April 12, 2012 / 9:05 PM / 5 years ago

TEXT-S&P rates to Elizabeth River Crossings 'BBB-'

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 	
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