[A-List] US legitimation crisis: pensions

["Keaney Michael" <Michael.Keaney@xxxxxx>]

GM pension fund shortfall highlights wider problem
By Julie Earle in New York
Financial Times; Oct 01, 2002

A warning by General Motors, the US carmaker, of a deepening pension
fund shortfall has thrown the spotlight on a growing nightmare for other
big US companies.

GM has said that although expectations of a 10 per cent return on its
fund are out of line with economic and stock market conditions, it is
sticking with its return assumption. Other big US corporations are also
staying with high pension return rates, in spite of the S&P 500 index
having slumped more than 19 per cent this year.

The pension liabilities issue has angered high-profile investors such as
Warren Buffett, the billionaire value investor, and prompted warnings of
severe pressure on these companies' earnings and share prices.

"This is a ticking time bomb. It is not a question as to whether it will
explode, but when it will," said Michael Hirsch, vice-president of
investments at the Lynnvest Group, the financial services group in New
York.

Mr Hirsch, a former investment officer for Republic National Bank in New
York, said investors should now avoid large-cap equity funds.

He said any shortfall in plans would eventually need to be met through
company earnings.

"It is the scariest accounting skeleton of all," he said.

According to UBS Warburg, companies in the S&P 500 are in cumulative
deficit on their pension funds for the first time since 1993, thannks to
a bear equities market.

UBS has warned that companies might further raise the return on their
asset assumptions to manage big pension liabilities, but most return
assumptions are already over optimistic.

Merrill Lynch has also warned that significant pension liabilities being
held off balance sheet would be likely to lead to "late" earnings
estimate downgrades.

A Merrill study looking at companies whose earnings would be reduced by
10 per cent or more if pension income was not included named Bell South,
Boeing, GE, IBM, Marsh & McLennan, SBC Communications and Consolidated
Edison.

Merrill believes accounting rules for pension benefits are "open to
manipulation by aggressive companies". Under current accounting rules,
known as SFAS 98 and 88, expected returns on pension plan assets are
included in the income statement.

Merrill said operating income of S&P 500 companies in fiscal 2001 was
overstated by 6 per cent, or $11.4bn, due to overly optimistic return
assumptions.

Mr Hirsch said that based on expected returns built into IBM's pension
plan for 2001, the company received a $2.2bn benefit, when it actually
lost $4.4bn.

"In reality, there was a $6.6bn swing in one year. How dare these
companies hold a 10, 11, 12 per cent return on a pension plan, when they
are losing money," he said.

GM made a negative 3 per cent return on its $67.3bn fund in the first
nine months of the year but stuck to its 10 per cent return assumptions.

This was in spite of a warning by Mr Buffett and others over too-high
return rates. Mr Buffett believes that 6.5 per cent is a reasonable
return for investors in a bear equities market.

The pension issue has also caught the attention of Standard & Poor's,
the credit ratings agency, which believes pension gains should not be
included in calculating core earnings.

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GM relies on revamp to escape pension gap
By James Mackintosh
Financial Times; Oct 04, 2002

General Motors, the world's biggest carmaker, is well advanced in
revamping its vehicle range and is making progress on market share, John
Devine, chief financial officer, says.

Two out of three is not bad. Sadly, the multi-billion dollar hole in
GM's pension fund means the company needs to be in overdrive just to
stop its finances from sliding backwards.

The size of the balance sheet problem, which some analysts believe is
approaching GM 's $22bn market value, has given the company's turnround
plan an added sense of urgency. Cost-cutting and more attractive designs
are essential to make up for the growing cost of plugging the pension
gap.

The scale of the problem is hard to overplay. Last year the company's
contributions to its main US pension fund, which was $9.1bn underfunded,
cost it $146m in pre-tax profits, or $30 for each of the 4.9m cars and
trucks it sold in the country.

If the fund's investment managers succeed in holding its fall to just 5
per cent this year - optimistic given market performance - the hit to
profits could rise to $2.1bn in 2003 before tax, or $429 per vehicle. At
the same time, the hole in the fund would have risen, hitting $16bn by
the end of this year.

"Could this black hole get so big that it swallows the company?" asks
David Bradley, analyst at JP Morgan. "The answer is yes. But I wouldn't
put a very high probability on it."

GM is working hard to repair the damage to the fund from falling
markets. But a $2.2bn cash injection into the $67bn fund this year only
just made up for a 3 per cent fall in the value of the investments in
the first half of the year, and there have been further falls since.

The strategy of the company is now driven by its pension fund
requirements, reflecting the Wall Street joke that GM is a pension fund
with a sideline producing cars.

Rick Wagoner, chief executive, in February set the company the target of
generating $10bn of cash to bolster the balance sheet this year. By the
end of June GM's revitalised car and truck business had contributed
$4.8bn of cash, while $4.6bn of bond and convertible issues meant the
full-year target had almost been reached.

It now looks as though that will not be enough.

"The pressure on the pension fund has increased since we said that," he
says. "We need to keep focus on cash generation from all sources."

The need to generate cash to fund the pensions hole, and at the same
time to cut costs to make up for the damage done to profits, has given
rivals a competitive advantage.

GM is in the worst pensions position of the "big three" Detroit vehicle
makers because it has 2?-times as many pensioners as active workers.
Ford Motor, the second-biggest car manufacturer, is at a 1:1 ratio,
while Japanese and south Korean plants set up in the US have virtually
no pension bill.

GM insists there is no need to panic. In 1993 the fund had an $18.5bn
hole, and recovered, thanks to large cash infusions and the bull market.

But it faces a further hit at the end of this year when actuarial
assumptions are revised. Mr Devine made clear last week that the assumed
investment return of 10 per cent a year "looks somewhat high" given low
inflation and interest rates.

The company takes a $700m pre-tax hit to profits for each one point cut,
and analysts have factored in reductions. A 0.25 point cut to the
discount rate also appears likely, which would knock another $125m from
profits before tax.

GM has promised to cut costs to compensate for any changes, and remains
committed to its $10 earnings per share target by mid-decade, up from
its forecast of $6 this year.

If the sale of Hughes, the satellite and pay-TV arm, goes through and
all the cash raised is contributed to the fund, that could help by
adding $420m to profits.

Even if the deal is blocked, which seems increasingly likely, the hole
in the balance sheet need not be filled immediately.

Under arcane US pension laws, the company only needs to ensure the
pension fund has enough investments to prevent contributions to the
government agency that insures retirement income from moving into a
higher penalty zone.

The money does have to be found eventually. But just as the hole was
created by falling markets, it could be plugged by rising markets.