Shareholder Equity Expected to Drop 6% Due to New FASB Rules

October 4, 2006 ( - A new Pension and Endowments Newsletter from Merrill Lynch analyzes the impact the Financial Accounting Standards Board's (FASB) new Statement 158 will have on the market.

Based on Merrill Lynch’s analysis, assuming a 35% corporate tax rate, aggregate shareholder equity is estimated to drop by $217 billion, or 6%, due to the new accounting standards. Lower book values and more leverage could impact loan covenants and companies’ ability to pay dividends.

The new FASB rule requires companies to report funding status of their pensions and other post-employment benefits (OPEB) on their balance sheets (See FASB Publishes Final Standards for Pensions and OPEB ). Based on 2005 10-K filings projected to the end of 2006, Merrill estimates the aggregate S&P 500 underfunding that will appear as a liability on company balance sheets at $397 billion ($87 billion for pensions and $310 billion for OPEB). The pension funding status is estimated to improve to 94% (from 90% last year).

Merrill’s assumed tax rate generates a $117 billion deferred tax asset. Companies unable to generate sufficient taxable income (to use their deferred tax asset) will take a larger hit to equity, Merrill points out. Five companies’ shareholder equity could be wiped out entirely, its report said.

Though corporations are still expected to issue debt and use proceeds to increase plan funding status, this will not impact the end-of-year charge to equity. As Merrill says, “Funding won’t erase past accounting sins.”

Merrill Lynch looks at how the new accounting standards differ from the old standard’s smoothing mechanisms, corridors, long amortization periods, and footnote reporting of pension assets and liabilities in revealing the equity risk of pension plans. Debt-to-equity ratios are expected to increase for all industries, up to 50% for some.