Wall Street’s blue-chip blues: Gottliebsen

Low US interest rates are set to ravage the profitability of the large swathe of leading US companies that have defined benefit pension obligations. This is a new hazard for the American stock market.

Ground-breaking research just released by Goldman Sachs’ Michael Moran and Abby Cohen shows that if American interest rates remain at current levels until December 31 the unfunded pension liabilities of S&P 500 companies are set to rise by about $106 billion from $210 billion to $316 billion.

Around $65 billion of the increase arises from the low interest rate affect on fund returns and ratios and the balance stems from a fall in the value of other assets.

However, if the US were to raise interest rates to overcome the pension problem it would remove a significant pillar in US economic stimulation.

In previous big pension fund asset declines, US companies have been able to amortise the problem over an extended period but in 2010 much of that ability has already been used up and as a result there are heavy blows to US profitability in the pipeline.

Moreover, many big US companies have pension liabilities that exceed 25 per cent of their market capitalisation so we are dealing with a problem that is significant.

Most Australian companies have accumulation superannuation funds where the risks are borne by the employees, but a large number of US companies have funds which promise payout levels that are guaranteed by the employer. Money is set aside in a fund to make the payments – so-called defined benefit funds.

According to Moran and Cohen a $106 billion fall in the funding of pension liabilities would mean that companies in the S&P 500 would only have assets in their funds backing 75 per cent of the liabilities. That’s an average figure so some would be much worse.

The pension fund shortfall calculations are made annually on companies’ fiscal year-end balance date. Goldman Sachs emphasises that their estimates are theoretical calculations that can change with circumstances but it is clear that some of the cream of US companies face serious issues. Two companies FedEx and General Mills balanced on May 31. In response, FedEx made a $260 million provision, while General Mills made a $100 million provision.

Among those balancing on June 30 are Sara Lee (with the percentage of it pension liability to market capitalisation at 45%; Parker Hannifin (33%); Archer (12%); and Campbell Soup (17%). They will face the problem in then next few weeks.

The bulk of US companies balance on December 31 and among those likely to be affected are Sprint Nextel Corp (percentage of pension liability to market capitalisation is 13%); Dominion Resources (18%); United Parcel Service Inc (31%); GPC Genuine Parts (22%); AT&T Inc (37%); Questar Corp (18%); General Dynamics (36%); Pepco (51%); Marsh & McLennan (30%); Unum Group Life & Health (16%); SunTrust Banks Inc. (18%); Reynolds American Inc (34%); L-3 Communications (24%) Raytheon Co. (93%); Verizon Communications Inc (42%); Allstate Corp (35%); MetLife Inc. Life & Health (22%); Pfizer Inc Pharmaceuticals (12%).

While the US will keep interest rates low as long as it can, this growing problem is a sign that low interest rate days are numbered. That fact that China has downgraded ratings on US debt is yet another.

This article first appeared on Business Spectator.