DBRS Confirms 407 East Development Group at A (low), Stable Trend

DBRS has today confirmed the ratings of A (low) with Stable trends 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 (ProjectCo), the special-purpose entity (SPE) 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 ratings are 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 ratings are 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, Ontario, by approximately 20.3 kilometres to Oshawa, Ontario, 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). Generally, the construction 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, 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 also assists in mitigating construction risks, including parent guarantees 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.

Since the construction phase started in May 2012, the Construction Contractor has made good progress in fulfilling its start-up obligations. Geotechnical and archeological site inspections are close to completion and no major issues have been found. Two public consultation sessions have taken place and stakeholders are generally supportive. The subcontractor procurement is progressing.

The Province has experienced some delays in securing the land required for the Project, although the Province is already in possession of more than 90% of the required land and plans to acquire the balance by August 2013. DBRS takes comfort in that various sections of the Project will be constructed simultaneously and the Construction Contractor has re-sequenced its activities to mitigate the impact of unavailable land on the overall schedule. Furthermore, in accordance with the PA, any delay by the Province in giving access to the site will be treated as a Delay Event and a Compensation Event, provided that ProjectCo is in compliance with its obligation to mitigate such delay.

Work to date has focused on optimizing and refining the design, with particular attention to highway interchanges. No variations have been initiated by either ProjectCo or the Province. The bridge concrete works are expected to start in May 2013 and the roadway pavement works are expected to start next year. By the end of March 2013, approximately 10% of the design and construction works have been completed, as measured by the cost of work completed by the Construction Contractor. The Project is on track to reach substantial completion on December 18, 2015 (the Scheduled Substantial Completion Date), for a total construction duration of 43 months.

The 30-year operating phase will formally begin upon substantial completion. 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 250% of the average annual operation, maintenance and rehabilitation (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.

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 (November 2012), which can be found on our website under Methodologies.