During a conference call, International Paper’s
CFO highlighted a growing method corporate America is employing to solve its gaping unfunded pensions gap – issuing debt.
Borrowing money to pay into employees’ retirement accounts can come off as another one of Wall Street’s attempts at financial jiggery, but analysts say the economics of such moves are sound. Highly rated corporate issuers are for the first time in a place where the price of issuing debt is below the cost of having unfunded pension liabilities on the books.
That’s because the Pension Benefit Guaranty Corporation, an independent government agency tasked with bailing out failed company pension funds, has slowly raised the insurance fee on unfunded pensions to around 3.4% in 2016, according to Bank of America Merrill Lynch. In the backdrop of strong appetite for corporate debt, yields for investment-grade corporate paper fell below the insurance fee (see chart below).
The average yield in the BofA Merrill Lynch Corporate Master Index, the benchmark for the universe of investment-grade bonds, fell to 3.16% from 3.52% in December.
“Companies can issue to reduce the pension deficit at little to no incremental cost,” wrote Hans Mikkelsen, credit strategist at BAML. “The economics of carrying large underfunded pension liabilities is deteriorating over time.”
Others have followed International Paper’s example. Large blue-chip firms that have a large pension shortfall relative to their firm’s value include Delta Airlines
, General Motors
. Sure enough, General Motors issued $2 billion in February for that very purpose, with Delta selling the same amount in March.
Some investors are applauding the moves if only because U.S. firms have resisted setting aside money for pensions, often choosing to use their leftover profits for stock buybacks. Thomas Atteberry, a bond fund manager at FPA, said borrowing money to contribute to pension plans show a strange prudence as the problem of unfunded pension gaps are not going away anytime soon.
In a report by S&P Dow Jones Indices published in August, the corporate pension funding gap for companies listed in the S&P 500
was $390 billion in 2016, or 80.7%.
Those in charge of the firm’s finances often overlook these large deficits as a constant stream of retirees can seem an ever-present problem. Corporate treasurers might, then, fall into temptation and deal with the issue later.
A recent survey by BAML highlights their skewed priorities. The polled companies said the most important priority for repatriated earnings would be paying down debt, followed by stock repurchases. In that same survey, contributing to pensions lurked in last place.
But others are less impressed. Marc Bushallow, managing director of fixed income at Manning & Napier, said his investment firm views pension obligations as another form of debt. As such, moves like those made by International Paper only shifted the composition of its debt, without making a “material difference” to its finances.
Even so, more companies might join the bandwagon if a tax overhaul makes strides in Washington. Companies can deduct pension contributions from taxes. But if corporate taxes fall as President Donald Trump promised, the window of opportunity from accruing that tax benefit may vanish, creating “strong incentives for dealing with the pension issue between now and year-end,” said Mikkelsen.
And the benefits can prove substantial. International Paper’s
decision to issue $1.25 trillion of debt to pay down its pension obligations helped the paper manufacturer reap $400 million in tax savings.
For those tempted to wait out the problem, the Federal Reserve’s push to raise rates could alleviate the weight of unfunded pensions.
Prior to 2008, corporate America was awash in money, its pension funds filled to the coffers. After the implosion of the economy and the subsequent shift to ultra-low interest rates, the value of corporate pension liabilities ballooned, widening their funding gap.
But if inflation sticks on its slow and steady pace, a rapid tightening of monetary policy is unlikely to come forth.