Views and opinions expressed on this blog are solely my own and do not reflect views of any organizations or employers with whom I am affiliated.

Saturday, June 21, 2014

Valuing Multiemployer Pension Liability For Investments





In my previous post, I shared some background information about multiemployer pension plans and discussed the possible impact of these plans, specifically as it relates to bankruptcy. In this post, I want to talk more about disclosures of multiemployer pension liabilities, and how these disclosures can be used for valuation purposes.

FASB Required Disclosures:
Under the previous disclosure rules set by the Financial Accounting Standards Board (FASB), employers who contributed to multiemployer plans were only required to disclose their own historical contributions. FASB's Accounting Standards Update No. 2011-09 presented a new set of disclosure requirements for public companies participating in the plans, effective December 2011.

The new rules require:
  • Identifying plan information. 
  • The employer’s level of participation in the plan:
    • Contributions made for each period of Income Statement 
    • Whether the contributions represent more than 5% of total contributions to the plan 
  • The financial health of the plan:
    • The most recently available funded status:
      •  < 65% funded (red zone)
      •  65-80% funded (yellow zone)
      •  > 80% funded (green zone)
  • As of the end of the most recent year presented:
    • Whether a funding improvement plan or rehabilitation plan has been implemented or was pending; and
    • Whether a surcharge has been paid to the plan by the employer.
  • Information about when the collective bargaining agreements and when are set to expire.

The ASU notes that factors other than the amount of the employer’s contribution to a plan (e.g., the severity of the underfunded status of the plan) may need to be considered when determining whether a plan is significant. (Moody, Famiglietti & Andronico).


YRCW:

So now that we know what must be disclosed, let's look at a real-life disclosure. I've chosen YRCW which, as a less-than-truckload service provider, is comprised of 78% union workers and contributes to 32 separate multiemployer plans. The company contributed a total of $88.7 million to multiemployer pension plans in 2013, or approximately 34% of adjusted EBITDA. (YRCW 10-K)

The company contributed $52 million in both 2012 and 2013 to the Central States, Southwest and Southwest Areas Pension Fund (CSSSA), which represents the Company's largest contribution to one multiemployer plan. The disclosure looks like this (I've reorganized the exhibit to make it more visible; take a look at page 66 of the 10-K for more details).

































Notice the CSSSA is in the red zone, so as an investor, I'd want to find out what that plan looks like. Since we have an EIN Number, we can look up the most recent funding data on the Department of Labor's website. Since CSSSA is a prodigious plan, we can get funding information directly from the CSSSA's site.


The 2013 Annual Report for this plan provides exactly the kind of information that we need to do one more layer of analysis on the risk pertaining to this specific plan. Here, we find out that the plan's assets were valued at $18.7 billion on a mark-to-market basis and the plan was approximately 52% funded as of 2013. The plan's total contributions by employers for 2012 were $764,042,58, of which YRCW made up 6.8% (at $52.1 million).



Estimating Future Payments

An obvious way to incorporate liabilities for multiemployer pension plans in an investment analysis is to estimate future contributions and include them as operating expenses and as part of cash flow. The less obvious part of this is figuring out what the expense ought to be.

At times, the company will provide guidance for future cash outflow expected for multiemployer  pension plans. If not, the financial statements of the funds will provide projected contributions in the coming years. You can use the percent of contributions from the previous year and total contributions projected for the upcoming year to estimate the expense.

CSSSA expects total contributions in 2014 to be approximately $632 million. Using YRCW's 2012 contribution percent of 6.8%, we can estimate YRCW's 2014 payments to be around $43 million. As an investor, you can dig a little deeper to find out if future contribution number is closer to $43 million or 2012's number of $52 million. That is, you can do a little more work to find out how many beneficiaries YRCW supports via CSSSA and what the average payment per those beneficiaries is likely to be in the next year.

Employer Risk:
Major types of risk to a particular multiemployer plan from contributing employers are:

  1. Financial stability risk from contributors
  2. Upcoming collective bargaining agreements 
  3. Any increases in contributions required from employers 

     1. The form 5500 is required to list major employer participants and their contribution levels. From a risk perspective, it is important to look at financials of these major participants to assess the companies' ability to continue making fund contributions. In the case of CSSSA, the other big contributor (besides YRCW) is ABF Freight, which has a total of 114 pension accounts with the fund.

     2. Moreover, the form lists the expiration dates of collective bargaining agreements and the number of accounts that the agreements will impact. For example, YRC has 240 accounts for which a collective bargaining agreement expires on 3/31/2015. The negotiations leading up to the expiration date could result in volatility in the securities' prices and lead to operational risks.


     3. The notes to the financial statements of the fund will also have information about any aberration of contributions or withdrawal from the fund. In this case, the notes indicate that YRCW entered into a Contribution Deferral Agreement ("CDA") in June 2009:


"YRC’s outstanding balances under the CDA at December 31, 2012 and 2011 were $84.4 million and $90.2 million, respectively...YRCW is assumed to remain on the Distressed Employer Schedule and make Primary Schedule contribution rate increases beginning in 2015." Form 5500, 2012.


From an investment perspective, it would be important to find out what the increase in rate will mean in terms of increased cash outflow for the company. For YRCW, the Contractual Obligations Section of the 10-K tells us that that pension deferral obligations due in 0 to 4 years equals $136 million. This includes all possible pension deferral obligations, not just those due to CSSA.


The question from a modeling perspective would be: in what quarters will these cash outflows occur? Then, I would do a liquidity analysis to make sure that there would be enough cash/revolver available to fund these outflows without a detriment to interest payments.


Plan Holdings: 

An important variable to expected returns from a particular plan is the asset allocation of funds. The form 5500 gives a detailed breakdown of the assets in the fund, including cost and current value of bonds and stocks. The data is likely old by the time we get the form 5500 (The one for 2013 isn't out yet), but the funding notice is more current and has a broad asset allocation table. An incredibly persnickety investor could do his own valuation of the fund based on the asset allocation information. In general, I will just use the market values for the assets and increase the possible future liabilities if the assets in the fund look particularly risky.


A&M Valuation: 

Alvarez and Marsal had an article recently on risks associated with investing in companies with multiemployer plans. There's some useful insight in the paper concerning impact of these pension plans in M&A transactions. In terms of valuation, the article states:


"In lieu of detailed projections, we recommend that a buyer contemplating the purchase of a business that participates in a “red zone” plan consider a minimum 10 percent increase in per annum contributions as a conservative starting point; in some cases, the annual increase could be as high as 20 percent." A&M


Liens on Assets: 
This part is probably the most important for bond-holders, especially those worried about a bankruptcy. In some cases, a withdrawal or deferral liability to a multiemployer pension fund may be secured by a lien on certain assets, which would then reduce any asset value available for unsecured bondholders and equity holders.

For example, CSSSA requires that any Distressed Employer:


"Provides the Fund with first lien collateral in any and all unencumbered assets to the fullest extent it is able in order to fully secure (i) any delinquent or deferred Contribution obligations owed to the Fund, (ii) the Employer’s obligation to make current and future pension contributions to the Fund, and (iii) any future withdrawal liability potentially incurred by the Employer (with the amount of such potential withdrawal liability to be determined based on estimates to be provided by the Fund)."


So I would make sure to find out which assets are encumbered by pension liabilities and adjust my valuation accordingly.


One Last Thing: I've ignored the validity of basic assumptions of pension accounting in this case, such as the discount rates and expected rate of returns used by specific plans. You can read more about those rules and assumptions on the American Academy of Actuaries website.


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