Morningstar DBRS Confirms Credit Ratings on Capital City Link General Partnership at A (low) With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and Long-Term Senior Bonds (the Senior Bonds) rating of Capital City Link General Partnership (ProjectCo or the Issuer) at A (low). All trends are Stable.

ProjectCo is a special-purpose entity (SPE) created to design, build, finance, and operate (DBFO) the 27-kilometre (km) northeast leg of Anthony Henday Drive in Edmonton (the Project) under a 34.5-year DBFO agreement (the DBFO Agreement) with the Province of Alberta (Alberta or the Province; rated AA with a Stable trend). The Project has been open to traffic since October 2016.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations stem from the Project's stable operating and financial performance in 2023 and for the first six months of 2024. The penalties incurred by Volker (the Operator) in 2023 declined by approximately 80% compared with 2022 and these were related to lane closures for paving. For the first seven months of 2024, the penalties incurred remain modest and the penalties were fully paid by the Operator, who performs the Operating and Maintenance (O&M) responsibilities in the Project. Since the opening of the highway, the total penalties paid by the Operator have been relatively minor. Moreover, ProjectCo has not incurred any penalties since 2020.

The discussion with the Province related to the rehabilitation works for certain parts of the previously existing infrastructure, which ProjectCo had considered the Province's responsibility, has entered into a formal dispute process. A referee has been selected and ProjectCo indicated that the referee's decision on the dispute will not be available until Q4 2024. Furthermore, any rulings from a referee are not binding on all project parties (including the Province). Therefore, it's possible the dispute may not be resolved by the end of Q4 2024 and the project parties may refer their dispute to an arbitrator to settle the dispute. In the event of any unfavorable outcome at the end of the formal dispute process (post-arbitration), the risk to ProjectCo is expected to be limited. The potential additional cost to ProjectCo relates to the additional power cost for the highway lighting on the existing infrastructure, which is expected to be relatively modest. In addition, the risk of additional rehabilitation responsibilities as pertaining only to some small culverts, signs, and other appurtenances will be passed down to the Operator. Despite the initiation of a formal dispute process, ProjectCo confirmed that the relationship between the Operator, ProjectCo, and the Province remains good.

ProjectCo completed some minor paving tasks in 2023 and the lifecycle budget for 2024 is fairly modest. At present, ProjectCo estimates there could be some lifecycle savings by the end of 2024. Lifecycle cost in 2025 is expected to rise to $1.0 million, which is still relatively minor. However, the Project is expected to increase its lifecycle spending considerably in the 2026 -- 30 period as it enters its First Intervention Work. The First Intervention Work will entail overlay and mill and fill rehabilitation work on some sections of the highway. These activities are projected to be carried out between April 2026 and September 2030 and the total cost of the First Intervention Work is projected to exceed $60 million.

We note the material increase in lifecycle cost in 2026 -- 30 was expected as it has always been part of the Project's lifecycle cost profile at financial close. ProjectCo will undertake the Second Intervention Work in 2038 -- 42 in order to meet the handback requirements at the end of the 30-year operating period. We further note that the Technical Advisor (TA) will be performing the First Intervention Deficit Test in Q4 2024 in preparation for the First Intervention Work. The TA will review the Major Rehabilitation Expenditure Budget to determine whether the remaining Major Rehabilitation Payments payable by the Province will be sufficient to cover the expected cost of the First Intervention Work. If the TA determines that the anticipated cost exceeds the remaining Major Rehabilitation Payments (a First Intervention Deficit Amount), ProjectCo will be required to deposit additional funds into the Rehabilitation Account on a quarterly basis in order to eliminate the First Intervention Deficit Amount before the First Intervention Work is scheduled to take place.

Given the Project's good operating track record, the financial performance of ProjectCo has been relatively stable. For the year ended June 30, 2024, ProjectCo's debt service coverage ratio (DSCR) was 1.32x. This is higher than expected because of higher-than-expected interest income and lower-than-expected special-purpose vehicle (SPV) cost than projected at financial close.

CREDIT RATING DRIVERS
Morningstar DBRS believes a positive rating action is unlikely because of a fixed availability payment profile over a 30-year operating period. In contrast, Morningstar DBRS could take a negative rating action if there is a significant increase in the projected lifecycle cost, which could potentially lead to a material deterioration of the financial metrics.

FINANCIAL OUTLOOK
ProjectCo has benefitted from the higher-than-expected interest rate, mainly through receiving higher interest income, and lower-than-expected SPV cost compared with projection at financial close. As a result, ProjectCo's debt service coverage ratio (DSCR) of 1.33 times (x) for the year ended December 31, 2023, was above the projected DSCR of 1.27x. For the year ended June 30, 2024, the DSCR was 1.32x.

Despite the better-than-expected financial performance, ProjectCo's financial risk assessment is underpinned primarily by a lifecycle breakeven ratio of 28.6% and a projected minimum DSCR of 1.27x.

CREDIT RATING RATIONALE
The credit rating strengths of ProjectCo is underpinned by (1) a relatively more stringent lifecycle inspection and reserving mechanism as compared with peers; and (2) straightforward O&M requirements. The challenge relates to ProjectCo's risk of incurring higher-than-expected lifecycle cost driven by a higher-than-expected traffic volume.

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

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

RATING DRIVER AND FINANCIAL RISK ASSESSMENT (FRA)

A) Weighting of Rating Driver
In the analysis of ProjectCo the relative weighting of the Rating Driver factors listed in Part One - Rating Availability-Based PPP of the methodology was approximately equal.

B) Weighting of FRA Factors
In the analysis of ProjectCo, the following FRA factor listed in Part One - Rating Availability-Based PPP of the methodology was considered more important.
-- O&M and lifecycle breakeven ratios

C) Weighting of the Rating Driver and the FRA
In the analysis of ProjectCo, the FRA carries greater weight than the Rating Drivers.

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

Morningstar DBRS applied the following principal methodology:

Global Methodology for Rating Public-Private Partnerships (August 13, 2024) https://dbrs.morningstar.com/research/437820

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (15 April 2024), https://dbrs.morningstar.com/research/431186 which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following criteria has also been applied:
Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-factors-in-credit-ratings.

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

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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 info-DBRS@morningstar.com.

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.

Morningstar DBRS 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. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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