DBRS Finalizes A (low) Rating and Stable Trends for Rainbow Hospital Partnership

DBRS has today finalized the ratings of A (low) with Stable trends on the $51.5 million Series 1 Senior Bonds and the $71.4 million Series 2 Senior Bonds (collectively, the Bonds) of Rainbow Hospital Partnership (ProjectCo), the special-purpose entity created to design, build, finance and maintain a new 360,000 square foot mental health facility (the Hospital) under a 33.1-year project agreement (PA) with the Province of New Brunswick (the Province, rated A (high) with a Stable trend). The ratings are underpinned by the pass-down of all construction risk and responsibilities to a construction team supported by an investment-grade contractor, a project of low-to-moderate complexity and a solid construction security package. However, the ratings are constrained by the customary factors affecting all public-private partnerships (PPPs), and in particular, the construction phase rating is impacted by ongoing construction delays which limit the rating of the construction phase to a level one notch lower than otherwise justified by the levels of performance and financial supports, and ultimately by the rating of the Province, as DBRS typically views a level of two notches below that of the public sector counterparty as the ceiling for a project’s rating.

The Hospital will feature two storeys above ground and a basement level under a portion of the project. As is typical for PPP projects, the construction work has been passed down to a design-build joint venture, between subsidiaries of SNC-Lavalin Group Inc. (rated BBB (high) by DBRS) and Bird Construction Inc. (the Construction Contractor) under a fixed-price date-certain contract valued at $124 million. The Construction Contractor has provided a letter of credit (LC) of 9% of the contract price, and as mandated by the project agreement, a 100% performance bond and a 50% labour and materials bond. Parent guarantees have been provided by SNC-Lavalin Group Inc. and Bird Construction Inc. for the performance of their respective subsidiaries, with an ultimate liability cap of 50% of the construction price. In DBRS’s view the construction enhancement package is more than sufficient for the rating given the low-to-moderate complexity of the project.

Construction began in September 2011 and is currently 22.5 months into a 37-month schedule, with a target substantial completion date of October 14, 2014. However, a performance failure of the structural steel subcontractor and a prolonged consultation process with the Province regarding roof design specifications has led to an eight-week delay in the schedule relative to the base plan at financial close. A remedial plan is in place to recover the delay, and involves re-sequencing work to permit better efficiency in the use of trades. The remedial plan will involve additional labour resources for mechanical and electrical work, which is critical to the execution of the new schedule. The Technical Advisor (TA; Turner and Townsend cm2r) believes that the recovery plan is adequate to meet the target substantial completion date, but that the success of the plan rests on the ability to find and dedicate more trade resources to the project and on the close monitoring of progress by the project management team. The TA also warns that any further erosion in the schedule could compromise the completion of the project by the target date, as all schedule contingencies have been exhausted.

While believing that the remedial plan, though challenging, is adequate, the TA estimates that by the end of the year it will be in a position to assess, with greater certainty, whether the project will be able to meet substantial completion by the target date. DBRS notes that the PA offers a longstop date that is 12 months after the target substantial completion date, and that the lender’s longstop date is three months prior to the PA longstop. The delay is mitigated by the Construction Contractor’s LC, which is sufficient to cover more than 12 months of liquidated damages (LDs).

After substantial completion is achieved, the service phase will commence, with a planned duration of 30 years. All risks and responsibilities with respect to ProjectCo’s maintenance and rehabilitation responsibilities under the PA will be passed down to SNC-Lavalin O&M Inc. The scope of services required under the PA is fairly standard and includes preventive and lifecycle maintenance of the facility, plant services, help desk services and energy consumption management but excludes the low complexity items of grounds keeping services and snow removal.

Typical of PPPs, leverage will be high at the end of the first full year of operations. Debt-to-cash flow available for debt servicing will stand at approximately 9.7 times while the debt service coverage ratio is expected to be 1.22 times. Given that ProjectCo’s revenues are fixed for the life of the project, there will be limited ability to absorb any unexpected shocks that may occur, such as replacement of the Service Provider. Nonetheless, DBRS’s break-even analysis points to resilience to material budget changes during the service phase that are supportive of the A (low) ratings.

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.

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

The applicable methodology is Rating Public-Private Partnerships, which can be found on our website under Methodologies.