When Big Brown took on billions of dollars of debt in 2007 to buy some employees out of a union-run pension plan, it seemed like a good idea.
Then the recession hit, hammering the fund. Recently, the company found itself dealing with concerns about its riskier debt strategy.
UPS, long a conservative company that eschewed debt and risk, was given what would amount to a “yellow caution” flag by a credit rating agency in January. This was after the Sandy Springs-based company had a pension plan fall below the amount it would need to cover its obligations.
Standard & Poor’s Ratings Services said UPS’s credit metrics had “deteriorated ... due to profit pressures related to the global economic downturn and a large increase in unfunded postretirement obligations.”
S&P kept UPS’s rating at AA- (the equivalent of Moody’s Aa3), which is still a high grade.
The ratings agency did, however, change UPS’s outlook from “stable” to “negative,” saying that if UPS doesn’t have enough cash to fund its pension obligations within 18 to 24 months, the agency would lower UPS’s credit rating.
The pension funds the retirement benefits of about 400,000 UPS employees, from management to union rank and file.
Kurt Kuehn, UPS’s chief financial officer, addressed the issue during the company’s February call with Wall Street analysts about earnings.
“By their calculation, UPS is slightly below their target,” Kuehn said of the S&P report. “We have 18 to 24 months to close the gap, which I’m very confident we can do.”
According to an annual report that came out in late February, UPS has already started to close the gap. At the end of 2009, it had pension benefit obligations of $17.8 billion and plan assets of $15.4 billion, for an unfunded balance of $2.4 billion.
At the end of 2008, obligations were $16.3 billion with plan assets of $12.8 billion, for an unfunded balance of $3.5 billion.
“Every fund hit a speed bump in 2008,” said Andy Dolny, with UPS investor relations. “The plan lost about 25 percent [of its value] in that year. Keep in mind the unfunded balance, or liability, is like a mortgage. It’s not something that’s due now like a credit card bill.”
He explained that the pension fund losses “didn’t cost us a thing because we were so well-funded. That rainy day came — the worst rain in 100 years — but we were still in good enough shape that we didn’t have to put a dollar into it.”
Prior to the downturn, the fund was over-funded by 30 percent, he said.
S&P’s ratings — and those of the two other major ratings agencies — are important because they determine how much a company will pay to borrow money.
In other words, if S&P were to lower UPS’s credit rating, UPS would pay higher interest rates on debt.
Borrowed money typically is what companies use to grow operations and cover short-term operating costs and other large expenses.
UPS says there is nothing to worry about; the company has nearly two years to make sure this pension plan is fully funded before S&P will downgrade its credit rating.
Still, the issues raised by S&P stem directly from a riskier debt strategy UPS embarked on in 2007.
For years, UPS had maintained the highest rating possible: AAA. But the company wanted to leverage its cash, assets and borrowing ability to buy about 45,000 employees out of a non-company-controlled pension fund.
Specifically, UPS borrowed $4 billion in 2007 to buy a group of Teamster employees out of the Central States pension plan and put them in a new UPS portfolio. The total check UPS wrote to Central States was $6.1 billion, Dolny said.
UPS’s prior conservative approach to debt is actually very rare for a publicly traded company.
S&P’s Philip Baggaley, managing director of the transportation, aerospace and defense team for the ratings service, said UPS is “one of our highest-rated companies in the team we’re in. We characterize UPS as still conservative, but not as conservative as it was previously.”
He said that about 40 percent to 50 percent of the transportation companies his team follows “have negative outlooks and negative credit watch. At one point, that was close to 60 percent.”
He said his team lowered Boeing’s rating last summer because of “problems in their commercial aircraft business and development delays of the 787, but they also had a dramatically wider pension deficit.”
Governments too – such as the city of Atlanta – are struggling with how to meet pension obligations.
Dolny said UPS has not had to infuse this pension fund with cash in order to be fully funded.
He believes it won’t be long, especially as markets improve, that the pension will be fully funded again.
S&P, and other credit ratings agencies and analysts, will be watching.
