DBRS Confirms 407 East Development Group General Partnership Long-Term Senior Bonds and Short-Term Senior Bonds at A (low), Negative Trend

DBRS has today confirmed the rating of A (low) with a Negative trend 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), 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 which passes 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, Negative) 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 is mainly bounded by the current scheduling pressure, ProjectCo’s relatively limited resilience to shocks in the lifecycle budget, as well as other typical uncertainties with respect to large construction projects.

On October 17, 2013, DBRS changed the trend to Negative to reflect the downgrade and maintenance of the Negative trend on SNC-Lavalin Group Inc. (Please see the DBRS press release for details). Given such rating action and recent developments of the Project (see below), DBRS now expects that should the pace of the works remain materially behind schedule by the end of this summer, further negative rating action will likely result.

Based on the latest report from Lenders’ Technical Advisor (TA – Leigh Fisher), approximately 25% of the design and construction works have been completed as of April 20, 2014, measured by the payments received by the Construction Contractor. This is approximately 40% behind the maximum payment curve, partially attributable to the delay in the girder production and inclement weather conditions. On April 14, 2014, the Province requested a schedule mitigation plan, which is being prepared by ProjectCo. Although the TA is also concerned about the lack of progress, it still believes that substantial completion will be achieved by December 18, 2015 (Scheduled Substantial Completion Date). Benchmarked against a revised cash flow profile provided by the Construction Contractor in February 2014, the TA is satisfied with the adherence to the revised schedule and the progress made since then. The TA has also opined that relevant risks are well understood and being actively managed.

A significant amount of construction activities are planned for this summer, including works such as granular base, grading, paving, and drainage. According to the revised cash flow profile, roughly a third of total construction contract value is expected to be realized during this summer, which will be decisive to the timely completion of the construction works. While notable progress is anticipated, DBRS notes that certain environmental permitting issues and utility relocations may cause additional schedule pressures.

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. 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.

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.

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