TEXT-S&P revises SNC-Lavalin Innisfree McGill Finance outlook to negative

Mon Nov 5, 2012 11:01am EST
 
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(The following statement was released by the rating agency)
Overview
     -- We are revising the outlook to negative from stable and affirming our 
'A-' rating on SNC-Lavalin Innisfree McGill Finance Inc.'s senior secured 
notes.
     -- The negative outlook reflects the project's dependency on SNC-Lavalin 
Group Inc. (BBB+/Negative/--) as the main counterparty and guarantor for the 
project.  
     -- The outlook revision also reflects the risk that as a result of the 
material delay that continues to persist, the construction may not be 
completed on time.  

Rating Action
As Standard & Poor's Ratings Services previously announced, on Nov. 1, 2012, 
Standard & Poor's revised its outlook to negative from stable and affirmed its 
'A-' issue-level rating on SNC-Lavalin Innisfree McGill Finance Inc.'s C$764.1 
million senior secured bond due June 30, 2044, and C$392.5 million senior 
secured construction bank facility due Sept. 30, 2014. 

The outlook revision is based on the project's dependency on SNC-Lavalin Group 
as the main counterparty and guarantor for the project. Furthermore, there's a 
risk that as a result of the continued material delay, the construction might 
not be completed  on time.

Rationale
Groupe immobilier sante McGill S.E.N.C. (McGill Health or Project Co) was 
selected to design, build, finance, maintain, and rehabilitate the McGill 
University Health Centre (MUHC) for a concession of approximately 34.3 years. 

SNC-Lavalin Innisfree McGill Finance Inc. has on-lent the proceeds of senior 
secured notes and construction bank facility to McGill Health. The issue-level 
rating on SNC-Lavalin Innisfree McGill Finance's C$764.1 million senior 
secured bond due June 30, 2044, and C$392.5 million in a senior secured 
construction bank facility due Sept. 30, 2014, broadly reflects Standard & 
Poor's opinion of the following positive factors:

     -- A strong rationale for the project, because the new facilities will 
replace and consolidate a number of medical services and research facilities 
in one integrated campus;
     -- A very experienced project team, including a highly rated design-build 
(DB) contractor in SNC-Lavalin Services Ltd.; SNC-Lavalin Group Inc. 
(BBB+/Negative/--; 60%) and Innisfree Ltd. (40%) as equity sponsors; and 
highly capable operators in SNC-Lavalin Operations and Maintenance Inc. 
(SNC-OM) and Johnson Controls L.P. (JCLP). All are leaders in their respective 
businesses;
     -- Project agreements that provide clearly defined roles for the private- 
and public-sector participants with an appropriate allocation of key risks for 
a project of this size and type, and a clearly defined and manageable 
deduction regime;
     -- A highly rated government offtaker in the MUHC, bolstered by a strong 
letter of funding support by the Quebec government (A+/Stable/A-1+);
     -- A robust construction security package, featuring a parental guarantee 
from SNC equal to 55% of the DB contract value and sufficient on-demand 
liquidity to remedy construction challenges. An unconditional letter of credit 
(LOC) equal to 10% of the DB contract value (C$157 million) posted at 
financial close provides liquidity during construction. Standard & Poor's 
expects that the DB contractor will secure 50% performance bonds for major 
subtrades, especially for the important mechanical and electrical ones;
     -- Strong cost-to-complete and time-to-complete provisions, allowing for 
monthly lenders technical advisor certification of completed work and Project 
Co's ability to hold back monthly remittances to the DB contractor should it 
not complete work to project specifications;
     -- Operational services for the 30-year operating period that we believe 
are quite standard and involving limited soft facilities maintenance (FM) 
services. Importantly, MUHC will assume clinical services;
     -- A payment mechanism that provides for a fixed capital payment, 
inflation and labor indexation for operating payments, and inflation 
indexation for life-cycle payments. A manageable deduction regime during the 
operational phase matches these payments;
     -- Strong operators in SNC-OM and JCLP to manage the FM services and a 
portion of the life-cycle risks during the concession. Standard & Poor's 
understands that SNC-OM is offering a relatively robust security package that 
features a parental guarantee of 100% of the annual FM fee and 200% upon 
termination. SNC will guarantee SNC-OM's performance. In addition, Project Co 
will receive an LOC equal to nine months of the annual service payments. 
JCLP's security package consists of an LOC equal to 2.44% of the total 
life-cycle payments to McGill Health and a parental guarantee equal to 6.1% of 
the total from JCLP's parent, Johnson Controls Inc. (BBB+/Stable/A-2). JCLP's 
maximum liability is 12.2% of the total life-cycle payments owed to it;
     -- A fully amortizing senior debt profile that we believe provides for 
robust minimum and average senior debt service coverage ratios (DSCR) of 1.27x 
and 1.37x (excluding interest income), respectively, during the concession's 
life. Our ratings do not reflect the potential for an additional C$61 million 
reflected in the bond indenture or additional debt due to scope variations, 
which would compress these DSCRs; 
     -- Robust life-cycle costing, which reduces the likelihood that the 
contract will become uneconomical. In addition, JCLP is retaining the risk 
with respect to cost overruns for its portion of the life-cycle expenditures. 
Project Co will retain the risk for the non-JCLP portion of the life-cycle 
expenditure. Somewhat mitigating the risk of timing differences between 
forecast and actual expenditures associated with the lumpy life-cycle payment 
profile are a full-term life-cycle look-forward and reserve mechanism and 
McGill Health's full prefunding of the following year's life-cycle 
expenditures on the non-JCLP scope of life-cycle work.

Somewhat offsetting these strengths, in our view, are the following weaknesses:
     -- A moderately geared capital structure during construction, with senior 
debt to total capital equal to 86%. Once McGill Health repays the construction 
bank facility upon completing the project, we understand the leverage declines 
significantly to 80%. However, the bond indenture leaves room for additional 
debt upon completion. We understand that additional debt will be subject to a 
ratings confirmation test. We have not factored the additional debt into the 
rating;
     -- A relatively complex project, in our opinion, given its size compared 
with other Canadian public-private partnership (P3) hospitals we rate, 
entailing the design and construction of an integrated hospital complex (the 
Glen Campus). The project currently under construction has been experiencing a 
continuing material delay, which has yet to be corrected and could result in a 
delay in achieving global substantial completion;
     -- A distribution lock-up at 1.15x, which we believe provides adequate 
protection for senior bondholders compared with the 1.27x minimum;
     -- A six-month senior debt service reserve fund that is standard for a 
project of this size and at the rating level; 
     -- A debt tail at six months of revenues that is comparable with that of 
other Canadian P3 projects we rate. 

Outlook
The negative outlook reflects the project's dependency on SNC-Lavalin Group as 
the main counterparty and guarantor for the project. Our outlook also reflects 
the risk that as a result of the continued material delay, the construction 
may not be completed on time.  We could lower the rating on the project, if we 
lower the rating on SNC-Lavalin Group or the current delay in the design and 
construction cannot be mitigated by the parties involved. There is limited 
scope for higher ratings or an outlook revision to stable before the end of 
construction if these issues persist.

Related Criteria And Research
Criteria | Corporates | Project Finance: Project Finance Construction And 
Operations Counterparty Methodology, Dec. 20, 2011

Ratings List
SNC-Lavalin Innisfree McGill Finance Inc.
Outlook Revised, Rating Affirmed   To            From
Senior secured                     A-/Negative   A-/Stable



Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.

 (New York Ratings Team)