Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Potential Interest Rate Risk Exposure
The Company, through its subsidiary, MSG National Properties, is subject to potential interest rate risk exposure related to borrowings incurred under its credit facilities. Changes in interest rates may increase interest expense payments with respect to any borrowings incurred under these credit facilities. The effect of a hypothetical 200 basis point increase in floating interest rate prevailing as of March 31, 2023 and continuing for a full year would increase the Company’s interest expense on the outstanding amounts under the credit facilities by $13,464.
Defined Benefit Pension Plans and Other Postretirement Benefit Plans Risk Exposure
Sphere Entertainment sponsors several pension, savings and postretirement benefit plans including the defined benefit pension plans (“Pension Plans”), postretirement benefit plan (“Postretirement Plan”), The Madison Square Garden 401(k) Savings Plan and the MSG Entertainment Group, LLC Excess Savings Plan (collectively, the “Savings Plans”), and The Madison Square Garden 401(k) Union Plan (the “Union Savings Plan”). Certain of these Pension Plans and the Postretirement Plan, such as the Cash Balance Plan and Excess Plans, historically included participants of the Company as well as Sphere Entertainment and MSG Sports (“Shared Plans”). Other plans, such as the Union Plan, only included participants of the Company and not of MSG Sports and Sphere Entertainment (“Direct Plan”). See Note 15. Pension Plans and Other Postretirement Benefit Plans, included in the Company’s Audited Combined Annual Financial Statements for more information regarding these plans.
For the historical periods, Sphere Entertainment was the legal sponsor of the Pension Plans and Postretirement Plan. For purposes of the condensed combined financial statements, it was determined that these plans’ assets and liabilities were attributable to the Company. Therefore, the condensed combined financial statements reflect the full impact of the Shared Plans and the Direct Plan on both the condensed combined statements of operations and condensed combined balance sheets. The pension expense and liabilities related to employees of other Sphere Entertainment businesses participating in the Shared Pension Plans and Postretirement Plan were immaterial for the three and nine months ended March 31, 2023 and 2022.
The Company utilizes actuarial methods to calculate pension and other postretirement benefit obligations and the related net periodic benefit cost which are based on actuarial assumptions. Key assumptions, the discount rates and the expected long-term rate of return on plan assets, are important elements of the plans’ expense and liability measurement and we evaluate these key assumptions annually. Other assumptions include demographic factors, such as mortality, retirement age and turnover. The actuarial assumptions used by the Company may differ materially from actual results due to various factors, including, but not limited to, changing economic and market conditions. Differences between actual and expected occurrences could significantly impact the actual amount of net periodic benefit cost and the benefit obligation recorded by the Company. Material changes in the costs of the plans may occur in the future due to changes in these assumptions, changes in the number of the plan participants, changes in the level of benefits provided, changes in asset levels and changes in legislation. Our assumptions reflect our historical experience and our best estimate regarding future expectations.
Accumulated and projected benefit obligations reflect the present value of future cash payments for benefits. We use the Willis Towers Watson U.S. Rate Link: 40-90 Discount Rate Model (which is developed by examining the yields on selected highly rated corporate bonds) to discount these benefit payments on a plan by plan basis, to select a rate at which we believe each plan’s benefits could be effectively settled. Additionally, the Company measures service and interest costs by applying the specific spot rates along that yield curve to the plans’ liability cash flows (“Spot Rate Approach”). The Company believes the
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Spot Rate Approach provides a more accurate measurement of service and interest costs by improving the correlation between projected benefit cash flows and their corresponding spot rates on the yield curve.
Lower discount rates increase the present value of benefit obligations and will usually increase the subsequent year’s net periodic benefit cost. The weighted-average discount rates used to determine benefit obligations as of June 30, 2022 for the Pension Plans and Postretirement Plan were 4.86% and 4.62%, respectively. A 25 basis point decrease in each of these assumed discount rates would increase the projected benefit obligations for the Pension Plans and Postretirement Plan at June 30, 2022 by $3,660 and $30, respectively.
The weighted-average discount rates used to determine service cost, interest cost and the projected benefit obligation components of net periodic benefit cost were 3.11%, 1.92% and 2.87%, respectively, for Fiscal Year 2022 for the Pension Plans. The weighted-average discount rates used to determine service cost, interest cost and the projected benefit obligation components of net periodic benefit cost were 2.65%, 1.51% and 2.17%, respectively, for Fiscal Year 2022 for the Postretirement Plan. A 25 basis point decrease in these assumed discount rates would increase the total net periodic benefit cost for the Pension Plans by $30 and would result in no impact to the net periodic benefit cost for the Postretirement Plan for Fiscal Year 2022.
The expected long-term return on plan assets is based on a periodic review and modeling of the plans’ asset allocation structures over a long-term horizon. Expectations of returns for each asset class are the most important of the assumptions used in the review and modeling, and are based on comprehensive reviews of historical data, forward-looking economic outlook, and economic/financial market theory. The expected long-term rate of return was selected from within the reasonable range of rates determined by (a) historical real returns, net of inflation, for the asset classes covered by the investment policy, and (b) projections of inflation over the long-term period during which benefits are payable to plan participants. The weighted average expected long-term rate of return on plan assets for Sphere Entertainment’s funded pension plans was 4.94% for Fiscal Year 2022.
Performance of the capital markets affects the value of assets that are held in trust to satisfy future obligations under the funded plans. Adverse market performance in the future could result in lower rates of return for these assets than projected by the Company which could increase the Company’s funding requirements related to these plans, as well as negatively affect the Company’s operating results by increasing the net periodic benefit cost. A 25 basis point decrease in the long-term return on pension plan assets assumption would increase net periodic pension benefit cost by $350 for Fiscal Year 2022.