DBRS Confirms 407 East Development Group at BBB, Negative Trend

DBRS Limited (DBRS) has today confirmed 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) at BBB while maintaining the Negative 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), Stable).

The rating is supported by the availability-based revenues from the Province, the construction contract passing 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 continues to be constrained by the slower-than-expected pace of construction, which has resulted in ProjectCo’s failure to achieve substantial completion by December 18, 2015, the date mandated by the Project Agreement to open the highway to the public. The rating is also bound by ProjectCo’s relatively limited resilience to shocks in the lifecycle budget during operation.

DBRS downgraded the ratings from A (low) to BBB (high) on October 17, 2013, to reflect the downgrade of SNC-Lavalin Group Inc. and downgraded the ratings again to BBB on December 4, 2015, 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 trend has remained Negative since October 17, 2013, mainly as a result of the construction-related difficulties.

The latest remedial plan dated February 26, 2016, indicates that the Construction Contractor anticipates substantial completion by June 14, 2016, which is four days before the Construction Contractor Longstop date. The PA longstop date remains December 18, 2016. According to the Senior Creditors’ Technical Advisor (the SCTA), LeighFisher Canada Inc., the success of the remedial plan is heavily dependent on the Construction Contractor’s ability to timely address all the non-minor deficiencies discovered through the commissioning process, as well as the deficiencies identified during the Stage 4 Road Safety Audit Process.

As measured by the value earned by the Construction Contractor, approximately 98.4% of the design and construction works have been completed by the end of February 2016, with approximately $13 million of works remaining. A total of 13 variations were reported to have been approved and/or executed during 2015, with a total value of approximately $4.3 million, which are excluded from substantial completion and will be funded through the stakeholder cash allowance or paid directly by the Province.

While the SCTA still considers it possible for the Construction Contractor to reach substantial completion by June 14, 2016, it also noted that the Construction Contractor will have to maintain the current high level of due diligence in order to complete the remaining works and rectify all the deficiencies in a timely fashion. Given that there is no float left in the current schedule and the pavement works, which have resulted in many non-minor deficiencies, are still weather-dependent, DBRS remains concerned that the Project may be unable to achieve substantial completion by the new target date of June 14, 2016.

DBRS expects that if the pace of the works further deviates from the latest remedial plan and it becomes apparent that the June 14, 2016, date for substantial completion will be materially delayed, additional negative rating action may result. Conversely, should the Project successfully achieve substantial completion on or prior to June 14, 2016, a stabilization of the rating could be expected.

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. DBRS notes once the final completion is achieved with minimal ongoing payment deductions, further positive rating action is possible.

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, which can be found on our website under Methodologies.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.