DBRS Comments on Hospital Infrastructure Partners (NOH) Partnership

DBRS Limited (DBRS) has today commented on the status of its review of Hospital Infrastructure Partners (NOH) Partnership (ProjectCo), the entity responsible for the design, construction, maintenance and financing of the new Oakville Hospital (the Project or the Hospital). The purpose of the commentary is threefold: (1) to provide a synopsis of events that have taken place at the Hospital; (2) to discuss the next steps in the DBRS review process; and (3) to detail the likely impact of the outcome on the creditworthiness of the Project.

(1) Synopsis of Events
On May 24, 2016, DBRS placed the Project Under Review with Negative Implications following the issuance of a notice of default under the Common Terms and Intercreditor Agreement. A service contract event of default arose after a Monitoring Notice was issued by the Hospital to ProjectCo as a result of flooding, heating, ventilation and air conditioning as well as door locking and hardware issues. When the service contract event of default was not cured within 30 days, an event of default was triggered under the Common Terms and Intercreditor Agreement. DBRS notes that this development is atypical for public-private partnership projects as service requirements for hospitals are generally tasks of relatively low complexity and the 30-day cure period under the Common Terms and Intercreditor Agreement is also viewed as unusually stringent. ProjectCo usually has the ability to replace a defaulted service provider prior to the issue resulting in a default at the ProjectCo level.

Since that time, DBRS and ProjectCo have had regular status update calls and DBRS has participated in a site visit with representatives of ProjectCo, the construction contractor, the service provider and the Hospital. Much work has been done to address the issues relating to the Monitoring Notice and the Hospital has remained cooperative. The original deadline for addressing the issues identified by the Monitoring Notice was July 14, 2016, although this was subsequently extended until August 15, 2016. On July 25, 2016, ProjectCo submitted its request to the Hospital to withdraw the Monitoring Notice and, on July 28, 2016, the notice was withdrawn. As part of the rectification process, a new Operations and Improvements Plan (OIP) is being developed, which will address the shortcomings highlighted by the Monitoring Notice along with any areas of improvement identified by the ongoing review process, including the Ernst & Young (E&Y) audit described below. Generally speaking, the OIP will cover items concerning governance, maintenance, helpdesk, emergency planning, quality management and personnel. Going forward, ProjectCo will be obligated to implement and adhere to the OIP.

The Lenders’ Technical Advisor completed a Monitoring Notice Review and released its report on June 27, 2016. Its findings show that virtually all failure points accumulated as a result of the issue were related to construction issues and equipment failures. The report also recommends amending the Service Contract to allow the service provider to cure a Monitoring Notice within 90 days before becoming a service provider Event of Default as opposed to the current inability to cure.

E&Y has performed an audit of ProjectCo’s and all relevant ProjectCo parties’ (including the service provider’s) systems and operations in relation to the Hospital. E&Y has met with ProjectCo staff several times in the performance of its audit. ProjectCo will need to implement all of the E&Y Recommendations contained in the Final E&Y Report as they will be incorporated into the OIP. The Final E&Y Report was released to the Hospital on September 9, 2016, and the E&Y Recommendations must be implemented by December 9, 2016, or some other mutually agreed-upon date.

(2) Next Steps
With the withdrawal of the Monitoring Notice, DBRS understands that ProjectCo intends to arrange a bondholders’ vote to approve several matters, including a waiver of default pursuant to the Common Terms and Intercreditor Agreement. It is DBRS’s understanding that a bondholders’ meeting is being convened on October 31, 2016, at 10:00 a.m.

In addition to requesting a waiver of default from bondholders, ProjectCo intends to explore amendments to the transaction and financing documents to incorporate more standard cure periods and to provide for improved ongoing performance monitoring, which should be beneficial for bondholders. In this fashion, ProjectCo is hoping to lessen the likelihood of a recurrence of a similar event of default in the future.

ProjectCo is also focused on improving the robustness of its operating procedures, internal reporting and communications.

(3) Likely Outcome
DBRS intends to conclude its review after the bondholders’ vote has been conducted. As part of its analysis, DBRS will primarily focus on two fundamental issues: (a) the likelihood of further material service failures and ensuing payment deductions as well as accumulation of failure points and (b) the permanent enhancements made to ProjectCo’s operating framework to address the internal protocols and performance monitoring as well as reporting issues that beset the Project and that caused DBRS to place the rating under review.

Given the progress made in addressing the issues that caused the event of default, the E&Y Recommendations meant to enhance the management of the Project and the cooperation obtained from all major stakeholders, DBRS is hopeful that the situation will be resolved in the near term. Regardless of the outcome, DBRS believes that it will take time to demonstrate with certainty that the facility and its equipment are free of issues and can operate efficiently and reliably. DBRS is also of the opinion that the recent events likely took a toll on the relationship between the Hospital and ProjectCo and on the tolerance of the former toward future major operational issues.

As such, even with a favourable vote from the bondholders and a solid plan to address the previous events, DBRS continues to view a one-notch downgrade as a distinct possibility as the Project has demonstrated material performance-related issues. In the event that the Project were downgraded, DBRS expects that the facility would be operated until July 31, 2017 (12 months after the withdrawal of the Monitoring Notice), without any material adverse incidents and with only modest accumulation of payment deductions or failure points before reconsidering its views on the credit.

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

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.