Morningstar DBRS Confirms OMERS Administration Corporation at AAA and OMERS Finance Trust at AAA and R-1 (high), Stable Trends

DBRS Limited (Morningstar DBRS) confirmed OMERS Administration Corporation's (OMERS or the Fund) Issuer Rating at AAA. Morningstar DBRS also confirmed the R-1 (high) credit ratings on the Canadian Commercial Paper (Canadian CP) and U.S. Commercial Paper (U.S. CP; collectively, with the Canadian CP, the CP) of OMERS Finance Trust (OFT), as well as the AAA credit rating on OFT's Medium-Term Notes (MTNs). The trends on all credit ratings are Stable. The credit ratings on the CP and MTNs are predicated on the unconditional and irrevocable guarantees provided by OMERS on issuances. Despite the funding deficit in the OMERS Primary Pension Plan (the Plan), the credit ratings continue to be supported by the Fund's high level of assets, low-recourse debt burden, large base of financially sound employers, and healthy demographic profile.

The year 2023 began with continued patterns of persistent price inflation, high interest rates, and global economic slowdown from 2022. Most of the central banks, including the Bank of Canada (BoC) and the U.S. Federal Reserve (the Fed), maintained their tighter monetary policies to combat inflation during the year. The BoC and the Fed increased the overnight rate to 5.0% and 5.5%, respectively, before holding the rate stable as price inflation cooled during the second half of the year and fears of recessions eased down. Despite of above factors, since the Coronavirus Disease (COVID-19) pandemic, OMERS generated a three-year average annual net return of 8.0%, which enabled the Fund to weather the impact of high inflation on pension obligations. OMERS ended 2023 with a positive growth in net assets to $128.8 billion as at December 31, 2023 (from $124.4 billion in 2022), with an investment return of 4.6% (4.2% in 2022) net of expenses, generating $5.6 billion of investment income. Public assets registered strong performance with public equities benefitting from a rebound in stock market indices and fixed income benefitting from higher interest rates. With recessionary fears subsiding and expectations of interest rate cuts emerging, bond market indices got a boost, especially in the last quarter. However, the positive returns from public investments were partially offset by private investments returns, which were muted because of increased cost of debt, increased operating costs, and anticipated slower economic growth. Additionally, unhedged exposure to foreign currencies contributed to unrealized foreign currency loss of $1.5 billion, primarily due to the impact of weaker USD against the Canadian dollar (CAD),further offsetting investment income.

On both a fund and asset class level, OMERS measures return performance against the respective benchmarks (BMs). For the year 2023, these BMs were established in December of 2022 with an aim to earn returns that meet or exceed the one-year BMs approved by the OMERS' board of directors (Board). OMERS sets absolute return BMs rather than relative returns BMs to focus on annually growing the assets, irrespective of market volatility and economic conditions, given the Plan's current funding risk profile and discount rate strategy. Although, OMERS delivered a positive investment return of 4.6%, this return fell short of the absolute return BM target of 7.0%. Public asset classes gained 9.0%, outperforming the BM of 5.8%. Within this asset class, public equities gained 10.4%, bonds gained 5.8%, and credit investments delivered gains of 8.3%. Within the private investments, each asset class (private equity, real estate, and infrastructure) underperformed by delivering returns of 3.9%, (7.2)%, and 5.5%, respectively, against their BMs of 9.6%, 6.3%, and 7.7%. Real estate was the only asset class generating negative returns because of lower valuations impacted by high interest rates. The higher interest rate environment provided improved returns from fixed income investments and returns from private asset strategies were held back by the impact of higher interest rates which increased the cost of debt, and by anticipated slower economic growth. Net investment income of $5.6 billion contributed to 3.6% in net asset growth, more than offsetting net pension payments of $1.1 billion and $123 million in pension administrative expenses. As the Plan continues to mature, the Fund relies more on investment returns to grow and meet financial obligations. Net assets backing the Plan (which excludes the Retirement Compensation Arrangement (RCA) and the Additional Voluntary Contributions (AVC) component) increased to $127.0 billion as at year-end (YE) 2023 from $122.7 billion in the prior year. The Plan's funded ratio on a going-concern basis rose up to 97% again as at YE2023 from 95% in YE2022. This improvement was generated by strong investment gains from prior years. However, the unrecognized investment returns dropped from a cumulative gain of $0.6 billion as at YE2022 to a $3.4 billion cumulative loss mainly because OMERS net return was less than the actuarial smoothing rate as at YE2023. OMERS' annual pensions increase formula, which is linked to Canada's Consumer Price Index, generated an increase to pension in pay of 4.9% effective January 1, 2024. This includes 0.51% carry forward from the cap-affected January 2023 COLA. In the valuation as at December 31, 2023, the COLA assumptions for 2025 and 2026 are 3.0% and 2.5% respectively. As confirmed last year, Shared Risk Indexing will not affect the annual inflation adjustment to pensions in pay in 2024 and 2025.

OMERS continued to issue MTNs while reducing its reliance on CP. Debt with recourse to the Fund increased to $13.1 billion from $11.4 billion, equivalent to 9.3% of adjusted net assets as at YE2023. Debt with recourse to the Fund remains below the internal long-term 10% limit set by the OMERS Board and still provides some room for cyclical fluctuations in asset values. During 2023, OFT issued a USD 1.0 billion five-year note bearing a coupon of 4.00% maturing in 2028 and a 10-year note of USD 1.0 billion bearing a coupon of 5.50% maturing in 2033. OMERS maintains a credit facility as backup liquidity support for the CP programs, which meets the Morningstar DBRS criteria outlined in the commercial paper liquidity section in Morningstar DBRS Global Corporate Criteria. Morningstar DBRS notes the maximum authorized CP limit (Canadian and U.S. CP programs combined) remained at $5.0 billion. The limit on the credit facility used as backup liquidity support for the CP program was $4.3 billion (three-year revolving facility maturing in 2026). While OMERS will likely continue to use leverage as the Fund broadens its global reach in private market assets and seeks to support liquidity needs and enhance investment returns, Morningstar DBRS expects recourse debt to remain within OMERS' internal 10% limit over the long term.

OMERS continues with its 2025 Strategy, a multiyear plan that focuses on several priorities. The strategy addresses plan maturity, longer life expectancy, and decreasing investment return expectations; changing demographics and workplace trends; diversification of investments globally; and the incorporation of environmental, social, and governance (ESG) factors. OMERS adopts specific governance and risk management practices with a fundamental focus on funding risk to achieve the strategy's objectives.

Morningstar DBRS' credit rating on the MTNs 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 MTN 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 credit 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.