DBRS Finalizes SNC-Lavalin Innisfree McGill Finance Inc. at A (low)

DBRS has today finalized its rating of A (low) with a Stable trend on the $764 million Series A Senior Amortizing Bond issue of SNC-Lavalin Innisfree McGill Finance Inc. (the Issuer), the financing vehicle unconditionally guaranteed by Groupe immobilier santé McGill S.E.N.C. (ProjectCo) and its general partners. ProjectCo is the special-purpose entity created by SNC-Lavalin McGill (Partner) Inc. and Innisfree McGill (Partner) Inc. to design, build, finance and maintain a new 217,500 m2 hospital under a 34.3-year public-private partnership (PPP) with the McGill University Health Centre (MUHC or the Hospital), Québec’s largest health-care institution. DBRS notes that the senior bond issue was slightly larger than indicated in the June 21, 2010 DBRS presale report due to the impact of tighter-than-expected spreads on the benchmark interest rate determination mechanism embedded in the financing framework. Improving spreads combined with a lower base rate also led to notably lower interest expenses for the project, which reduced the capital component of the service payments to be received by ProjectCo during the service phase and allowed the sponsors to increase the gearing modestly to 86:14. As a result, proforma financial metrics have weakened slightly but are still considered adequate for the rating, thanks in part to a reduction in the additional bond issue contemplated after the construction phase by the equity sponsors.

The rating reflects the strong expertise of the DB Contractor hired by ProjectCo to assume all construction risks related to the project and the strength of its parent guarantor, along with the moderate complexity of the project and the 10% letter of credit provided by the DB Contractor to secure its performance during construction. Also supporting the rating is the pass down of all operating and routine maintenance responsibilities and of the most technical lifecycle obligations to very experienced contractors and the low credit risk of the availability-based payments to ProjectCo, which will originate from the Province of Québec and MUHC. Proforma credit metrics are solid although the rating incorporates the effect of another potential debt issue shortly after completion of construction, which could reduce the robustness of the project. The usual uncertainties related to large construction projects and the retention by ProjectCo of a portion of lifecycle obligations also limit the rating to the A (low) level.

Located about five kilometres west of downtown Montréal, the project involves the construction of four buildings to accommodate paediatric and adult inpatient care activities, a research centre, a cancer centre and the Montreal Chest Institute. The facilities will house 500 patient beds, 20 operating rooms, 3,000 m2 of retail space and a 2,735-space parking facility, although parking operations are excluded from the project. Construction is scheduled to start in July and will extend over a 51-month period ending in September 2014. SNC-Lavalin Services Ltd will assume all construction obligations under a fixed-price contract of $1.57 billion, with a performance guarantee from its parent SNC-Lavalin Group Inc. (rated BBB (high) by DBRS) for up to 55% of the contract price. No major issues have been identified by the technical advisor (TA) who notes, among other things, that the design is not particularly complex despite the significant excavation required and that the schedule seems reasonable.

Starting at stage 1 substantial completion, the service phase entails a relatively standard range of services, including routine and lifecycle maintenance of the facilities, their components and non-medical equipment, as well as management of energy consumption and customary ancillary services. ProjectCo has passed down to SNC-Lavalin Operations and Maintenance Inc. (the O&M Contractor) on a back-to-back basis all responsibilities for O&M activities and energy consumption for the term of the project. The O&M Contractor has extensive experience in facility management, currently servicing more than 7,500 facilities across Canada.

Johnson Controls L.P. (the Lifecycle Contractor or JCLP) will undertake the lifecycle maintenance of the more technical elements of the facilities such as electrical and mechanical components, IT systems and certain non-medical equipment, also under a fixed-price contract. Both O&M and Lifecycle Agreements mirror the relevant sections of the Project Agreement with MUHC, including the performance standards, and hold each contractor accountable for payment deductions unless caused by ProjectCo. The balance of lifecycle obligations, which accounts for 37% of the real lifecycle budget, remains with ProjectCo and will be managed on a fee basis by the O&M Contractor, which introduces an element of risk in the credit not seen in recent accommodation PPPs.

The base case scenario points to a debt-to-cash flow available for debt servicing (CFADS) ratio of 9.2 times in year one of operation and a relatively robust senior debt service coverage ratio (DSCR) of around 1.38 times over the life of the project. However, the project sponsors are entertaining the possibility of issuing up to $61 million in additional debt in the early years of operations if market conditions are suitable and the additional indebtedness test is satisfied. The transaction is tentative but is viewed by DBRS as highly probable. Under such a scenario, debt-to-CFADS would instead start around 10.5 times while the DSCR would fluctuate around 1.27 times, reducing the robustness of the service phase. Nonetheless, these credit metrics remain reasonable for an A (low) rating, though somewhat tight within the benchmark range after accounting for the lifecycle risk retained by ProjectCo. Mandatory audits of the facilities and the reserve mechanism embedded in the financing framework in the event of a shortfall in ProjectCo’s lifecycle budget should help mitigate this risk.

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

The applicable methodology is Rating Canadian Public-Private Partnerships, which can be found on our website under Methodologies.

This is a Public Finance rating.