension contributions beginning in 2012. The US Senate has approved the bill to amend the law in mid-March, and it is currently pending in the House of Representatives.


According to Moody’s, the aerospace and defense sector is among those most burdened with pension deficits.

It cited in particular Boeing, Lockheed Martin, Northrop Grumman, United Technologies, Honeywell, Raytheon, General Dynamics and Textron.

Those eight companies ended 2011 with $35bn in unfunded liabilities, nearly two-thirds of the entire $54bn pension deficit for the 55 companies Moody’s rates in the sector.

The pension deficit is more than $15bn for the eight, Moody’s said, and the sector’s average funded status of 77% has plunged from 2010’s average of 82% at the end of 2010.

“At a combined $51bn plus, the funding gap for these eight companies equates to about 95% of the level of under-funding for the entire 55 company rated industry group just one year ago,” Moody’s said in the report released this week.

Corporates are also increasingly adopting liability driven investment (LDI) initiatives to reduce the level of volatility in their pension funds. One way to reduce volatility is to cut back on equity investments, which have typically been the dominant asset class in pension funds.

For the first time in the 12 years that Milliman has been tracking pension funds, the amount of assets the funds have in fixed-income investments exceeded that in equities in the top 100.

In 2011, the percentage of pension-plan assets invested in equities dropped to 38.1% from about 43.8%, while fixed-income allocations increased to 41.4% from 36.4%.

It was the first time Milliman had seen a reduction in equity investments versus an increase in fixed income, and that shift reflects the huge volatility that pension funds have suffered by being invested too much in equities.

“Plan sponsors have several options to reduce or completely eliminate pension risk,” said Wesley Smyth, an analyst at Moody’s.

“We view the elimination or reduction of pension risk as a credit positive; however the resulting positive must be weighed against the cost involved.”

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