Power Engineering - Underfunded pensions may not be a near-term problem for U.S. utilities

NEW YORK, July 17, 2003 -- Fitch Ratings has published a report on the funding status of U.S. investor-owned power and gas issuers.

Although the sector as a whole has shared the move of other industrial corporations from pension surplus to pension deficit, following the combination of poorly performing equity markets and falling interest rates, a range of mitigants limit the likely impact on power & gas companies. As a consequence, Fitch does not anticipate that any negative rating actions will occur as a direct result of pension deficit levels over the near term.

Rating actions are unlikely for a combination of reasons. First, U.S. utilities regulated on a cost-of-service basis may be able to apply for higher tariffs to recoup increased pension funding. Second, most plans' asset values were particularly low when they were measured in late 2002 and have rebounded significantly in 2003.

Third, an underfunded pension plan does not necessarily imply that cash contributions will be required immediately. In many cases, several years can elapse before a plan sponsor may be forced to reduce pension deficits. Finally, for many companies, the funding deficit is not material relative to cash flow.

Some statistics can easily overstate the magnitude of the problems. The Fitch study indicates that 86% of defined benefit pension plans were underfunded, when computed according to generally accepted accounting principles (GAAP).

The median funding gap, however, at 21% was below that for a number of other heavily-unionized U.S. corporate sectors rated by Fitch, such as Automotive and Airlines, and only slightly above the underfunding average for the S&P 500 at year-end 2002 (YE02) of 18%. Also, in striking contrast to both the U.S. Automotive and Airline sectors, Fitch notes that approximately 30% of power & gas companies remain near or fully funded.

Some of the issuers with the highest level of underfunding also enjoy the highest stability of income streams, and low debt leverage, which both combine to limit the credit impact of current pension deficits. Conversely, for the issuers at the low end of the speculative rating range, pension considerations may be an issue, but not have a material incremental impact relative to other current challenges, noticeably high debt leverage.

Many of the lower-rated unregulated businesses, given their relatively recent inception, are also more likely to have the majority of employees in defined contribution, rather than defined benefit plans.

While pension commitments do not represent the same threat to utility credit quality that they have created for other industrial sectors, changes in funding levels and the manner in which these will be addressed will both need to be monitored over the coming years. The report also discusses factors influencing contribution requirements, and the effect underfunded U.S. pension plans have on recovery prospects for other creditors in the event of bankruptcy.

'U.S. Utility Sector Pension Funding' is available on the Fitch Ratings web site at 'www.fitchratings.com' in the 'Global Power' sector page under 'Highlight Reports', or by contacting the Ratings Desk at 800-893-4824.

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