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Analysis: Ford could close U.S. pension funding gap by end of 2014

A Ford logo is seen on a car during a press preview at the 2013 New York International Auto Show in New York, March 28, 2013. REUTERS/Mike S
A Ford logo is seen on a car during a press preview at the 2013 New York International Auto Show in New York, March 28, 2013. REUTERS/Mike S

By Deepa Seetharaman

DETROIT (Reuters) - Thanks to rising interest rates and an injection of cash, Ford Motor Co could be in a position that would have been unthinkable only a few years ago - with a fully funded U.S. pension fund.

Ford, which went through a searing restructuring in 2006, but avoided the bankruptcy route of its rivals General Motors and Chrysler , could cut its U.S. pension shortfall by half or even more by the end of this year from $9.7 billion at the end of 2012, according to securities analysts and Reuters calculations.

And the gap could be eliminated by the end of 2014 provided interest rates rise as economists expect and the stock market remains robust. That may give Ford added resources to pay down debt, invest in its businesses, or boost dividend payments, analysts said.

"It is a true obligation of the company right now and it's taking quite a bit of capital," Ford Chief Financial Officer Bob Shanks said of the automaker's pension gap in an interview.

"Once we get it fully funded, de-risked and sort of put it in a box, it gives us the ability not to worry about it so much and take future cash flow and put it wherever we want," he said.

If Ford fully funds its U.S. pension plan by the end of next year that would be quicker than many analysts had expected. GM could be about one to two years behind Ford in closing its U.S. pension gap, said Guggenheim Securities LLC analyst Matt Stover.

But critical to this scenario is that interest rates used to calculate retiree pension obligations continue to rise. Ford would also have to be willing to contribute at least $1 billion in 2014 to close its U.S. pension gap, analysts said.

Eliminating the shortfall is "possible by the end of 2014 and it's going to be because interest rates climb," said Stover, who predicts Ford's U.S. pension plans will be underfunded by about $4 billion by the end of 2013.

Ford's U.S. pension obligation was $52 billion at the end of last year, while GM's was about $82 billion.

GM was the first of the U.S. automakers to establish a pension plan in 1950 as part of the "Treaty of Detroit," a contract negotiated by legendary United Auto Workers union leader Walter Reuther. Ford and Chrysler followed suit.

But by the mid-2000s, pensions and other retiree benefits became an ever-increasing liability that automakers said added as much as $2,000 to the cost of a vehicle and put them at a disadvantage against foreign rivals.

Since then, GM and Ford have both taken steps to "de-risk" their pension plans by closing off their plans to new participants, offering lump-sum buyouts and shifting to more conservative investments.

Last year, GM cut $29 billion, or one-fifth, of its global pension liability when it shifted management of white-collar pension plans for 118,000 salaried retirees to a unit of Prudential Financial Inc .

But underfunding remains an issue, partly because that shortfall is viewed by credit ratings agencies as debt.

Ford plans to inject $5 billion cash into its global pension plans this year to help reduce the underfunding - though some of that will go towards pension plans elsewhere in the world.

To put the underfunding and Ford's cash injection in context, the automaker spent $5.5 billion in 2012 on product development, building factories and other capital expenditures.

A $4 BILLION BOON

Companies calculate the present value of their future pension liabilities using a so-called discount rate, which is based on corporate bond rates. A higher rate means lower liabilities, meaning that a company doesn't have to set aside as much cash now to pay retirees in the future.

Based on the most optimistic scenario laid out by actuarial firm Milliman, higher rates alone could narrow Ford's pension gap by about $4 billion by the end of 2014. Stover said higher rates could close about half of Ford's U.S. pension shortfall.

"The auto companies have always been associated with having these big pension liabilities," Citi analyst Itay Michaeli said. "It becomes a frustration for investors to deal with more volatility on top of already volatile industry dynamics."

Closing the U.S. pension gap "takes an element that has arguably weighed on investor sentiment and just takes that issue away," Michaeli added.

The discount rate, which is based on corporate bond yields and is used to determine the present value of payments they make over the life of their plans, has risen this year to 4.74 percent in June from 3.96 percent in December, according to Milliman.

By the end of 2013, the discount rate could be as high as 5.04 percent, and by the end of 2014 it could be up to 5.64 percent, Milliman estimates.

A smaller pension gap would likely pave the way for Standard & Poor's to upgrade Ford's credit ratings upgrade to investment grade, Michaeli said. That would allow the automaker to fund the remaining U.S. pension gap with unsecured debt.

"By issuing debt, what you're doing is freeing up free cash flow," he said, adding that could be used to boost dividends, develop new vehicles or pay off debt.

For Ford, a one percentage point increase in the discount rate alone could lower its U.S. pension liability by $2.3 billion, Shanks said during Ford's second-quarter earnings call.

(Reporting by Deepa Seetharaman and Dan Burns; Editing by Martin Howell and Leslie Gevirtz)

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