DBRS Morningstar Downgrades Health Montréal Collective Limited Partnership/Collectif Montréal Santé S.E.C. to BBB (low) with Negative Trend

DBRS Limited (DBRS Morningstar) downgraded the Issuer Rating of Health Montréal Collective Limited Partnership/Collectif Montréal Santé S.E.C. (ProjectCo) and the rating of the $1,371 million Senior Secured Bonds to BBB (low) from BBB. The ratings were removed from Under Review with Negative Implications where they were placed on June 27, 2018, and the trends are now Negative. ProjectCo is the special-purpose vehicle created to design, build, finance, and maintain a new 772-bed healthcare facility (the Project) under a 38.8-year public-private partnership (PPP) with the Centre Hospitalier de l’Université de Montréal (CHUM or the Hospital) under the Project Agreement (PA).

The downgrade and Negative trend consider the latest alleged Event of Default (EOD) notice received by ProjectCo on July 1, 2020, and the still incomplete Phase 1 deferred works, which further strain the contractual relationship with CHUM. While EOD notices were issued on June 8, 2018, and August 12, 2019, the Hospital issued the latest EOD notice under the PA with respect to the Automated Guided Vehicle System (AGV System). The letter alleges that defects, operational issues, noncompliances, and minor deficiencies related to the AGV System dating back to 2017 have not been remediated to date, causing adverse effects on the clinical and nonclinical activities of the hospital facility (the Facility). A formal Notice of Dispute was issued on July 10, 2020, by ProjectCo refuting the Hospital’s allegations of incomplete work and deficiencies to the AGV System. The Hospital alleges that the incomplete work relates to work that was certified as complete in accordance with the Travaux Reportés – 2 (TR-2, i.e., the second deferred works certification) completion milestone. The formal Notice of Dispute effectively suspends the effects of an EOD notice until a formal resolution is reached. On July 17, 2020, ProjectCo sent an information package to the Hospital providing a summary of the work completed to date in regard to the minor deficiencies and nonconformities for the AGV system. ProjectCo contends that the alleged failures to complete the corrections to the AGV System have been rectified and completed, the majority having been completed as part of TR-2, which was achieved on October 31, 2018. DBRS Morningstar notes that failure point penalties from deficiencies related to the operation of the AGV System do not count toward an EOD under the PA and, while the allegations made by the Hospital have been formally disputed, there is no formal resolution of the matter at this time. ProjectCo indicates that, while the allegations with respect to the Hospital’s claim that ProjectCo has breached its obligations under the PA have been previously addressed, it is amicably working with the Hospital to improve the performance of the AGV system and any other claimed issues that the Hospital and ProjectCo have mutually agreed will extend beyond the 10 business day time frame in the PA under the dispute resolution procedures.

In addition to the EOD notice furnished by CHUM, the downgrade is also a result of the outstanding deferred works that are yet to be fully completed and certified. As part of the achievement of Phase 1 Substantial Completion on March 31, 2017, several items were contractually agreed to be completed as part of deferred works later in the year. The deferred works are being completed under a milestone approach with the third and final milestone referred to as TR-3. TR-1 was achieved on September 17, 2017, and TR-2 on October 31, 2018, subject to a list of deficiencies some of which remain to be remedied. Completion of the deferred works, including an agreement on new environmental performance metrics as well as any lingering commissioning activities, is progressing slowly. Full completion of outstanding items and the achievement of TR-3, may be achieved by the end of the year with the exception of the long-dated items, including the finalization of the new environmental matrix and the installation of new ventilation ducts throughout the Hospital. The remining deferred works are valued at roughly $8 million.

While there are no specific default or termination right provisions associated with the delay in completion of the TR-3 deferred works under the PA, CHUM, the Construction Joint Venture (CJV, Phase 1 Contractor), and ProjectCo are currently in ongoing discussions to clarify what work remains to be done to achieve TR-3, most notably in connection with compliance to the environmental matrix of the Facility. The incomplete Phase 1 deferred works have resulted in growing tensions between ProjectCo and the Hospital, and they continue to place pressure on the contractual relationship that, DBRS Morningstar believes, has the potential to affect the performance and financial metrics going forward. Furthermore, once TR-3 is successfully completed and outstanding issues are resolved, DBRS Morningstar expects that the relationship between CHUM and the major project parties could take some time to normalize.

The performance security has not been drawn and consists of (1) $60.0 million in letters of credit (LOCs) and 50% parent company guarantee from the Phase 1 Contractor for Phase 1; (2) $85.0 million in LOCs (21% of Phase 2 Contract Price), $50.4 million performance bond (12.5%), and $11.2 million in structured retention for Phase 2; and (3) $19.9 million in LOCs from the Service Provider. Upon substantial completion of the Phase 2 construction works, the debt service coverage ratio is projected to be 1.25 times. DBRS Morningstar could take negative rating action if ProjectCo does not complete the remaining deferred works in a timely manner or if CHUM takes further legal action. Successful completion and certification of the outstanding deferred works and a sustained improvement in the relationship between the Hospital and ProjectCo, along with a period of good service performance, could lead to positive rating action.

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

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The principal methodology is Rating Public-Private Partnerships (August 19, 2020) which can be found on dbrsmorningstar.com under Methodologies & Criteria.

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The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

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