Fitch: New Pension Rules Could Hurt Already Hurting
Airlines
As if the airline
industry wasn't already beset by all sorts of problems already, get
this:
Fitch Ratings is providing the following commentary on the US
Senate's passage last week of a broad pension funding reform bill
that includes targeted relief for the largest US airlines. The
Senate legislation, which passed by a vote of 86-9, now must be
reconciled with a House of Representatives bill that also includes
airline industry relief provisions. Pending the outcome of
House-Senate conference committee negotiations to determine the
final form of the bill (assuming no White House veto), it now
appears likely that significant changes will be made in the
required cash funding of the major airline's defined benefit
pension plans in 2004 and 2005. Fitch believes that the proposed
funding rule changes, while easing near-term liquidity pressures on
major US airlines, simply defer existing cash obligations, posing
long-term credit risks by magnifying the improvement in airline
operating performance necessary to meet potentially larger pension
plan funding requirements in 2006 and beyond.
While the passage of the pension relief legislation does not
immediately affect Fitch's current debt ratings of the largest US
airlines with defined benefit plans, it does pose long-term credit
risks by pushing out required pension plan contributions for those
carriers with the most seriously underfunded employee plans -- in
particular, United, Northwest, American and Delta. Provisions in
both the Senate and House versions of the legislation would reduce
dramatically the level of accelerated "catch up" payments to
underfunded plans -- known as deficit reduction contribution (DRC)
payments. The Senate bill passed yesterday would reduce required
DRC payments by 80% in 2004 and 60% in 2005. A House bill, passed
last October, would authorize DRC payment reductions of 80% in both
years.
It is important to
emphasize that the DRC waivers in 2004 and 2005 would not eliminate
the requirement to meet the long-term obligations of the major
airlines to their employees over the long term. Rather, it would
simply defer the requirement to make accelerated payments during a
period when the overall funded position (assets minus liabilities)
may ultimately worsen as a result of large existing underfunded
gaps. Even with actual market returns exceeding assumed historical
average returns, the steady accrual of pension liabilities will
make it difficult to narrow the funding gap appreciably. In a
moderate market downturn, moreover, asset values could deteriorate
and plan funding would suffer as a result of the shortfalls in DRC
funding.
Absent DRC payments over the next two years, the difference
between the value of plan assets and liabilities to current and
future retirees is likely to grow, putting a greater long-term
funding burden on carriers at the point when DRC waivers are
lifted. This poses a very serious threat, after 2005, that greater
levels of cash will be required to shore up underfunded plans. This
could ultimately impede the process of debt reduction and balance
sheet repair during a period when profitability and operating cash
flow generation for the major carriers, under intensifying pressure
from low-cost competitors, may be weak.
Over the near term, modest increases in interest rates would act
to moderate growth in airline pension liabilities. Further,
reductions in wage rates achieved by the restructured carriers --
notably United and American -- will limit growth in pension payouts
to employees as a result of changes in 'final average earnings'
formulas that determine the size of most airline employee pensions.
Still, the depleted asset bases of the major carrier plans --
eroded further in some cases by recent 'lump sum' payouts to
retiring employees -- will require consistently high returns to
eliminate the need for DRC payments by the end of the decade.
As envisioned by the
carriers with the larges pension funding gaps, the DRC relief would
provide time for better market fundamentals -- higher pension plan
asset returns and higher interest rates -- to shore up the funded
position of defined benefit plans over the next two years. The
funded status of big carrier pension plans had been undermined in
the 2000-2002 period as a result of weak returns on equities
(making up more than 50% of assets in most US corporate pension
plans) and steady declines in the interest rates used to calculate
the present value of pension obligations to current and future
retirees. The combined impact of low asset returns and low interest
rates drove major carrier plans from a marginally over-funded
position in 2000 to an aggregate underfunded liability in excess of
$20 billion (on a projected benefit obligation or PBO basis) at the
beginning of 2003.
In the absence of a solid industry revenue rebound that fuels
significant improvements in major carriers' operating cash flow
this year and next, airlines with seriously underfunded plans may
find themselves in an untenable funding position by 2006. This
should provide carriers with the most competitive cost structures
(e.g., American and Continental) incentives to make discretionary
cash contributions to their pension plans even after the DRC relief
legislation is passed.