Underfunded pension obligations are expected to play a big role in bankruptcies next year as troubled companies are forced to face up to massive gaps in their pension plans.
"Pension obligations will continue to be a consideration for companies filing for bankruptcy next year," said Victor Consoli, senior managing director of high-yield research at Bear Stearns. He estimated that underfunded pensions of the top S&P 500 companies could amount to more than $300 billion in 2006. This compares to an estimated $218-250 billion in 2005 and $165 billion in 2004.
The unfunded gap in pension plans has widened with the decline in equity prices and lower interest rates. In addition, the higher percentage of employees retiring, coupled with retirees living longer, has reduced the value of pension fund assets. The growing shortfall in pension funding is forcing companies to divert more of their cash flow to their pension and benefit plans. Delphi and General Motors are two high-profile companies that have sought this year to reduce their pension and employee benefit packages. Delphi has $8.5 billion of pension obligations, while General Motors alone has $51 billion of other post employment benefits (OPEBs).
The growing gap in companies' underfunded pension obligations will likely lead to pension legislation next year that will define discount rate methods and minimum funding requirements. "At some point there has to be recognition that pensions are underfunded," said Consoli. "The government may say that companies have to reduce the unfunded gap, which might force companies to issue bonds or take on more bank debt to fund the gap. It forces recognition of pensions as a credit concern."
Companies that have large underfunded pensions include Ford Motor, Georgia-Pacific, Eastman Kodak and Lockheed Martin. Bear Stearns expects rating agencies and credit analysts to pay more attention to pensions and OPEBs. It also expects bank covenants and high-yield indentures to evolve to include pension-related financial tests. Consoli predicts that credit default swap spreads of companies with large unfunded pensions will start to widen. Bear Stearns added in a report that new legislation would likely dilute the assets and cash flow available to unsecured creditors.