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No GM Buyback or Dividend Seen as Pension Gap Freezes Cash: Cars
General Motors Co. (GM), holding cash until it learns the magnitude of retiree obligations at year- end, may find a pension deficit that rivals its market valuation and delays a buyback or dividend.
GM’s pension shortfall may reach $35 billion when calculated using lower asset returns and a reduced rate for valuing future payments, estimates Kenneth Hackel, president of CT Capital LLC in Short Hills, New Jersey. GM’s market capitalization sank as low as $33.1 billion last month.
“The financial risk because of the pension is higher than people understand,” said Hackel, who wrote two textbooks on valuing securities. “The cold reality is if you used a conservative discount rate and you wanted to close out the plans, you would have to raise about $35 billion.”
The automaker’s pension plans have the biggest deficit among U.S. companies, according to data compiled by Bloomberg. The widening gap validates GM’s decision to wait before returning cash to shareholders, said analysts such as Credit Suisse AG’s Christopher Ceraso. Chief Executive Officer Dan Akerson has said it’s “imperative” that GM, the recipient of a $49.5 billion government bailout, fully fund U.S. pensions.
GM, two years removed from bankruptcy court protection, may fall further behind obligations even as it makes strides in the marketplace. The Detroit-based automaker topped Toyota Motor Corp. in first-half global vehicle sales and increased U.S. market share to 20 percent this year through July from 19.2 percent a year earlier, aided by demand for the Chevrolet Cruze.
Companies fell behind on funding pensions that cover future payouts for retirees by the most this year in July and August, according to Milliman Inc., which tracks the performance of the 100 largest corporate defined-benefit pensions. The slowing U.S. economy lowered bond yields that determine the present value of future obligations and the Standard & Poor’s 500 Index’s biggest drop since March 2009 hurt asset returns.
GM’s global pension plans were underfunded by $22.2 billion at the end of 2010, according to its 10-K regulatory filing. The shortfall for the U.S. was $12.4 billion. Those figures don’t take into account a stock contribution of about $2.2 billion that GM made to pensions in January.
The company’s pensions may be underfunded by $30.7 billion by year-end, according to Ceraso, who is based in New York and rates the automaker’s shares “outperform.” His projection in an Aug. 18 report assumes that the discount rate for GM’s U.S. pensions falls 50 basis points to about 4.5 percent and that asset returns range from 0 percent to 2 percent.
“That’s a reasonable number,” Glenn Reynolds, chief executive officer of research firm CreditSights Inc., said of the estimate in a phone interview. Reynolds called GM’s exposure to pension risk “other worldly” in an Aug. 4 report.
The shortfall for GM’s U.S. pensions alone last year was bigger than the deficit in any large-cap company’s global plan except Exxon Mobil Corp. (XOM), whose market value is more than nine times GM’s, according to CreditSights. Exxon’s global pensions were underfunded by $13.1 billion at the end of last year.
There were 21 U.S. companies whose pensions were underfunded by at least $3 billion last year, according to Bloomberg data. Only AMR Corp. (AMR) and Delta Airlines Inc. have plans that were underfunded by more than current market cap, the data show. Aside from AMR and Delta, GM had the largest pension deficit as a percent of market cap, at more than 60 percent.
GM has reported six consecutive quarterly profits, including $2.99 billion in the second quarter. The company generated $4.37 billion cash from automotive operations in the six months through June 30, boosting cash holdings in that part of the company to $33.8 billion.
The growing cash pile has led analysts such as Himanshu Patel of JPMorgan Chase & Co. to speculate about stock buybacks. The analysts have said such moves may alleviate concerns about the U.S. Treasury Department flooding the market by unloading its remaining stake of more than 500 million shares.
“We’re obviously in a very volatile asset environment and a very volatile liability environment right now for the pension plan,” Dan Ammann, GM’s Chief Financial Officer, said during an Aug. 4 conference call. “We want to see what happens with that through the end of the year. Beyond that, obviously we have an objective to ultimately return cash to shareholders.”
JPMorgan’s Patel said in a May 6 report that GM was likely to consider a stock repurchase from the U.S. government. He has said in two August research reports that a buyback is unlikely until at least 2012’s second half.
GM paid $9.15 billion in benefits last year, about 10 percent of the fair value of total fund assets. That rate of “portfolio drain” is difficult to replace with asset returns because GM has allocated more of its investment portfolio to fixed income, CreditSights’ Reynolds said.
GM isn’t required to make contributions to its U.S. pension plans this year, according to its 10-K filing. The automaker doesn’t project required contributions until at least 2015 and is evaluating whether to make additional voluntary inputs still this year, according to the filing.
“We suspect GM will make a large voluntary contribution late this year or early next year, as the company has frequently repeated its conviction to ‘fully fund and de-risk’ its U.S. pension plan,” Ceraso said in the Aug. 18 Credit Suisse report.
The U.S. took a 61 percent ownership of GM as part of the automaker’s government-led bankruptcy reorganization in 2009. The rescue protected the U.S. pensions of more than 120,000 retired salaried employees and 400,000 retired hourly workers, most of which are represented by the United Auto Workers.
Akerson, 62, told reporters before the company’s June 7 annual meeting in Detroit that he wanted GM’s U.S. pensions funded within his tenure.
“Regardless of the government’s involvement with the company longer term, how long that might be or not be, it’s imperative that this management team assume that responsibility,” Akerson said in a speech to shareholders.
GM’s goal to fully fund U.S. pensions in the next few years may be unrealistic, said Hackel, whose firm CT Capital advises institutional investors.
“It’s not the world we live in,” Hackel said. “Stocks are down the last five years, and over the last 10 years. And, of course, the most important metric that goes into actuarial work is the discount rate.”
The discount rate is used to determine the present value of future cash flows. The discount rate fell 31 basis points in July alone, according to Seattle-based Milliman. A 25 basis- point drop in the discount rate increases pension obligations by $2.54 billion, according to GM’s 10-K.
GM used a discount rate of 4.96 percent last year to calculate present value of future obligations. That was the most conservative among companies with pensions underfunded by at least $3 billion, according to Bloomberg data.
The Federal Reserve pledged on Aug. 9 to hold interest rates near zero until mid-2013. That announcement was bad news for pension funds, said John Ehrhardt, a New York-based principal and actuary for Milliman.
“For a year and a half I’ve been hearing that interest rates have to go up from here, and they continue to chug downward,” said Jon Waite, a director and chief actuary at investment manager SEI Investments Co.’s institutional group, in Oaks, Pennsylvania, which oversees $180 billion.
Milliman, which tracks the performance of the 100 largest corporate defined-benefit pensions, says companies contributed a record $60 billion to their plans in 2010. Contributions will probably set records this year and next year, Ehrhardt said.
“Companies are certainly not going to see any liability relief from rising interest rates,” he said in a phone interview. “GM and everybody else are going to be counting on the asset side of the equation to try and reduce the funding deficit.”
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