DBRS Assigns Provisional Rating of A (low) to 407 East Development Group

DBRS has today assigned a provisional rating of A (low) with a Stable trend to both the proposed $[120.0] million Long-Term Senior Bonds (the Long-Term Bonds) and the proposed $[455.7] million Short-Term Senior Bonds (the Short-Term Bonds) of 407 East Development Group General Partnership (ProjectCo), the special-purpose entity created to design, build, finance, maintain and perform lifecycle obligations of the Highway 407 east extension (the Extension or the Project) under a 33.6-year project agreement (PA) with the Province of Ontario (the Province; rated AA (low), Stable). The rating is based on the availability-based revenues from the Province, the construction contract which passes down all of ProjectCo’s construction period risks under a date-certain, fixed-price contract to a strong construction contractor, as well as the pass-down of all service period obligations, including lifecycle risk, to an experienced service provider. The rating is bounded by the typical uncertainties with respect to large construction projects, as well as by ProjectCo’s relatively limited resilience to shocks in the lifecycle budget.

The Project involves the construction of 148 lane-kilometres of tolled, controlled-access highway which will extend Highway 407 from its existing eastern terminus in Pickering by approximately 20.3 kilometres to Oshawa, as well as the design and construction of the West Durham Link to connect Highway 407 to Highway 401 (approximately ten kilometres). All design, construction and commissioning obligations have been passed down under a fixed-price contract valued at $796.4 million to a general partnership of subsidiaries of SNC-Lavalin Group Inc. (rated BBB (high), Stable) and Ferrovial Agroman S.A. (the Construction Contractor). The construction phase will start in May 2012, and is scheduled to reach substantial completion on December 18, 2015 (the Scheduled Substantial Completion Date), for a total duration of 43 months. The scale of the project and the integration with existing infrastructure is viewed by DBRS as the most challenging aspect of the construction task and will require careful planning and schedule management. The project will also span across four municipalities, which will entail a somewhat more complex permitting process. However, generally the work is typical of a civil construction project and DBRS regards the complexity of the construction task as in the low-to-moderate range. In particular, the techniques required for the project are standard, geotechnical conditions are well known, the schedule and budget are viewed as adequate by the technical advisor (TA) and the largely greenfield site entails limited demolition work. The performance security package will assist in mitigating construction risks, including parent guarantees of their respective subsidiary’s joint and several obligations under the construction contracts for up to 40% of the contract price, and a 10% letter of credit, which places the project strongly in the A (low) category during the construction phase, in accordance with DBRS’s methodology. The letter of credit can be reduced to 8% of the construction price if certain ratings triggers are met, although at the 8% level the letter of credit is still supportive of the Project’s A (low) rating.

Similar to the construction phase, all risks and responsibilities pertaining to routine and lifecycle maintenance during the service phase will be passed down to a general partnership, indirectly owned by SNC-Lavalin Group Inc. and Cintra Infraestructuras, S.A. (Cintra; the Service Provider). The scope of services required under the PA is standard and includes preventive and lifecycle maintenance of the highway and coordination of emergency services. Parent guarantees of 200% of the average annual OM&R payment (indexed) upon termination, with liquid security provided by a letter of credit of 250% of the average annual OM&R payment (indexed), will back the Service Provider’s obligations. DBRS notes that the letter of credit may be reduced to 50% of the average annual OM&R payment (indexed) in the event that certain ratings triggers are met, still supportive of an A (low) rating for the Project.

Nonetheless, leverage will be high during the service phase, which is standard for a public-private partnership (PPP). This is reflected in the debt-to-cash flow available for debt servicing ratio of 10.6 times projected in the first year of the service phase and the debt service coverage ratio of 1.20 times foreseen over the Project’s term. While the results of the breakeven analyses are tight, they are viewed as adequate for the rating given the quality of the Service Provider, the protection provided by the lifecycle monitoring and reserving mechanisms – which requires annual inspections and reserving of any forecast deficiencies in years 15, 19 and 22 of the service phase – and the standard, straightforward nature of the service requirements.

Notes:
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.