LONDON Oct. 30, 2020?S&P Global Ratings today took the rating actions listed above.
ProjectCo used the proceeds of the senior debt issuance to finance the construction and refurbishment of a mental health facility and an acute inpatient facility at the existing Queen Elizabeth Hospital in Birmingham. Balfour Beatty Construction Ltd. and Haden Young Ltd. (both part of the Balfour Beatty group [BB]) completed construction of the two facilities in 2008 and 2012, respectively.
ProjectCo operates under a 40-year agreement expiring in 2046. It subcontracts hard FM services to Engie. The trusts retain soft FM services.
Strengths
- ProjectCo benefits from an availability-based payment mechanism, which supports cash flow stability.
Risks
- If BB fails to rectify the latent defects, and the costs of rectification could not be recovered from BB, Consort would have to bear material costs fixing them. The comparatively large levels of cash trapped in the project largely mitigate potential exposure to the latent defects' rectification costs.
- If the trust declared SPFs for the open works order, ProjectCo could exceed SFP termination thresholds under the project agreement, which increases the risk of the trusts taking adverse steps against ProjectCo. Exceeding termination thresholds in the project agreement could also lead to an event of default under the financing documents, potentially giving the majority creditors the right to accelerate the senior debt.
- While Engie's improved facilities management performance has led to a fall in SFPs, having dropped below warning notice thresholds, Engie's performance in delivering major maintenance (lifecycle) works and variations continues to lag expectations.
The downgrade primarily reflects Consort's potential exposure to costs of rectification of latent defects, which are material, if BB were to fail to cover them. It also reflects continued elevated operating and financial risks if the trusts were to declare SFPs for non-completed facilities management works, and trigger contractual provisions. These could range from the termination of the contract with Engie to termination of the project agreement and debt acceleration.
Consort would be liable for costs of rectification of latent defects associated with PFPs, which are in our view significant, if BB failed to remedy them. Although the construction contractor's obligations are covered by the parent company guarantee from BB, Consort could be ultimately liable if BB were unable or unwilling to cover the costs. We expect the costs to be material, as works will involve rectification of deficiencies in the construction of the hospitals' walls and floors that allow smoke to pass between various fire protective compartments. The works are expected to last about two years, during which BB will be liable to bear unavailability deductions for wards that will be closed due to the works.
The trusts, who are increasingly frustrated that defects which raise safety concerns are still outstanding 10 years into the hospitals' operations, may start imposing SFPs or applying unavailability deductions in relation to these defects after the expiration of the standstill agreement in December 2020.
The project currently maintains sufficient liquidity to mitigate the potential exposure to the latent defects' rectification costs. However, liquidity could become insufficient if the project restarted distributions before the defects are addressed. Consort has been in a distribution lockup since 2017, when the majority creditor did not approve a standstill agreement that Consort entered with the trusts for not applying unavailability deductions related to the PFP defects. The majority creditor has withheld rights from approving the financial model, and continues to not approve it, therefore distributions cannot be made. Majority creditor's consent is required for Consort restarting distributions.
We expect the majority creditor will not allow distributions until at least Consort and BB sign a settlement agreement with the trusts setting the terms of remediation of PFP defects. After signing the agreement, Consort will remain exposed to BB for as long as the rectification works are completed. Therefore, we expect that if the project were to restart distributions, we may lower our rating unless Consort maintains sufficient cash to mitigate the potential exposure to latent defect costs.
If declared, the SFPs for the open and not closed FM works could trigger the project's event of default and give the majority creditor right to accelerate debt. Some of the backlog of about 3,000 jobs that were logged and closed in 2019, but due to the change in reporting were not reported as closed on the help desk (open works order), are still outstanding. If SFPs associated with these works were to be declared, they would exceed the contractor and project termination thresholds under the FM contract and the project agreement respectively. If not remedied or waived, this could lead to termination of the project, which would allow the majority creditor to accelerate Consort's outstanding senior debt. However, the trusts have not invoked any of their rights under the project agreement, the first of which would be additional monitoring. Since 2020, Engie's performance has improved thanks to a management change and workforce restructuring.
The settlement agreement that would clear the accrued SFP and compensate the trusts was set to be reached by the end of 2020 but, due to the COVID-19 pandemic, has been delayed to the first half of 2021.
Delaying lifecycle expenditure could pressure credit metrics. The project continues to underspend on lifecycle compared with its budget. The project holds the unspent amounts within major maintenance reserve account and continues to assume that the underspent amount to date will be disbursed over the remaining course of the concession.
In our view, changes to the timing of expenditure could pressure financial metrics in periods of reserving for increased spending. We are now expecting minimum ADSCR of 1.11x in September 2027 and March 2028, down from the 1.15x we expected previously. This coincides with increased contractually required reserving ahead of peak lifecycle spending in 2028-2031.
The negative outlook reflects the project's potential exposure to material latent defect rectification costs. It also factors in our view that Consort faces uncertainty following a potential breach of contractual thresholds in the project agreement.
We would take a negative rating action if in our view, operating risk increased, or if ProjectCo's financial profile weakened such that we were expecting minimum ADSCR below 1.10x.
We could lower the rating by one or more notches if the project's potential exposure to latent defect costs were not mitigated by sufficient liquidity. Specifically, we could lower the ratings if Consort's cash balances (excluding the reserve accounts) were to fall below our estimate of the cost of remediating or compensating defects in the buildings. We could also lower the rating if the trusts attempted to take other steps that demonstrate elevated risk that the project could be terminated.
We could also lower the rating if the project's financial profile weakened due to changing timing or amounts of lifecycle costs, or if Consort were to incur higher operating costs because it had to replace Engie or if it were to share settlement costs for the open works order with Engie.
We could revise the outlook to stable following a period of operational stability that demonstrates the subcontractor's ability to remain well within contractual thresholds, the settlement agreement for open works orders is reached, and there is good progress in rectifying latent defects.