Updated to reflect Gimmie Credit analyst comments
NEW YORK (TheStreet) - For investors, the near 5% dividend yields of telecom giants AT&T (T) and Verizon (VZ) proved a safe trade in 2012, amid continued Federal Reserve easing and an uncertain economic backdrop. Now, as both carriers prepare for fourth-quarter earnings, the Fed's low interest rates are proving a 'double edged sword.'
While low interest rates continue to make AT&T and Verizon a safe yield trade for flighty stock market investors, the Fed's support of cheap money is also wreaking havoc on their balance sheets.
Notably, AT&T and Verizon now face multi-billion dollar fourth-quarter charges as they adjust unfunded pension liabilities to reflect lower projected interest-based earnings. Meanwhile, low rates are also increasing the present value of pension liability.On Thursday, AT&T said it will take a $10 billion charge as it adjusts the value of pension liabilities to reflect lower interest rates. In two simultaneous balance sheet adjustments, AT&T will record an actuarial loss of roughly $12 billion as it lowers its return estimates on assets to cover pension plan liabilities from 8.25% to 7.75%. AT&T is also lowering the discount rate on its unfunded pension liability from 4.3%, increasing the net present value of those costs. AT&T's $12 billion actuarial loss is offset by roughly $2 billion in asset gains, putting the telecom giant's fourth quarter earnings hit at $10 billion. In the fourth quarter, Verizon will record a similar sized charge to reflect the impact of low interest rates. In an 8-K filing with the Securities and Exchange Commission earlier in January, Verizon said it expects to record a pre-tax charge of between $7 billion and $7.5 billion in the fourth quarter due to a reappraisal of pension and postretirement liabilities. Verizon also said it will record between $1 billion and $1.5 billion in charges as it calls in debts early and books restructuring costs. For AT&T and Verizon, the pension losses don't impact operating results or margins, which will be closely followed by investors and analysts as they try to quantify the impact of Apple (AAPL) iPhone 5 subsidy costs on wireless earnings. Still, for some watchers of telecom stocks, the earnings-wrecking fourth-quarter charges highlight a hitch in the logic that makes both dividend-yielding telecom carriers attractive investments in a low rate environment. A year ago, telecom sector analyst Craig Moffett of Bernstein Research highlighted a troubling interplay between low interest rates and pension liabilities as one reason to hold a negative view of both carriers. "Last year, we downgraded AT&T in the wake of declining interest rates, noting that low prevailing interest rates are a double-edged sword," wrote Moffett, in an Friday note to clients. "Low interest rates make AT&T's and Verizon's dividend yields enticing for investors. But it's precisely these low rates that wreak havoc on the Telcos' massive unfunded pension and OPEB liabilities," the analyst added.
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