Pension reforms may slash valuations

On the Money

Your Money

August 27, 2006|By Gail Marksjarvis | Gail Marksjarvis,Chicago Tribune

There's a joke among certified public accountants that tax reform - generally done in the name of simplification - is always good for their business.

You would think reform would put CPAs out of work - making tax calculations so easy to do that no one would need the pros to navigate the system. But reform seemingly makes a convoluted system all the more complex.

The same might be said of pension reform. The grandiose package that was passed into law this month supposedly will fix the arcane system so companies no longer overpromise.

It's clear some companies are going to have to pump in millions of dollars to bolster their pension plans.

Pension accounting analyst David Zion of Credit Suisse is urging investors to keep asking questions about pension obligations.

Even he can't be certain about the numbers because the formulas are so complex, and corporate reporting requirements so lenient.

"Cash flow will probably be diverted to fund the pension plan," Zion said. "That means less cash available to the shareholders, reducing the value of the stock from the shareholder's perspective."

He estimates that during the next couple of years, 195 of the Standard & Poor's 500 companies could face larger pension funding requirements than they have had. That could cause a drain on cash flow and change the value of some companies.

Some companies with deeply underfunded pension plans are expected to borrow money during the next couple of years to bring asset levels up, even though they don't have to make improvements until 2008.

In some circumstances, the borrowing could cause companies to exceed the covenants lenders require them to stay within, so they may need to seek waivers, according to Gregory Jonas at Moody's Investors Service.

Companies will be required to phase in higher contributions to pension plans beginning in 2008, so that they are at least 80 percent funded to deliver on promises to retirees. Ultimately, they'll have to be 100 percent funded.

According to Zion's calculations, 367 companies in the Russell 3000 have plans that are less than 80 percent funded. Among the S&P 500 companies, 99 companies are currently under the threshold, and 29 are under 65 percent funded.

Companies have until 2011 to get to 80 percent funding levels.

Moody's anticipates that some companies will start borrowing soon to start building their funds toward appropriate levels.

Zion expects similar behavior, but also said companies probably will be freezing pension plans - perhaps closing them to newly hired employees, or other adaptations - so they can keep future responsibilities from building.

Under the new rules, companies will face higher costs if they remain underfunded. They will have to freeze their plans if they are less than 60 percent funded.

"A key question for investors is how much of a company's future cash flows will have to be contributed to a defined-benefit pension plan instead of being used to invest in or grow the business, buy back stock, pay down debt or pay dividends," Zion said.

You can leave a message for Gail MarksJarvis at 312-222-4264.

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