Posted on 10/27/2002 5:08:05 AM PST by sarcasm
NEW YORK - Even if the economy manages to bounce back, don't expect corporate profits to soar. Not if underfunded pensions keep crimping the bottom line.
When Wall Street was going up and up, companies shifted more of their pension funds into stocks and watched their assets grow.
But the plunging stock market has sent their holdings tumbling, and now they will have to contribute big money to cover their costs.
That's sure to knock down earnings, in some cases taking millions of dollars out of profits.
"Earnings won't be able to come back so fast, if only for the problem with pensions," said Frederic M. Stiner, chairman of the accounting, taxation and law department at Long Island University in Brooklyn, N.Y.
The pension crunch only affects companies with defined benefit plans, those that promise future pension payments. About 360 of the 500 companies in the Standard & Poor's 500 stock index offer them.
Unaffected are defined contribution plans, such as 401(k)s. In these plans, employees pitch in part of their salary each month, with the company sometimes making matching contributions.
During the stock market boom, soaring share prices resulted in a big boost to pension assets, with growth far outpacing expenses. Accounting rules let companies add that extra income to their earnings, spaced out over 15 years.
The pension surplus in 1999 was $252 billion, the highest in more than a decade, according to a recent study from UBS Warburg. But that drastically changed over the last three years, with UBS Warburg now estimating a current pension deficit of $126 billion.
When pension plans are underfunded by at least 10 percent of their obligations, companies have to fill the void.
So even when the economic recovery kicks in, many companies may still be pressed for cash, and that will likely mean lower profits.
A recent study by Credit Suisse First Boston estimates that companies in the S&P 500 with defined benefit plans will have assets to cover only 79 percent of their liabilities by the year's end.
The number of companies with underfunded plans jumped to 240 at the end of 2001, the highest level in the last 10 years, and that is expected to jump to 325 companies by the end of this year, CSFB said.
CSFB expects 30 companies within the S&P 500 to have plans that are 25 percent underfunded.
One factor that many on the Street aren’t talking to investors about is the major pension shortfall that is going to hammer earnings in Q4 and all of next year. Many companies got away with nominal contributions to pension plans in the 90’s due to rising stock prices. Just like consumers who quit saving during the 90’s because of rising stock prices, corporations quit contributing to pension plans. The stock market rose each year doing the savings for the companies. This made company earnings look much better. Corporations could forgo making contributions as the assets of the pension plan rose along with rising stock prices. That was the '90s; now we’re in a totally different environment. This is the 21st century where stocks have been declining double-digits for the last three years. According to pension analyst David Zion at CB First Boston, 360 companies in the S&P 500, who have defined benefit pension plans, could be underfunded by $243 billion at the end of this year. Company pension plans have 10% returns factored into their estimates. Instead of 10% returns, company pension plans have been losing over 10% a year. In 2001 the 50 largest companies in the US lost collectively $36 billion in their pension plans. However, by aggressive accounting assumptions made on the returns of their plans, these same companies recorded hypothetical gains of $54 billion versus an actual loss of $36 billion. According to CSFB, the typical pension plan went from being 7% overfunded in 2000 to 6% underfunded in 2001. That figure will rise even higher this year as result of the losses in the financial markets. CSFB estimates that S&P 500 companies will need to contribute $29 BILLION to pension plans next year. That $29 billion is going to be taken out of the corporate bottom line, which will be a drag on profits next year. It will also impact corporate plans for capital investment.
Big Blue May Be Singing The Pension Blues IBM is typical of many companies facing this problem. IBM reported that profits fell 18% in the third quarter. The company helped to ignite a rally in the stock market by beating estimates. However, buried in IBM’s footnotes was about 10% of its pretax profits came from investment income earned by its employee pension fund. IBM has been losing money in its employee pension fund even though it has been reporting profits from pensions in its operating income. IBM has been using 10% returns in its pension assumptions. That assumption will no longer fly, given the actual losses in the plan. At the same time, IBM reported lower Q3 profits, the company also alerted the Street that it would have to divert $1.5 billion to its pension plan by year-end. That is $1.5 less for Q4 profits.
Pension shortfalls could have a major effect on company earnings, credit quality, and alter debt covenants, forcing the company to renegotiate debt at much higher rates. Underfunded pension liabilities caused Standard & Poor’s to lower GM’s credit quality because of a huge increase in pension liabilities. GM’s underfunded pension liabilities could grow to $23 billion by the end of the year.
Under current accounting conventions, if a pension plan is at least 90% funded, the shortfall can be spread over a 30-year period. However, if funding falls below 90%, companies have to make up the difference with larger cash contributions within three to five years. The list of blue chip companies currently underfunded makes up over 70% of the S&P 500. They range in blue chips such as IBM, GM, Boeing, DuPont, AMR Verizon, GE, and SBC.
http://www.financialsense.com/Market/daily/wednesday.htm
Part of the problem was that overfunded pension plans artificially inflated earnings in the first place. Plan contributions in the next quarter may act to hold back the bears for a while as a lot of corporate cash will flow into pension trusts whose managers will put them in the traditional vehicles -- stocks, bonds and to a lesser extent real estate.
The number of assumptions in a traditional defined benefit pension plan is maddening ... and only by luck will any of them reflect what actually occurs.
BTW, in a perverse way, contribution of cash to plans actually results in higher profits because of the tax effect and the earnings assumptions built into plan models.
We're suckers.
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