European Infrastructure Finance Yearbook - Investing In Bonds ...

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PROJECT FINANCE/PUBLIC-PRIVATE PARTNERSHIPS Publication Date: Oct. 11, 2007 Issue Credit Rating: Senior secured debt AAA, BBB-(SPUR)/Stable Primary Credit Analyst: James Hoskins, London, (44) 20-7176-3393 Secondary Credit Analyst: Jose R Abos, Madrid, (34) 91-389-6951 142 ■ NOVEMBER 2007 TRANSFORM SCHOOLS (NORTH LANARKSHIRE) FUNDING PLC Rationale The £88.7 million index-linked senior secured bonds due 2036 and the £70 million European Investment Bank (EIB; AAA/Stable/A-1+) loans due 2034 issued by U.K.-based special purpose vehicle Transform Schools (North Lanarkshire) Funding PLC (Issuer) have a ‘AAA’ insured rating and a ‘BBB-’ Standard & Poor’s underlying rating (SPUR). The outlook on the SPUR is stable. In addition, the underlying rating on the bonds has a recovery rating of ‘2’, indicating Standard & Poor’s expectation of substantial recovery of principal (70%–90%) in the absence of a guarantee in the event of a debt default. The insured rating reflects the unconditional and irrevocable payment guarantee of scheduled interest and principal provided by XL Capital Assurance (U.K.) Ltd. (AAA/Stable/--). The underlying ‘BBB-’ rating represents a composite of credit factors, outlined below. The funds have been onlent by the Issuer to Transform Schools (North Lanarkshire) Ltd. (ProjectCo), and are being used to finance the design and construction of 17 new facilities for 24 schools for North Lanarkshire Council in Scotland. Following the completion of construction, ProjectCo, via its subcontractor Haden Building Management Ltd. (HBML), will provide hard and limited soft facilities maintenance services, including building maintenance, lifecycle, security, energy management, cleaning and janitorial services to the schools for the remainder of the 32-year project agreement, which expires in 2037. Construction commenced in October 2004 under an advanced works agreement and continued under the private finance initiative (PFI) contract upon financial close in April 2005. Final completion is due to occur in October 2008 and works are being undertaken by an unincorporated joint venture between Balfour Beatty Construction Ltd. and Balfour Kilpatrick Ltd. (construction joint venture; CJV), both of which are subsidiaries of Balfour Beatty PLC (not rated). Construction works are currently proceeding reasonably well, with 11 facilities successfully completed, two facilities due to be completed in October 2007, two in November 2007, and the final two schools in October 2008. The ‘BBB-’ underlying rating reflects the following credit risks: • Although the completion of this multisite project should be within the capabilities of STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK the contractor Balfour Beatty PLC to deliver successfully, it is being run concurrently with a number of other Scottish education PFI portfolio projects. The ability to procure sub-contractors to carry out key construction activities in a reasonably constrained labor market will be crucial, therefore, in ensuring construction delivery in line with the contractually agreed timetable. Furthermore, Balfour Beatty itself is undertaking a number of significant PFI projects at this time so its ability to manage this project alongside others will be challenging, although achievable given the company’s significant experience in the sector. • One school facility, St. Ignatius and Wishaw Academy Primary, which was handed over in August 2007, was found to be about 136 square meters smaller than required by the output specification immediately prior to handover. In addition, one school is currently in delay by around 12 weeks due to poor ground conditions. ProjectCo is being protected from the financial impact of these two issues by CJV. At Wishaw, CJV is currently implementing the additional works required to bring the floor area of the school up to standard at its own expense. • The project relies on about £23 million of revenue earned through phased construction to provide funding for further construction activities. Any delays to the attainment of these revenues could reduce the funding available for construction. • The third-party financial support and liquidity during the construction phase is relatively low, although adequate. Construction risk is partially financially mitigated through an adjudication bond from Banco Bilbao Vizcaya Argentaria S.A. (AA-/Positive/A-1+). • ProjectCo is exposed to the uncertainty, in terms of budgeting and timing, of more than 32 years of capital-replacement risk. This risk is partially mitigated by: a three-year forward-looking reserve; a 12-year limit on the construction joint-venture liabilities for serious latent defects; and the relatively simple nature of schools projects. • The financial structure is aggressive, as is typical for the PFI sector. Senior debt to total funds is 90% (excluding construction
evenue), and base-case senior debt-service coverage levels are a minimum of 1.19x and average 1.21x, which is low but in line with most recently rated PFI projects in the U.K. In addition, forward and historical distribution lock-up levels are slightly lower than recent transactions at 1.125x. The financial model, however, performs satisfactorily under a range of stress scenarios. These risks are mitigated at this rating level by the following credit strengths: • The project receives an availability-based revenue stream, with no volume or market exposure, no reliance on third-party revenues, and a relatively benign payment mechanism. • The experience and capability of Balfour Beatty and its subsidiaries in their capacities as sponsor, constructor, and facilities maintenance (FM) provider. • All individual schools will be 100% newbuild, with construction on largely vacant sites within the existing school sites. Furthermore, the project is likely to benefit from the portfolio effect of construction on various sites. • The FM service requirements are relatively simple and, therefore, are likely to be within the capabilities of the FM provider. In addition, benchmarking and market testing provides an adequate pass-through of operational risks from ProjectCo. • With the exception of the two schools mentioned above, progress on the construction is adequate to date, with a total of eight sites (accounting for 11 schools) completed so far, with works having commenced on all tranche-2 schools as anticipated. A number of minor grantorfunded variations have been executed and relations between parties continue to be positive. Construction remains on schedule for final completion and handover in October 2008. STANDARD & POOR’S EUROPEAN INFRASTRUCTURE FINANCE YEARBOOK PROJECT FINANCE/PUBLIC-PRIVATE PARTNERSHIPS Recovery analysis The secured bonds and EIB loan have been assigned a recovery rating of ‘2’. This indicates Standard & Poor’s expectation of substantial recovery of principal (70%-90%) in the absence of a guarantee in the event of a debt default. To date, however, there has been limited experience regarding default or loss in this sector. This recovery rating reflects the strong security package, covenants, and contractual features for compensation on termination that are inherent in U.K. public-private partnership (PPP) transactions. A key feature supporting this assessment is the creditor-friendly U.K. insolvency framework. Secured creditors of PPP transactions with step-in rights that have floating charges have additional advantages, because they are one of the categories of creditors that can appoint an administrative receiver to enforce security and thereby control the insolvency process. Additional features supporting Standard & Poor’s expectation of substantial recovery include the relative clarity of the termination regime (although this is largely untested), the expectation of timely repayment according to defined procedures and dates by the procuring authority, and the robust credit quality of the procuring authority as payor of termination sums. Exposure to authority credit default following termination is, therefore, minimal. Outlook The stable outlook reflects our expectation that the necessary rectification works at St. Ignatius and Wishaw Academy Primary will be completed to the satisfaction of ProjectCo and in a timely manner. If further significant delays are encountered or the rectification works are not adequately completed the outlook may be revised to negative or the rating lowered. There is currently limited scope for an upgrade. ■ NOVEMBER 2007 ■ 143
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November 2007 Infrastructure Financ
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CONTENTS Introduction STANDARD & PO
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INTRODUCTION 2007: New Challenges A
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COMMENTARY Publication Date: Sept.
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UTILITIES EUROPEAN UTILITIES Once a
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UTILITIES approach to ownership unb
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