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

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating of the Ontario Pension Board (OPB) 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 Public Service Pension Plan's (PSPP or 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 Plan’s substantial net assets and liquidity and low debt burden further support the ratings.

OPB earned a total return of -7.8% (net of all expenses) in 2022, compared with 9.4% in 2021. The return exceeded its benchmark of -8.1%. Total Plan performance was driven primarily by the significant declines in stock and bond markets. The increase in interest rates in 2022 led to losses in government bonds. Under fixed income investments, government long-term had a return of -22.6% in 2022, compared with -4.9% in 2021. Inflation-linked bonds provided a return of -13.7%, compared with 3.8% in 2021. Canadian and global public equities had significant negative returns in 2022. The rates of return in Canadian equities, foreign developed equities, and emerging equities were -4.2%, -13.6%, and -17.2%, respectively. Positive returns of 8.3% in private equity and 7.9% in infrastructure investments helped offset some of the losses from stocks and bonds, which supported the Plan’s investment decision in recent years to shift more heavily into private market investments. In real estate, OPB has significant exposure to retail and office properties, and these real estate assets were largely affected by the economic uncertainty associated with monetary and fiscal policy actions. Rising interest rates and an increase in office vacancies put pressure on real estate values in 2022, and the real estate portfolio returned -0.2% compared with 12.9% in 2021. Global credit was introduced in 2020 and returned -5.2% in 2022, outperforming the benchmark of -12.8%. The past five years have delivered investment returns of 3.8% compounded annually. As a result of the negative investment returns, net assets declined by 8.3% from the prior year to $31.0 billion as at December 31, 2022. OPB approved the new Strategic Asset Allocation (SAA) in April 2021 to be phased in gradually over the following four years. Portfolio leverage was introduced to the new SAA to reduce volatility and improve risk-adjusted returns. The portfolio leverage amount was 5.1% as of December 31, 2022.

The Plan's funded status on a financial statement basis increased to a $3.96 billion deficit in 2022 from a $852 million deficit in 2021, mainly as a result of the investment losses and the spike in inflation, which was slightly offset by the increase in bond yields that supported an increase in the real discount rate to 3.64%. OPB is required to file an actuarial funding valuation with the regulatory authorities at least triennially, which includes smoothed investment returns. In 2022, OPB filed the actuarial valuation calculated as at December 31, 2021. Under the filed valuation, the Plan is 94% funded and includes a plan to return it to a fully funded status through special payments made by the Province of Ontario (Ontario or the Province; rated AA (low) with a Positive trend by DBRS Morningstar), as the Plan’s sponsor, over a 10 year period.

The Plan continues to have a weaker demographic profile than other rated plans, with an active-to-retired membership ratio of 1.16 times (x), compared with 1.12x in 2021. The increase was the result of more than 1,000 new members joining the PSPP from the consolidation of Ontario Health and eHealth into the PSPP, plus an overall increase in the active population of the Ontario public service.

After the full repayment of the Series D Debentures in February 2022, debt with recourse to the Plan decreased to $1.7 billion as of December 31, 2022, or 5.1% of adjusted net assets. The recourse debt ratio remains below OPB’s internal 10.0% limit on all debt. 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 fifth year of operation in 2022, 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.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

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

The principal methodologies applicable to the ratings are Rating Canadian Public Pension Funds & Related Exclusive Asset Managers (April 27, 2023; https://www.dbrsmorningstar.com/research/413011) and North American Structured Finance Flow-Through Ratings (November 22, 2022; https://www.dbrsmorningstar.com/research/405619).

Other methodologies referenced in this transaction are listed at the end of this press release.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

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 under Related Documents or by contacting us at [email protected].

The rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

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].

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The rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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