Air Canada’s pension pact with Ottawa explained — is it a bailout?
Ottawa’s agreement to extend a special deal made with Air Canada to help address the airliner’s yawning pension deficit has riled competitors like WestJet, but has provided the country’s biggest carrier with a path to sustained health, experts say.
Faced with a multibillion-dollar shortfall, federal Finance Minister Jim Flaherty has said the government will let Air Canada lower its mandatory contributions to $150-million annually until 2021 – diverting an estimated payment of $800-million to the underfunded plan next year alone.
The bailout of sorts is expected to let Air Canada, which has laboured under pension woes and tough market conditions in recent years, to eke out some profits.
Little will go toward shareholders or the carrier’s management under the new agreement, however, which caps executive pay hikes to match inflation and no more. Bonuses have also been axed. Higher cash flows will similarly be prevented from going to dividends or share buybacks that would otherwise lift the stock price.
They are rare constraints for a public company but not unlike the strings governments attached to loans given to some financial firms and automakers during the credit crisis in 2008.
“They’re putting some covenants or conditions in that any extra cash flow the company gets may not be distributed to the owners or executives,” Giri Kanagaretnam, associate dean and finance professor at the DeGroote School of Business at McMaster University explains.
“They’re giving the airliner the ability to stretch out payments over a longer period of time to cover the shortfall. That will benefit Air Canada with extra cash, [but] the government wants to ensure that won’t be distributed to executives as bonuses or additional pay, nor to the shareholders though dividends or share buybacks.
“Any extra funds will go to the pension or will be reinvested in the company, such as buying new aircrafts.”
Below are a few other questions Global News had:
Why is there an agreement between Air Canada and the government?
The two struck a deal in 2009 to provide the carrier pension relief in the form of lower mandatory payments to its underfunded plan. Air Canada needed legal consent from the government on the plan, which has in effect been extended now to 2021.
What would happen if the government didn’t give Air Canada an extension?
“They would have to commit their cash flows, meaning a larger amount of money would have to contributed [to the plan],” Prof. Kanagaretnam said. Bound by pension laws, the carrier would have to contribute hundreds of millions of more dollars to the plan next year and going forward – a move that may have resulted in the carrier filing for bankruptcy protection.
Why didn’t Air Canada simply go to a bank for a loan to cover the shortfall?
“They could have. But banks or capital markets would likely not have been interested in funding a shortfall. By just giving them loans or even equity [ownership stake] is not going to help with the operations. It’s something Air Canada couldn’t easily finance on its own,” Kanagaretnam said.
A big part of the problem stems from pensions set up under defined-benefits programs, generous plans set up by companies years ago that promise a lot but are costly to maintain in the current economic environment. Is Air Canada an outlier in not meeting its obligation or are other companies in similar positions?
“This is specific to firms and organizations with such plans, it is similar in the public sector. Most are underfunded.”
Can this be looked at as a bailout?
“They’re not bailing them out now but they’re giving them extra time.”
The stock price is up on the news as investors cheer on the plan and positive effect it will have on Air Canada. But could the enthusiasm wear off?
“The market is positively reacting. You’re somewhat pleased because the immediate cash flow is increasing which improves the [company’s] current position and reduces the risk of bankruptcy. But it may not be very attractive over the long term because your payouts are restricted by this agreement.”
How has WestJet taken the news? Gregg Saretsky, the chief of Air Canada’s main competitor within the country responds:
“We are supportive of a strong and competitive aviation industry in Canada. To that end, we trust this marks the end of special treatment for Air Canada as such treatment at the expense of other industry players has become too common. We look forward to working with the government to create a level playing field and an environment that supports a healthy industry that benefits the travelling public.”