Pensions

Tackling a Pension Shortfall by Taking on Debt

July 21, 2017 11:58 p.m. ET

It must have raised some eyebrows on Monday when supermarket chain


Kroger

launched a big $1.5 billion bond sale—with a primary goal of funding its pension plans. Contributing to retirement plans may seem to be a surprising priority for a leader in an industry that is now squarely in


Amazon.com’s



AMZN -0.29454651501895596%



Amazon.com Inc.


U.S.: Nasdaq


USD1025.67


-3.03
-0.29454651501895596%



/Date(1500670800314-0500)/


Volume (Delayed 15m)
:
2639838



AFTER HOURS



USD1026


0.33
0.03217409108192693%


Volume (Delayed 15m)
:
95139




P/E Ratio
193.00190053252544

Market Cap
491692865440.063


Dividend Yield
N/A

Rev. per Employee
417613









More quote details and news »


sights.

In fact, issuing debt to fund corporate pensions is a growing trend. A bunch of large companies have done the same thing as Kroger (ticker: KR) this year, including


FedEx



FDX 0.2973381159146687%



FedEx Corp.


U.S.: NYSE


USD212.51


0.63
0.2973381159146687%



/Date(1500670921324-0500)/


Volume (Delayed 15m)
:
1208740



AFTER HOURS



USD212.51



%


Volume (Delayed 15m)
:
26925




P/E Ratio
19.19658181424003

Market Cap
56651409839.4774


Dividend Yield
0.941132182014964%

Rev. per Employee
356917









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(FDX),


Delta Air Lines



DAL -1.0789324247586598%



Delta Air Lines Inc.


U.S.: NYSE


USD52.26


-0.57
-1.0789324247586598%



/Date(1500670839332-0500)/


Volume (Delayed 15m)
:
6805546



AFTER HOURS



USD52.25


-0.01
-0.019135093761959432%


Volume (Delayed 15m)
:
42058




P/E Ratio
10.40124193933604

Market Cap
38250507773.4925


Dividend Yield
1.5499425947187142%

Rev. per Employee
474655









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(DAL), and


DuPont



DD -0.34186019097017567%



E.I. DuPont de Nemours & Co.


U.S.: NYSE


USD84.54


-0.29
-0.34186019097017567%



/Date(1500671041983-0500)/


Volume (Delayed 15m)
:
1738530



AFTER HOURS



USD84.54



%


Volume (Delayed 15m)
:
15551




P/E Ratio
30.90590041675806

Market Cap
73550324656.4306


Dividend Yield
1.7979654601372133%

Rev. per Employee
542239









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(DD).

To investors more accustomed to companies issuing debt to fund acquisitions and stock buybacks or issue dividends, this may sound like a troubling trend. But it is actually a very good idea. More companies with underfunded pension plans should do the same thing.

At midyear, the average corporate defined-benefit pension plan was only 83% funded, according to Goldman Sachs Asset Management. That’s up from 81% at the start of the year, but it’s still a big shortfall.


General Electric



GE -2.9224428624953167%



General Electric Co.


U.S.: NYSE


USD25.91


-0.78
-2.9224428624953167%



/Date(1500670820179-0500)/


Volume (Delayed 15m)
:
89783737



AFTER HOURS



USD25.89


-0.02
-0.0771902740254728%


Volume (Delayed 15m)
:
866153




P/E Ratio
23.886788973909837

Market Cap
232435551701.736


Dividend Yield
3.705133153222694%

Rev. per Employee
404685









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(GE),


Lockheed Martin



LMT -0.1898712327821314%



Lockheed Martin Corp.


U.S.: NYSE


USD289.12


-0.55
-0.1898712327821314%



/Date(1500670922564-0500)/


Volume (Delayed 15m)
:
1207188



AFTER HOURS



USD289


-0.12
-0.04150525733259546%


Volume (Delayed 15m)
:
22893




P/E Ratio
22.23503987572003

Market Cap
83842955716.3976


Dividend Yield
2.5179856115107913%

Rev. per Employee
505619









More quote details and news »


(LMT), and


Exxon Mobil



XOM -0.9151620084095968%



Exxon Mobil Corp.


U.S.: NYSE


USD80.12


-0.74
-0.9151620084095968%



/Date(1500670821184-0500)/


Volume (Delayed 15m)
:
11408128



AFTER HOURS



USD80.16


0.04
0.04992511233150274%


Volume (Delayed 15m)
:
860477




P/E Ratio
33.490782928562474

Market Cap
342625340506.144


Dividend Yield
3.8442336495257114%

Rev. per Employee
2902010









More quote details and news »


(XOM) all had plans funded at just around 70% of assets at the end of last year. The shortfalls are “despite very benign equity markets,” notes Kevin McLaughlin, who heads liability risk management in North America at Insight Investment. “The need to make contributions to close these deficits is real.”

There are several reasons borrowing to fund pension plans makes particular sense right now. First, current interest rates are very low, making issuing debt cheap, especially for investment-grade companies. What’s more, corporate contributions to pension plans are tax-deductible. If corporate tax reform is passed later this year or next—a major goal of Republicans—the tax benefit of making those contributions would shrink.

Most pressingly, the cost of having an underfunded pension is growing, as annual fees on shortfalls charged by the Pension Benefit Guaranty Corp., which guarantees benefits to retirees, rise. Those fees have grown from less than 1% in 2013 to 3.4% today and are scheduled to rise above 4% by the end of the decade. That increase has been a key catalyst for the new spate of bond deals, says Mike Moran, chief pension strategist at Goldman Sachs Asset Management.

There aren’t a lot of downsides to issuing debt for this purpose. Far from frowning on the activity, credit-rating agencies see it as neutral to positive. An underfunded pension already counts as a form of debt, so it doesn’t add to total liabilities. Moody’s, for example, said Delta’s contributions to its pensions are improving its credit profile in an April note.

From a bond investor’s perspective, it’s a lot better for companies to use debt to fund pensions than using it for dividends or stock buybacks, which only benefit equity holders, says Matt Brill, a bond fund manager at Invesco. “We don’t feel negative toward it at all,” he says. “At the end of the day, they owe the money anyway.”

Ideally, companies would fund pensions with cash from current operations or issue equity, but that’s not always realistic, Brill notes. Companies are also reducing the amount of equity risk in their pension portfolios, which Brill says he likes to see.

Too few investors pay attention to pension shortfalls at companies in their portfolio, says Mark Grant, chief strategist at Hilltop Securities. “You better be careful of what you own,” he wrote in a commentary on Friday warning there could be a corporate pension crisis looming. “It may not be today and it may not be tomorrow and, if a company wises up, it may not happen at all.”

In this context, doing nothing to close a pension gap is the biggest risk. And issuing debt to fund a pension shortfall now, is the kind of smart fiscal management bond investors should look for. 

Email: amey.stone@barrons.com

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