Tuesday, March 19, 2013

Air Canada Bonuses Tied to Pension Payments?

Guy Dixon of the Globe and Mail reports, Bonuses for Air Canada executives tied to pension deficit payments:
The federal government is offering a carrot to Air Canada to pay down the company’s pension deficit, even as it wields a heavy stick in imposing detailed restrictions on how the company’s executives are paid over the next seven years.

In an unusual move of government intervention in Air Canada’s program of executive performance incentives, Ottawa will allow the Montreal-based airline’s top executives to receive performance bonuses that grow as the company contributes money to its pension deficit.

Those bonuses, based on the company's financial performance, would be paid in full once the airline pays up to $200-million a year toward its pension deficit, according to union leaders who were briefed by Finance Minister James Flaherty about the conditions to be imposed on Air Canada executives.

As part of the deal announced Tuesday between Air Canada and the government, the airline has been given another reprieve on financing its debilitating pension deficit of $4.2-billion.

Over the course of seven years, beginning in 2014, Air Canada only has to contribute a minimum of $150-million a year, or an average of $200-million annually over seven years, towards its pension deficit – far below what regulations would normally require.

Air Canada and its unions have argued that low interest rates, and therefore low returns on pension investments, have made pension funding requirements too onerous, a problem faced throughout much of corporate Canada.

In granting this arrangement, the government has imposed conditions included limiting increases in executive pay to the rate of inflation, a prohibition on special bonuses and limits on executive incentive plans.

However, in a conference call and letters to unions on Tuesday, Finance Minister Jim Flaherty noted that the top 24 executives at Air Canada can still receive bonuses under the company’s annual incentive plan, according to people who were part of the call and received the letter.

Union representatives confirmed that Mr. Flaherty told the unions that if Air Canada makes its $200-million annual pension payment, then the executives will receive their full annual incentive plan bonuses. (The annual incentive plan covers cash bonuses given when the airline meets its financial targets.)

If Air Canada only makes a payment of $175-million to its pension deficit in the year, the top executives would receive only half of their annual incentive plan, or AIP. If the airline only pays $150-million, then no performance incentives would be paid to the executives. Other bonuses, such as retention payments to keep an executive at the company, would be eliminated.

According to union representatives familiar with the arrangement, restrictions on stock options are unclear. As the letter sent to union explained, a “limit will be imposed on equity-based executive compensation and prohibit any special bonuses outside of the AIP while the regulations are in force, as long as Air Canada has not elected to opt out of the regulation.”

Union representatives briefed about the arrangement said that the deal is still being hammered out between Air Canada and Ottawa and that the terms announced Tuesday were just the broad brush strokes.

Air Canada would not comment Thursday about the terms outlined in the conference call and the letter to unions. The arrangement still needs to be approved by an order-in-council before it turns into official regulation for Air Canada, union leaders explained.
Last week, I discussed whether Air Canada deserves a pension lifeline, going over the pros and cons of this deal. The follow-up announcement that the federal government will allow bonuses once the airline pays up to $200 million a year towards its pension deficit is also a step in the right direction.

Why is this the case? Basically the government doesn't want to slap Air Canada with overly onerous conditions which will end up hurting the management of the company. By allowing bonuses to be paid once a certain target amount is reached toward paying off the pension deficit, the government is striking a balance between the dual priority of ensuring sound pension management and sound management of the company.

Scott Deveau of the Financial Post noted the following in his article last week, Skies clearing for Air Canada after pension relief:
Walter Spracklin, an RBC Capital Markets analyst, said he believed Air Canada’s pension obligations would have increased by a further $2-billion in 2013 – partially offset by a $1.1-billion reduction stemming from the agreement reached with its labour unions to move new hires into a hybrid pension plan.

He estimated Air Canada’s pension funding deficit would still have increased in 2013 to roughly $5-billion, which would have left the carrier on the hook for more than $1-billion in annual pension payments starting next year when its current funding cap expires.

“In the current low interest rate environment, Air Canada’s pension solvency deficit funding payments would not be sustainable without the seven-year extension in place,” Mr. Spracklin said in a note to clients.

The seven-year extension buys Air Canada some time, with the hope that interest rates will rise over that period.

Mr. Spracklin, who has an “outperform” rating on the stock and a $3.50 price target, noted for every one percentage point increase in the discount rate, Air Canada’s pension solvency deficit would be reduced by $1.85-billion.

Therefore, if a 2.7 percentage point increase were to occur over the next seven years, Air Canada’s deficit would be effectively “wiped out.”

“The key here is that with the extension in place, what we believe to be a significant risk discount and an overhang will start to lift and the [Air Canada] shares will begin to approach fair valuation,” he said.
Keep in mind that a 2.7 percentage point increase in the discount rate over the next seven years isn't beyond the realm of possibility, aiding Air Canada and other Canadian corporations struggling with their deepening pension hole.

Of course, one thing that concerns me is that Canadian households are drowning in debt and are extremely vulnerable to any rise in interest rates. In short, Canada's perfect storm doesn't augur well for a sustained rise in interest rates over the next five to ten years but if they do rise, it will benefit savers with no debt and pensions plans struggling with huge pension deficits.

Below, CCTV's Kristiaan Yeo reports on Canada's housing market. After long held beliefs that Canada's housing market would remain stable throughout the financial crisis there are concerns now that it may drag down Canada's economy. The international monetary fund warns that the economy may be facing a housing bubble and housing prices are ten percent over valued.