DBRS Upgrades 407 East Development Group Long-Term Senior Bonds to BBB (high), Stable Trend

DBRS Limited (DBRS) has today upgraded the rating on the Long-Term Senior Bonds (the Long-Term Bonds) of 407 East Development Group General Partnership (ProjectCo or 407 East Development Group) to BBB (high) from BBB, while maintaining the Stable trend. 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) with a Stable trend by DBRS).The upgrade is primarily supported by the fact that ProjectCo has not incurred any payment deductions since substantial completion was achieved in June 2016. The rating continues to be supported by the availability-based revenues from the Province and the pass-down of all service period obligations, including lifecycle risk, to an experienced service provider.

All of ProjectCo’s construction period risks are passed down under a date-certain, fixed-price contract to the general partnership of subsidiaries of SNC-Lavalin Group Inc. (rated BBB, Under Review with Developing Implications, by DBRS) and Ferrovial Agroman S.A. (collectively, the Construction Contractor). DBRS downgraded the rating from A (low) to BBB (high) on April 10, 2015, to reflect the slower-than-expected pace of construction, and downgraded the rating again to BBB on December 4, 2015, while maintaining the Negative trend, after the announcement by the Ontario government that no payments will be made to the consortium until the road is open, which was not expected to be achieved until spring 2016. The target substantial completion date was December 18, 2015, with the PA longstop date being December 18, 2016. The rating was stabilized on June 13, 2016, following the achievement of substantial completion on June 9, 2016, upon which ProjectCo received the substantial completion payment from the Province, with which ProjectCo redeemed its Short-Term Senior Bonds and Senior Construction Facility on June 14, 2016. The Construction Contractor has made the required delay liquidated damages payments to cover debt service payments and other ProjectCo or service provider expenses during the delay.

As of substantial completion, ProjectCo had executed 24 variations, with a total value of approximately $10.7 million, and received approvals or partial approvals for another 14 variations. All approved variations are funded either through the stakeholder cash allowance or paid directly by the Province. At substantial completion, the independent certifier estimated the value of the remaining minor deficiencies to be approximately $6.2 million. In its final report issued in August 2016, the senior creditors’ technical advisor (SCTA), Leigh Fisher, reported that as of August 2016 the Construction Contractor had resolved or been found compliant on 50% of a total 4,386 minor deficiencies and was of the opinion that all major variations would not materially and adversely affect the risk profile, including the financial risk profile, of the Project. According to ProjectCo, as of May 9, 2017, a total of 4,508 minor deficiencies had been reported, out of which only 5%, or 230 items, remained outstanding. ProjectCo confirmed that to date it has not incurred any payment deduction as a result of any availability or quality failures or a failure to close out any minor deficiencies within the required timeframes.

All risks and responsibilities pertaining to routine and lifecycle maintenance during the service phase are passed down to a general partnership (the Service Provider), indirectly owned by SNC-Lavalin Group Inc. and Cintra Infraestructuras, S.A. 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 potentially supportive of the rating for the Project during the service phase.

The Construction Contractor continues to focus on the rectification of remaining deficiencies, with final completion targeted for June 2017. DBRS notes that if final completion is achieved, there are minimal ongoing payment deductions and the SCTA confirms that the impact of variations on the OM&R budgets are insignificant, further positive rating action is possible. However, DBRS notes that ProjectCo’s relatively limited resilience to shocks in the lifecycle budget during operation is expected to constrain the rating to a maximum of A (low).

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 principal methodology is Rating Public-Private Partnerships, which can be found on dbrs.com under Methodologies.

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.