In Air Canada’s dream scenario, rising interest rates in the years ahead would create an environment to ease concerns about the airline’s massive pension deficit.
The country’s largest carrier had a pension solvency deficit of $4.2-billion at the start of last year. For every 0.25-percentage-point increase in the discount rate – which determine liabilities on an accounting basis for pensions – Air Canada’s pension solvency deficit would fall $460-million, PI Financial Corp. analyst Chris Murray said in an interview Wednesday. (Air Canada calculates its pension obligation using a discount rate based on corporate bonds rated double-A or better.)
Air Canada’s pension hole would nearly disappear if rates were to rise 2.25 percentage points from the Bank of Canada’s current overnight rate of 1 per cent. But if rates stay the same or even dip, the Montreal-based carrier will find itself in a tough spot years from now. For every 0.25-percentage-point decrease in discount rates, the airline’s pension solvency deficit would rise $587-million, Mr. Murray said.
He made the comments after Ottawa announced on Tuesday that it has granted a reprieve to Air Canada to give it seven years to meet pension funding obligations. Air Canada had originally sought permission to limit its payments to $150-million annually over 10 years. In the deal, the company agreed to pay at least $150-million a year, with an annual average of $200-million spread over seven years.
Air Canada faces long-term challenges to keep its defined-benefit pensions going. The carrier has roughly 26,000 employees supporting more than 30,600 retirees, according to recent corporate figures.
In 2009, Air Canada had a close call with hitting the financial gutter, but it secured an arrangement with its labour unions and Ottawa for a 21-month moratorium on past service contributions. The company paid $150-million in 2011, $175-million in 2012 and will be on the hook for $225-million in such payments this year.
Mr. Murray said the airline has obtained a measure of certainty over its cash flow during an important phase, given that plane orders are due to arrive over the next several years for new Boeing 787 Dreamliners. It would have been crippling to force Air Canada to somehow come up with huge annual cheques of $840-million over a five-year period to whittle down its $4.2-billion solvency deficit, as calculated on Jan. 1, 2012, he said.
National Bank Financial analyst Cameron Doerksen described Ottawa’s decision as “not quite as positive as hoped.”
RBC Dominion Securities Inc. analyst Walter Spracklin said current low interest rates have hampered the carrier’s balance sheet, but a rise in rates over the next seven years would reduce or even eliminate the pension woes. “The funding cap allows Air Canada the ability to invest in new growth opportunities, including a fleet replacement plan with 37 Boeing 787s, which is set to further improve profitability and operating cash flows,” Mr. Spracklin said in a research note.
Rival WestJet Airlines Ltd. does not have a pension plan, but many of its employees do participate in incentive programs, including one that rewards them with the Calgary-based company’s shares if workers buy stock.