April 12 - Overview -- U.S. public/private partnership Elizabeth River Crossings OpCo is issuing senior bonds and obtaining a federal loan under the Transportation Infrastructure Finance and Innovation Act program to build, rehabilitate, and operate a tunnel/expressway project in Virginia. -- We are assigning our 'BBB-' rating to the debt. -- We base the stable outlook on our assessment of current construction arrangements and counterparty dependency assessments. Rating Action On April 12, 2012, Standard & Poor's Ratings Services assigned its 'BBB-' rating to the $663.75 million senior-lien revenue bonds due January 2042 (issued by the Virginia Small Business Financing Authority) and to Elizabeth River Crossings Opco LLC's (ERC) $422 million Transportation Infrastructure Finance and Innovation Act (TIFIA) loan due January 2047. The outlook is stable. Rationale The rating reflects the traffic ramp-up risk, a well-mitigated construction program, and a highly leveraged financial profile. A key credit challenge for the project is the impact on existing traffic levels after establishing tolls on the Midtown and Downtown tunnels. These tunnels connect the two cities, Portsmouth and Norfolk, and run across the Elizabeth River. At the same time, the project will build a new, two-lane tunnel adjacent to the existing Midtown Tunnel, thereby doubling the capacity of the existing Midtown Tunnel. The project will also build the Martin Luther King extension expressway (MLK) that will provide links to the Midtown and Downtown tunnels. ERC is developing and will operate the project. It is wholly owned by Elizabeth River Crossings Holdco LLC, which is equally owned by Macquarie Midtown Holdings Inc., wholly owned by vehicles managed by Macquarie Infrastructure and Real Assets, and Skanska ID ERC Holdings LLC, an indirect subsidiary of Skanska Inc. ERC will build and operate the project under the terms of the Comprehensive Agreement (CA) with the Virginia Dept. of Transportation (VDOT), the owner of the project assets. The CA is in place for 58 years from financial close and we believe it provides a reasonable framework to build and operate the facilities. An unusual provision under an amendment to the CA allows VDOT to postpone tolling of the tunnels at any point up to substantial completion as long as VDOT replaces the toll revenue based calculated based on the sponsor base case less operating expenses with appropriated funds or authorized funds. Another amendment requires ERC to allow trips considered local traffic traveling on the MLK to travel for free. Based on the analysis by ARUP USA Inc., the independent traffic and revenue engineer, the impact on total project revenues is less than 1%. We have factored this into our base case. Our rating assumes that VDOT has the authority to grant to the project the right to collect toll revenues and opinions are being issued by the Virginia Attorney General's office on behalf of VDOT and Hunton & Williams LLP, counsel to the project, to that effect. The project is funding construction and rehabilitation work with bond proceeds, the TIFIA loan, a contribution from VDOT, sponsor equity, and expected toll revenues on the existing tunnels during the five year construction phase. All funds are committed at closing, except the expected toll revenues; the lack of full funding at closing is a credit weakness. The TIFIA debt is meant to provide greater credit support to senior debt, by having provisions that permit deferral of payments for principal and interest. Under this loan structure, there are no TIFIA interest payments until 10 years after financial close, and from years 11 to 18 only a portion of the interest payments are mandatory. TIFIA principal payments begin in 2037, 25 years after financial close. The TIFIA loan payments come after senior debt service in the payment waterfall. However, in our analysis of financial performance, we examine cash flow coverage of both the senior secured and mandatory TIFIA loan payments because the distribution test is after the TIFIA loan payments in the waterfall and failure to make two mandatory TIFIA payments, along with a project bankruptcy filing can lead to default that cross-defaults to the senior debt. The project has the following risks: -- The project is exposed to traffic volume risk that is tied to regional and economic trends, including ramp-up and uncertain long-term growth trends. -- The construction program is a large, complex project and, given the degree of specialization, the replacement market for a new design build (DB) contractor is limited. -- The risk that construction costs are not fully funded at financial close because about 17% of sources are coming from net toll revenue collected during the construction period. -- Uncertainty regarding people's willingness to pay the toll. While tunnels and other area facilities had tolls, they were removed more than 20 years ago and the region does not have recent experience with tolled facilities. We believe this factor will affect the toll ramp-up, which we have considered in our base case. The 'BBB-' rating reflects the following strengths: -- Strong existing demand for the Midtown and Downtown tunnels, which are currently untolled and are used primarily by passenger cars commuting to and from work. While there are competing alternatives, these are equally congested during peak hours. -- The tunnels are in the Hampton Roads region, an employment and residential center dominated by stable U.S. Navy and port employment and sound healthcare and tourism sectors. -- Construction risk of the new Midtown Tunnel is mitigated by using commercially proven technology and building processes, performed by experienced, top-tier design-build (DB) contractors. -- The tolling technology is commercially proven and readily available. Federal Signal Technologies is the tolling contractor and is capable of installing and operating the all-electronic toll system. In addition, there is a deep market for replacement contractors if needed. We believe a key risk is the uncertainty about the initial traffic volume and the level of traffic reduction at the existing tunnels once tolling begins. ERC is establishing an all-electronic toll collection infrastructure on the Midtown and Downtown tunnels by September 2012, with a modest initial toll rate of $1.84 during peak periods and $1.59 for passenger cars during off-peak. In addition, we believe the ramp-up period will be longer than the sponsor's base case, and the sponsor's long-term growth rate, a key driver to future project revenues, is aggressive. Standard & Poor's base case adjusts for these aggressive assumptions. Under our base case, we believe average annual daily traffic will decline by 44% in 2012 when tolls go into effect, compared with a 28% decline under the sponsor base case. Our assumptions include a 12-month toll rate ramp-up and a six-month traffic ramp up. Our long-term growth rate averages 1.3% from 2016-2045, lower than the 1.5% growth rate under the sponsor's case. One reason for our lower initial traffic is we assume a lower number of electronic toll collection transactions and higher number of video toll transaction with a toll rate that is double the electronic rate. This difference creates a higher average toll rate and drives more users to the free alternatives. Traffic at the tunnels grew by an average rate of 1.5% from 1993 through 2010, slower than the region's employment and population growth. Traffic growth was relatively stable during the period of heavy military spending. Tunnel users are primarily commuting passenger cars (about 60% during peak hours) in the Hampton Roads region, providing sound demand for the tunnels with limited alternatives. The U.S. Navy and port operations account for most employment in Hampton Roads, and the city also has sound healthcare and tourism sectors. During the recent recession, traffic dropped by just under 1%, mirroring regional and national trends when regional unemployment doubled to 7% and population growth was flat to declining. We expect that traffic trends will continue to reflect regional and national economic trends and also be heavily influenced by changes in the region's military bases and centers. While several bases may close over the next few years, we have assessed the essentiality of the bases and consider them to be moderately to highly essential. ERC has mitigated construction risk by passing it to the DB contractors through a fixed-priced, date-certain, DB contract with SKW Constructors, a joint venture of Skanska USA Civil Southeast (45%), Kiewit Infrastructure Co. (40%), and Weeks Marine (15%), with obligations guaranteed by Skanska AB and Kiewit Infrastructure Group Inc. The DB contract has liquidated damages provisions to provide appropriate incentive to perform and adequate liquidity under the parent guarantee to fund needs through the long stop date (final completion), or 18 months after the project reaches scheduled substantial completion. While the guarantors' credit profiles are above that of the project, the parent guarantees cover 45% of the DB contract, not the full value of the construction works. However, we concluded that ERC can replace SKW and meet the requirements under the CA. Therefore, under our counterparty criteria, the project rating is not linked to the assessment of the DB contractor. Construction is not fully funded at financial close and will rely on a portion of net toll revenues for $368 million, or 17%, of total funding generated during the six years of construction. The sponsor is providing a $50.6 million letter of credit to backstop a shortfall in toll revenues. Starting with our base case, if traffic declined by another 24%, the full letter of credit would be drawn and construction and reserve funds would still be fully funded. Under our base case, the minimum debt service coverage ratio (DSCR) of senior obligations and mandatory TIFIA loan payments is 1.48x, with an average of 1.93x, and will average 1.79x during the senior debt's term. Additionally, all except for $1 million of the contingent equity is used to fund the construction works. If the project delays toll implementation for six months, then the minimum DSCR drops to 1.15x. We believe the project can withstand several downside stress scenarios. Under our downside stresses, including changes in inflation, operating and capital expenses, toll escalation, and competing facilities, cash flow is able to cover project obligations, and fund the construction and reserve funds. Liquidity The project's level of funding is adequate, and funds the reserves slightly higher than similar projects. Lenders can access a debt service reserve fund that will get funding at financial close at an amount equal to the next six months of senior debt service and mandatory TIFIA loan payments. In addition, the project has a major maintenance reserve that initially is required to be funded for the projected requirements for the period between substantial completion of the new project assets and 10 years after financial close. In year 11, the requirements change to a four-year rolling need, in line with other similar projects. Outlook We base the stable outlook on our assessment of current construction arrangements and counterparty dependency assessments. A higher rating is not likely during construction, even if counterparty ratings increase, based on the construction, ramp-up, and operating risks. After construction, an improvement in the rating would require comfort that performance would well exceed our current expectations over the debt and loan's tenor. Factors that could lower the rating are major construction problems that seem remote presently, the debt service or major maintenance funds are not fully funded at substantial completion, or the initial traffic is significantly lower than our base case. Related Criteria And Research Project Finance Construction and Operations Counterparty Methodology, Dec. 20, 2011 Updated Project Finance Summary Debt Rating Criteria, Sept. 18, 2007 Ratings List New Rating Elizabeth River Crossing Opco LLC (obligor) $422 million debt BBB-/Stable Virginia Small Business Financing Authority $663.75 mil senior lien revenue bonds BBB-/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. Use the Ratings search box located in the left column.