DBRS Morningstar Confirms Ontario Pension Board and OPB Finance Trust at AA (high)

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating of the Ontario Pension Board (OPB or the Plan) at AA (high) and the rating on OPB Finance Trust’s Debentures at AA (high). All trends are Stable. The ratings are supported by strong legislative and governance frameworks that create a highly captive asset base, require the Plan’s sponsor to be responsive to deteriorations in the funding status, and impose high standards of care and prudent decision making on OPB’s board and management. The ratings are further supported by the Plan’s substantial net assets and liquidity and low debt burden.

OPB earned a total return of 10.2% (net of all expenses) in 2019, compared with 1.3% in 2018. The return was strong in absolute terms but fell short of its benchmark of 12.1%. The increase from the previous year’s return of 1.3% was mainly because of strong returns in the public equity market and fixed income portfolio, supported by a bull market and a decline in bond yields. Canadian equities and emerging equities rebounded to 15.6% and 14.9%, respectively, from losses of 6.9% and 8.1%, respectively, in the prior year. Performance of foreign developed equities and fixed income portfolios improved in 2019 to 20.1% and 9.3%, respectively, from 1.4% and 1.9%, respectively, in 2018. While all asset classes delivered positive results, the Plan continued to experience challenges with its real estate portfolio, which generated a 3.1% annual return in 2019 and a 2.1% annual return in 2018. The past five years have delivered strong investment returns of 6.9% compounded annually. Net assets increased by 10.5% to $29.3 billion as at December 31, 2019.

Although the decline in bond yields was a key driver for the strong returns, it also meant the Plan’s liabilities increased significantly over the past year. The Plan’s deficit increased to $2,477 million, or 7.8% of the accrued pension obligation, on a financial statement basis. The effective discount rate was lowered to 5.25% in 2019 from 5.64% in 2018 because of the decline in long-bond yields. The increase in the pension liability offset the strong investment returns and resulted in the funded ratio remaining stable at 92%, compared with 93% in 2018. The Plan's sponsor, the Province of Ontario (rated AA (low) with a Stable trend by DBRS Morningstar), approved a contribution rate increase based on OPB’s recommendation following a long-term funding study in 2016. The contribution rate increased by 0.5% in April 2018 and increased another 0.5% in April 2019. Both increases have been matched by the employers.

The Plan continues to have a weaker demographic profile than other rated plans, with an active-to-retired membership ratio of 1.12 times (x), compared with 1.18x in 2018. The reduction was the result of a combination of events: (1) the onboarding of the Ontario Northland Transportation Commission pensioners, which increased the number of retired members; and (2) the implementation of the Transition Exit Initiative plan by the government, which offered younger active members enticements to voluntarily terminate their employment and plan membership while offering the opportunity for older members with longer service to retire early. However, OPB expects the ratio to improve over the next few years as other pension plans with more active members than retired members are integrated with the Plan.

Debt with recourse to the Plan increased slightly in 2019 to $2.4 billion, or 7.6% of adjusted net assets. The recourse debt ratio remains below OPB’s internal 10.0% limit on all debt and OPB has no immediate plans to issue further term debt.

The governance and management framework for the Plan as well as management’s investment strategy will likely remain stable over the near term. OPB transferred its investment and investment finance functions to the Investment Management Corporation of Ontario (IMCO) after IMCO launched and began operations in July 2017. During IMCO’s second year of operation in 2019, it continued the strategic shift of OPB’s assets to private markets from public markets, building its asset management and client servicing capabilities and enhancing its risk and performance reporting. OPB continues to own its assets and strategic asset mix and be responsible for its pension and guaranteed debt obligations through OPB Finance Trust. DBRS Morningstar believes that the launch of IMCO and the associated benefits of asset pooling are modestly positive for OPB’s credit profile.

DBRS Morningstar expects the ratings to remain stable for the foreseeable future, though erosion in the Plan’s demographic profile over the longer term could eventually put pressure on the ratings.

The rating includes additional analysis on the expected performance as a result of the global efforts to contain the spread of the coronavirus pandemic.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodology is Rating Canadian Public Pension Funds & Related Exclusive Asset Managers (April 27, 2020), which can be found on www.dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

For more information regarding structured finance rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/358308

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 [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

The full report providing additional analytical detail is available by clicking on the link under Related Documents below or by contacting us at [email protected].

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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