DBRS Confirms OPB Finance Trust’s Debentures at AA (high)

DBRS has today confirmed the ratings on the outstanding Debentures of OPB Finance Trust (the Trust or the Issuer) at AA (high), with Stable trends. The Issuer is a wholly owned subsidiary and special purpose trust of the Ontario Pension Board (OPB or the Fund). The ratings are primarily supported by the unconditional and irrevocable guarantees provided by OPB on the Debentures. Additionally, the Trust benefits from OPB’s exclusive mandate to manage the assets of the Ontario Public Service Pension Plan (the Plan), and the high level of Plan assets available to meet outstanding guaranteed obligations. However, DBRS notes that the demographics of the Plan are notably weaker than that of other rated peers, which limits the rating to the current level.

OPB generated a second consecutive double digit investment return of 12.5% in 2013, exceeding its benchmark by 305 basis points. Strong gains were seen in public equities portfolios, as markets remained buoyant across most developed economies, as well as private market assets, which helped to offset sluggish fixed income performance owing to a jump in long-term bond yields in the latter half of the year. Nearly all major asset classes outperformed their benchmarks, except private equity, despite experiencing a robust 17.8% return for the year. Financial markets have been fruitful thus far in 2014, as market volatility remains low. However, geopolitical concerns, a dramatic expansion in equity market valuations, and the prospect of rising interest rates have added uncertainty to markets and could lead to more subdued investment performance in 2014.

Net assets rose by 10.1% to $20.9 billion for the year ending December 31, 2013, driven primarily by $2.2 billion in net investment income, but partially offset by net contribution outflows of $280.5 million. The Plan recently completed a triennial actuarial valuation that showed a going concern deficit of $814.2 million, or 3.7% of accrued liabilities, down from the $1.3 billion going concern deficit revealed in the 2012 valuation. The improvement in the funded status is notable as several actuarial assumptions were adjusted to better reflect plan experience and economic realities which resulted in an increase to Plan liabilities. However, lower than expected inflation and salary restraint, as well as solid value-added investment returns provided offsets. The Plan continues to grapple with a weak demographic profile, as evidenced by an active-to-retired member ratio of 1.17 times in 2013, which is lower than other rated pension plans and in decline for a second consecutive year. Further, some uncertainty exists with respect to how the Plan’s membership may evolve in the coming years. A long term funding study is currently being conducted which will shed light on any changes to contribution rates and/or benefits that may be required to address the current funding shortfall.

The Fund is currently in the third year of a five year transition to a new asset mix policy, which similar to OPB’s peers, calls for an increased exposure to less liquid private market assets, coupled with a decline in fixed income investments, more specialty public equities mandates, and use of tactical asset allocation strategies. This push to illiquid asset classes and more complex investment strategies is a marked departure from OPB’s more conservative roots, and will translate into a risk/return profile that is more consistent with its larger peers, but is also expected to provide diversification and benefit returns over the longer term.

OPB maintains a strong liquidity position with cash and short-term securities of $1.7 billion as at December 31, 2013, providing financial flexibility. Owing largely to the Series C Debentures issued in May 2013, OPB’s recourse debt rose to $780.0 million by year-end 2013, up from $500.0 million a year earlier. Despite the increase, recourse debt only accounted for 3.6% of adjusted net assets at year-end 2013, up modestly from 2.6% in 2012. This is lower than most other DBRS-rated pension fund managers and remains adequate for the current rating level. No new borrowings are anticipated over the near term. While DBRS expects that OPB’s strategy to grow private market assets, particularly real estate, will likely place upward pressure on debt, recourse leverage is expected to remain very manageable for the foreseeable future. In fact, in 2013, the board revised OPB’s internal debt policy to limit total debt (including both recourse and non-recourse) to 10% of the market value of the Fund, which is more conservative than other rated pension plans.

It is anticipated that OPB’s annual report will be made public in the coming weeks, at which time DBRS will provide a full report with additional analytical detail.

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

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 to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Canadian Public Pension Funds & Related Exclusive Asset Managers (May 2014) and DBRS Criteria: Guarantees and Other Forms of Explicit Support (July 2013), which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.