From Barron's:
Pension Funds Move From Red Ink to Black
By DIMITRA DEFOTIS
FOR THE LAST two years, investors have feared that corporate pension
obligations will gouge some companies' earnings. But things are
looking up.
Big stock market gains last year helped pension fund assets grow
again. That means companies have to put less money into their
retirement plans this year.
And federal legislation may reduce corporate America's future
pension obligations substantially over the next two years.
Some unprofitable industries that have huge pension obligations,
including airlines and steel companies, still may need government
intervention. But an improving economy and rising interest rates
could take the heat off some old-line companies by reducing the cash
they must set aside now to meet their obligations later.
"Pensions are less of an issue now versus a year ago, because the
stock market has cured some of the problem, and some earnings
improvement at companies means [they] can put more money into
their pension plans," says John Carey, manager of the Pioneer Fund.
Companies that promise a defined payout when an employee retires
must set aside roughly 80% of those estimated future obligations.
Those assets have been partly invested in the stock market, which is
still down 25% from its peak in March 2000.
That's why most of the 358 companies in the Standard & Poor's 500
that still pay out pensions have underfunded plans.
But 18 of those companies' pension plans moved to overfunded status
in 2003 from a deficit in 2002, according to S&P. The biggest flip-
flops among the 18 companies: SBC Communications International,
Consolidated Edison and Citigroup, according to S&P (see Chart).
Financial companies were among the biggest beneficiaries of the
turnabout.
Another 26 companies' pensions were flush in both years: Bank One
and Tribune reported the greatest percentage gains in assets, and
General Electric and AT&T had the biggest gains in dollar value,
according to S&P.
Even the 256 companies that had underfunded pensions in 2003 grew
their assets by 21%, says Howard Silverblatt, an S&P equity market
analyst.
"We believe the market will return 12% in 2004, and we think 2005 is
going to continue with a positive return, … so we project pension
improvement," Silverblatt says.
There are two other reasons the pension situation should improve.
First, interest rates are expected to rise. Higher rates, when used to
discount future pension obligations, will reduce the amount of money
needed to fund pensions now. Secondly, there appears to be
bipartisan agreement in Congress that the current rate companies use
to discount their future pension liabilities is too low.
A Congressional committee, facing pressure this week from
manufacturers who must make mid-April pension payments, could
set a high-grade corporate bond rate (now near 6%), not the lower
30-year Treasury bond rate (4.78%), as a benchmark for discounting
future pension obligations back to the present.
Such a discount rate change could save companies $80 billion over
the next two years, says Anne Mathias, a pension expert at Schwab
Soundview Capital Markets' Washington Research Group.
Those extra dollars can boost these companies' cash flow and
earnings, Silverblatt says.
The National Association of Manufacturers is lobbying Congress to
provide pension fund discount-rate relief before April 15, when
members must pay into underfunded plans, says Dorothy Coleman, a
lobbyist for the association. The discount rate change, however, is
tied to some other knotty issues, so passage isn't certain.
Future pension obligations can put companies that have weak
earnings behind the eight ball, since these firms must fund pensions
even when operating losses are mounting.
For instance, in 2003 Boise Cascade earned a paltry $8 million before
extraordinary items, and its pension was underfunded to the tune of
$460 million, according to S&P.
The automotive industry is struggling, too. Truck-engine maker
Cummins' pension obligation is $671 million, though the fund's
assets grew by 17% in 2003 (see Weekday Trader, "Pensions Could
Mean Wrong Turn for Auto Suppliers," October 21, 2002).
Ronald O'Hanley, vice chairman of Mellon Financial Corp. and head of
Mellon's pension group, says investors should consider more carefully
how a pension plan's volatility affects companies' financial
statements.
"The pension fund can whip everything around and is much more
significant than anything management can do with the income
statement," O'Hanley says.
Even when a pension plan looks healthy, its long-term obligations
may be staggering, says Wayne Guay, assistant professor of
accounting at the Wharton School of the University of Pennsylvania.
"You need to dig into the footnotes on a firm with a large, defined-
benefit pension plan because the balance sheet and income
statements are not likely to portray the real economic impact of the
pension plan in a clear manner," Guay says.
Some Washington observers are skeptical Congress will be able to
pass a bill raising the discount rate before its April recess.
But barring another big bear market, companies should be able to
fund their pensions while growing their businesses and earnings.
And any relief lawmakers come up with in this area would be like a
check in the mail for investors.
Copyright © 2004 Dow Jones & Company, Inc. All Rights Reserved
Pension Funds Move From Red Ink to Black
By DIMITRA DEFOTIS
FOR THE LAST two years, investors have feared that corporate pension
obligations will gouge some companies' earnings. But things are
looking up.
Big stock market gains last year helped pension fund assets grow
again. That means companies have to put less money into their
retirement plans this year.
And federal legislation may reduce corporate America's future
pension obligations substantially over the next two years.
Some unprofitable industries that have huge pension obligations,
including airlines and steel companies, still may need government
intervention. But an improving economy and rising interest rates
could take the heat off some old-line companies by reducing the cash
they must set aside now to meet their obligations later.
"Pensions are less of an issue now versus a year ago, because the
stock market has cured some of the problem, and some earnings
improvement at companies means [they] can put more money into
their pension plans," says John Carey, manager of the Pioneer Fund.
Companies that promise a defined payout when an employee retires
must set aside roughly 80% of those estimated future obligations.
Those assets have been partly invested in the stock market, which is
still down 25% from its peak in March 2000.
That's why most of the 358 companies in the Standard & Poor's 500
that still pay out pensions have underfunded plans.
But 18 of those companies' pension plans moved to overfunded status
in 2003 from a deficit in 2002, according to S&P. The biggest flip-
flops among the 18 companies: SBC Communications International,
Consolidated Edison and Citigroup, according to S&P (see Chart).
Financial companies were among the biggest beneficiaries of the
turnabout.
Another 26 companies' pensions were flush in both years: Bank One
and Tribune reported the greatest percentage gains in assets, and
General Electric and AT&T had the biggest gains in dollar value,
according to S&P.
Even the 256 companies that had underfunded pensions in 2003 grew
their assets by 21%, says Howard Silverblatt, an S&P equity market
analyst.
"We believe the market will return 12% in 2004, and we think 2005 is
going to continue with a positive return, … so we project pension
improvement," Silverblatt says.
There are two other reasons the pension situation should improve.
First, interest rates are expected to rise. Higher rates, when used to
discount future pension obligations, will reduce the amount of money
needed to fund pensions now. Secondly, there appears to be
bipartisan agreement in Congress that the current rate companies use
to discount their future pension liabilities is too low.
A Congressional committee, facing pressure this week from
manufacturers who must make mid-April pension payments, could
set a high-grade corporate bond rate (now near 6%), not the lower
30-year Treasury bond rate (4.78%), as a benchmark for discounting
future pension obligations back to the present.
Such a discount rate change could save companies $80 billion over
the next two years, says Anne Mathias, a pension expert at Schwab
Soundview Capital Markets' Washington Research Group.
Those extra dollars can boost these companies' cash flow and
earnings, Silverblatt says.
The National Association of Manufacturers is lobbying Congress to
provide pension fund discount-rate relief before April 15, when
members must pay into underfunded plans, says Dorothy Coleman, a
lobbyist for the association. The discount rate change, however, is
tied to some other knotty issues, so passage isn't certain.
Future pension obligations can put companies that have weak
earnings behind the eight ball, since these firms must fund pensions
even when operating losses are mounting.
For instance, in 2003 Boise Cascade earned a paltry $8 million before
extraordinary items, and its pension was underfunded to the tune of
$460 million, according to S&P.
The automotive industry is struggling, too. Truck-engine maker
Cummins' pension obligation is $671 million, though the fund's
assets grew by 17% in 2003 (see Weekday Trader, "Pensions Could
Mean Wrong Turn for Auto Suppliers," October 21, 2002).
Ronald O'Hanley, vice chairman of Mellon Financial Corp. and head of
Mellon's pension group, says investors should consider more carefully
how a pension plan's volatility affects companies' financial
statements.
"The pension fund can whip everything around and is much more
significant than anything management can do with the income
statement," O'Hanley says.
Even when a pension plan looks healthy, its long-term obligations
may be staggering, says Wayne Guay, assistant professor of
accounting at the Wharton School of the University of Pennsylvania.
"You need to dig into the footnotes on a firm with a large, defined-
benefit pension plan because the balance sheet and income
statements are not likely to portray the real economic impact of the
pension plan in a clear manner," Guay says.
Some Washington observers are skeptical Congress will be able to
pass a bill raising the discount rate before its April recess.
But barring another big bear market, companies should be able to
fund their pensions while growing their businesses and earnings.
And any relief lawmakers come up with in this area would be like a
check in the mail for investors.
Copyright © 2004 Dow Jones & Company, Inc. All Rights Reserved
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