oWhile U.K.-based special-purpose entity Connect Plus (M25) Issuer plc has sufficient liquidity to finance its budgeted lifecycle program, it is behind on spending. Given exceptionally large investments planned for the fiscal year ending March 31, 2021 (FY2021), we expect the gap between budgeted and actual spending will widen.
oThe failure to spend the budgeted amounts raises questions as to the reliability of the lifecycle plan, and availability of funding toward the end of the project's life, especially given the lifecycle's front-heavy budget.
oFurthermore, we see a risk that the project's annual debt service cover ratio (ADSCR)--from which we exclude manual working capital adjustments the project's includes in reported ratios to smooth the effect of cash flow variability--could drop to or below 1.40x in FY2021-FY2022.
oWe are therefore revising our outlook on the bonds issued by Connect Plus (M25) Issuer to negative from stable, while affirming our 'A+' long-term issue rating.
LONDON (S&P Global Ratings) --S&P Global Ratings today took the rating actions listed above.
In August 2018Connect Plus (M25) Issuer issued £892.6 million senior secured fixed-rate bonds due March 31, 2039. The issuer on-lent the proceeds to the limited-purpose entity Connect Plus (M25) Ltd. (ProjectCo, CP) primarily to refinance commercial loan facilities and to unwind interest rate hedges.
The ProjectCo was incorporated to design, finance, and implement significant improvement works on London's main ring road network, the M25 Motorway. It operates the network under an availability-based private finance initiative (PFI) concession that was awarded in 2009 and expires in September 2039. The M25 comprises a 200-kilometer (km) ring road around London, about 200 km of radial trunk roads, and several complex structures, including the Dartford Crossing, which crosses the River Thames to the east of London. The network's trunk roads facilitate access to Heathrow, Gatwick, Stanstead, Luton, and London City airports. The geographic area inside the M25 Motorway is home to a population of about 9 million, making it one of the busiest road projects around one of Europe's largest metropolitan areas.
oThe availability-based payment mechanism reduces operating risk and supports cash-flow stability.
oThe ProjectCo has demonstrated a stable operational track record of about 11 years.
oThe ability to pass down the O&M risks and deductions to the operations and maintenance (O&M) joint venture (JV), thereby providing predictability and stability to cash flows to the ProjectCo.
oBespoke handback reserve mechanism mitigates handback risks at the end of the concession.
oThe complexity of the structures increases the risk that major maintenance (lifecycle) cost could exceed long-term budgets.
oHigh traffic volumes and frequent congestion complicate operations and maintenance works.
oHandback requirements expose the ProjectCo to the risk of higher-than-expected costs during the last five years of the project.
We have revised the outlook to negative given our concerns about reliability of the lifecycle plan.
The project has a history of being unable to spend budgeted amounts, mainly due to operating constraints. According to management, operational constraints will probably keep lifecycle cash spending below £75 million in the year to March 31, 2021. Having consistently deferred part of budgeted costs from one year to another, as of March 31, 2020, the project carried forward £15.3 million of underspending. We expect the gap between budgeted and actual spending will widen, given for FY2021 the project has budgeted to spend about £91 million. This includes about £69 million for: pavement and structural works, other reprioritized critical elements, work on road markings and studs, as well as lightning and tunnel and electric works, which turned out to be more complexed than expected. The amount includes also about £7 million for Gade Valley Viaduct repair works, and the carried forward lifecycle underspending. After the Gade Valley works are concluded in FY2023 and the carried over lifecycle costs spent, the project expects lower annual spending typically of £40 million-£50 million.
In our opinion, the project's failure to spend the budgeted amounts raises questions as to reliability of the lifecycle plan. Given the budget is front-heavy, it creates uncertainty as to availability of sufficient funding for the lifecycle later in the project's life, when the forecast expenditure is lower. It also undermines our confidence in the assumptions that underpin our calculation of the project's credit metrics.
The credit metrics under our base case are lower than reported by the project, because we exclude from ADSCR the manual working capital adjustments that the project includes in reported ratios to smooth the effect of variability of cash flows. It is unclear whether the project's contractual definitions of net cash flows and project revenue for the purpose of ADSCR calculation allow for inclusion of such intraperiod cash movements. The documentation does allow for the project's financial model be modified, among other reasons, "to correct any material deficiencies in the Financial Model; or to take account of any additional assumptions which it considers should be incorporated into, or assumptions which it considers should be deleted from, the Financial Model so that the accuracy of any Forecast may be improved." The modifications require lenders approval. Although the project discloses the ADSCR calculation to lenders, we have not received evidence of explicit approval of these adjustments.
The project's manual working capital adjustments do not have impact on our view of its credit quality. This is because the ADSCRs under our base-case and downside scenario are calculated according to our criteria. Cash flow available for debt service is calculated strictly as operating revenue less operating and maintenance expenses. As an operating cash flow number, it excludes any cash balances that a project could draw on to service debt, or cash balances that are not required to be kept in the structure. We forecast ADSCR in March 2021 at 1.41x (calculated under our criteria). As of March 2020, the project reported ADSCR of 1.83x (calculated including manual working capital adjustment). Under our calculations, we assess the preliminary operations phase stand-alone credit profile (SACP) at 'a-'.
The project displays strong resilience under our downside scenario, maintaining coverage well above 1x while retaining substantial contractually required liquidity. We add a notch to reflect this strength under the downside.
We also recognize that in addition to required reserving, the project retains the unspent amounts for delayed lifecycle works in the major maintenance reserve account (MRA). By reserving and carrying forward the unspent amounts in the MRA, the project's management ensures cash will be available for these works when they can be delivered in the future, rather than distributed. This is because any withdrawals from this account require consent from the lenders' agent. We reflect availability of this additional cash by adding a notch under our comparable rating adjustment (CRA) to the project's preliminary operations phase SACP.
The negative outlook reflects a risk of ADSCR weakening to below to or below 1.40x, at what point we could lower the rating. Specifically, we believe this could happen in FY2021-FY2022 when the project has its highest budgeted lifecycle expenditure.
We could also lower the rating if operating performance falls short of requirements under the concession agreement and the ProjectCo is unable to pass through the consequent performance deductions to the O&M JV in a timely manner. An update to our macroeconomic assumptions could also cause weakening of the credit metrics.
We would revise the outlook to stable if the ProjectCo and the O&M JV continue to deliver routine O&M satisfactorily, lifecycle works are managed in line with the budget, and the project's financial risk profile demonstrated a minimum ADSCR above 1.60x.
We are unlikely to raise the rating, since this would require a significant increase in the projected minimum ADSCR under our base case, which we consider unlikely. This is because the contractual framework limits the possibility for higher revenue without associated increases in costs. There is only limited potential for the ProjectCo to achieve significant cost savings without passing those through to the O&M JV.
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oConnect Plus (M25) Issuer plc, Nov. 6, 2019
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