Wednesday, March 13, 2013

Does Air Canada Deserve a Pension Lifeline?

Brent Jang of the Globe and Mail reports, Ottawa grants Air Canada pension reprieve, imposes executive pay freeze:
Ottawa has granted Air Canada more time to meet its pension funding obligations, but with tough conditions that include the airline’s executives taking a hit to the wallet.

Ottawa needed to act to ensure the carrier’s fiscal health, Finance Minister Jim Flaherty said in a statement Tuesday. “Air Canada is the country’s largest airline and contributes significantly to the Canadian economy,” he said.

In what appeared to be a message to other organizations that might want financial aid, Mr. Flaherty made it clear that this is an extraordinary case that required imposing strict conditions in exchange for the pension funding extension. The Finance Minister is slated to present the 2013-14 federal budget within weeks.

The Montreal-based carrier will freeze executives’ compensation at the rate of inflation, ban special bonuses and limit management incentive programs.

The airline’s chief executive officer, Calin Rovinescu, had a total payout of nearly $4-million in 2011, including $1.4-million in salary and $1.2-million in share-based awards.

The federal government also said the airline won’t be able to declare any dividends and embark on share repurchases.

Faced with a $4.2-billion pension solvency deficit at the start of 2012, Air Canada had originally sought permission to limit its payments to $150-million annually over 10 years. In Tuesday’s deal, the company must pay at least $150-million a year, with an annual average of $200-million spread over seven years.

“During lengthy discussions with the company, the government demanded that Air Canada strengthen its initial proposal with tough new conditions such as greater solvency payments, a shortened term and measures that will ensure that employees and executives of Air Canada are part of the solution,” the Finance Department said.

The conditions suggest Ottawa wants to ensure that, after giving Air Canada an extension, it won’t be faced with the poor optics of big executive bonuses. And one Finance Department official said the government believes the tough conditions will be an incentive for Air Canada to pay off its pension deficit faster and return to business as usual.

The Air Transport Association of Canada, whose members include smaller carriers such Porter Airlines Inc., complained last month about the prospect of Ottawa helping the former Crown corporation. “The cap requested by Air Canada would barely cover the deficit’s annual interest and would do absolutely nothing to tackle this crippling deficit,” the association wrote on Feb. 12 to Mr. Flaherty, Prime Minister Stephen Harper and Transport Minister Denis Lebel.

Mr. Flaherty defended the decision. “It’s important to note that Air Canada’s unions and retirees have been supportive of the company’s request for further solvency funding relief for its pension plans,” he said. “This regulatory change is not costing Canadian taxpayers a single dollar, but it is providing Air Canada time to pay off the sizable pension deficit.”

Air Canada obtained pension funding relief in 2009, but that arrangement was set to expire on Jan. 30, 2014.

The new agreement means that for the period from 2014 through 2020, “Air Canada will contribute an aggregate minimum of $1.4-billion in solvency deficit payments, in addition to its pension current service payments,” the airline said, adding that for 2009-2013, it will have contributed nearly $1.48-billion in past service contributions and current service costs.

Air Canada doesn’t currently pay any dividends, but rival WestJet Airlines Ltd. does. Calgary-based WestJet has complained in the past about Air Canada gaining an unfair competitive advantage through pension relief.

“In the current extremely low-interest-rate environment, Air Canada’s pension solvency deficit funding payments would be unsustainable without this extension in place,” the company said late Tuesday. “Air Canada will submit to the Office of the Superintendent of Financial Institutions all communications materials it intends to send to pension plan beneficiaries prior to funding the plans in accordance with the new regulations.”
CBC also covered this story, publishing an article from the Canadian Press, Air Canada gets pension lifeline from Ottawa:
The federal government announced Tuesday that it would give Air Canada more time to eliminate the $4.2-billion deficit in its pension plan, but imposed strict rules on the airline that limit executive pay and prevent it from paying dividends.

"By taking this action, we are ensuring that Air Canada remains viable, that thousands of jobs are protected and the service is there when Canadians need it," Finance Minister Jim Flaherty said in a statement.

"Air Canada is the country's largest airline and contributes significantly to the Canadian economy."

The deal requires the airline to make contributions to the plan of at least $150 million a year totalling at least $1.4 billion over seven years, on top of the regular contributions required by the plan.

Executive pay frozen

The agreement also freezes increases in executive pay at the rate of inflation, prohibits special bonuses and puts limits on executives' incentive plans. The airline will also be prevented from paying dividends and buying back stock as well as making any pension plan benefit improvements without regulatory approval.

Air Canada's pension deficit has been a chronic problem for the airline due to low interest rates which have driven up liabilities.

The airline had wanted Ottawa to put a $150-million cap on its annual solvency deficit payments for the next decade, starting in 2014.

Flaherty noted that Air Canada's unions and retirees have been supportive of the company's request for help with its pension deficit.

"This regulatory change is not costing Canadian taxpayers a single dollar, but it is providing Air Canada time to pay off the sizeable pension deficit," the minister said.
Pension holiday extended

In 2009, Air Canada signed a deal with the federal government that granted the airline a moratorium on special pension contributions to reduce its deficit for that year and 2010. Under that deal, which expires next year, Air Canada was required to make $150 million in special payments in 2011, $175 million in 2012 and $225 million in 2013.

The Air Transport Association of Canada had argued against Ottawa granting Air Canada pension relief, saying it would create an uneven playing field.

The group, which represents small regional carriers and training centres, argued that Ottawa should provide broad pension assistance to all Canadian companies, instead of giving a competitive advantage to the former Crown corporation.

"We don't really have anything to add, but that we respect the government's decision," said John McKenna, president and CEO of ATAC.

McKenna said the group has decided to be more "cautious" after it was falsely accused of being overly critical of the airline.

Last week, it posted a public apology on the front page of its website for the open letter it had written to the federal government to voice its concerns.

Air Canada has said that cost savings from its recent labour agreements, the startup of low-cost carrier Rouge and pension relief will help to lead the airline to sustainable profits.

Shares in Air Canada closed down six cents to $2.57 Tuesday on the Toronto Stock Exchange.
So did the Department of Finance Canada take the right decision by granting Air Canada a pension lifeline? Yes and no. Let me explain. First have a look at a profile of Air Canada by the numbers (click on image):


As you can see, 26,000 employees are counting on the health of this national airline to provide for their families. They are also counting on their defined-benefit pension plan to help them retire in dignity and security.

As I mentioned in a recent comment on confusion over volatility strategies, the people managing Air Canada's pension plan are doing a stellar job. They were put in place after the crisis and have outperformed their peer group ever since.

But they're not magicians and no matter how good they are, they can't solely rely on exceptional investment returns to get out of a $4.2-billion pension deficit. By granting Air Canada a pension reprieve and imposing strict conditions, the federal government is allowing the company to focus on strengthening its core business and buying their pension plan time to significantly improve its deficit.

Of course, critics will claim Air Canada's pension isn't the only one flying off course. Why can't they cut the same deal for other large Canadian corporations who are also struggling with their pension hole? True but I'm sure these corporations don't want the strict conditions that accompanied this deal which include a freeze on executives’ compensation at the rate of inflation, a ban special bonuses and limit management incentive programs.

And then there are regional carriers which are right to claim that this deal is another form of government subsidies and creates an uneven playing field. A family member of mine is a pilot for one of these regional carriers and he has mixed feelings about this deal as he worries about his job and unfair competition but understands why the government threw Air Canada a lifeline.

A buddy of mine in Vancouver is a lot more critical of Air Canada's management. I told him that they recently turned a profit and he replied: "They should be making a killing given they're gouging Canadians with ridiculously high air fares. We need a lot more competition in this country. When you can travel within Europe on cheap fares but pay exorbitant fees to travel within Canada, something is seriously wrong."

As I've stated plenty of times, something is wrong with our retirement system. Ottawa and the provinces need to expand C/QPP and stop granting companies special pension reprieves which may or may not turn out in the best interest of all stakeholders. Companies should focus on their core business, not pensions.

Below, Gerald Greenwald, co-founder of Greenbriar Equity Group LLC, talks about the performance of the airline industry. Greenwald speaking with Tom Keene, Scarlet Fu and Francine Lacqua on Bloomberg Television's "Surveillance," also discusses the impact of bank stress tests on the markets.  

Update: Read my update, Air Canada bonuses tied to pension payments. Also, Reuters reports Air Canada pension deficit estimate falls on higher plan returns:
Air Canada said a preliminary estimate of its pension solvency deficit has dropped to C$3.7 billion ($3.6 billion) from C$4.2 billion a year ago, reflecting a better-than-expected 14 percent return on plan assets.

Canada's largest carrier said in a recently filed annual information form that the estimate, as of January 1, 2013, was hurt by a decrease in the solvency discount rate to 3 percent from 3.3 percent. Valuations to determine the actual deficit will be completed in the first half of 2013.

Earlier this month, the airline won an extension of the cap on special payments to erase its pension fund deficit. Under the plan, which smaller rivals had objected to, Air Canada will have to pay a total of C$1.4 billion over seven years, or an average of C$200 million a year, with a minimum payment of C$150 million a year.
Outstanding returns for 2012 but they still need help to tackle their pension deficit. Hopefully they will maintain these stellar returns in the years ahead and interest rates will rise enough to lower liabilities.