Moody’s Ratings (Moody’s) has today downgraded to Baa1 from A3 the underlying and backed senior secured ratings of the GBP163 million index-linked senior secured bonds due 2043 (the Bonds) issued by BY Chelmer plc (ProjectCo or BY Chelmer). The outlook was changed to negative from stable.
The rating downgrade comes after Service Failure Points (SFPs) for the project breached a Warning Notice threshold under the terms of the agreement (the Project Agreement) between ProjectCo and the Mid and South Essex NHS Foundation Trust (formerly the Mid Essex Hospital Services Trust; the Trust).
RATINGS RATIONALE
The rating downgrade reflects the risks to ProjectCo of increasing SFPs. These result in financial deductions and may give the Trust the right to issue Warning Notices which, in the case of persistent failure, can lead to termination under the Project Agreement. The rating action also takes into account the risks and potential costs (including potential revenue losses) to ProjectCo of a recent fire stopping and door survey and a potential legacy construction defect.
After appointing an independent third-party consultant, P2G LLP (P2G), to monitor operations at the hospital, the Trust began challenging ProjectCo’s reporting of performance of estate and helpdesk services by the FM Contractor appointed by the project vehicle. Following P2G’s appointment, SFPs were found to have breached the estates Warning Notice threshold of 3,600 points in November 2023. Moody’s understands that ProjectCo does not expect the Trust to issue the corresponding notice but it will, nevertheless, be entitled to make deductions from its payment under the Project Agreement.
Moody’s also understands that while self-reported SFPs have been below the Project Agreement warning notice thresholds except in November 2023, the SFP levels and associated deductions for the months from August 2023 could yet be revised as they are still to be agreed with the Trust. ProjectCo advises that they have held workshops involving all parties and are trying to reach an agreed position.
ProjectCo is able to pass deductions made by the Trust due to facilities management performance failures to the FM Contractor but subject to liability caps and the project vehicle is exposed to the risk of persistent shortfalls. In addition, the Project Agreement gives the Trust the right to terminate if there are 10 or more warning notices for estate and helpdesk failures in any rolling six-month period and a further 5 notices in the subsequent 3-month period.
The Trust has recently carried out a fire stopping and door survey. The findings are currently being reviewed by ProjectCo. The extent of necessary work and the potential costs are not yet clear but identified issues could result in further payment deductions under the Project Agreement and remediation costs for ProjectCo, should they not be fully borne by the FM Contractor, to the detriment of its liquidity and financial profile.
Furthermore, and as part of the end of defect liability period surveys, investigation of a potential defect on the hospital façade is ongoing. ProjectCo reports that this defect is expected to be low risk but could require remedial works. Moody’s understands that a Standstill Agreement extending the Construction Contractor’s defect liability period with regard to the façade is in place until July 2024. ProjectCo expects this period to be further extended until investigations and works are completed, and the cost of these works to be borne by the Construction Contractor.
There is currently uncertainty as to which, if any, contractual remedies the Trust may seek to pursue as a result of the survey findings or the façade defect. However, if they were to include significant deductions, these could weaken ProjectCo’s liquidity as the liability caps of the FM Contractor are substantially lower than those in other comparable PFI hospital projects: these include an annual and a cumulative hard FM liability cap of 30% and 100%, respectively, of the annual hard FM fee.
In addition to the above, the ratings also remain constrained by ProjectCo’s high leverage, which reduces its ability to withstand unexpected stress linked to potential revenue deductions and/or increased costs. The ratings continue to benefit from: (1) the long-term project agreement (the PA) between BY Chelmer and the Trust; (2) the availability-based revenue stream and stable cost profile under its contractual arrangements; (3) a range of creditor protections included within the financing structure, such as debt service, change in law and lifecycle reserves; and (4) our expectation of a high level of recovery for senior creditors in the event of any default by BY Chelmer.
