Moody’s Investors Service says that pension funding deficits are material to some Canadian companies and they are having an influence on debt ratings.

In a new report, Moody’s says that it views any underfunding among Canadian companies as a debt-like obligation and adds any deficit to the company’s balance sheet, as it does for U.S. companies.

“While on a stand-alone basis an underfunded pension plan will not drive the rating process, it does raise a red flag as to future funding requirements and their potential impact on cash flow,” says Moody’s vice president Waylon Iserhoff, author of the report on Moody’s treatment of Canadian pension underfunding.

Canadian law requires companies to perform plan evaluations generally only once every three years, allowing for plans to become significantly underfunded during the intervening period, Moody’s says.

Another factor contributing to underfunding is Canadian bankruptcy law regarding pension funding. “Any pension overfunding in a bankruptcy belongs to the members, not the company, and this, together with tax code limitations on overfunding, encourages systemic underfunding,” says Iserhoff.

Under the Canadian system, solvency deficits are paid off over five years, while going concern deficits are paid off over 15 years. On November 7, the federal government in Canada issued final regulations that extend the pay periods for funding deficits, which were previously announced in its May 2006 budget. These provisions allow sponsors to either consolidate current solvency payment schedules and repay the
amount over a new five-year period, or extend the payment period to 10-years provided plan members do not object or if a letter of credit is posted. Moody’s says these extensions are a positive to credit quality.

Moody’s also expects the Canadian Institute of Chartered Accountants to require companies to include the funded status of its retirement plans on the balance sheet starting with fiscal years ending in 2008. The Canadian guidance, which will be neutral to credit ratings because Moody’s already adds any deficits to the balance sheet, should be similar to new US guidance that will become effective for calendar year-ends in 2007, it adds.