November 21, 2017 / 5:06 PM / a month ago

Fitch Downgrades Derby Healthcare's GBP446.6m Bonds to 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) LONDON, November 21 (Fitch) Fitch Ratings has downgraded Derby Healthcare PLC's (DHC) GBP446.6 million bonds, maturing in 2041, to 'BBB-' from 'BBB'. The Outlook is Stable. The rating action reflects a realignment of DHC with its peers and the debt metrics guidance in Availability-Based Projects Rating Criteria as well as the underlying short term volatility of the debt service coverage ratio (DSCR) when excluding the non-contractual cash cover ratio smoothing mechanism. KEY RATING DRIVERS The 'BBB-' rating reflects stable availability-based revenues from a creditworthy counterparty and low cost risk due to pass-through to contractors. The project's stability is evidenced by robust operational performance with minimum deductions and strong relationship shown between all parties. The rated debt is senior, fully amortising and benefits from adequate reserving mechanisms. The average projected Fitch-calculated DSCR is 1.22x with a minimum of 1.15x, which positions the rating at the lower end of Fitch's indicative 'BBB' rating category range of 1.20x-1.35x for availability-based projects with moderate cost volatility and without detailed cost analysis. DHC's debt metrics are below higher-rated peers such as Meridian Hospital PLC's (BBB+/Stable) average DSCR of 1.51x. Revenue Risk: Stronger Revenue is derived from a unitary charge paid by Derby Teaching Hospitals NHS Foundation Trust (Trust) that is based on a well-defined performance regime and subject to deductions for adverse performance across the services provided (hard facilities management (FM), soft FM and sterile services). The project continues to present low levels of deductions. The unitary charge features some inflation-linkage and is divided into portions that fluctuate with the corresponding costs. Fitch's assessment of the Trust's payment obligation towards DHC does not constrain the rating. Cost Risk: Midrange Overall cost risk is assessed as Midrange given the assessment of the following elements: Scope risk - Midrange DHC is a large single-site hospital, mostly new build but with some pre-existing facilities. Derby Hospital's technical complexity is assessed as moderate, with the project company being responsible for part of the O&M and full scope of lifecycle responsibilities, which has some concentration. Cost predictability - Midrange The company's management and the sponsors have strong experience in the sector. The technology is established and performance has consistently been strong. These considerations mitigate the lack of detailed cost analysis from a technical advisor. Cost volatility and structural protection - Midrange Cost volatility risk is mitigated by back-to-back benchmarking/market-testing provisions and a fixed contract for soft FM linked to inflation. Hard FM costs are also fixed contract and linked to inflation, but cost risk on benchmarking/market-testing is retained by DHC. Life cycle costs risk, which also lies with the project, is mitigated through five-year reviews subject to scrutiny by the technical advisor and the benefit of a three-year maintenance reserve account (MRA). Debt Structure: Stronger The rated bonds are senior, fixed-rate and fully amortising, with a two-year tail to concession maturity. In addition to the MRA, the project also features a six-month debt service reserve account and a change in law reserve. Financial Profile Fitch base case and rating case do not include any cost stresses due to the lack of cost stress analysis from the technical advisor. Instead, we increase the relevant metrics threshold to 1.2x-1.35x from 1.15x-1.3x in line with rating criteria for projects with moderate cost volatility but with no detailed realistic outside cost (ROC) assessment supported by a technical advisor. Fitch-calculated minimum and average DSCRs are 1.15x and 1.22x respectively, which position the rating at the lower end of Fitch's indicative 'BBB' cover ratio range of 1.20x-1.35x. The project benefits from a positive track record of operations, the hard FM, lifecycle & SPV operating cost break-even ratio is robust at 42% and pass-through to the Trust on benchmarking of soft FM costs limits the risk of future increase in costs. DHC's bonds benefit from a financial guarantee provided by MBIA Assurance S.A. Fitch does not assign any credit to the guarantee as it does not maintain a rating on the guarantor and therefore the rating of DHC's bonds solely reflects the project's underlying credit quality. Peer Group DHC shares the same key sponsor (Innisfree) and soft FM provider (ISS) with Meridian Hospital Company PLC, its closest Fitch-rated peer. Meridian has stronger metrics with an average DSCR of 1.51x, justifying the higher rating. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action: -Projected average DSCR consistently above 1.25x. Future Developments That May, Individually or Collectively, Lead to Positive Rating Action: -Projected average DSCR consistently below 1.15x, possibly as a result of a sustained increase in project costs (e.g. lifecycle costs); -Persistent material deductions and disputes or a major breakdown in relations between DHC, the Trust and other major project parties; and -Failure to undertake active and forward-looking treasury management as per management plan. Performance Update DHC's performance in 2017 was positive. Performance deductions continue to be higher than in previous years but remain at minimal levels. The relation with the Trust is reported as constructive and trouble-free. Treasury management operations continue to be aimed at reserving cash in excess of what is contractually required to minimise the risk of liquidity stress in the future. This highlights the project's tight financial coverage as well as management's active and forward-looking approach to dealing with potential issues. Transaction Summary DHC in 2003 entered a 40-year concession into a private finance initiative with the Trust to build a new acute hospital and refurbished other retained facilities. Construction was certified as finished in 2009. DHC is now responsible for maintenance and facility management services to the Trust. Contact: Primary Analyst Kim Locherer Director +44 20 3530 1918 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Christiane Kuti Director +44 20 3530 1396 Committee Chairperson Ian Dixon Managing Director +44 20 3530 1815 Media Relations: Rose Connolly, London, Tel: +44 203 530 1741, Email: rose.connolly@fitchratings.com. 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