Plenary Health Vaughan LP -- Moody's revises to positive the outlook on Plenary Health Vaughan LP's senior secured bonds; A3 rating affirmed

Rating Action: Moody's revises to positive the outlook on Plenary Health Vaughan LP's senior secured bonds; A3 rating affirmedGlobal Credit Research - 14 Jan 2022Approximately CAD $278 million (face value) of rated debt affectedToronto, January 14, 2022 -- Moody's Investors Service ("Moody's") has affirmed Plenary Health Vaughan LP's (Project Co or Issuer) A3 senior secured rating. The rating outlook was changed to positive from stable.RATINGS RATIONALEThe rating action reflects the relatively smooth transition to the operating phase of the project despite incurring some deductions which are expected in most hospital project transitions to operating phase, the strength of the project's offtaker, Mackenzie Health (MH or the Authority), a counterparty directly linked to a highly rated entity (Province of Ontario, Aa3 stable), the relatively low complexity of Project Co's Facility Management (FM) and lifecycle responsibilities. The key consortium members also have a strong track record of delivering similar or larger size healthcare projects in the region. Despite these strong project characteristics, the rating is constrained by relatively weak but adequate financial metrics for an operating P3.The project reached Substantial Completion in August 2020 with minor construction deficiencies addressed by the construction contractor. Since Substantial Completion, the project has been operating well with manageable deductions which have been passed down to the subcontractor. The availability payment mechanism is considered standard, although it includes a system failures point deduction. The technical advisor believes that the failure point deduction system, which we understand was derived from lessons learned at other projects, should provide additional clarity with respect to deductions.The project's responsibilities with respect to FM and lifecycle are fully subcontracted on a back-to-back basis to Johnson Controls Canada, LP, an experienced service provider. The performance security during the operating phase is adequate, with a parent company guarantee provided by Johnson Controls International plc (Baa2, stable), plus a L/C sized at 50% of the annual average operations and maintenance costs and lifecycle costs with a 200% aggregate liability cap over the life of the project.Credit metrics are considered tight, but adequate, with a low average annual DSCR of 1.17x and weak breakeven ratios towards the last decade of the project's life in the high-teens, with a minimum of 18%. There is also a 1.00x financial covenant that if not met would result in an event of default, subject to limited equity cures, which we view as weak, and a 1.13x equity lock-up test. These structural weaknesses are partially mitigated by a strong service provider with experience in similar or larger projects with additional FM complexities. The project also benefits from standard security package of pledged agreements and shares including covenants to limit future debt, restricted payment test, lender step-in rights, and compensation on termination.There is a standard 6-month debt service reserve funded with cash at Substantial Completion that could be replaced with an L/C recourse to the project. Reimbursement obligations, should the L/C be drawn, would result in project level subordinated indebtedness. Moody's views the flexibility for the sponsor to replace a cash funded debt service reserve with a project level L/C as a credit negative and a structural weakness for bondholders. That said, the assigned rating acknowledges the view that the related debt incurred should the L/C be drawn would be repaid subordinate to senior lenders pursuant to a cash flow waterfall and subject to Project Co meeting the 1.13x restricted payments test. Moreover, we understand that pursuant to the terms of the subordination agreement, should an event of default occur, the subordinated debt must standstill until the senior debt is repaid.RATING OUTLOOKThe rating outlook is positive, reflecting our expectation of a transition to steady state operations with manageable deductions, supported by the relatively straightforward hospital hard FM requirements and the FM service provider's successful track record in operating similar infrastructure projects.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGFACTORS THAT COULD LEAD TO AN UPGRADEContinued strong operations with stabilized/minimal deductions and failure points, while maintaining forecasted debt service coverage ratios.FACTORS THAT COULD LEAD TO A DOWNGRADE** The actual debt service coverage ratio is consistently below 1.17x** Difficulties in the project operations leading to the accrual of additional failure points to levels that breach Warning/Monitoring Notice or Event of Default thresholds** Material changes during the operating phase that result in significant deductions from the availability payments or increases to the maintenance and lifecycle costs that cannot be passed down to FM service provider** The credit quality of FM service provider's guarantor (Johnson Controls International plc) deteriorates materially** A material downgrade of the Province of Ontario's ratingPROFILEProject Co is a special and single purpose vehicle that entered into a Project Agreement (PA) with Mackenzie Health to design, build, finance and maintain the Cortellucci Vaughan Hospital Project (formerly Mackenzie Vaughan Hospital Project) for a term equal to construction period plus 30 years from the Scheduled Substantial Completion date.The Cortellucci Vaughan Hospital is located in the City of Vaughan, in the Province of Ontario, Canada. Vaughan is approximately 40 kilometers northwest of the City of Toronto. The project is at the northeast quadrant of Major Mackenzie Drive (Highway 400) and Jane Street, close to Canada's Wonderland theme park. Cortellucci Vaughan Hospital is the first hospital in the Southwest York Region. The purpose of the project is to establish a two site hospital service delivery model with Mackenzie Richmond Hill Hospital and the Cortellucci Vaughan Hospital to accommodate anticipated population growth. The project includes approximately 1.2 million square feet which houses a medical facility with 367 beds in an 11-story building plus 4 levels of parking. The facility offers 24/7 emergency services, medical, surgical and critical care beds, obstetrics, pediatrics, preoperative and diagnostic services, mental health support, among other services. The project also included the construction of a central utility plant that provides 72-hour emergency energy needs of the project and a water management system.METHODOLOGYThe principal methodology used in this rating was Operational Privately Financed Public Infrastructure (PFI/PPP/P3) Projects Methodology published in June 2021 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1244911. 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. 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