Pension Issues are the next market Contagion
The first full week of the third-quarter earnings season brought a torrent of nasty disclosures, as company after company reported huge shortfalls in their employee pension funds. To make up for the shortfalls, executives are being forced to divert billions of dollars to pension plans in moves that will lower earnings, limit spending and choke expansion plans. "Everyone knew the drop in the market would affect the value of the pension funds, but people weren't familiar with what the ramifications were," said Robert Willens, accounting analyst at Lehman Brothers. IBM said it will contribute $1.5 billion to its fund by 2005, including $700 million next year alone.
Let’s face it, there is great uncertainty about future stock market returns and that should be prompting many companied to reduce their fund expectations from the high levels of the past (10-12%); to more realistic expectations, according to my calculations 6-6.5% is a realistic expectation. This past week IBM said it is looking at reducing its expected rate of return to between 8-8.5%, down 1.5% from its previous range of 10%. But I must state that even this new level may be too high, for this reason, I am very skeptical of the earnings presented by the Dow components and many of the S&P 100 starlets. I have been speaking regularly about pension fund accounting and how unrealistic the accounting premises and projections are; and how they are subject to great manipulation; along with hyper inflating the earnings outlook. Now, do not get me wrong, there are some very respectable firms/funds that have had proverbial cushions left over from the last bull market, when returns were higher than they had projected. However so many firms like IBM, GE, MMM, PG, GM, F, CAL, UTX, MOT, IR, WHR just to name a few used the surpluses to pad their profits.
During this so-called mild recession we're seeing plan assets finally melting; last Friday (sort of under the radar)
**NUI Corp. said it will record a pension expense in 2003, instead of a credit, for the first time in eight years.
This past week alone
**IBM said it will have to contribute $1.5-2.0 billion to its fund by 2005, including $700 million next year alone.
***United Technologies stated that they made cash infusions totaling $1 billion to its fund in the last 12 months; and they may need to add another 2-3 billion over the next 2-3 years.
**Ingersoll-Rand (last paragraph). On their conference call with analysts, that it may have to put more assets into its pension plan as a result of recent stock market declines. The exact amount will be determined as of November 30th, the end of the plan year. Based on current market levels, 2003 earnings per share could be hurt by 25 cents to 30 cents a share, Chief Financial Officer Tim McLevish said. He said the company was considering making a cash contribution to the plan, although it would not be required to make one.
**Motorola said it expects to contribute $150 million to $200 million to its fund in 2003.
A recent study by Credit Suisse First Boston estimates that of the 360 companies in the Standard & Poor's 500 index that have pension plans, 325 will have shortfalls by year end and only 33 out of 360 will be over-funded. Currently on my radar screen, and according to David Zion, the study's author; the airline and automobile industries will be hit hardest, companies in the S&P 500 will face a total pension shortfall of $240 billion by the end of the year simply put about the gross domestic product of Hungary. The pension fund issues are also spurring downgrades of debt downgrades, which will put additional pressure on profits by raising borrowing costs. Let’s fact it folks, accounting 101 states an underfunded pension plan is equivalent to debt, plain and simple; however you will not see a line item for it as firms burry this information deep in their 10-Q/10-K’s.
Merrill Lynch & Co. last month estimated that pension plans of 98% of the 346 Standard & Poor's 500 companies it surveyed will be underfunded by year end. Struve said: "Two-and-a-half years of negative stock market returns, a recession, weak operating earnings, and low interest rates are the perfect storm for pensions."
U.S. auto-related companies will likely end their 2002 fiscal year with more than $30 billion of underfunded pensions, more than double the level a year ago, as stocks head for a third straight annual loss, according to Fitch Ratings. General Motors Corp. and Ford Motor Co. might be responsible for $22 billion of underfunded pensions together by year end, Fitch said. Suppliers such as tire maker Goodyear Tire and Rubber Co and diesel engine maker Cummins Inc. might also face "challenges," it said. Fitch said it expects the funding shortfall for GM, which is based in Detroit, to rise this year to about $17 billion from $9.1 billion. It said the shortfall for Ford, which is based in Dearborn, Michigan, should total at least $5 billion, compared with a $596 million over funded status last year.
I personally believe there needs to be more regulation on pension fund assumptions, and a cap put in place. I do not expect that significant downward revisions will become a trend, until such measures are undertaken. There are still way to many aggressive “floundering / irresponsible and hinging on legal fraud” accounting tricks for companies to manipulate pension fund numbers.
For example, corporations' continue to use a best fit matrix which include assumptions about future wages over-time levels, as well as life expectancy, that can greatly affect the status of the pension funds. This is the next area of corporate manipulation that must be addressed.
Best of Luck
Steve
www.twaves.com
