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

DBRS Limited (Morningstar DBRS) 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 (PPP) agreement with the Halton Healthcare Services Corporation (HHS or 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 (DSRA), 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.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations are underpinned by the various measures that the Service Provider has implemented to mitigate the operating issues that have negatively affected the Project's operating performance for the first 10 months of 2024. In addition, despite ProjectCo breaching various contractual failure points thresholds (e.g., breaching the PA rolling six-months nonperforming service provider failure points threshold in September and October 2024) caused by high levels of failure points accrued for the month of May 2024 and September 2024, Morningstar DBRS does not believe the parking management service issues (that gave rise to such high level of failure points) are recurring problems. Morningstar DBRS understands the Service Provider and its subcontractor have replaced the failed parts and the Service Provider reported there are no material issues related to parking management in October 2024 (failure points related to parking management services in October 2024 declined by 60% compared with September 2024). Finally, the Hospital did not exercise its rights to have ProjectCo replace the Service Provider in light of the contractual threshold breaches.

Nevertheless, Morningstar DBRS notes the operating performance for the first 10 months of 2024 has deteriorated notably compared with the same period in 2023. Failure points related to availability failures increased significantly in January 2024. This was a result of hot water outages in several areas of the building and a slower-than-expected response and rectification times for plumbing tasks. These issues gave rise to failure points that breached the PA rolling three-months monitoring notice threshold for availability failures. A monitoring notice was issued by the Hospital in March 2024 and the Hospital subsequently withdrew the monitoring notice in June 2024 after ProjectCo and the Service Provider rectified the underlying issues and increased the level of monitoring.

The Service Provider identified the hot water outages were a result of a widespread failure of mixing valves. As a result, the Service Provider had to replace a large number of mixing valves to rectify the problem. A root cause analysis was also performed by the Service Provider and identified the damage to the mixing valves were caused by sediments coming from the boilers. To mitigate this issue from recurring, the Service Provider has now added additional filtering/debris catchment in critical areas. Furthermore, the Service Provider has now included the mixing valves into their lifecycle replacement plan and it will be based on the manufacturer's recommendation.

In addition, the Service Provider has also implemented temporary measures to improve the response and rectification times for plumbing tasks by hiring some subcontractors while it continues to search for two additional full-time plumbers to be placed on-site.

Morningstar DBRS understands the Service Provider is proactively implementing short-term measures to mitigate the ongoing hard facilities management (FM) service issues. These ongoing issues have led to an increase in failure points that have breached the PA rolling three-months monitoring notice threshold in September 2024 and October 2024. At this time, the Hospital has not issued a monitoring notice for the hard FM service. A majority of these recurring hard FM service issues relate to the intermittent access control issue, failing to respond to fridge and freezer alarms, and bedpan washers issues (e.g., mechanical failures and detergent replacement). A long-term solution has also been developed by the Service Provider and the implementation will start in 2025. Meanwhile, Morningstar DBRS believes failure points associated with the hard FM service is likely to remain elevated in the short-term and the Hospital has the contractual rights to issue a monitoring notice if the failure points remain above the contractual threshold.

Despite the ongoing operating challenges, ProjectCo confirmed the relationship between the Hospital, the Service Provider, and ProjectCo remains good. Furthermore, ProjectCo's financial performance has not been negatively affected by the operating performance issues. For the year-ended October 31, 2024, the DSCR was 1.25x, in line with expectations.

CREDIT RATING DRIVERS
At this time, Morningstar DBRS 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. Morningstar DBRS could take a negative credit rating action if the mitigation measures implemented by the Service Provider are not able to stabilize the Project's operations as indicated by a sustained elevated levels of failure points. In addition, if the Project experiences more operating issues leading to another uptick of failure points, Morningstar DBRS may take a negative credit rating action. Although unlikely at this time, if the Hospital exercises its contractual rights to have the Service Provider to be replaced, Morningstar DBRS may place the credit ratings under review with negative implications.

FINANCIAL OUTLOOK
Based on the financial model at financial close, Morningstar DBRS expects the Project's DSCR to be 1.25x for the year ended October 31, 2025.

CREDIT RATING RATIONALE
The credit rating strengths of ProjectCo is underpinned by a tight lifecycle inspections and reserving mechanism that requires the Lenders' Technical Advisor to perform a lifecycle audit of the Project every two years starting five years after substantial completion. In addition, a look-forward lifecycle reserving mechanism will be triggered in years 15 and 20 and at any date request by ProjectCo if there is any lifecycle deficiency exceeding 7.5% of the remining budget. In contrast, the challenges relate to ProjectCo's operational issues and Service Provider replacement risk.

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 Drivers 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 (April 15, 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 methodology has also been applied:

Morningstar DBRS Criteria: Approach to ESG Factors in Credit Ratings (August 13, 2024)
https://dbrs.morningstar.com/research/437781

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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