NEW YORK - Many of the nation's largest corporate pension plan sponsors could be getting lumps of coal this Christmas.
Delphi Corp., Honeywell International, Delta Air Lines Inc. and The New York Times Co. are among the nation's largest companies in the S&P 500 index that could take a large hit to their earnings if their defined benefit plans fail to earn enough to cover this year's interest expense on their pension obligations, according to a new analysis by Standard & Poor's.
A pension fund's interest expense is the annual increase in the present value of the deferred benefits. S&P executives believe pension funds have an obligation to earn returns sufficient to cover those expenses. Pension funds that fail to earn enough each year to cover the interest cost become more underfunded over time, forcing companies to shovel more cash into the funds instead of growing their businesses.
Standard and Poor's analysis is based on its modified approach to pension accounting, which it says gives investors a clearer picture of a company's finances than the existing accounting rules companies follow.
S&P estimates the stock market would have to be up 7.9% this year in order for those companies with pension funds in the S&P 500 index to cover an estimated $67.3 billion interest expense on their pension obligation this year. Yet year to date through Dec. 5, the S&P 500 was down 21%.
In its analysis, S&P made these assumptions:
* The pension funds of the S&P 500 companies have 60% of their assets invested in stocks and 40% in fixed income;
* These pension funds will lose 10% this year on pension assets of about $1 trillion as of Jan. 1; and
* The S&P 500 will end the year down about 20%, and bonds will earn 10%.
(Companies that have invested their pension portfolio entirely in bonds could earn higher returns, and those with a higher allocation to stocks could lose more. Also, companies that didn't rebalance when their equity allocation dropped below the targets might not be hurt as badly as those companies that rebalanced regularly.)
"A lot of companies will have to put a lot of cash in, and they're not used to doing that," said Howard Silverblatt, an analyst in the equity analysis division of Standard & Poor's, New York. "The interest expense is a legitimate annual cost of the company and the pension fund has a duty to earn that money each year. If they don't earn that money, they still have to come up with that money."
With those assumptions in mind, S&P estimates Delphi, with $6 billion in pension assets, would need to earn 9.91% on its pension investments to meet its interest obligation this year. On its equity portfolio alone, the rating agency says, Delphi would need a 12.52% return.
Brad Johnson, a spokesman for Delphi, didn't return calls seeking comment.
The extent of the gap between investment performance and interest expense will lead S&P to reduce a plan sponsor's earnings by that amount. The company assumed it would earn 10% on its pension assets this year, and used a 7.25% interest rate to calculate the present value of its pension obligations.
General Motors Corp, the nation's largest corporate pension plan sponsor, with $67 billion in assets at the end of 2001, would need to earn 8.95% on its pension assets, or 10.91% on equities alone, to cover its interest expense of $3.9 billion net of taxes.
But Jerry Dubrowski, a company spokesman, said the S&P analysis was off the mark because "there are a lot of levers and components to pension expense, and they include UAW contracts, and contributions that can lower the pension expense."
Mr. Dubrowski also noted GM's pension fund doesn't have the stock-bond allocation the rating agency assumed, but approximately 40% in U.S. equities, 20% in international stocks, 30% in fixed income and the balance in real estate and other alternative assets - which, he said, have "done quite well."
GM's pension assets logged a -10% return for the first nine months of 2002, while the S&P 500 was down about 30% for the period, Mr. Dubrowski noted.
Moreover, GM already contributed $2.2 billion in cash to its pension fund this year, and is not required under federal pension law to make another contribution until 2004, but might decide to contribute more money next year, he said.
Other companies that S&P says have a shortfall are making pension contributions this year. Honeywell, for example, plans to contribute about $900 million in company stock this month to its $9.4 billion pension fund.
According to S&P, Honeywell has a net $765 million interest expense and would have to earn 7.7% on its pension assets - and 8.82% on equities.
Honeywell spokesman Michael Holland declined to comment.
Delta Air Lines already has announced it will take a charge of between $700 million and $800 million on its shareholders equity in the fourth quarter because of its burgeoning pension liabilities, and contribute $250 million to its pension fund. More recently, the company announced it will convert its $7.1 billion defined benefit plan to a cash balance plan in an effort to trim its pension costs by about $500 million over the next five years.
Under the S&P analysis, Delta would need to earn 10.2% on its pension assets (and 13% on equities) to cover net interest expense of $763 million. Peggy Estes, a Delta spokeswoman, didn't return calls seeking comment.
Understanding the true impact of a pension fund on a corporation's earnings is further complicated by current accounting rules.
To minimize the volatility of the pension earnings, Financial Accounting Standard 87, the accounting rule governing pensions, lets companies smooth those returns by taking expected long-term returns, rather than the actual returns, into account in calculating their pension cost.
Under FAS 87, a company's pension cost - as represented by the service cost, or the present value of benefits earned in the current year, and the interest expense or the time value of the benefit earned - are offset by the assumed return on pension assets, producing a net cost or gain if the assumed return exceeds the service and interest expenses.
But a few dozen companies, including McGraw-Hill Cos., S&P's parent, are in an enviable position. Because they have a low interest expense on their pension assets, they would need to earn low returns on their pension assets to cover those expenses.
McGraw-Hill, for example, would need to earn only 4.95% on its pension assets, or 4.5% on its equity portfolio to meet its approximately $42.5 million interest expense on its pension assets this year.
McGraw Hill, Bank of New York Co. and a few others could meet their interest expense on their pension funds by investing their entire portfolio in fixed-income securities, S&P's Mr. Silverblatt noted.
Bank of New York's $1.2 billion pension fund would need to earn only 1.2% on its equities portfolio to meet its $35 million net interest expense.