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Debt Market Lures Billions as Verizon, GM Pursue Pension Trade

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Employers saddled with swelling pension obligations and higher government fees on those liabilities are finding some relief in the corporate debt market.

Delta Air Lines Inc., Verizon Communications Inc., and FedEx Corp. have issued more than $14 billion in bonds this year in which some proceeds were flagged for bolstering their retirement programs, according to data compiled by Bloomberg. Last year, General Motors Co. did the same, and International Paper Co. had a debt sale as part of a plan to fund expenses including pension costs.

Companies are looking to avoid the higher premiums required on liabilities by the Pension Benefit Guaranty Corp., a government agency that acts as a backstop when plans fail. The cost per thousand dollars of unfunded benefits has more than tripled in recent years, making it more attractive for employers to shift risk to bondholders.

(Related on ThinkAdvisor: Wall Street Has Found Its Next Big Short in U.S. Credit Market)

“The PBGC premiums are a constant and nagging concern,” Richard McEvoy, the U.S. leader of the financial strategy group at consulting firm Mercer, said in an interview. Issuing bonds to bolster pensions “is a very clearly good trade.”

In 2016, companies voluntarily added about $40 billion to pensions, the first year since 2012 that the figure increased, according to an estimate by Goldman Sachs Group Inc. based on an analysis of the S&P 500 Index. Still, corporate America had a shortfall of more than $300 billion on pensions at the end of December, according to a review of 100 large plans by Milliman, the provider of actuarial products.

Buyout Deals

By filling the gaps, companies can also make it easier to transfer obligations to an insurer looking to add assets under management. Prudential Financial Inc., MetLife Inc. and Massachusetts Mutual Life Insurance Co. have been winning deals in the growing pension-risk transfer market. Athene Holding Ltd., the annuity seller with ties to Apollo Global Management LLC, is also seeking such transactions. There were more than $13 billion of pension buyout deals in 2016, according to industry group Limra, and the volume of transactions has been climbing in recent years.

Companies may also use debt-issuance as a path toward offering lump-sum payments to retirees, or even to allocate assets into more stable investments. Mercer said it may make sense to act soon to fill funding gaps, because potential changes in tax law under President Donald Trump could erode some of the advantages.

Using debt is more attractive for high-grade borrowers who benefit from lower costs in the corporate bond market. Delta, which carries the lowest investment-grade credit rating from Moody’s Investors Service, was able to issue five-year debt at a coupon of 3.625%. Verizon, rated two steps higher, priced five-year notes at 3.125%. By the end of the decade, companies will likely be paying the PBGC more than 4%on the underfunded portions of the plans.

‘Attractive Economics’

“A key economic benefit of funding the pension plan with debt is reducing the unfunded liability, which in turn reduces the rising PBGC variable-rate premiums we have to pay,” Bob Varettoni, a spokesman for New York-based Verizon said by email. GM’s Tom Henderson said that reducing pension risks with bond proceeds offered “moderately attractive economics.”

After years of low bond yields sapped returns on assets, pension managers have learned not to count on a quick return to historical averages, or to get too excited about the rise in rates in the latter part of 2016. The funded status of pensions held by companies in the S&P 1500 Index was just 82% at the end of 2016, the same as 12 months earlier, according to a report by Mercer.

“Rising rates alone are not going to close the gap. Some amount of funding has to happen,” said Ajay Khorana, global head of Citigroup Inc.’s financial strategy and solutions group. “Money is flowing into fixed income, and companies will take advantage of it.”

Pensions were stung in the financial crisis as markets plunged. After that, near-record low interest added to the pain, as the funds were stuck with lower-than-expected returns on bonds. Verizon still had more than $20 billion in projected remaining obligations at the end of 2016, and its plan was underfunded by about $6.4 billion.

“People have just become tired of the pension plan being such a significant issue to their overall corporation,” said Greg Calnon, managing director at Goldman Sachs Asset Management.

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