Sergio Marchionne

The new Fiat Chrysler faces a rougher road than most think

February 5, 2014: 5:00 AM ET

Now that Fiat owns all of its American partner, the new company is officially on the hook for the $5.5 billion shortfall in Chrysler's pension funds.

chrysler-pension

FORTUNE -- Sergio Marchionne, Fiat's chief executive, is an even bigger corporate cowboy than he seems to be. Not only is he trying to combine two smallish, debt-laden auto companies from two separate continents into a single efficient global giant, which is an enormous gamble, but he's also taken on a huge risk that very few people recognize. A risk that Fiat declined to discuss with me. A risk that I didn't hear a single analyst raise during the company's recent two-hour conference call to discuss its fourth-quarter earnings and its plans for the future.

I'm talking about the risk that Fiat has now assumed for the shortfall in Chrysler's pension funds. This liability, $5.5 billion by U.S. accounting standards, exceeds the $4.9 billion that Fiat paid for all of Chrysler. The pension liability is considerably less than the $8.9 billion it was a year ago, for reasons I explain at the bottom. But it's still very large, even for what is now the world's seventh-largest auto company.

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Fiat took on this obligation on Jan. 21, when it bought the 41.5% Chrysler stake owned by a trust for Chrysler retirees. Because Fiat now owns 100% of Chrysler, all of Fiat's assets -- not just Chrysler's assets, as was previously the case -- are now at risk should Chrysler, which has had three near-death experiences since the late 1970s, get into financial trouble yet another time.

That liability isn't something that I've conjured up. It's a real obligation, as the U.S. Pension Benefit Guaranty Corp. told me when I asked. This federal agency, which insures corporate pensions, told me that all of Fiat's assets are liable for any pension shortfalls should Chrysler run into big financial trouble.

When I asked Chrysler about this, I was referred to Fiat. I tried to engage Fiat spokesman Richard Gadeselli in a conversation, but all I could extract from him, via email, was the following elegantly phrased "no comment": "I would mention that since the consolidation of Chrysler's numbers [in 2011], Fiat's balance sheet has included the pension obligations to which you refer. It is therefore incorrect to assume that these liabilities are somehow 'new' following the final acquisition of outstanding Chrysler shares. The Company has no further comment to make at this time."

What Gadeselli isn't addressing, however, is that for pension liability purposes, there's a big difference between controlling Chrysler, as Fiat has since 2009, and owning 100% of it. When Fiat owned only 58.5% of Chrysler, the PBGC told me, it wasn't clear whether the agency could successfully pursue Fiat's non-Chrysler assets if Chrysler got into big trouble. But the PBGC says that because Fiat now owns 100% of Chrysler, there's no question that all of what will become Fiat Chrysler Automobiles is "jointly and severally liable" for pension shortfalls if Chrysler's plan has to be terminated.

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The PBGC has gotten increasingly aggressive when it comes to joint-and-several liability for non-U.S. companies owning U.S. businesses. The agency has successfully (at least so far) sued a Japanese company, Asahi Tec, for pension shortfalls at its bankrupt Michigan auto parts subsidiary, Metaldyne. The PBGC also managed to get Germany-based Daimler, which owned Chrysler from 1998 to 2007, to put cash into the Michigan automaker's pension plans as a condition of approving sale of a majority stake in Chrysler to Cerberus, the big private equity house.

So why is Fiat doing this? Even though the company wouldn't talk to me, I think it's clear what's going on. Total ownership of Chrysler makes it easier for Fiat to move its headquarters from business-unfriendly Italy to England. In addition, allocating costs, doing taxes, and shifting money around between a wholly owned Fiat and a partly owned Chrysler would be hideously complex. This way, things are simpler.

Finally, you can make a case that Fiat might not be viable, long term, on its own. So why not go all in on Chrysler? You may still lose -- but at least this way, you have a chance to win. Which is how corporate cowboys play the game.

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Here's how higher interest rates helped reduce the shortfall in Chrysler's pension plans last year.

You determine today's cost of tomorrow's pension payment by using what's known as a discount rate. You figure out how many dollars you will pay in the future, then discount that number to today's value in order to calculate the obligation in current terms.

Let's say you've promised to pay someone $10,000 15 years from now, and you use a discount rate of 4.84%, which is the rate Chrysler used for its 2012 pension calculations. Today's cost of that obligation is $4,921. But let's say that instead, you use a discount rate of 5.43%, which is what Chrysler used for its 2013 calculations. Today's cost of the obligation is only $4,524.

The higher discount rate for 2013 accounted for $2.6 billion of the $3.4 billion shrinkage of Chrysler's reported pension shortfall. The rest came from the plans' assets earning more than their projected return of 7.41%, and from a variety of other factors.

This story is from the February 24, 2014 issue of Fortune.

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