Allen ein frohes, neues und gesundes (Bären-) Jahr!

verfasst von XERXES, 31.12.2002, 13:36

-->Earnings `Time Bomb' Looms in U.S. as Pension Fund Losses Mount
By David Evans
New York, Dec. 30 (Bloomberg) -- According to its annual report released in March 2002, Verizon Communications Inc., the largest U.S. local phone company, had a strong year in 2001. In the opening pages of the report, the company announced an annual profit of $389 million.
Only those investors who dug into the small print at the back of the document learned that Verizon's reported earnings included $2.7 billion in gains from its pension fund investments -- profit that didn't really exist. The company pension fund actually lost $3.1 billion in 2001, a footnote on page 58 of the 68-page report revealed.
In reporting gains it hadn't made, Verizon didn't violate any rules. Like other U.S. companies, Verizon was following accounting practices as written in 1985 by the Financial Accounting Standards Board, which sets U.S. accounting standards.
The FASB rules say that in preparing income statements, companies should include estimated gains -- not actual gains or losses -- from pension fund investments.
Legal or not, the practice has incensed some investors. ``There's a serious illness pervading a portion of the financial market,'' says Kathleen Connell, California controller and a board member of the state's two largest pension funds: the California State Teachers' Retirement System and the California Public Employees' Retirement System.
She says accounting rules are allowing companies to artificially increase stock prices. ``Phantom pension earnings are portrayed as income,'' she says. ``It's a ticking time bomb.''
As the stock market plunged during the past three years, the pension funds of companies in the Standard & Poor's 500 Index lost more than $200 billion in value, according to studies by actuaries and several investment banks, including Credit Suisse First Boston and UBS Warburg LLC.
Losses Weren't Reported
Because of FASB accounting rules, many of those losses weren't reported on balance sheets.
If pension liabilities had been counted in financial statements, aggregate earnings for the S&P 500 would have been 69 percent lower than the companies reported for 2001, or $68.7 billion rather than $219 billion, the CSFB study found.
``We're starting to see billions of dollars of shareholder equity vaporized because of pension underfunding,'' says Marc Siegel, a senior analyst at the Center for Financial Research & Analysis, an accounting research firm in Rockville, Maryland. ``It's much more pervasive than anything Enron was doing.''
Over the past three years, most companies have allowed their pension fund losses to grow -- out of the sight of balance sheets and investors -- without addressing the problem, says David Bianco, who headed research into the issue for UBS Warburg.
Too Big to Ignore
Now, the liabilities have become too big to ignore. Many of the largest companies will be spending hundreds of millions -- and in some cases, billions -- of dollars to replenish pension funds in 2003 and beyond, according to CSFB and UBS Warburg.
Ford Motor Co., the world's second-largest automaker, said in November it would put $500 million into its pension fund in both 2003 and 2004.
SBC Communications Inc., the second-largest U.S. local phone company, said in November it would pay $1 billion to $2 billion into its pension and postretirement health benefit funds in 2003, thereby reducing earnings by 20 cents to 40 cents a share.
On Dec. 5, Verizon said its earnings per share in 2003 would decline by between 27 cents and 33 cents because of lower pension income.
Many companies' reported profit will be reduced, say CSFB and UBS Warburg.
Other companies could face the same dilemma as Georgia- Pacific Corp., the world's second-largest paper and building- products manufacturer, which said in November that pension fund losses would require a charge to shareholder equity as high as $600 million in the fourth quarter of 2002.
Violation of Agreement
The charge would have placed the company in violation of a $2.4 billion loan agreement until a group of lenders, including Bank of America Corp., agreed to a waiver. Georgia-Pacific was required to pay the lenders an undisclosed fee to receive the waiver.
In October, Standard & Poor's lowered the long-term debt rating of both General Motors Corp. and Ford to BBB, two levels above junk, from BBB+, citing pension fund liabilities.
Another complication: As companies spend more to replenish pension funds in the next two years, that money will not be available for spending on such improvements as new buildings and manufacturing equipment. A study by Goldman Sachs Group Inc. estimates companies will need to channel an extra $80 billion a year to adequately fund pension accounts.
Economic Output
Bobby Inman, director of the U.S. National Security Agency from 1977 to 1981 and a board member of four companies -- Fluor Corp., an international construction company; coalmine operator Massey Energy Co.; Temple-Inland Inc., a paper-products manufacturer; and SBC -- says the pension liabilities could trim national economic output.
``What it's taking is the money that could otherwise be used for growth,'' says Inman, who chairs SBC's compensation and pension committee. ``There clearly will be an impact.''
The pension fund time bomb is coming as a shock to many investors because accounting rules have allowed the liabilities to remain virtually incomprehensible in the footnotes of financial statements, says Howard Schilit, an accountant and president of the Center for Financial Research & Analysis.
``There should be better disclosure,'' Schilit says. ``Even our clients, who are sophisticated investors, don't completely understand.''
General Electric Co., the world's largest company by market value, reported pension fund gains of $2.1 billion for 2001, or 11 percent of the company's pretax profit of $19.7 billion.
Lost $2.9 Billion
Difficult to find in GE's annual report was the fact that the company hadn't gained $2.1 billion from its pension investments that year; it lost $2.9 billion.
GE spokesman David Frail says the company reported the pension gain according to FASB rules. ``It's not hard to spot the loss,'' says Frail. ``It's on page 72, in footnote six.''
General Motors, the world's largest automaker, said in October that the value of its U.S. pension funds had fallen by 10 percent, or $6.7 billion, in the first nine months of 2002. That's the same percentage the company told shareholders on March 12 it had expected to gain in all of 2002.
GM said its pension funds were valued at $73.7 billion on Dec. 31, 2001 -- more than triple the $21 billion current market value of GM stock.
``It just keeps getting worse,'' says UBS Warburg analyst Bianco. ``GM is a highly leveraged mutual fund with a car company attached.''
Payments to Retirees
Pension fund losses should not disrupt payments to retirees even if a pension fund runs out of money because the Pension Benefit Guaranty Corp. (PBGC), a federal agency funded by mandatory insurance payments from companies, pays retirees when a company fails. The agency pays annual pension benefits of as much as $42,954 per person, says spokesman Jeffrey Speicher.
``We are the insurers of last resort,'' Speicher says. ``If a pension plan is underfunded and has to terminate, we step in and pay the benefit.'' The agency had reserves of $7.7 billion as of Sept. 30, 2001.
Among S&P 500 companies, 360 have defined-benefit pension plans, which are funded by the companies and guarantee a certain payment every month. Many of the newer companies, including certain large technology firms, never had defined-benefit pension plans.
Benefit Executives
Some retirees who remain shareholders in their companies say corporations are using pension funds to benefit executives at the expense of investors. At annual meetings in 2002, shareholders of International Business Machines Corp., GE and Verizon introduced proposals that would stop companies from including pension gains as part of the earnings companies use to determine executive bonuses.
All of the proposals were opposed by the companies and were defeated in shareholder votes. ``The retirees' pension fund has become a profit center for the company,'' says Joe Ristuccia, 71, who retired as a Verizon district plant superintendent in 1989 after 33 years of service.
Ristuccia cosponsored the proposal at Verizon, which garnered 43 percent of shareholder votes. ``It's outrageous,'' he says. ``I was betrayed by my company.''
Ivan Seidenberg, Verizon's chief executive officer, was paid a $2.4 million cash bonus for 2001. Company spokesman Varettoni says pension income is one of many factors used in determining bonuses.
Estimated Gain
Most companies have been reporting an estimated gain of about 9.5 percent in pension fund investments during the stock market slide that began in 2000, UBS Warburg says. For a company as large as IBM, that meant reporting a gain of $1.3 billion from pension fund investments in 2001, after expenses.
An investor reading IBM's annual report filed in March would look at the balance sheet and the management discussion that follows without seeing any mention of actual pension fund returns. The discussion does refer to recent stock-market losses.
``Although actual returns in 2001 were less than expected returns in the U.S. pension plan, the cumulative excess of actual returns over expected returns was $5.3 billion since 1986,'' the report says.
The reader would have to go 35 pages deeper into the report to find a footnote containing dozens of raw numbers related to pension investments and obligations. The footnote says that for 2000 and 2001, while IBM recorded assumed pension returns of $12.2 billion, the funds actually lost $2.8 billion -- a disparity of $15 billion.
`Billions of Dollars'
``If you've got assumptions that make a difference of billions of dollars in your bottom line, it seems to me that's the kind of thing people want to know about,'' says Simon Lorne, former general counsel at the U.S. Securities and Exchange Commission.
Lorne, now a partner at law firm Munger Tolles & Olson in Los Angeles, says that when it comes to pension performance, financial statements talk about the trees and ignore the forest. ``These numbers ought to be clearly shown in companies' financial reports,'' he says.
IBM spokeswoman Carol Malkovich defends the company's reporting practices. ``This accounting treatment is not unique to IBM,'' she says. ``It's FASB accounting followed by thousands of companies and fully disclosed in our annual report.''
On Dec. 4, IBM said it had paid $3 billion into its U.S. pension fund to cover all of its underfunding. Chief Financial Officer John Joyce declined to say how the payment would affect fourth-quarter earnings.
Smooth Out Volatility
FASB's decision that companies should use an estimate for pension fund investment gains every year was intended to smooth out potential stock market volatility in earnings computations, says Tim Lucas, project manager of the FASB team that wrote the rule known as Financial Accounting Standard No. 87, or FAS 87.
Lucas says that when FASB decided on the standard in 1985, it reasoned that stock-market trends had historically shown a gain during any 10-year period. So, regardless of market performance in a given year, an estimated gain over time was a safe and logical bet.
``We thought the investor was not going to be a whole lot better served by having the bottom line move around wildly each year,'' Lucas says. The plan worked without problems in its first decade, Lucas says.
What the rule's authors didn't anticipate was the stock- market boom of the late 1990s and the equally large decline that began in March 2000.
Two or Three Times
In the late 1990s, as companies reported pension fund earnings of about 9.5 percent, those investments had actually made two or three times that amount, company filings show. As a result, many companies made small or no contributions to pension funds during those years, says SBC director Inman.
``They earned so much money that corporations didn't have to put in anything annually to cover pension costs,'' he says. ``It was a free ride.''
As pension investments began losing money in 2000, most companies still had a cushion in their pension funds, annual reports show. Even as the losses mounted in 2001, most companies weren't concerned about pension deficits, Inman says.
In December 2001, billionaire investor Warren Buffett started to caution companies that pension losses had the potential to cause huge disparities if companies didn't address the issue. He began suggesting in public statements that companies should lower annual pension income estimates to 6.5 percent, as he did with his Berkshire Hathaway Inc.
Buffett's cautions went largely unheeded in 2002, as most companies kept pension gain estimates at about 9.5 percent, SEC filings show. ``Generally, people don't think this is an issue,'' says UBS Warburg's Bianco. ``They think it's a bunch of balance sheet hocus-pocus. They don't know how to deal with it.''
Lowered Rates
Some companies have already lowered their estimated rates. In July, Marsh & McLennan Cos., an insurance and money management firm, lowered its assumed rates of return to 9.25 percent from 10 percent; in November, Georgia-Pacific said it would lower its expected rate to 8.5 percent in 2003 from 9.5 percent.
Those rates are still far too high, says Joshua Dietch, a consultant at Cerulli Associates, a Boston-based financial research and consulting firm. ``Companies got caught with their pants down using high assumptions,'' he says.
An examination of company filings with the SEC, comparing balance sheet earnings reporting with numbers found in complex footnotes deeper in the reports, shows how reported income can be distorted by including pension fund investment returns that never materialized.
Weyerhaeuser Co., the world's biggest lumber company, relied on reported pension earnings for 66 percent of its net income in 2001: $234 million out of $354 million. The company used an 11 percent assumed rate of return in 2001 -- one of the highest of any company in the S&P 500, according to CSFB and UBS Warburg.
Lost 9.5 Percent
Its pension fund actually lost 9.5 percent on its investments. The estimated pension fund investment income before expenses was $437 million, while the pension fund lost $412 million.
Weyerhaeuser achieved an 18 percent actual rate of return over the 17 years through 2001 by taking on slightly more risk than other pension funds, says Richard Taggart, the company's vice president of finance. That included $47 million invested in LJM2 LP, the now bankrupt special-purpose entity formed in 1999 by Andrew Fastow, Enron Corp.'s former chief financial officer.
Initially, LJM2 produced an internal rate of return of more than 40 percent, says Robert McCullough of McCollough Research Associates in Portland, Oregon. Taggart says the investment in LJM2 was written off in 2001 for a loss of less than $5 million.
Lower Returns
In November, Weyerhaeuser said it would reduce shareholder equity by $90 million in the fourth quarter because of lower investment returns on its pension funds. Weyerhaeuser dropped its expected rate of return to 10.5 percent in 2002, and company officials say another decline seems likely in 2003.
``It's not unreasonable to assume we might do that, considering where the financial markets have gone,'' says Taggart.
SBC didn't lower the expected rate of return on its pension fund during the market decline of 2001. Instead, it increased the estimated rate to 9.5 percent from 8.5 percent in 2000. By doing so, the phone company was able to add $360 million to its earnings for 2001. That change is permitted under FASB standards.
``I can't think of a rational reason for it,'' says Siegel of the Center for Financial Research & Analysis. ``The vast majority of pension plans lowered or left unchanged rates of return in 2001.''
High Historical Rates
Inman says the rate was raised because of the pension fund's high historical rates of return and bullish expectations for the future. ``I've never ever encountered a discussion, `How can we do this to make our earnings appear stronger than they are?''' he says.
SBC's $40.8 billion pension fund lost 6.9 percent, or $2.8 billion, in 2001, while the expected return reflected in its pension footnote was $3.5 billion. The company reported net income of $7.24 billion in 2001; the total included $1.45 billion in assumed gains from its pension fund.
SBC didn't mention the pension fund's contribution to earnings in any of its press releases through 2001 or in the management discussion section of its annual report filed with the SEC on Feb. 28, in which the company did note the increase in the expected rate of return.
Inman says he favors improving the disclosure of pension income on corporate earnings. ``I'm not sure the bulk of the public has any understanding at all on the issue of rate of return that you're projecting and what impact that's going to have on your earnings or absence of earnings,'' he says.
Weak Stock Market
In November, in an SEC filing, SBC cautioned investors that a continuing weak stock market could cause the company to lower its estimated pension rate of return.
Companies with the biggest pension fund disparities are large manufacturers with unionized workforces. Hardest hit are the auto, airplane and steel industries, CSFB and UBS Warburg say.
General Motors said in October that by the end of 2002, its U.S. pension plan could be underfunded by $23 billion. Pension plans are considered underfunded when pension fund obligations exceed the value of the fund's assets.
GM's pension fund covers about 650,000 active and retired U.S. workers. GM estimated in November it would have to add to its pension plan $14 billion to $17 billion if the company earns less than 10 percent on its pension fund investments every year through 2006.
If GM doesn't reach those funding levels, the company says, it will have to pay higher premiums to the PBGC. The premiums could increase by as much as $207 million a year if the underfunding is $23 billion in 2004, based on standards set by the PBGC.
`A Manageable Situation'
``We didn't get ourselves into this hole in one day and we're not going to get out right away, but we do believe this is a manageable situation,'' says GM spokesman Jerry Dubrowski.
Ford said in its 2001 annual report, filed with the SEC on March 28, that it expected its U.S. pension funds to earn 9.5 percent in 2002. In November, Ford said in a press release that it had lost 11.5 percent on its U.S. pension funds during the first nine months of 2002. The automaker said its pension funds would be underfunded by about $6.2 billion at year-end.
``Overall, the company believes its pension obligations are very manageable,'' the company said.
Omitted from Ford's press release was any reference to its foreign pension fund investments. An estimate in an appendix to the company's quarterly filing with the SEC in November predicted an additional $5.7 billion year-end loss for the foreign pension funds, for a total underfunding of $11.9 billion -- about 67 percent of the market value of Ford shares.
Investors Bewildered
Citing pension investment gains as part of company earnings leaves many investors bewildered, says Dennis Beresford, former chairman of FASB and now a professor of accounting at the University of Georgia.
``The mere notion of pension income is counterintuitive,'' Beresford says. Pension income doesn't belong to a company, he says. A company holds pension money in trust for its employees. Companies aren't allowed to use the funds to pay dividends or buy machinery, he says.
``Someone who wanted to could purposely choose bad assumptions to manipulate financial results,'' he adds.
That can no longer happen in the United Kingdom, where the smoothing concept central to FAS 87 has been scrapped. In November 2000, the U.K.'s Accounting Standards Board approved a new rule to replace smoothed pension asset values with actual market prices.
`Impenetrable Black Box'
``Pension cost accounting has for a long time been an impenetrable black box,'' says David Tweedie, a native of Scotland who now heads the International Accounting Standards Board in London, which is pushing for worldwide regulations similar to those in the U.K. ``In my view, the U.K. now has the best standard in the world.''
The U.S., too, should adopt a standard that reflects actual market value of pension assets, says Walter Schuetze, chief accountant at the SEC from 1992 to 1995. He says companies should update the performance of pension fund investments four times a year.
Lucas, the project manager of FAS 87, agrees that it's time for a new rule to clear up investor confusion. Lucas, who's now a consultant, suggests that pension income and expenses be listed and identified clearly in income statements. He'd also eliminate assumed rates of return and use actual pension earnings to replace artificial smoothing techniques.
Patrick Durbin, an FASB practice fellow, says the accounting board isn't working on any changes to FAS 87. ``There isn't anything on the FASB agenda to reconsider the rule,'' he says.
Lucas says the current system will likely stay the same for now because U.S. companies contend the smoothing concept reduces earnings volatility quarter to quarter. ``Accounting makes progress in small steps,'' he says.
So companies will continue to report earnings that don't match up to reality -- and many investors will continue to base their decisions on numbers they have no reason to trust.

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• Allen ein frohes, neues und gesundes (Bären-) Jahr! - XERXES, 31.12.2002, 13:36
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