EUROPE – Ratings agency Standard & Poor’s has put some of Europe’s leading companies onto negative credit watch because of their unfunded pension liabilities.
S&P has put the following companies with long-term ratings on credit watch with negative implications: steel maker Arcelor, French tyre maker Michelin, Deutsche Post and subsidiary Deutsche Postbank, UK engineering company GKN Holdings, German gas maker Linde, UK glassmaker Pilkington, Portugal Telecom, UK aerospace supplier Rolls-Royce, German steel maker Thyssen Krupp and Dutch logistics firm TPG.
The move hit some of the companies’ shares and corporate bonds.
In response to S&P, Michelin said in a statement that the ratings agency’s decision was not based on any new information. “This decision entirely relies on a change in the methodology of evaluation of this rating agency.”
The companies, S&P says, are “those for which deteriorated equity values may have created substantial pension deficits, or for which the flexibility under the existing ratings, factoring in all other aspects of S&P’s credit analysis, appeared insufficient to offset the negative impact of total post-retirement deficits”.
How each company plans to manage its pension fund liabilities will also affect the final decision to issue a downgrade. During a conference call, the S&P team cited German industrial group Siemens as one borrower that, despite suffering from a significant pensions deficit, had demonstrated that the underfunding was manageable, and had suitably addressed the issue of liabilities over last two years.
S&P reviewed unfunded pensions liabilities at more than 500 rated European companies, representing the most comprehensive credit analysis in that field to date. The analysis was based on estimates of the value of equity assets in each company’s pension fund at the end of 2002, and on the totality of each company’s unfounded pension obligations – whether funded on a pay-as-you-go basis, or subject to regulations requiring pre-funding.
UK retailer J Sainsbury and BAE were placed on credit watch in January and December respectively and remain on watch subject to review.
Of the companies, Sainsbury, BAE Systems, Rolls-Royce and Thyssen-Krupp could be subject to a two-notch downgrade, as the companies were already on negative credit watch for reasons other than pensions liabilities.
Risks arising from pension fund liabilities have increased with stricter funding rules, rising health-care costs, continued equity weakness, and a struggling economic environment. As a result some corporates have had to inject additional assets into their schemes, or increase contributions to “plug the pensions gap”. S&P views unfunded pension liabilities as “debt-like”, given the future call on cash these liabilities represent.
John Ball, a partner at Watson Wyatt, said there is a danger that just because a scheme may be unfunded under the FRS17 accounting rule, it does not mean that funds have to be injected into the scheme right away. He said it may be too “simplistic” to view unfunded pension deficits as being like debt.
Charles Cowling, worldwide partner at Mercer Investment Consulting, said that treating a company’s unfunded pension as being like debt is a “perfectly reasonable way of looking at it”. “These pension liabilities are real liabilities,” he said, adding that it was only natural that they should be a factor in a credit risk assessment.
Cowling said the S&P move could herald a new approach to rating stocks. He foresaw an increase in volatility in such stocks, whose pension schemes act like a geared investment trust.
The S&P assessment reveals that several different factors have combined. First there’s the new FRS17 accounting rule which takes a snapshot of a scheme’s liabilities. Then there’s the shrinking of traditional manufacturing industry, leaving large pension schemes, often larger than the sponsoring company. Add to this mix the decline in capital markets.
S&P expects to resolve all of the credit watch listings within the next two months.
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