DBRS Morningstar Changes Trends on SNC-Lavalin Innisfree McGill Finance Inc. to Positive from Stable, Confirms BBB (high) Ratings

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the Series A Senior Amortizing Bonds rating of SNC-Lavalin Innisfree McGill Finance Inc. (the Issuer), the financing vehicle unconditionally guaranteed by McGill Healthcare Infrastructure Group, G.P. (ProjectCo) and its General Partners, at BBB (high). The trends changed to Positive from Stable. ProjectCo is the special-purpose vehicle responsible for the design, construction, financing, and maintenance of a new 217,500-square-metre hospital under a 34.3-year public-private partnership (the Project) with McGill University Health Centre/Centre universitaire de santé McGill (MUHC or the Hospital; rated AA (low) with a Stable trend by DBRS Morningstar). The Hospital is currently in its 73rd month of operations after having achieved Global Substantial Completion on November 5, 2014.

The trend change to Positive is supported by the resolution of outstanding material disputes and the implementation of performance protocols in October 2018, followed by a period of good service performance to date that has been evidenced by minor monetary deductions to the monthly service payment and minor failure point accumulation. A settlement agreement was finalized to resolve the outstanding commercial negotiations in November 2019 related to outstanding Minor Works and Variations, and a final release document was issued.

Since the finalization of the amendments to the Operating and Maintenance (O&M) Contract and the implementation of the performance protocols in 2018, DBRS Morningstar notes the improvement of service performance in the Hospital to date. For the 12-month reporting period from October 2019 to September 2020, there were relatively low Hospital-levied deductions related to service performance after the revised Project Agreement (PA) tolerances were applied. The largest availability deduction in the past 12 months occurred in October 2019, resulting in a deduction of $25,000 related to a malfunction of a storage room access entry way. Furthermore, failure point accumulation is well within PA thresholds for warning notices, subcontractor replacement, and Events of Default (EODs), with failure points at 0% of the service provider replacement PA threshold and 0% of the EOD PA threshold. Discussions are ongoing as it relates to the renewal of the security contract for facility security services as part of the PA benchmarking regime. Despite the continued tracking and monitoring of service performance, the Hospital has agreed to suspend the Payment Mechanism regime and the application of service performance related deductions and failure points until the Coronavirus Disease (COVID-19) abates. All coronavirus-related costs, including installation of hand-wash stations and temporary plexiglass for isolation, have been paid for by the Hospital. Despite the spike in gas consumption for domestic hot water use and increased consumption related to pressurization and temperature for space cooling as a result of the coronavirus, the consumption trend is positive for October 2019 to September 2020 with electricity and natural gas consumption anticipated to be below the overall energy target consumption level. ProjectCo has taken initiatives to manage overall energy consumption in the past, including fine tuning chillers, colling tower systems, and upgrading to LED lighting throughout the Hospital. Deductions are passed down from ProjectCo to the Service Provider, SNC-Lavalin Operations and Maintenance Inc. (SNC O&M).

Budgeted lifecycle in the near term consists of a WiFi migration project in Year 7 (2020–2021; or Year 7 following substantial completion on November 5, 2014) with a value of $3.2 million, which encompasses a replacement of over 2,000 Cisco WiFi routers throughout the Hospital, exterior wall repairs in Year 9 (2022–2023), multiple mechanical and electrical refurbishment/replacement projects, and replacement of parking equipment in Year 8 (2021–2022). Starting from the fifth year following commencement of the operational term (2018–2019), both SNC O&M (for architectural elements of the facility) and Johnson Controls L.P. (JCLP) (for technical elements of the facility) are required to deliver to ProjectCo an Annual Lifecycle Report. Regardless of the works undertaken and the amount expended on lifecycle, the Annual Lifecycle Payments from MUHC to ProjectCo and from ProjectCo to Johnson Controls International plc and SNC O&M are fixed. Notwithstanding, the Facilities Management Services Contract and subcontract include a mechanism to review the lifecycle budgets against the actual spending and forecasted lifecycle activities, allowing ProjectCo to retain funds from SNC O&M and JCLP if there is a discrepancy. The cumulative lifecycle activities to date are generally consistent with the Lifecycle Payments made by ProjectCo and spending is roughly $9.6 million up to mid-October 2020. While spending reported by SNC O&M and JCLP is generally in line with ProjectCo’s reported spending, there are ongoing discussions as to the level of detail reported for lifecycle costs.

On November 2, 2020, DBRS Morningstar downgraded the Issuer Rating and Senior Debentures rating of SNC-Lavalin Group Inc. (SNC) to BB (high) from BBB (low) and maintained the Negative trend. While the SNC O&M provided a parent guarantee for an amount equal to the contract’s liability cap of 200% of the annual service payment, DBRS Morningstar believes that, as long as SNC continues to meet its contractual obligations under the services agreement, its below investment-grade creditworthiness is not expected to affect the ratings or trends on ProjectCo, which is protected by adequate resilience against unexpected shocks to the O&M budget as measured by DBRS Morningstar’s breakeven analysis. The O&M resilience and lifecycle resilience is 60% and 125%, respectively.

The debt service coverage ratio (DSCR) was slightly better than expected at 1.41 times (x) for the trailing 12 months as at June 30, 2020, and is projected to be a minimum of 1.38x, on a full-year basis, throughout the term of the service phase. The better-than-expected DSCR is as a result of the better-than-expected interest rates on cash balances. DBRS Morningstar may take a positive rating action in the near term with a continued period of relatively low deductions and sustained stable contractual relationship between the Hospital and ProjectCo. Negative rating pressure could result if there is material deterioration of the operating and financial performance of the Project.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

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

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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@dbrsmorningstar.com.

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.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.

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