DBRS Downgrades 407 East Development Group Long-Term Senior Bonds and Short-Term Senior Bonds to BBB (high), Negative Trend

DBRS Limited (DBRS) has today downgraded the ratings assigned to the $120.4 million Long-Term Senior Bonds (the Long-Term Bonds) and the $450.9 million Short-Term Senior Bonds (the Short-Term Bonds) of 407 East Development Group General Partnership (ProjectCo) from A (low) to BBB (high) while maintaining the Negative trend. The rating action stems from a slower-than-expected pace of construction, exacerbated by permitting delays and harsh seasonal conditions over the past winter. ProjectCo is 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 supported by 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 the general partnership of subsidiaries of SNC-Lavalin Group Inc. (rated BBB, Stable) and Ferrovial Agroman S.A. (collectively, the Construction Contractor), as well as the pass-down of all service period obligations, including lifecycle risk, to an experienced service provider. The rating is mainly bounded by the weak protections of the current schedule against delays and ProjectCo’s relatively limited resilience to shocks in the lifecycle budget, as well as other typical uncertainties with respect to large construction projects.

On October 17, 2013, DBRS changed the trend to Negative to reflect the downgrade and maintenance of the Negative trend on SNC-Lavalin Group Inc. Since that time, the project has encountered construction-related difficulties, and in May 2014 the rating was confirmed, but with the expectation that DBRS would revisit the construction progress later in that year. Although SNC-Lavalin Group Inc.’s rating was stabilized in late 2014, providing support to the rating, DBRS maintained the Negative trend as a result of the construction-related delays (please see DBRS press releases for details). The latest remedial plan, dated September 9, 2014, features a target substantial completion date of November 18, 2015, in advance of the December 18, 2015, substantial completion date mandated by the Project Agreement. However, the construction activities have fallen behind the remedial plan and the schedule is still under pressure. To date, the PA long stop date remains December 18, 2016.

DBRS expects that if the pace of the works further deviates from the remedial plan, additional negative rating action may result. Conversely, if the Project is able to converge to the remedial plan by the end of this summer, the trend could be stabilized. Should the Project successfully achieve substantial completion on or prior to December 18, 2015, a positive rating action would be expected.

Based on the latest report from Lenders’ Technical Advisor (TA – Leigh Fisher), approximately 54.7% of the design and construction works have been completed as of January 31, 2015, measured by the payments received by the Construction Contractor. This is approximately 16.7% behind the maximum payment curve, mainly attributable to delays in utility relocations, road loading restrictions and inclement weather conditions. Although the TA still considers it possible for the Construction Contractor to recover the delay through mobilization of additional resources to multiple locations, it notes that the management of such additional resources is likely to be challenging and the TA will not be in a position to gauge the effectiveness of the mitigation measures until the end of June 2015. For certain critical path activities, including a utility relocation and some grading works, several months of delays have been reported, compared with the remedial schedule.

The 30-year operating phase will formally begin upon substantial completion. All risks and responsibilities pertaining to routine and lifecycle maintenance during the service phase will be passed down to a general partnership (the Service Provider), indirectly owned by SNC-Lavalin Group Inc. and Cintra Infraestructuras, S.A. (Cintra). 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 250% of the average annual operation, maintenance and repair (OM&R) payment (indexed) upon termination, with liquid security provided by a letter of credit of 300% 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 during the service phase.

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 methodology is Rating Public-Private Partnerships (March 2015), which can be found on our website under Methodologies.

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

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.