Anticipated rising interest rates will increase companies’ borrowing costs in the long-term, but for at least a few years rate increases will reduce their pension, healthcare and other post-retirement employee benefit liabilities (PRLs)—to the tune of $2.4 trillion.
Standard & Poor’s published a report Sept. 12 that notes those liabilities for the 2000 listed companies examined fell at the end of 2012 by $400 billion, or 14 percent, to $2.4 trillion from $2.8 trillion. The decline resulted from companies increasing the discount rates they use when anticipating higher rates.
“Any increase in the discount rate lowers the value of these liabilities,” said Paul Kuria, director at S&P in a video accompanying the report. “Companies use different assumptions when they pick a discount rate, but in general discount rates are linked to interest rates.”
Their liabilities may rise this year if rates remain low or does not rise enough to offset other factors, such as revised actuarial assumptions related to increasing life expectancy. As rates rise in the following couple of years, however, post-retirement liabilities are anticipated decline significantly, according to the report, by as much as $2.4 trillion.
“Our key assumption that bond yields (for AAA bonds, our convenient indicator of interest rates) will rise by 0.5 percent over 2015 and 2016 is consistent with the approximately 0.5 percent 2013 rate increase, which contributed to a 14 percent PRL decline,” the report says.
Mr. Kuria said that the rating agency found that 47 percent of the examined companies reported unfunded post-retirement liabilities at year-end 2013, meaning they weren’t offset or backed by assets.
“We view the unfunded portion as debt-like and therefore a credit risk. A reduction of the unfunded portion is therefore a credit positive from our point of view,” Mr. Kuria said.
The report notes that an additional “credit positive” is that lower liabilities reduce expenses related to these liabilities, such as interest payments, and that results in higher EBITDA. It also says the best prospects for companies improving their leverage are not necessarily within sectors with the largest PRLs or the largest unfunded PRLs. Rather, S&P says, debt leverage declines the most for sectors with the largest ratio of unfunded PRL to reported debt. Those sectors include aerospace and defense, automobiles, capital goods, chemicals, mining and metals, and transportation.
“An interesting fact that leaps out of this chart is that aerospace and defense, automobiles, and capital goods owe more in total retirement obligations than they do in debt,” the report says. Companies with the largest unfunded PRLs relative to debt are led by General Electronic, followed by Boeing and General Motors.
S&P notes that the report focuses on 2015 and 2016, even though interest rates may continue to rise after that, because the passage of time raises the odds that other variables will influence PRLs.
“In the long run, factors such as changes to actuarial assumptions may size PRLs more than interest rate rises,” the report says.