Morningstar DBRS Upgrades Credit Ratings on Strait Crossing Development Inc. to BBB, Stable Trend

DBRS Limited (Morningstar DBRS) upgraded both the Issuer Rating on Strait Crossing Development Inc. (SCDI or the Company) and the rating on the Company's 6.17% Revenue Bonds to BBB from BBB (low). The trends on both ratings are Stable. The upgrade is primarily based on SCDI's financial metrics, which have improved above Morningstar DBRS' expectations; resilient traffic fundamentals; continued good expense management; and ongoing debt reduction. Also, the Company's General Revenue Account (GRA) funds available have been sustained at pre-pandemic levels.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings upgrade is underpinned by the strong 2023 debt service coverage ratio (DSCR) of 1.62 times (x), as calculated by Morningstar DBRS, which exceeds Morningstar DBRS' rating case 2023 DSCR of 1.50x, and the expected 2024 DSCR of 1.70x.

Traffic in 2023 increased 12% compared with 2022, surpassing the 2019 volume by 7%. As of Q3 2024, traffic has reached its highest level since the start of the concession. The Morningstar DBRS rating case projects a 2025 DSCR of 1.52x, supporting the strength of the Company. Morningstar DBRS expects DSCRs to remain at or above 1.50x until the end of the concession, as well as a healthy GRA balance, supporting the upgrade. However, a stress case cutting of revenues by 5% would result in a minimum DSCR of 1.40x, representing a notable erosion of financial metrics.

Traffic volume as of September 30, 2024, is at the highest level since the start of operations, reaching 778,308 transactions, a 3% increase compared with the same period last year and 10% higher than the 2019 level. This increase is mainly due to population growth (+2.8% as of July 2024) as well as good weather conditions. Also, 2023, and to a greater extent 2024, saw numerous shutdowns of the competing ferry because of mechanical issues.

For the second consecutive year, as of January 1, 2024, the Government of Canada (the Government; rated AAA with a Stable trend by Morningstar DBRS) imposed a toll freeze so that 2024 toll rates would remain the same as in 2022 and 2023. As compensation, SCDI received $4.5 million in government assistance, which the Company is recognizing each month based on traffic volumes. As of September 30, 2024, SCDI has recognized $3.45 million.

The annual independent engineer (IE) review for 2023 confirmed that the Confederation Bridge (the Bridge) is well maintained, its various components continue to function as intended, and its structure is sound. The IE is satisfied that the developer is complying with the maintenance requirements and the long-term maintenance plan, opining that the Bridge is in the Required Condition, as defined in the Developer Agreement.

CREDIT RATING DRIVERS
Morningstar DBRS could take a positive rating action if the DSCR remained comfortably above 1.60x and was able to withstand an economic downtown scenario without eroding materially. Morningstar DBRS could take a negative rating action if there were a significant decline in traffic or change in traffic mix such that revenues fall materially, affecting the Company's business and financial profile, resulting in a materially lower GRA balance and lower DSCR, as calculated by Morningstar DBRS. Morningstar DBRS could also take a negative rating action if there were new debt issuance that could result in lower DSCR, as calculated by Morningstar DBRS.

FINANCIAL OUTLOOK
The 2023 DSCR as calculated by Morningstar DBRS was 1.62x and 1.45x as calculated for a 24-month period per the Master Trust Indenture (MTI). The six-month debt service reserve account and the GRA mandated by the MTI continued to provide substantial flexibility. Based on the Q3 2024 financial statements, these reserves totaled approximately $27 million, covering about one year of debt servicing. The Morningstar DBRS rating case projects a DSCR of 1.70x for 2024 and 1.52x for 2025, supporting the upgrade.

CREDIT RATING RATIONALE
The credit ratings are underpinned by (1) the essentiality of vehicular traffic between Prince Edward Island and the mainland, (2) the Bridge's monopoly on vehicular access during winter months and its considerable time savings for most traffic year round, and (3) the Company's reserves that provide a cushion against significant unforeseen expenses and, as at September 2024, are sufficient to cover approximately one year of debt service. Challenges to the credit ratings include (1) the effects of currency exchange rates, gas prices, and Prince Edward Island's agricultural- and tourism-based economy on traffic volumes; (2) the capping of annual toll increases at 75% of the national Consumer Price Index that greatly limit the ability to offset unexpected shocks; (3) the Bridge's long life and complex engineering and design structure could lead to unforeseen maintenance costs; and (4) the modest historical traffic trend with a compound annual growth rate of 2.6% during 2013-23.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors 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) at https://dbrs.morningstar.com/research/437781.

RATING DRIVERS AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of Rating Driver Factors
In the analysis of SCDI, the Rating Driver factors listed in the volume-based section of the methodology are considered in the order of importance.

(B) Weighting of FRA Factors
In the analysis of SCDI, the following FRA factor listed in the volume-based section of the methodology was considered more important: minimum DSCR.

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

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 Environmental, Social, and Governance 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 https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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