A majority of large U.S. corporate pension plans were underfunded at the end of 2012, but Fitch Ratings said Thursday it believes funding levels at mid-year have improved with recent discount rate increases and strong equity market performance.
While pension underfunding gaps have narrowed, Fitch believes severely underfunded plans taking advantage of funding relief could still face steep funding requirements in the years ahead.
Fitch's review included 224 nonfinancial U.S.-based companies with defined benefit pensions plans that have projected benefit obligations of $100 million or more. Of the 224 companies analyzed, 148 were less than 80 percent funded and warrant further investigation, based on the 80 percent “at-risk'” threshold in the Pension Protection Act.
Of the remaining 76 companies, 57 were funded in the 80 to 90 percent range while 19 companies were funded above the 90 percent level. The oil and gas energy, retail and telecommunications sectors stood out with median plan funding levels of 70 percent or less.
Fitch believes the contribution amounts are material for many issuers. In Fitch's sample, 36 percent of the 224 companies have an estimated pension outflow as a percentage of pre-contribution funds from operations (cash flow from operations less working capital) above a 10 percent threshold.
Fitch estimates that the potential funding requirements of the 16 companies could amount to 40 percent or more of their 2012 pre-contribution funds from operations.
Relief provided for under the Moving Ahead for Progress in the 21st Century Act, which was signed in July 2012, allows plan sponsors to lower their near-term pension contributions through a materially higher discount rate for funding purposes. In Fitch's opinion, cash flow constrained issuers may benefit from the near-term relief, but for the majority of plan sponsors a more prudent approach will call for funding above minimum levels.
Fitch said it does not anticipate taking any rating actions on an issuer based solely on possible pension contributions in 2013 or 2014. However, for a company on the edge of a rating category, the combination of weak earnings and the need for ongoing pension contributions could lead to a negative rating action. Fitch would evaluate the company's plans to address pension plan funding needs in the context of potential pressure on its liquidity needs.
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