Legislation that takes effect next year to better protect defined benefit (DB) pension plans in a corporate insolvency may raise funding costs and tighten lending conditions for companies with these exposures, says Moody’s Ratings.
In a new report, the rating agency examined the potential impact of federal legislation that comes into force in April 2027, which grants “super priority” status to unfunded pension liabilities and solvency shortfalls, ranking them above other secured and unsecured creditors in the event of a company’s bankruptcy.
“… if a company with unfunded pension plan liabilities were to go bankrupt, it would be required to pay any pension deficit from the company’s assets before paying secured lenders, bondholders or other creditors’ claims,” the report said.
And, the complexity of assessing unfunded liabilities in the midst of a bankruptcy could also delay payouts to lower-ranked creditors, it noted.
As a result, this new treatment for pension liabilities “will increase expected losses for all debt instruments with lower payment priority, and will potentially lower their ratings,” it said.
In turn, this may impact companies’ access to funding, the report suggested.
“Private-sector companies with unfunded DB pension liabilities in Canada could face higher funding costs, tighter lending conditions and difficulty obtaining credit because they are exposed to the possibility of lower recoveries in insolvency proceedings,” it said.
Moody’s said that about one third of the speculative-grade, private-sector Canadian companies that it rates have DB pension plans with unfunded liabilities, “most of which represent less than 5% of each company’s total debt obligation.”
These liabilities have declined in recent years, thanks to several years of strong equity market performance. However, it noted that “market downturns are a key risk.”
In the meantime, plan sponsors have taken steps to reduce the risks related to their DB plans, Moody’s said — including entering into pension risk transfer deals, closing or converting their DB plans and using longevity swaps/insurance “to hedge the risk of retirees living longer than expected.”
Additionally, secured lenders are adding protections to new loan agreements, it noted — including requiring greater disclosure of a plan’s funded status throughout the term of the loan, reducing the amount of credit provided and requiring additional security. Lenders are also restricting borrowers from opening new DB plans, or acquiring companies that have existing plans, it said.