Evaluating Corporate Pensions from a Rating Agency Perspective

Transcription

1 Evaluating Corporate Pensions from a Rating Agency Perspective Waylon Iserhoff Vice President CIA Pension Seminar Colloque sur les régimes de retraite April 16, 2007

2 Canadian Pension Obligations Overview Moody s views the underfunded status of defined benefit pension plans as a debtlike obligation. No revisions necessary to Moody s standard methodologies for Canadian based issuers. Plan Valuations Moody s will make inquiries about valuation dates as minimum triennial valuation requirement often exacerbates underfunding

3 Canadian Pension Obligations Ranking in Bankruptcy Senior Unsecured claim Funding Requirements Recent 2006 federal changes which extended the period for companies to fund solvency deficits, will benefit an entity s financial flexibility. Proposed Accounting Changes Minimal impact from a credit perspective

4 What s wrong with pension accounting? Smoothing inconsistent with economics Excessive netting of components into pension expense Inappropriate classification in cash flow statement Sometimes aggressive, unrealistic assumptions

5 Moody s pension adjustments Balance sheet Recognize pension under-funding (ABO FMV of plan assets) as debt like liability Removes all other pension assets and liabilities

6 Pension adjustments (continued) Income Statement Eliminate smoothing by: Reverse all pension costs in income Recognize service cost (best estimate of the operating cost of the plan) in Cost of Goods Sold and Selling, General and Administrative expenses Recognize interest cost on PBO in other income/expense Add or subtract actual losses or gains on pension assets in other income/expense 1 Attribute interest expense to pension-related debt, which we reclassify from other income/expense to interest expense 1 We limit gains to amount of interest on PBO to avoid net pension income

7 Pension adjustments (continued) Cash Flow Statement Recognize only service cost as an outflow from cash from operations (CFO) Reclassify cash contributions to pension trust in excess of service cost from an operating cash outflow to a financing cash outflow 1 1 We do not adjust the cash flow statement if pension contributions are less than the service cost

8 Scrutiny of assumptions Comparability and reasonableness of assumptions: Discount rate Expected return on plan assets Salary progression Nothing below public radar screen Changes Plan amendments Measurement date

9 Asset Allocation Evaluate reasonableness of asset allocation and investment guidelines Evidence of swinging for the fences Rarely see plans with unreasonable asset allocations or big investments in illiquid assets

10 Assess volatility in future pension contributions Through private discussions we seek to understand: Expected payments for next few years Required minimum payments Factors that affect required payments (including impact of asset liability mismatch) Possible and worst case scenario

11 Other considerations Unfunded plans, defined benefit plan considered partially debt-like Adjustment reduces debt and increases equity Simulates a pre-funding of the obligation OPEB s not considered debt-like, unless: Workforce significantly unionized Older workforce Discretionary adjustment considered by rating committee

12 Typical metrics most affected Pension adjustments affect leverage, profitability and coverage ratios, that are used as key metrics in industry methodologies used to assign ratings Ratio % of Industry Methodologies Debt/EBITDA 50% FCF/Debt 55% EBIT(A) Margin 38% EBIT/Interest 45%

13 Change in Pension Accounting Funded status of pension and OPEB plans fully recognized on the balance sheet Increases balance sheet volatility related to pensions Minimal impact from a credit perspective

14 Impact of Proposed Accounting Changes Company (C$ 000 s) Funded Status of Retirement Plans (Fiscal 2005) Shareholder Equity Impact of ED Pension OPEB Nortel Networks (2,910,000) (972,000) -64% Bombardier (2,625,000) (490,000) -59% Abitibi-Consolidated (874,000) (256,000) -35% Fraser Papers (204,000) (75,000) -30% Canadian Pacific Railway (842,000) (487,000) -29% Tembec (274,000) (75,000) -23% Domtar (282,000) (125,000) -20% CHC Helicopter (74,000) - -19% BCE (2,431,000) (2,032,000) -18% Quebecor World (519,000) (81,000) -13% Catalyst Paper (114,000) (217,000) -9% Alcan (3,105,000) (1,252,000) -8% Cascades (86,000) (96,000) -8% Petro-Canada (378,000) (330,000) -4%

15 Moody s Early Observations SFAS 158 December 31, 2006 Alcan Nortel CN 1 (millions of US$) Reported Debt 4,674 4,464 5,604 Moody's adjustment to debt: 1,697 2, Moody's Debt adjusted for pensions 6,371 6,469 5,771 No significant changes to credit metrics subsequent to the adoption of SFAS 158 Moody s adjustment to debt to be more precise due to enhanced disclosure requirements.

16 Moody s Early Observations SFAS 158 December 31, 2006 Alcan Nortel CN 1 (millions of US$) SFAS 158 Liability Recognized: Pension: Current liability (64) (40) - Long-term liability (2,316) (1,965) (167) Long-term asset ,093 (2,338) (2,000) 926 OPEB: Current liability (65) (36) (15) Long-term liability (1,065) (625) (231) (3,468) (2,661) 681 Defined benefit plan (under)over funded status - net: Funded plans (1,199) (2,000) 926 Unfunded plans (1,139) - - (2,338) (2,000) Translated to U.S. at rate of C$ = US$1.00