The decline in worldwide stock markets has reduced defined benefit pension plan assets and caused many pension trusts to become underfunded, says a new report from Moody’s Investor Services.

Despite this finding Moody’s says it doesn’t expects to initiate and rating downgrades in the U.S., based solely on pension-related issues, at this stage. “However, says Moody’s, “if equity values continue to decline from year-end 2002 levels, causing further deterioration of pension plan assets, there could be significant pressure on companies’ cash flows and weakening of their balance sheets and profits. Under such a scenario, the decline in credit quality could lead to rating downgrades.”

In its analysis Moody’s places the greatest emphasis on assessing the future cash flow requirements to fund a company’s defined benefit pension plan. “Through conversations with company management and our own estimates derived from available information, we seek to assess the range of probable contributions. When these required contributions
appear likely to exceed a company’s internal funding capabilities, or could impair the company’s ability to make other critical business investments, a reassessment of the rating may be warranted.”

Moody’s views underfunded pension liabilities as debt-like and incorporates them into certain adjusted leverage measurements as debt equivalents, it says. “The variability caused by changes in market values leads us to conclude that we should evaluate adjusted leverage measurements over a period of time.”

“It is critical to understand how pensions can affect a company’s overall credit quality, including minimum future funding requirements, alternative strategies available to meet these requirements, implications for labor relations, potential risks in maintaining covenant compliance, and potential issues affecting priority of claims.”