NEW YORK - The three major credit-rating agencies - Standard & Poor's, Moody's Investors Service and FitchRatings Inc. - have increased their corporate-pension research capabilities in the past 12 months, spurred by the rising number of underfunded defined benefit plans and their effect on sponsors' bottom lines.
Officials at the New York-based agencies say pension funding and liabilities alone have not resulted in any credit downgrades. But pension-related issues have contributed to downgrades in the airline and auto industries and could affect more if the economy doesn't improve.
Standard and Poor's established firm guidelines in May 2002 on evaluating the impact of pension income on corporate earnings and the equity valuation process, the first rating agency to do so. In February, S&P placed 10 European companies - including Compagnie Generale Des Establissments Michelin SCA; Deutsche Post AG; Rolls-Royce PLC; and Portugal Telecom - on its credit watch with negative implications largely because of their unfunded pension and post-retirement liabilities. S&P also created an internal accounting task force to provide guidance and information to its analysts on pension issues and other accounting related matters after the Enron Corp. and WorldCom Inc. scandals.
In addition, S&P executives at the U.K.'s National Association of Pension Funds conference in Edinburgh in March have floated the possibility of issuing separate ratings for pension funds.
Moody's and FitchRatings also have established divisions to keep track of the impact of growing pension liabilities on corporate finances.
Moody's plans to hire up to 20 additional professionals by year's end to staff a new "accounting specialists group" to research corporate pension funding issues as well as other accounting related issues such as stock compensation, cash flow analysis, revenue recognition and evaluating restructuring changes.
Greg Jonas, a former Arthur Andersen LLP accountant who was hired in September to head the division, said the increasing complexity of pension accounting, mounting pension liabilities and funding problems prompted questions and requests for more information from Moody's 800 analysts. "Moody's intends to increase the noise level on financial related reporting and disclosure topics," he said.
In January, Moody's published its first broad commentary on its rating methodology for U.S. pension obligations. Moody's said it doesn't expect any credit downgrades "at this stage based solely on pension-related issues" but deteriorating credit quality could lead to downgrades in the future. Moody's said it will "adjust reported profits to exclude net periodic pension income, if any" and views underfunded pension li abilities as "debt-like" and would incorporate them into its adjusted leverage measurements as "debt equivalents."
Meanwhile, FitchRatings is taking a slightly different view from the other credit-rating agencies by focusing more attention on the impact of pension liabilities on cash flow. "Pensions are long-term issues," said Mark A. Oline, managing director at Fitch. "We are not as concerned with the balance-sheet impact as we are the cash-flow impact."
According to Fitch's published pension policy statement, "the single most important issue for fixed-income investors is a pension plan's current and future claims on a company's cash flow." Thus, said Fitch, a company's funding policy becomes paramount, especially during periods of economic uncertainty and market downturns.
"Fitch believes that should the markets continue to underperform (relative to expectations) that most companies will have to lower their expected rate of return. On an accounting basis, this will result in higher pension expense, which reflects the economic reality that companies will have to make higher cash contributions to offset lower actual pension fund returns," according to the Fitch pension policy.
Mr. Oline said Fitch could also add professional staffing to address the growing pension problems among the corporations it follows.