Evaluating Corporate Pensions from a Rating Agency Perspective Waylon Iserhoff Vice President Waylon Iserhoff Vice President CIA Pension Seminar Colloque sur les régimes de retraite April 16, 2007

Canadian Pension Obligations Corporate Pensions - A Rating Agency Perspective Overview Moody’s views the underfunded status of defined benefit pension plans as a debt- like obligation. No revisions necessary to Moody’s standard methodologies for Canadian based issuers. Plan Valuations Moody’s will make inquiries about valuation dates as minimum triennial valuation requirement often exacerbates underfunding

Ranking in Bankruptcy Senior Unsecured claim Funding Requirements Recent 2006 federal changes which extended the period for companies to fund solvency deficits, will benefit an entity’s financial flexibility. Proposed Accounting Changes Minimal impact from a credit perspective Canadian Pension Obligations Corporate Pensions - A Rating Agency Perspective

What’s wrong with pension accounting? Smoothing inconsistent with economics Excessive netting of components into pension expense Inappropriate classification in cash flow statement Sometimes aggressive, unrealistic assumptions Corporate Pensions - A Rating Agency Perspective

Moody’s pension adjustments Balance sheet Recognize pension under-funding (ABO – FMV of plan assets) as “debt like” liability Removes all other pension assets and liabilities Corporate Pensions - A Rating Agency Perspective

Pension adjustments (continued) Income Statement Eliminate smoothing by: Reverse all pension costs in income Recognize service cost (best estimate of the operating cost of the plan) in Cost of Goods Sold and Selling, General and Administrative expenses Recognize interest cost on PBO in other income/expense Add or subtract actual losses or gains on pension assets in other income/expense 1 Attribute interest expense to pension-related debt, which we reclassify from other income/expense to interest expense 1 We limit gains to amount of interest on PBO to avoid net pension income Corporate Pensions - A Rating Agency Perspective

Pension adjustments (continued) Cash Flow Statement Recognize only service cost as an outflow from cash from operations (CFO) Reclassify cash contributions to pension trust in excess of service cost from an operating cash outflow to a financing cash outflow 1 1 We do not adjust the cash flow statement if pension contributions are less than the service cost Corporate Pensions - A Rating Agency Perspective

Scrutiny of assumptions Comparability and reasonableness of assumptions: – Discount rate – Expected return on plan assets – Salary progression – Nothing below public radar screen Changes – Plan amendments – Measurement date Corporate Pensions - A Rating Agency Perspective

Asset Allocation Evaluate reasonableness of asset allocation and investment guidelines Evidence of swinging for the fences Rarely see plans with unreasonable asset allocations or big investments in illiquid assets Corporate Pensions - A Rating Agency Perspective

Assess volatility in future pension contributions Through private discussions we seek to understand: – Expected payments for next few years – Required minimum payments – Factors that affect required payments (including impact of asset liability mismatch) – Possible and worst case scenario Corporate Pensions - A Rating Agency Perspective

Other considerations Unfunded plans, defined benefit plan considered partially debt-like – Adjustment reduces debt and increases equity – Simulates a pre-funding of the obligation OPEB’s not considered debt-like, unless: – Workforce significantly unionized – Older workforce – Discretionary adjustment considered by rating committee Corporate Pensions - A Rating Agency Perspective

Typical metrics most affected Pension adjustments affect leverage, profitability and coverage ratios, that are used as key metrics in industry methodologies used to assign ratings Ratio % of Industry Methodologies Debt/EBITDA50% FCF/Debt55% EBIT(A) Margin38% EBIT/Interest45% Corporate Pensions - A Rating Agency Perspective

Change in Pension Accounting Funded status of pension and OPEB plans fully recognized on the balance sheet Increases balance sheet volatility related to pensions Minimal impact from a credit perspective Corporate Pensions - A Rating Agency Perspective

Impact of Proposed Accounting Changes Company (C$ 000’s) Funded Status of Retirement Plans (Fiscal 2005) Shareholder Equity Impact of ED PensionOPEB Nortel Networks(2,910,000)(972,000)-64% Bombardier(2,625,000)(490,000)-59% Abitibi-Consolidated(874,000)(256,000)-35% Fraser Papers(204,000)(75,000)-30% Canadian Pacific Railway(842,000)(487,000)-29% Tembec(274,000)(75,000)-23% Domtar(282,000)(125,000)-20% CHC Helicopter(74,000)--19% BCE(2,431,000)(2,032,000)-18% Quebecor World(519,000)(81,000)-13% Catalyst Paper(114,000)(217,000)-9% Alcan(3,105,000)(1,252,000)-8% Cascades(86,000)(96,000)-8% Petro-Canada(378,000)(330,000)-4%

Corporate Pensions - A Rating Agency Perspective Moody’s Early Observations – SFAS 158 No significant changes to credit metrics subsequent to the adoption of SFAS 158 Moody’s adjustment to debt to be more precise due to enhanced disclosure requirements.

Corporate Pensions - A Rating Agency Perspective Moody’s Early Observations – SFAS 158