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

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating of the Ontario Pension Board (OPB) at AA (high) and the credit rating on OPB Finance Trust's Debentures at AA (high). All trends are Stable. The credit 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) 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 credit ratings.

OPB earned a total return of 3.1% (net of all expenses) in 2023, compared with -7.8% in 2022. The return underperformed its benchmark of 5.2%. The positive returns in the Public Equity and Fixed Income portfolios made the most significant positive impact on the total return. The returns of the Global Equities portfolio, the Canadian Equities portfolio, and Emerging Markets equity portfolio reached 21.6%, 14.2%, and 7.8%, respectively. Within Fixed Income, Government Long-Term had a return of 9.0% in 2023, compared with -22.6% in 2022. Inflation-Linked Bonds provided a return of 1.5% in 2023, compared with -13.7% in 2022. The Global Credit portfolio returned 8.5% in 2023, compared with -5.2% in 2022. However, the total return underperformed its benchmark of 5.2%, primarily because of the significant declines in the Real Estate portfolio, which had a loss of 15.8% in 2023. The Public Market Alternatives portfolio had a 2023 return of 1.8%, compared with 3.1% in 2022. The Private Equity portfolio generated a positive return of 3.5% in 2023; however, it was significantly less than the benchmark return of 12.7%. Private equity activity in 2023 was negatively affected by rising interest rates, inflation, a looming recession, and geopolitical uncertainty. As a result of the positive investment returns, net assets increased by 2.3% from the prior year to $31.7 billion as at December 31, 2023. The past five years have delivered investment returns of 4.2% compounded annually. OPB approved the current Strategic Asset Allocation (SAA) in April 2021, which introduced portfolio leverage to reduce volatility and improve risk-adjusted returns. The portfolio leverage amount was 7.9% as of December 31, 2023. In 2024, OPB partnering with Investment Management Corporation of Ontario (IMCO), are planning to conduct a new long-term funding study and a new asset/liability study to review the SAA and determine if adjustments to the asset mix are necessary.

The net return of 3.1% in 2023 was less than the discount rate of 6.1% assumed in the Plan valuation, which together with losses because of continued high inflation, led to the funded status of the Plan dropping to 85% from 89% on a financial statement basis. The Plan's deficit increased to $5.62 billion in 2023 from $3.96 billion in 2022. OPB is required to file an actuarial funding valuation with the regulatory authorities at least triennially, which includes smoothed investment returns. OPB filed the December 31, 2022, actuarial valuation with the Financial Services Regulatory Authority. The next required filing will be as of December 31, 2025. Under the filed valuation, the Plan was 94% funded at December 31, 2022, and included a plan to return it to a fully funded status through special payments made by the Province of Ontario (Ontario; rated AA with a Stable trend by Morningstar DBRS), as the Plan's sponsor, over a 10-year period.

The Plan continues to have a weaker demographic profile than some other rated plans, with an active-to-retired membership ratio of 1.21 times (x), compared with 1.16x in 2022. The increase was the result of continued growth of the active population of the Ontario public service, as well as the consolidation of Legal Aid Ontario, which brought more active members into the PSPP.

After the full repayment of the Series C Debentures in May 2023, debt with recourse to the Plan decreased to $1.5 billion as of December 31, 2023, or 4.4% of adjusted net assets. The recourse debt ratio remains less than 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 IMCO after IMCO launched and began operations in July 2017. During IMCO's sixth year of operation in 2023, 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. Morningstar DBRS believes that the use of IMCO to manage the Plan's assets and the associated benefits of asset pooling are modestly positive for OPB's credit profile.

Morningstar DBRS expects the credit 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 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 Factors in Credit Ratings at https://dbrs.morningstar.com/research/437781 (August 13, 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 ratings were initiated at the request of the rated entity.

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

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

These are solicited credit ratings.

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 https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.