DBRS Morningstar Confirms Hospital Infrastructure Partners (NOH) Partnership at BBB (high) With Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the credit rating on the Series A Senior Secured Bonds (the Bonds) of Hospital Infrastructure Partners (NOH) Partnership (ProjectCo) at BBB (high) with Stable trends. ProjectCo is the special-purpose entity (SPE) tasked with the design, construction, financing, operation, and maintenance of the new Oakville Trafalgar Memorial Hospital (the Project) under a 34-year public-private partnership agreement with the Halton Healthcare Services Corporation (the Hospital). The Bonds mature six months before the last payments under the Project Agreement (PA) and include standard protection features, such as a six-month debt service reserve account, a distribution test requiring a minimum debt service coverage ratio (DSCR) of 1.15 times (x) on a historical and prospective basis, and additional senior indebtedness subject to the Bondholders’ approval.

The Project has been in operation for more than eight years and the facility remains in good condition. The Lenders' Technical Advisor performed their second lifecycle audit on the Project in April 2023 and concluded that the Project is in good condition and is well maintained by EllisDon Corporation (the Service Provider) without deferring any significant maintenance work. There has also been minimal lifecycle work performed because the facility is still relatively new. Lifecycle works planned for the next several years will remain relatively modest.

Operationally, the Project suffered a few incidents toward the end of 2022 that led to an increase of about 57% in total failure points in Q4 2022 compared with Q4 2021. The availability failure points represented most of the total failure points and were primarily related to some room temperatures exceeding the temperature range as permitted in the PA and a flooding incident in the facility.

A major flooding incident occurred on December 25, 2022, that was initially confined to the elevator shaft but it escalated quickly that affected the lobby areas and clinical areas with significant water damage to three elevators, ceilings, drywall, and floorings on multiple levels. The Service Provider responded quickly by shutting off the valves and immediately notified the remediation companies to begin restoration of the damaged areas. The Service Provider investigated this incident and identified the cause of the flood was a result of a fan coil unit burst pipe. Typically, an incident of such magnitude would have resulted in significant deductions. However, the Service Provider and the Hospital reached an agreement to waive the deductions in exchange for service improvements that the Service Provider will undertake. DBRS Morningstar understands the agreement does not materially affect the PA requirements and should not have any material impact on ProjectCo. Moreover, the cost of repair was fully paid by the Service Provider and an insurance claim has been filed by the Service Provider.

Since the beginning of 2023, the monthly total failure points averaged nearly 40% lesser than what was reported in December 2022. Despite the improvement, DBRS Morningstar notes the monthly failure points related to hard facility and utilities management services (Category A) remain elevated and the three months rolling indicator (from July to September 2023) reached about 91% of the PA Monitoring Notice threshold. According to ProjectCo, the failure points related to Category A was a result of staffing shortage that negatively affected the rectification time. ProjectCo confirmed that the staffing shortage is no longer an issue and DBRS Morningstar notes that the failure points in October 2023 declined by about 29% from the level reported in September 2023. Despite the improvement in October 2023, the three months rolling indicator for the period ended October 2023 remains more than 90% of the PA Monitoring Notice threshold. If the monthly failure points continue to decrease in the next several months, DBRS Morningstar expects the three months rolling indicator to begin to decline more meaningfully, all else being equal.

Correspondingly, the deductions associated with the total failure points for the nine months ended September 2023 declined by about 9% compared with the same period in 2022, and these have been paid by the Service Provider. DBRS Morningstar believes the temperature control issue will likely persist until a permanent solution is identified and implemented. Thus, DBRS Morningstar believes the Project's operating performance has yet to normalize to a level commensurate with an A (low) credit rating because there is still a greater likelihood of incurring higher levels of deductions and failure points.

Since the beginning of Energy Year 1 (from August 2017 to July 2018), the Project had been incurring energy painshare deductions each year as a result of a much higher consumption of natural gas than contractual target. ProjectCo confirmed that the Project's energy painshare deductions from Energy Year 1 to Energy Year 4 have been paid by the Service Provider. The energy consumption for Energy Year 5 is currently under review and ProjectCo recently submitted the Energy Year 6 report to the Hospital for review in September 2023.

ProjectCo indicated that the Project is likely to continue to incur energy painshare deductions in the foreseeable future. At present, ProjectCo and the Service Provider and in collaboration with the Hospital, are identifying further energy efficiency initiatives that they could undertake to reduce future energy consumption.

DSCR for the year ended October 31, 2023, was 1.19x, which was lower-than-expected DSCR of 1.25x. The lower-than-projected DSCR is primarily a result of incurring higher-than-expected SPE costs including insurance. DBRS Morningstar understands that the payment mechanism under the PA permits the annual service payment to be adjusted for higher insurance cost. However, at this time, the Hospital has not adjusted the insurance component of the annual service payment. ProjectCo indicated that it is currently in discussion with the Hospital on this issue. In the absence of an adjustment in the annual service payment, the Project's projected DSCR may be negatively affected by the higher insurance cost. Nevertheless, DBRS Morningstar believes the increase in insurance cost is likely to be manageable given that the annual insurance cost accounts for a very small proportion of the Project's annual revenue.

DBRS Morningstar notes that, despite the Project's financial resiliencies mapping to a higher credit rating level than the current credit ratings, the ongoing operational challenges negatively affect the Project's overall credit rating. At this time, DBRS Morningstar believes a positive credit rating action is unlikely until the Project has demonstrated that its operations have normalized, as evidenced by a sustained reduction in failure points along with a final agreement on the energy gainshare/painshare calculations. DBRS Morningstar could take a negative credit rating action if the Project's operating performance deteriorates significantly, leading to a greater likelihood of breaching various failure points-related contractual thresholds.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (July 4, 2023).

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

DBRS Morningstar applied the following principal methodology:
-- Global Methodology for Rating Public-Private Partnerships (October 11, 2023), https://www.dbrsmorningstar.com/research/421701/global-methodology-for-rating-public-private-partnerships

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.

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 under Related Documents or by contacting us at [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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

Information regarding DBRS Morningstar credit ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at [email protected].

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