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Government Accounting Could Affect Corporate Bonds

Tammy Whitehouse | July 3, 2012

Corporate bonds could end up looking a little more attractive compared to government bonds after government entities begin adopting new accounting standards for their underfunded pension plans.

That's one possible outcome for companies considering how they might be affected by a recent requirement from the Government Accounting Standards Board for government entities to put their unfunded pension liabilities on their balance sheets. GASB approved two new standards that require government entities to report the net pension liability in their statement of net position and to immediately recognize more pension expense that the rules currently require. Experts have predicted the new measures will bring trillions of dollars in pension liability on to government balance sheets.

“The new GASB standards could depress the market value of bonds that have been issued by state and local governments, especially once the standards become fully effective,” says Bruce Pounder, director of professional programs for accounting education firm Loscalzo Associates. That could make corporate bonds look a little more enticing, he says. “Consequently, corporations may enjoy a lower cost of debt capital if there is a significant flight to quality in the wake of the new GASB standards.”

Jonathan Waite, chief actuary with SEI's Institutional Group, says he doesn't expect any immediate or significant effect on bond ratings. “I would hope for at least the larger governmental entities out there that the pension is already taken into account by bond rating agencies,” he says. “For the smaller ones, it might be something new on the balance sheet, so it will be a case-by-case basis working through the ramifications on ratings.”

Waite expects the more immediate effect to focus on making pension participants more aware of the funding challenges that both governmental entities and corporate pension sponsors have suffered the past few years. “This may make the average citizen more aware and give them reason to ask more questions of their own employers,” whether they work for the government, a public company, or some other private entity, he says.

It may also light a fire under the Financial Accounting Standards Board to revisit pension accounting for public companies, private companies, and not-for-profit entities. FASB put some pension accounting improvements into place in 2006 with plans to pursue a second phase later to eliminate some of the smoothing that takes place with pension earnings to make the actual performance of plan assets more apparent. However, the second phase of that project moved to the back burner as the board focused instead on converging U.S. accounting standards with international rules.