S&P Global Ratings rates 30 Canadian public-private partnership (P3) projects, including 11 health care P3s with construction and operations and/or maintenance risk, totaling ~C$ 3.7 billion of debt. Of our portfolio in Canada, 73% has an 'A' category rating and just two ratings are on negative outlook.

At S&P Global Ratings we analyze the creditworthiness of health care P3 projects using our "Project Finance Framework Methodology," published Sept. 16, 2014, and "Key Credit Factors For Social Infrastructure, Accommodation, And Entertainment Project Financings," published Sept. 16, 2014.

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All health care P3s in our portfolio are availability-based and now operational. Compared to other infrastructure asset types, availability-based social infrastructure projects tend to have a stable rating performance. A 2021 study on Annual Infrastructure Default and Rating Transition (D&R) by S&P Global Ratings confirms this. Between 1981-2020, there have been 64 upgrades and 76 downgrades in social infrastructure, leading to a low downgrades/upgrades ratio of 1.19x, second only to oil & gas within the infrastructure group. We note that this ratio has increased from 0.9x in our 2019 D&R study, primarily due to COVID-19's impact on volume-exposed assets within our social infrastructure group, such as stadiums and hotels.

Table 1

Similarly, our Canadian P3 portfolio, including hospital projects, has largely remained stable, as ~87% of our portfolio is availability-based. Thus, they benefit from a fixed revenue stream and well-defined contractual performance objectives with straightforward operational requirements and risk transfer. What has also worked in their favor is the collaborative approach adopted by the concessionaire and private industry to ensure steady asset performance, even against the backdrop of a rare event like the pandemic.

In this report we dive further into the performance of our 11 rated hospitals.

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Larger Size, Longer Ramp-Up, And Operational Challenges Drive Risks

Availability-based projects are inherently devoid of market risk as the project company receives a fixed (inflation-linked) payment from its government counterparty that covers its capital and operational costs.

Operational responsibilities can be classified as hard facilities management (hard FM), soft facilities management (soft FM), clinical services, and lifecycle management. Most hospital project agreements involve a drop down of hard FM and lifecycle management services from the authority to the project company. These operational services are bound by performance standards under the concession agreement and expose the project to penalties/deduction payments for failing to match these. Historically, hospital projects have displayed stable operational performance in terms of penalties assessed, which have been at the lower of end of our downside assessment (of typically 1% of capital payment) for most of them.

In addition to monetary deductions, the project can incur failure points for unavailability events and quality or service failures. The project agreement specifies various failure-point thresholds that, once reached, will lead to increasingly severe consequences, beginning with warning notices, and escalating to remedial rights, subcontractor replacement, and ultimately a possible project default. Having said that, at the time of financial close the lenders' technical advisor (LTA) usually opine that they expect deductions to be much lower than the prescribed thresholds for our hospital portfolio. In fact, we observed that a breach of these thresholds has been infrequent, and provide some examples where they did occur in table 2 below.

To rationalize performance irrespective of a hospital's size and complexity, we measure deductions as a proportion of capital payments. Based on our review of the rated portfolio, two key takeaways about deductions are as follows.

1. Asset size and complexity matters

Larger hospitals providing critical/acute care services to the public tend to have higher operational risks when compared to smaller health care facilities or those providing primary or secondary care. Three of the 11 hospitals in our portfolio have an asset size greater than the portfolio average. Each of these facilities witnessed significantly higher deductions as a percentage of their capital payments since the start of operations when compared to the portfolio average.

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The majority of hospitals, irrespective of size or complexity, face availability failures under hard FM due to elevator breakdowns. Gauged by performance standards defined in concession agreements, elevator failures have a tight timeline for resolution. As there are only a handful of elevator maintenance subcontractors in the marketplace (think Kone (unrated), Otis Worldwide Corp.), in most cases the restoration of elevator services falls outside the timeline prescribed in the contract, leading to failure points and consequentially associated penalties.

Similarly, temperature, humidity and pressure level issues have challenged a handful of hospitals particularly in shoulder seasons like spring when the heating is switching over to cooling, or vice versa in fall. Temperature maintenance related deductions are more common for rooms such as ICUs and thus the concession has narrow tolerance for temperature variance.

2. Ramp-up phase is the critical one

Contractual provisions in Canada's P3s are usually similar and provide for a bedding-in phase at the beginning of operations, whereby failure points assessed against service, quality, and availability failures are waived fully/partially in the first few months. Regardless, we observe that service failure penalties tend to peak during the ramp-up period after operations have commenced. Data indicates that a sizable portion of service phase penalties occur within the first three years of operations commencement.

Notably, penalties recorded were in the range of 0.6%-1.4% (as a percentage of capital payments) in the first five years, generally in line with our downside assumption of 0.5%-1.0% and reducing to 0.2% or below thereafter. However, if operational challenges persist, we may take a rating action depending on gravity of the issue; for example, the potential event of default that led to the one notch downgrade of NOH on Dec. 14, 2016. The chart below represents how operational challenges tend to ease over the asset life as management garners a deeper understanding of the asset functionality and contractual requirements.

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Notably, NOH experienced significant performance issues during its ramp-up. Following substantial completion, service problems led to failure points breaching the monitoring notice threshold under the project agreement (PA), which in turn caused an event of default (EoD) under the service agreement. As the breach was not cured in 30 days, it triggered an EoD under financing documents. Subsequently, the project was able to implement performance improvement measures and was supported by lenders, who agreed to an EoD waiver and raised the cure period duration to 120 days. HHSC also granted additional time to rectify the issues and temporarily suspended failure points. NOH continues to face temperature, pressure, and humidity control issues, albeit at much lower scale.

Healthy Collaboration Mitigates Operational Challenges

Canadian P3s in our portfolio have benefitted from good relationships with their contracting authority. In line with the view of market participants, we believe this is a direct consequence of a commitment in Canada to resolve issues through collaboration. For most of the hospital P3s in our portfolio, we observe that the authority is not excessively punitive in events involving a breach of failure point thresholds. There have also been instances wherein the authority granted a waiver for the breach.

Some of the more pertinent cases for effective collaboration efforts are NOH, THP Partnership, and Integrated Team Solutions PCH, as highlighted in table 2 below.

Indeed, we can attribute performance across some assets to whether the concession provider's relationship with concessionaire is strained or supportive. For example, in case of THP Partnership, where we view the relationship between the project and concession provider is strong, the concession grantor waived deductions related to service/availability failures for a period when the service provider was performing preventive maintenance. Whereas in the case of Plenary Health Care Partnerships Humber LP, it was assessed deductions for service/availability failures during preventive maintenance period.

Table 2

Robust Asset Condition And Lifecycle Management

Lifecycle management is a critical component of P3 concessions, which usually span decades and thus necessitate proper asset maintenance. Given how critical lifecycle management is, Canadian P3s have contractual provisions that ensure the service provider spends adequately and in a timely manner to maintain the asset. Refer to "Canadian P3 Lifecycle Risk: “Ticking Time Bomb” or Dud?", published Nov 18, 2019, for some of the common provisions observed in the case of hospital projects we rate.

Moreover, projects also undergo a Joint Technical Review (JTR) performed by an independent consultant, to ascertain the facility condition usually every five years. For a handful of hospital projects that have undergone the JTR, the consultants have favorably opined on the facility condition and noted that the level of maintenance and lifecycle work performed is generally consistent with the age of the asset. Also, in the event of consultant observations leading to remedial work, the associated cost is borne by the service provider thus de-risking the project.

Table 3

Counterparty Credit Risk Can Weigh On P3 Credit Quality

While market participants consider Canada's implementation of the P3 model a success generally, the model has also drawn criticism for issues such as inadequate procurement practices, poor risk management, and inability to deliver returns. More recently, the discussion was revived as Carillion PLC and Bondfield Construction Co. Ltd. were liquidated.

Contractual arrangement of hospital projects typically includes a dropdown of operational and lifecycle management responsibilities to the project companies, which in turn may pass on these responsibilities and associated risks to service providers or decide to self-perform. In our rated portfolio, operational risk is mostly passed through to reputable, credit-worthy facility management organizations such as Honeywell Inc. and Johnson Controls Inc. However, while the operations and maintenance contract insulates the project from underperformance, it also exposes the project to counterparty creditworthiness risk.

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Appendix

Table 5