Morningstar DBRS Confirms AAA Credit Ratings on Public Sector Pension Investment Board and PSP Capital Inc.

DBRS Limited (Morningstar DBRS) confirmed the Public Sector Pension Investment Board's (PSP Investments or the Corporation) Issuer Rating at AAA. Morningstar DBRS also confirmed its credit ratings on PSP Capital Inc.'s (PSP Capital) Medium-Term Notes at AAA as well as Canadian Short-Term Promissory Notes, U.S. Commercial Paper Notes, Euro Commercial Paper Notes at R-1 (high). All trends are Stable. 

PSP Investments is a non-agent Crown corporation created, under the Public Sector Pension Investment Board Act (the PSPIB Act), to manage the net contributions received since April 1, 2000, for the pension plans of the federal Public Service (the Public Service), the Canadian Forces, and the Royal Canadian Mounted Police (RCMP); and, since March 1, 2007, for the pension plan of the Reserve Force. As at March 31, 2024 (F2024), PSP Investments held net assets under management (AUM) of $264.9 billion (gross AUM less leverage). PSP Capital is a wholly owned subsidiary of PSP Investments that was created in 2005 to raise financing for investment activities through short-term and long-term borrowing. The credit ratings on the debts issued by PSP Capital are predicated on the unconditional and irrevocable guarantee provided by PSP Investments.

KEY CREDIT RATING CONSIDERATIONS
The AAA credit ratings and Stable trends are supported by the exclusive mandate to manage the assets of four depository pension plans, a substantial and captive asset base, low leverage, ample liquidity, strong long-term operating performance and creditor priority of debtholders to pensioners. The credit ratings also acknowledge the Corporation's independent board, experienced management team, and strong corporate governance. Moreover, the Government of Canada (the Government; rated AAA) is the sponsor of all four plans, which provides considerable stability and certainty of cash flows. The Corporation is not responsible for its clients' pensions liabilities as same is guaranteed by the Government. PSP Investments' portfolio also includes a sizable portion of private equity, real estate, and infrastructure, which can be riskier or less liquid but has higher return potential, which is essential to keep plans in a surplus position. This is demonstrated by the portfolio generating consistently good returns over short-term and long-term investment horizons. Nonetheless, the Corporation maintains a right-sized liquidity position to make up for the illiquid nature of these investments as well as allow the flexibility to allocate capital to new opportunities, portfolio companies, and investment funds.

CREDIT RATING DRIVERS
Morningstar DBRS would downgrade the credit ratings if PSP Investments were to experience a material change in its legislative framework and regulations. The credit ratings would also be downgraded if there are material risk management failures leading to a sustained weakness in investment returns over a medium-term horizon.

CREDIT RATING RATIONALE
Legislated Framework: AAA
PSP Investments was established in 1999 under the PSPIB Act with an exclusive mandate of managing the federal government's pension plan assets for the Public Service, the Canadian Forces, and the RCMP and the Reserve Force. PSP Investments' mandate is to invest its assets with a view to achieving a maximum rate of return, without undue risk of loss, having regard to the funding, policies, and requirements of the Plans and the ability of the Plans to meet their financial obligations. Based on the actuarial reviews of plans, there are federal laws in place to ensure PSP Investments and holds sufficient assets (guaranteed by the Government) to provide the accrued pension benefits to Plan members. The Corporation is not directly responsible for pension obligations and operates at arm's length from the Government. Lastly, the exclusivity of the mandate adds to the certainty of the cashflows and makes the AUM captive in nature.

Plan Sponsors and Demographics of a Plan's Membership: AAA
During their working life, Canada's Public service employees and members of the Armed Forces (Regular and
Reserve Forces) and RCMP contribute jointly with their employers to their respective pension plans. The Government transfers to PSP Investments an amount equal to the total contributions less expenses and funds used to pay pension benefits for service after 2000. The Government being the sponsor of the four pension plans provides considerable stability and certainty of cash flows. The overall net contribution level in F2024 stood at $3.5 billion, which supports liquidity and AUM growth. However, Morningstar DBRS notes as the Corporation continues to gain scale, net pension contributions become less important to AUM growth. Since April 1, 2000, transfers received from the government represent about 35% of net assets; the remaining 65% is attributable to investment returns. On the funding health of the managed plans, the plans have healthy funding ratio of >100% except for the Reserve Forces, which is at 93.2%.

Management Framework: AAA
PSP Investments operates at arm's length from the Government and has independent investment decision-making and accountability. Its management reports to an independent Board, which is responsible for supervising the management of the Corporation's business. The Government's tolerance for funding risk is communicated to PSP Investments through a Reference Portfolio (RP), followed by the Policy Portfolio construction that aims at achieving its mandate to maximize returns without undue risk of loss or funding risk over a long-term horizon. Over a 10-year period, PSP Investments' net return exceeded the performance of the RP by 1.1% per annum, or $24.5 billion, without incurring more pension funding risk than indicated by the RP. PSP Investments is exposed to various risks such as market, concentration, counterparty, liquidity, leverage, credit and nonfinancial risk; however, these risks remained within the internal guidelines and manageable relative to the Corporation's net AUM of $264.9 billion and one-year portfolio return of 7.2% as of F2024.

The Corporation's liquidity position remains sound, with sufficient funds equal to at least five business days of upcoming liabilities, and discounted assets covering maximum authorized CP program limit, which is consistent with Morningstar DBRS' policy on backup liquidity support for pension plans. At the end of F2024, the Corporation had sizeable liquidity sources such as cash and money market securities ($12.0 billion), public equity and marketable fixed income ($89.8 billion), net contributions ($3.5 billion), and unutilized revolving lines ($3.0 billion). This liquidity base of $101.8 billion from first two sources against total outstanding of $27.0 billion under capital market debt program provides strong liquidity coverage of 3.8 times. This highlights the Corporation's flexibility to meet its obligations through its diversified sources of liquidity with adequate cushion to absorb potential investment losses and shorter-term market swings.

Financial Resources: AAA
In F2024, the Corporation had gross AUM and net AUM of $302.7 billion and $264.9 billion, respectively. During the year, net AUM grew by $21.2 billion from $243.7 billion previously, reflecting investment gains of $17.8 billion and net client contribution of $3.5 billion. In F2024, public equity and fixed income constituted 21.0% and 21.2% of the net AUM respectively whereas the private asset mix stood at 55.1%. All asset classes were within the limits set by the rebalancing policy, except for private equity, which exceeded marginally because of the higher returns in the recent past.

PSP Investments ended F2024 with a net investment return of 7.2%, outperforming the respective Total Fund benchmark (BM) of 6.4%. Also, over the five-year and 10-year horizons, the Corporation delivered 7.9% and 8.3% which outperformed the respective Total Fund BMs of 5.3% and 6.7%, respectively. On an absolute basis, all asset classes generated a positive return except for real estate, which lost -15.9% as all sectors generated valuation losses due to capitalization and discount rate expansion, mainly driven by the office sector, which continues to face reduced demand, rising vacancy rates, declining rents, and higher capital requirements. Among others, public equities was the biggest contributor to PSP Investments' performance given the high portfolio allocation and return of 17.5%. Other noteworthy asset class absolute performances were Infrastructure (14.3%), Credit Investments (14.2%), Private Equity (12.1%), and the Complementary Portfolio (20.6%).

Funding Status: AAA
PSP is acting as an exclusive asset manager for pension plans and the Corporation is not directly responsible for pension obligations. Morningstar DBRS views this favorably relative to its pension funds peers. The plans' funding risk is borne entirely by the government and any deficit is funded with special payments that are made until plans reach fully funded status. Morningstar DBRS also noted that the largest pension clients have been fully funded for several years, indicating their long-term viability, the adequacy of the current contributions rates, and the growth prospects for the assets available to eventually repay outstanding debt. The most recent actuarial valuations show that plans were >100% funded on a going concern basis except small plan for Reserve Forces, which is 93.2% funded.

Liabilities: AAA
The Corporation is not directly responsible for pension obligations. The Corporation's combined investment-related liabilities and capital market debt decreased by 4.9% ($1.9 billion) to $37.8 billion in F2024, mostly driven by lower usage of repos. This total leverage of 14.3% against net AUM remained within the board limit. Derivative-related liabilities decreased from $1.6 billion in F2023 to $1.0 billion in F2024. Furthermore, the Corporation has internal guidelines limiting the amount of leverage that can come from its capital market program. As at F2024, recourse debt (medium-term notes, commercial paper, and short-term promissory notes) raised from the capital market debt program rose to $27.0 billion in F2024 from $24.0 billion in F2023, representing 9.3% of adjusted net assets but well within the internal management guidelines limits.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance (ESG) 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 methodology is Rating Canadian Public Pension Funds & Related Exclusive Asset Managers (April 16, 2024; https://dbrs.morningstar.com/research/431261). In addition, Morningstar DBRS uses the Morningstar DBRS Global Corporate Criteria (April 15, 2024; https://dbrs.morningstar.com/research/431186) and Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024; https://dbrs.morningstar.com/research/437781) in its consideration of ESG factors.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at https://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 conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit https://dbrs.morningstar.com..

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