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