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S&P says the transition to new International Financial Reporting Standards has had a 'pronounced impact' on the banks' financial statements through the emergence of considerable unfunded obligations related to postretirement benefit (PRB) pension plans.
It’s released a new report, 'Defined-Benefit Pension Obligations: New Accounting Rules Mean Past Promises Return To Haunt Western European Banks'.
'Pension obligations will continue to represent significant financial risk for certain banks, and we will closely monitor and factor in these risks in applying our established analytical process,' said S&P analyst Eddie Khamoo.
He added: 'European banks--with few exceptions--are failing to face up to the need to fund their pension liabilities properly and the IFRS accounting regime is not encouraging them to do so, despite the significant risk that pension obligations pose for banks.'
The agency has studied the DB schemes of 44 European banks, with the key findings:
The emergence of considerable underfunded obligations related to PRB pension plans under IFRS, and pension obligations will remain a significant financial risk for certain European banks. At year-end 2005, Standard and Poor's made a number of significant adjustments to reported shareholders' equity to calculate its capital measures, notably adjusted common equity.
The transition to IFRS reduced the shareholders' equity by Euro 20 bn (before tax). From a further Euro 20bn (before tax) of actuarial losses, only Euro 4bn has been charged to equity in the period subsequent to the transition, and Euro 16 bn remained unaccounted for in the books at December 31 2005.
Pension obligations (before considering plan assets) are significant, representing 34 percent of reported equity overall at December 31 2005. Such a high level of obligations expose the financial statements to volatility stemming from changes in actuarial assumptions, particularly discount and mortality rates. Pension obligations are particularly significant for UK, Irish, and Portuguese banks.
Pension plan expenses comprise a significant element of the income statement, representing 8 percent of reported net income for 2005.
Employers' contributions in 2005 did not reflect the sizable deficits. Net pension deficits grew by 16.7 percent over 2005.
Western European banks mainly use the corridor method, which not only results in significant unrecognized actuarial losses to be left off balance sheet, it makes a comparison among European banks difficult. This rift will increase further across the Atlantic with the U.S. banks, which under the new rules are required to recognize the full funded status on the balance sheet.
The quality of disclosures varies significantly among banks and across Europe, and more improvement in this area is considered necessary.
By Daniel Brooksbank