Updated to reflect Gimmie Credit analyst comments
NEW YORK ( TheStreet) - For investors, the near 5% dividend yields of telecom giants AT&T (T - Get Report) and Verizon (VZ - Get Report) 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 - Get Report) 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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