Morningstar DBRS Confirms Ontario Teachers’ Pension Plan Board at AAA and Ontario Teachers’ Finance Trust at AAA and R-1 (high), Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating of the Ontario Teachers’ Pension Plan Board (Ontario Teachers') at AAA. Morningstar DBRS also confirmed the ratings on the Ontario Teachers’ Finance Trust’s (OTFT) Long-Term Notes, Canadian Short-Term Promissory Notes, and U.S. Commercial Paper (CP) Notes at AAA, R-1 (high), and R-1 (high), respectively. All trends remain Stable. The ratings are supported by the strong legislative and governance frameworks that create a highly captive asset base, require the Ontario Teachers' Pension Plan (the Plan) sponsors to be responsive to deteriorations in funding status, and impose high standards of care and prudence on Ontario Teachers' board and management. The ratings are further supported by the Plan’s fully funded status on a going-concern basis for 11 consecutive years, substantial net assets and liquidity, strong long-term investment returns, and low recourse debt burden.

Ontario Teachers' achieved a net return of 1.9% in 2023, underperforming its benchmark (BM) of 8.7% by 680 basis points (bps). Strong performances in public equities and credit investments were partially offset by negative returns in real estate and infrastructure assets, which were affected by valuation adjustments to reflect the high interest rate environment and some specific asset events. The underperformance with respect to the BM was in part due to many asset classes being benchmarked against global stock indices that performed extremely well during the year and Ontario Teachers’ relative low allocation to public equities in the asset mix. As a result of the modest net positive investment results, net assets remained almost flat, increasing by $278 million to $247.5 billion.

Effective January 1, 2024, Ontario Teachers' established an in-house real estate group to oversee its global real estate investment activities. This initiative aligned its global real estate investment approach with that of other asset groups, which Ontario Teachers' expects will enable information sharing and co-sourcing investments across its global platform. Ontario Teachers' will focus on global real estate investment and portfolio management, while Cadillac Fairview Corporation (wholly-owned by Ontario Teachers’) will focus on growth, diversification, and densification of its real estate portfolio in Canada.

Debt with recourse to Ontario Teachers' rose in 2023 to $28.5 billion or 10.3% of adjusted net assets. During 2023, OTFT issued two senior unsecured notes, including a green bond. Recourse debt remains low compared with total net assets, providing considerable room for cyclical fluctuations in asset values. Morningstar DBRS notes that Ontario Teachers' continues to meet Morningstar DBRS criteria for CP liquidity support as outlined in the appendix to the “Rating Canadian Public Pension Funds & Related Exclusive Asset Managers” methodology titled “Self-Liquidity for Canadian Public Pension Funds and Related Exclusive Asset Managers’ CP Programs.” Ontario Teachers' liquidity position remains sound with sufficient same-day available funds equal to at least five business days of upcoming liabilities and discounted assets equal to the remaining maximum authorized CP program limit, which is consistent with Morningstar DRBS’ policy on backup liquidity support for pension plans and provides considerable short-term financial flexibility.

Ontario Teachers' primary challenge continues to be the Plan’s demographics. The ratio of active-to-retired members stands at 1.2 times in 2023, and is expected to fall in the near term. The aging demographics result in growing net pension payments (contributions minus benefit payments) and reduced ability to equitably offset significant investment losses through contribution increases. To help mitigate the risk of its declining active-to-retired ratio, the Plan sponsors introduced conditional inflation protection in the Plan in 2008, which promotes intergenerational equity by allowing retired members to share the risk of a funding shortfall along with active members. Furthermore, to mitigate risk relating to increasing net pension payments, Ontario Teachers' has been increasing its capital allocation to private assets, which tend to provide more predictable income.

The Plan’s surplus on a financial statement basis declined to $36.1 billion in 2023 from $41.0 billion in 2022. While the valuation of the pension liability decreased due to a 20 bps increase in the discount rate (net of the long-term inflation rate), this was offset by lower-than-expected investment returns, higher-than-expected increases to pensions in pay, and a provision for the estimated impact of retroactive salary increases for certain years. The discount rate used to value the pension liability in the financial statements is based on market rates of bonds issued by the Province of Ontario (rated AA (low) with a Positive trend by Morningstar DBRS), with characteristics similar to the obligations under the Plan. On a going-concern basis, the Plan has been fully funded for 11 consecutive years. The Plan sponsors filed the funding valuation in 2023 and classified the $17.5 billion surplus as a contingency reserve, maintaining the average contribution rate at 11% and the 100% inflation protection on all pensions. As of January 1, 2024, the Plan had a preliminary surplus of $19.1 billion. The January 1, 2024, valuation is not required to be filed with the regulatory authorities, but the Plan sponsors may elect to do so.

Morningstar DBRS expects the ratings to remain stable, given the current outlook for the Plan’s funding status.

Morningstar DBRS’ credit rating on the Long-Term Notes and CP addresses the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. The associated financial obligations for each Long-Term Note and CP are the related principal amount and coupon payments.

Morningstar DBRS’ credit rating does not address nonpayment risk associated with contractual payment obligations contemplated in the applicable transaction documents that are not financial obligations.

Morningstar DBRS’ long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued. The Morningstar DBRS short-term debt rating scale provides an opinion on the risk that an issuer will not meet its short-term financial obligations in a timely manner.

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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://dbrs.morningstar.com/research/427030 (January 23, 2024).

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 16, 2024; https://dbrs.morningstar.com/research/431261) and North American Structured Finance Flow-Through Ratings (November 13, 2023; https://dbrs.morningstar.com/research/423240).

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

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 info-DBRS@morningstar.com.

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

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

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

This is a solicited credit rating.

The full report providing additional analytical detail is available by clicking on the link under Related Research below or by contacting us at info-DBRS@morningstar.com.

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

A description of how Morningstar DBRS analyses structured finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/410863.

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.