DBRS Assigns Provisional Rating of AA (high) to OPB Finance Trust

DBRS has today assigned a provisional rating of AA (high) to the offering of up to $500million Series A Debentures(the Debentures) of OPB Finance Trust (the Trust or Issuer), a new wholly-owned subsidiary of Ontario Pension Board (OPB or the Fund) that will be its principal financing vehicle. The trend on the rating isStable. The rating is primarily supported by the exclusive mandate, history of prudent management, and high level of assets of OPB, which unconditionally and irrevocably guarantees the Debentures. However, the demographicsof the Ontario Public Service Pension Plan (the Plan), ofwhich OPB has an exclusive legislated mandate to manage the assets and administer the pension benefits,are weaker than rated peers, and this limits the rating to the current level.

The Plan is a relatively large contributory defined-benefit plan consisting of over 82,400 members, who are eligible employees of the Ontario government and its agencies’ boards and commissions.OPB manages a diversified investment portfolio with net assets of $17.3 billion at December 31, 2011, and has a track record of sound, less-volatile performance in relation to market benchmarks. Providing additional support to the rating is the role of the Province of Ontario (the Province, rated AA (low)), as the sole plan sponsor, which adds considerable stability and certainty to cash flows. OPB is managed independently from the Province, and the latter is required under legislation to make payments toward shortfalls identified in funding valuations and to cover pension obligations the Fund is unable to meet in any given year.

Leverage is currently limited to non-recourse debt related to real estate assets. Recourse debt is expected to rise by up to $500 million with thisinaugural debt issuance, the proceeds of which will be used to support the Fund’s private market investments. This would account for up to3% of net assets, which is low relative to peers. OPB has no immediate plans for additional debt for the foreseeable future, but DBRS notes that internal guidelines allow recourse debt to grow to 10% of net assets.

Net assets declined by 0.6% in 2011, as a result of weak investment returns and continued negative net contribution flows. The Fund delivered total portfolio returns of 0.43% in 2011, down from 9.4% in the prior year and 127 basis points below the benchmark return. A key highlight in the year was the performance of the Fund’s private market investments, which rose markedly. The sluggish investment performance in the year, and increased accrued benefits led the Plan’s funding status (on an accounting basis) to weaken significantly to a deficit of $2.3 billion, or 11.5% of pension benefits, up from 6.6% in the prior year.

Most notably, the Plan has historically had weaker demographics than other pension plansrated by DBRS. This was reflected in an active members-to-pensioners ratio of 1.21 times by year-end 2011, and has resulted in a persistent negative net contribution position, although both measures have improved in recent years. In light of ongoing challenges faced by the Province, a possible restructuring of the provincial labour force could potentially lead to deterioration in the Plan’s active members-to-pensioners ratio. This raises some uncertainty with regard to where the ratio will trend in the medium term, and limits the effectiveness of increases in contribution rates as a way to address funding deficiencies.

Consistent with the maturity of the Plan, OPB has historically maintained a relatively conservative policy mix and investment approach. However, over the next five years, a new asset mix strategy will be implemented, which calls for increased exposure to private markets, eventually accounting for over a third of portfolio assets, and a dedicated focus on growth opportunities in emerging markets. This new approach is expected to elevate the Fund’s risk/return profile, and deliver returns more in line with those seen among other large pension plans, which should have a positive effect on the Plan’s funding status. The very solid credit profile is expected to be maintained by OPB, given the long-term nature of plan obligations, steadily growing assets and stable liquidity position. In addition, as was the case with OPB’slast long-term funding study, an upcoming report by the Fund slated for release this fall is likely to lead to meaningful measures to address the funding shortfall.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Canadian Public Pension Funds and their Exclusive Asset Managers,which can be found on our website under Methodologies.