Friday, January 14, 2011

GM Loosening the Pension Noose?

Christina Rogers of The Detroit News reports, GM pays down its pension debt with $2B stock contribution:
General Motors confirmed today that it has made a $2 billion contribution to its underfunded U.S. pension plans, giving it 60.6 million shares in common stock.

The payment, which GM previously announced it would make, adds to the $4 billion cash the Detroit automaker contributed to its pension plans last fall. The plans are underfunded $29.4 billion globally, a liability Chief Financial Officer Chris Liddell says he wants to wipe off the books over the next few years.

GM's U.S. pension plans, which cover about 688,000 U.S. hourly and salaried retirees, are underfunded by $17.1 billion.

"We continue to take the steps necessary to lower our risk profile, so our focus can be on designing, building and selling the world's best vehicles," Liddell said, in a statement this morning.

Liddell has said the company has made paying down debt a priority. GM wants a stronger balance sheet to weather sudden, sharp downturns in the marketplace without having to borrow large sums of money - a trend that sank the old GM into financial peril.

Once the $100 billion pension plans are fully funded, he said the company will move assets into less risky investments, such as bonds.

GM also said this week it will pump $7 billion into product engineering and development this year - up from $5 billion during bankruptcy - and keep it a constant level. Liddell said the company has wasted billions of dollars starting projects in good times, only to abandon them in tougher years.

GM reported profits of $4.2 billion for the first three quarters of 2010.

The automaker returned to the public markets Nov. 18 and its initial stock sale raked in $23.1 billion making it the world's largest IPO.

In another Bloomberg article posted on Pensions & Investments, Mr. Liddell said it is “reasonable to think we’re in an interest rate-increasing environment over the next three to five years,” which would help GM to fund its pension. He said GM “is not relying on that.” The “first call” on GM’s cash is engineering and marketing, he said, while repaying debt and making pension plan contributions are secondary.

Finally, Joann Mueller of Forbes reports, GM Loosening The Noose From Its Massive Pension Plan:

As General Motors has shrunk, its pool of U.S. retirees has swelled. Today there are almost 700,000 GM retirees and just 70,000 active workers, a 10-1 ratio. The company’s $100 billion pension fund is twice the market capitalization of the automaker itself, and keeping up with funding obligations acts like a ball and chain on GM’s core car-making business. Small swings in the value of the pension plan can have massive effects on the value of the company. “That’s no way to run a company,” said GM’s chief financial officer Christopher Liddell.

I met with Liddell during the Detroit auto show this week, and he talked extensively about GM’s more conservative financial philosophy since emerging from bankruptcy in July 2009. GM’s objective is to carry no debt, fully fund its pension plan, and pay for its day-to-day operations using cash generated from the sale of cars and trucks. It sounds so simple, but that’s not the way GM has been run in many years.

GM took a big step in that direction Friday, announcing it had contributed $2 billion in newly minted GM stock to its U.S. pension plan, on top of $4 billion in cash it had contributed a couple of months back to try to bring that pension fund closer to fully funded status. As of the end of 2009, the portfolio was $17.1 billion short of what it should have, under government rules, to cover its current and future pension obligations.

The gap likely closed some in 2010, thanks to strong market returns, but the gains could be offset by further swelling in the retiree ranks. GM plans to give an annual update on the health of its pension plan next month when it announces its fourth-quarter financial results.

Three factors determine the health of any pension fund: asset returns, company contributions and the discount rate, which is used to calculate the present value of pension liabilities and is tied to interest rates. In the past, market swings and interest rates would cause GM’s pension fund to fluctuate wildly between being overfunded and underfunded. In the 1990s, GM borrowed heavily to pay off its pension plan, saddling itself with hefty interest payments. As long as the stock market remained high, the value of the assets in GM’s portfolio exceeded its liabilities. But even a change in the discount rate could cause big swings in the plan’s funding status.

Between 2005 and 2007, GM’s pension plan was in great shape, and the company didn’t need to make any contributions. But then the equity and credit markets collapsed, coupled with declines in the discount rate (which made the present value of GM’s pension liabilities rise significantly) and more early retirements at GM, increasing the number of beneficiaries. Suddenly, the pension plan was $17.1 billion in the hole.

“We’ve got to get this company to where the economics, everything, is driven around designing, selling and producing cars,” Liddell said. “Things like the pension plan don’t enter into the equation.”

Liddell said he believes GM can fully fund the pension plan within three years at which point, he plans to “de-risk” the portfolio by investing less in equities and real estate, and more in fixed income assets, which generally provide a lower rate of return. “Perfection to me would be where the assets exactly equal the liabilities in both their maturity and their risk profile,” he said.

He’s not expecting perfection, but he is expecting GM to operate debt-free in the future. It seems like forever that GM has been up to its neck in debt, including its pension and health care obligations to retirees. But it’s only in the past 15 years or so that GM has been highly leveraged. Before that, it was a AAA-rated company.

Now it’s working to get back there. It off-loaded retiree health care to a union trust fund in 2009, is working on the pension problem, and restructured the rest of its debt during its government-controlled bankruptcy. In 2010, GM lowered its debt from $14.2 billion to $5 billion, and reduced its $9 billion preferred share obligation to $7 billion. It obtained a $5 billion revolving credit loan, but Liddell said he doesn’t think GM will have to tap into it.

Perfection? No. But progress, yes.

I agree, it's not perfect but it's progress. GM is doing the right thing by topping up its pension plan now that times are good. If they can reach fully funded status in three years, so much the better. Of course that entirely depends on where markets are heading. In the meantime, GM can focus on its core business and hope that car sales pick up steadily in the next few years.

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