DBRS Rates OPB Finance Trust’s Debentures at AA (high)

DBRS has today assigned a provisional rating of AA (high) to the proposed $250 million Series C Debentures of OPB Finance Trust (the Trust or Issuer) and confirmed the AA (high) ratings of the Trust’s outstanding Series A Debentures and Series B Debentures (collectively referred to as the Debentures). The trends on the ratings are Stable. The Issuer is a wholly owned subsidiary and principal financing vehicle of Ontario Pension Board (OPB or the Fund). The Debentures are unconditionally and irrevocably guaranteed by OPB, and rank pari passu with all other present and future unsecured and unsubordinated obligations of the Trust. Net proceeds from the new debt issue will be used to finance the Fund’s recent real estate transactions.

The ratings remain supported by OPB’s exclusive mandate to manage the assets and administer the benefits of Ontario’s Public Service Pension Plan (the Plan), a history of prudent management and a high level of assets available to meet potential guarantee obligations. Additional support to the rating is provided by 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. However, the Plan’s demographics are notably weaker than other large rated pension plans, which limit the ratings to their current level.

The Fund delivered strong investment returns of 11.9% in 2012, rebounding from 0.4% the prior year. Solid performance was supported by tactical shifts in the portfolio’s composition. The Fund held an overweight position in the resurgent U.S. equity market and boosted its exposure to emerging markets, which performed well during the year. Private market assets continued to provide meaningful uplift, with real estate and private debt again delivering double digit gains, and the new infrastructure and private equity mandates posting strong first year gains. Healthy investment performance drove net assets up by 10% year-over-year to a record $19.0 billion, despite continued declines in net contributions.
Investment returns outpaced growth in actuarial liabilities during the year and an improvement in the funding shortfall at the end of 2012 is therefore expected. DBRS expects the next actuarial valuation, to be filed by September 30, 2014, as at a date not later than December 31, 2013, will reveal an improvement in the Plan’s funded status, despite the adoption of more conservative assumptions since the last filed valuation two years prior, as cumulative returns have exceeded the required rate and salary increases have been lower than assumed due to compensation restraint measures adopted by the Province in recent years.

However, DBRS notes that the Province’s human resources strategy continues to pose meaningful headwinds to the Plan’s demographics. After several years of consistent improvements in the Plan’s active-to-retired members ratio, further rationalization of the government’s workforce in 2012 caused the ratio to dip to 1.18 times, only slightly above the five-year average. This level remains notably lower than that of other large pension plans and continued declines could make addressing future funding challenges more difficult.

In an effort to optimize returns, OPB is expected to continue to shift its exposure from public to private market investments, which present stronger return opportunities but also often require more leverage. OPB adopted a new strategic asset allocation (SAA) in 2011, with a goal to achieve its new asset mix by 2016. As part of this new approach, OPB intends to maintain its exposure to higher volatility emerging markets, such as China, while decreasing its Canadian equities exposure. This push to less liquid and more complex investments was also observed at OPB’s peers. It may translate into more volatile returns relative to the Fund’s conservative roots, but is also expected to benefit returns over the longer term.

The Trust’s inaugural debt issue took place in June 2012, with $500 million in long-dated debentures issued. With no other debt issued during the remainder of the year, recourse debt is expected by DBRS to have ended 2012 at $500 million, or 2.6% of adjusted net assets, in line with expectations. Barring any additional issuances beyond the Series C Debentures during this year, and assuming returns meet plan assumptions, recourse leverage is expected to remain below 4.0% of adjusted net assets by year-end 2013. To provide a firmer grounding for leverage in the portfolio going forward, the board of directors recently approved a revised internal debt policy, which now limits total portfolio debt to 10% of the market value of the Fund. This policy is among the most conservative of rated pension plans, as it incorporates both recourse and non-recourse leverage within the standard 10% limit, rather than just recourse debt. The implementation of OPB’s SAA will likely continue to drive debt usage higher over the medium term, although overall leverage with recourse to OPB is expected to remain well below 10% of adjusted net assets.

It is anticipated that OPB’s financial statements will be made public in the late summer, at which time DBRS will provide a full report with additional analytical detail.

Notes:
All figures are in Canadian unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodology is Rating Canadian Public Pension Funds & Their Exclusive Asset Managers (May 2012), which can be found on our website under Methodologies.