Central Nottinghamshire Hospitals plc -- Moody's downgrades Central Nottinghamshire Hospitals plc's underlying rating to Ba1; outlook remains negative

Rating Action: Moody's downgrades Central Nottinghamshire Hospitals plc's underlying rating to Ba1; outlook remains negativeGlobal Credit Research - 27 Apr 2021London, 27 April 2021 -- Moody's Investors Service (Moody's) has today downgraded to Ba1 from Baa3 the underlying senior secured rating of the GBP352 million index-linked guaranteed secured bonds due 2042 (the Bonds) issued by Central Nottinghamshire Hospitals plc (the Issuer, ProjectCo or CNH). The outlook remains negative.RATINGS RATIONALEThe rating action reflects the continued delays in the finalisation of a settlement agreement between the project parties to resolve past and ongoing operating issues and the risk that the protracted discussions could result in increasingly strained relationships. While the Sherwood Forest Hospitals National Health Service Foundation Trust (the Trust) and ProjectCo continue to work on potential remedial actions, in Moody's view there is an increased risk that the Trust could consider taking further adverse actions under the Project Agreement (PA), including in connection with the recently initiated review by the UK Government's Infrastructure and Projects Authority (IPA) on the project. The rating action also reflects the expected deterioration in the project's Debt Service Coverage Ratios (DSCR) to levels very close to event of default covenant thresholds, mainly due to the continued delays and costs linked to the settlement agreement under discussion.CNH is a special purpose company that, in November 2005, signed a 37-year PA with the Trust to redevelop the King's Mill Hospital, Mansfield Community Hospital and Newark General Hospital in Nottinghamshire. Full facilities management (FM) services started in April 2011. FM services provided comprise hard FM services (mainly helpdesk and estate services) and soft FM services (mainly catering, cleaning, portering and parking). ProjectCo has subcontracted the provision of hard FM to Skanska Rashleigh Weatherfoil Limited (trading as Skanska Facilities Services, or SFS) and soft FM to Compass Contract Services UK Limited (trading as Medirest).From 2019, the project has reported a weak operating performance, mostly linked to the provision of estate services by SFS and the realignment of services and deductions to reflect the contract provisions more closely, resulting in the accrual of Service Failure Points (SFPs) which have breached warning thresholds under the PA on several occasions, while the PA event of default threshold and subsequent termination threshold were also reached in September 2020, thus resulting in the Trust's right to potentially terminate the PA. In this context, however, Moody's notes that the Trust and ProjectCo have different views on contractual interpretations related to current termination rights, with ProjectCo considering that the Trust no longer has the ability to terminate the PA due to the time elapsed since event of default thresholds were reached.Whilst the Trust had not previously taken any formal action against ProjectCo, with the aim to facilitate the formalisation of an improvement plan, the persistently weak operating performance resulted, for the first time, in the Trust's issuance of a formal warning notice to ProjectCo in August 2020. In December 2020, the Trust also issued a formal notice of increased monitoring, although these actions did not result in significant additional consequences for ProjectCo, given that the project was, in practice, already subject to increased monitoring, while distributions to shareholders have been suspended since the end of 2019. The Trust and ProjectCo are developing a plan to include improvements set out in an Operational Delivery Plan together with a review of contract interpretation issues ahead of entering into a settlement agreement which is not expected to be finalised before the end of the year.In Moody's view, the continued high level of SFPs reported by SFS, as well the delays in the agreement and implementation of a performance improvement plan and formalisation of a settlement agreement could result in strained relationships between project parties. In addition, Moody's notes the review recently initiated on the project by the IPA, a body established with the mandate of monitoring the UK Government's projects portfolio (including those managed by the private sector) and assessing the delivery of value for money objectives. In Moody's view, depending on the outcome of such review, there could be an increased risk that the Trust may need to use formal contractual remedies which could ultimately lead, in an extreme scenario, to termination of the project.In addition to a heightened project termination risk, the settlement agreement is resulting in additional legal and consultant fees for ProjectCo. These costs, coupled with an expected financial contribution stemming from the settlement agreement, as well as higher lifecycle expenditure and increasing tax liabilities resulting from the loss of tax deductibility on interest linked to CNH's subordinated debt, will weigh on credit metrics in the short term. More specifically, CNH expects DSCR to be only marginally above the event of default covenant threshold level of 1.05x under its financing documentation, which further weighs on CNH's credit quality.Notwithstanding the above, CNH's Ba1 underlying rating continues to benefit from: (1) the stable availability-based revenue stream under the long-term PA that ProjectCo entered into with the Trust; (2) a range of creditor protections included within ProjectCo's financing structure, such as debt service and maintenance reserves; (3) the expectation that there is a likelihood of high recovery for lenders in the event of any default by ProjectCo under the PA and termination by the Trust; (4) the protective mechanisms mitigating the offtaker's credit risks for ProjectCo's senior lenders; and (5) the fact that performance deductions are passed through to the respective FM contractors (subject to a cap of 100% of the annual payments) with no financial impact on ProjectCo.However, CNH's Ba1 underlying rating remains constrained by: (1) the project's high leverage, with minimum and average DSCR of 1.05x and 1.19x (Moody's calculated metrics), respectively, which reduces the Issuer's ability to withstand unexpected stress; (2) the exposure to hard FM cost benchmarking without the ability to pass all cost increases to the Trust, though partially mitigated through the hard FM service fee indexation and a hard FM reserving mechanism; (3) the continued weak operating performance, as confirmed by the issuance of formal warning notices and increased monitoring to ProjectCo; and (4) the continued delays in the finalisation of a settlement agreement with the Trust.Scheduled payments of principal and interest under the Bonds issued by CNH are unconditionally and irrevocably guaranteed by Assured Guaranty UK Limited (Assured Guaranty, rated A2 stable). The Ba1 underlying rating on the Bonds reflects the credit risk of the Bonds without the benefit of the financial guarantee from Assured Guaranty. The rating of the Bonds is determined as the higher of (1) the insurance financial strength rating of Assured Guaranty; and (2) the underlying rating on the Bonds. Since Assured Guaranty's rating is higher than the underlying rating, the backed rating of the Bonds is A2.Notwithstanding the continued discussions between the project parties, the negative outlook reflects the continued delays in the finalisation of a settlement agreement and the implementation of a performance improvement plan, which could ultimately lead to an increased risk of PA termination by the Trust. The negative outlook also reflects the additional risks linked to the ongoing IPA review on the project and deterioration in DSCR to levels close to event of default thresholds under the financing documentation.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGIn light of the negative outlook, upward rating pressure remains limited in the short term. Over the longer term, Moody's could upgrade CNH's underlying rating if: (1) operating performance sustainably returns to satisfactory levels and awarded SFPs fall comfortably below contractual thresholds; (2) the formal implementation of a settlement agreement between the project parties is finalised and executed in a satisfactory manner, with no permanent adverse impact on ProjectCo's financial metrics; and (3) credit metrics improve as a consequence of lower operating costs and lifecycle budget.Conversely, Moody's could downgrade CNH's underlying rating if: (1) the finalisation of a settlement agreement continues to be delayed or operating performance fails to improve, resulting in the Trust using formal contractual remedies and increasing the risk of project termination; (2) the IPA review concludes with a recommendation of PA termination; (3) the quality of relationships between project parties shows further signs of deterioration; (4) ProjectCo faced materially increased hard FM costs following a cost benchmarking exercise; or (5) the lifecycle cost budget or other operating costs were to materially increase.The principal methodology used in this rating was Operational Privately Financed Public Infrastructure (PFI/PPP/P3) Projects published in October 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1110140. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.REGULATORY DISCLOSURESFor further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. 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Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating. Raffaella Altamura VP - Senior Credit Officer Infrastructure Finance Group Moody's Investors Service Ltd. One Canada Square Canary Wharf London E14 5FA United Kingdom JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Kevin Maddick Associate Managing Director Infrastructure Finance Group JOURNALISTS: 44 20 7772 5456 Client Service: 44 20 7772 5454 Releasing Office: Moody's Investors Service Ltd. 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