Verizon, AT&T Pension Switch May Amplify Profit Swings

Verizon Communications Inc. and AT&T Inc.’s move to change the way they account for pension costs may increase the volatility of earnings if the economy hits another recession, accountants say.

The companies said last month they will record gains or losses on pension assets in the year they occur, rather than spreading them out over several years as they’ve done in the past, to provide more transparency. The new approach also let the companies redistribute across previous quarters some $37.2 billion in expenses that may have hurt future earnings.

AT&T and Verizon may be left more vulnerable to swings in the stock market, making some investors less willing to hold their stock, said Robert Willens, head of the tax consulting firm Robert Willens LLC in New York. A decline in pension assets, like in 2008 when the Standard & Poor’s 500 Index tumbled 38 percent, would hit earnings in a single year, rather than over ten or more years as in the past.

“These companies are not going to be able to spread the loss over an extended period of time and blunt the impact” if there’s a similar market drop in the future, said Willens, previously a managing director in charge of tax and accounting analysis at Lehman Brothers Holdings Inc. “Investors, in my view, will shun the company’s stock because of the difficulty in forecasting the company’s earnings.”

Verizon and AT&T, the largest U.S. phone companies, have said the changes will make it easier for investors and analysts to understand changes in their pension costs. The companies will record changes in their pension funds in the fourth quarter of each year.

Pension Obligations

Verizon fell 7 cents to $36.31 in New York Stock Exchange composite trading at 4 p.m. The shares have gained 1.5 percent this year. AT&T, based in Dallas, declined 2 cents to $27.97 and dropped 4.8 percent this year.

Pension obligations are substantial for Verizon and AT&T because of their history as part of the U.S. phone system that was one of the country’s largest employers. Verizon had 222,900 employees and 213,000 retirees drawing benefits from the company at the end of 2009. AT&T hasn’t disclosed comparable figures.

In October, Craig Moffett, an analyst with Sanford C. Bernstein & Co. in New York, calculated that the companies had the largest underfunded pension and other post-retirement benefit obligations among the S&P 500 at the end of 2009. The underfunded benefits totaled $28.7 billion for AT&T and $27.5 billion for Verizon, according to regulatory filings. The companies haven’t yet released 2010 figures.

The accounting change won’t affect how much money the carriers have to put in their pension accounts and the changes in earnings won’t force them to dip into cash, said Bob Varettoni, a spokesman for New York-based Verizon.

Break Out Earnings

The change will tie the funds’ projections and performance much more closely to the overall market and provide a more transparent way of evaluating the companies, said Brooks McCorcle, AT&T’s senior vice president of investor relations.

AT&T and Verizon will probably break out earnings without pension charges so investors can see the pension impact separate from operations, said David Zion, a New York-based accounting and taxation analyst at Credit Suisse AG.

“You’d want to highlight the volatility from the pension plan,” Zion said. “You’ve got the core underlying results and what’s going on in the pension.”

Recording drops in pension accounts -- which have to be funded by about 90 percent or more of projected obligations -- won’t require companies to increase contributions to the funds, Varettoni said. While the pensions are governed by generally accepted accounting rules, the funding level requirements are enforced by the U.S. Internal Revenue Service, he said.

More Explicit

The new method will make companies’ pension investing a higher-profile issue for investors, making explicit riskier and safer strategies, Zion said.

“That could result in some behavior changes and might have companies rethink the amount of chance that they’re taking in their pension plans,” Zion said.

The fair value of Verizon’s pension fund assets shrank by more than a third to $27.8 billion in 2008 from $42.7 billion the year before. AT&T’s plan asset value shrank to $46.8 billion in 2008 from $70.8 billion.

The new accounting approach will present challenges for companies that adopt it, said Willens.

“The company’s story becomes more difficult to tell when its earnings are so heavily influenced by non-operating items,” he said. “It’s always preferable for earnings to be affected only by operating factors rather than extraneous factors that are difficult to predict with any accuracy.”

To contact the reporter on this story: Amy Thomson in New York at athomson6@bloomberg.net

To contact the editor responsible for this story: Peter Elstrom at pelstrom@bloomberg.net

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