Fitch Maintains Rating Watch Negative on Kentucky Wired Infrastructure Company's Senior Revs.
--Approximately $232 million senior tax-exempt revenue bonds series 2015A;
--$58 million senior taxable revenue bonds series 2015B-1 and 2015B-2.
KEY RATING DRIVERS
Fitch's maintenance of the Negative Watch reflects continued uncertainty regarding the execution of a global settlement agreement among the Commonwealth of Kentucky (the Commonwealth), the concessionaire, and the design build (DB) contractors. Fitch views positively the Memorandum of Understanding (MOU) signed on March 30, 2018 by the Commonwealth and the concessionaire as it appears to address key issues and remedies outstanding supervening events by extending the project's construction schedule and covering added costs. All parties are currently moving toward finalizing the global settlement terms; however, terms of the funding remains a key issue. The Commonwealth has already paid $2 million of the $88 million owed under the MOU using available project liquidity. The Commonwealth continues to make availability payments to the project and has not disputed its responsibility to provide relief.
Extended Construction Duration, Sufficient Security Package - Completion Risk: Midrange
The medium-scale project benefits from a DB joint venture (DBJV) of experienced contractors, including Black & Veatch and Ledcor, with a joint and several liability. The contract is fixed-price with DB requirements passed down to the DBJV via the project agreement (PA). Cost and scheduling budgets were originally deemed in line with market standards by the technical advisor (TA), but construction will likely span several more years as a result of the pole attachment agreement, make ready construction, permitting, and easement delays.
Delays and potential cost overruns are currently expected to be mitigated via supervening events under the PA. Inadequate scheduling and cost relief from the Commonwealth could result in a downward revision to Weaker from Fitch's current assessment of Midrange. The project's security package, which contains a 40% limitation of liabilities (including a 10% liquidated damages cap) and 10% LOC, is not currently expected to be meaningfully eroded and should be sufficient to mitigate reasonably stressful scenarios such as simultaneous contractor default.
Limited Scope, Pass-Through Capex - Cost Risk: Stronger
Higher levels of cost predictability are made possible by the project's relatively limited scope of operations, established technology, and self-performed O&M by experienced operator, Ledcor, via the Services Contract in three 10-year contracts. Capital expenses in the form of replacement equipment and system upgrades will be mutually agreed upon by the Commonwealth and project company and fully compensated via an adjustment in the availability payments. The absence of lifecycle reserves is mitigated by the project's ability to fully pass-through capital expenses to the Commonwealth.
Payments Supported by Strong Counterparty - Revenue Risk: Stronger
The project's financial position is supported by availability payments from the Commonwealth (A/Stable), a financially strong counterparty. In Fitch's view, the project's contractual provisions establish strong incentives for grantor performance, involving strong compensation for debt and potentially equity under a voluntary termination scenario. Deduction exposure is deemed minimal as a result of modest performance requirements under the Service Level Agreements (SLAs) and cure periods for deduction events are considered adequate.
Conservative Structure, Adequate Reserves - Debt Structure: Midrange
The project's conservative debt structure features all senior, fully amortizing, fixed-rate debt with a flat debt service coverage ratio (DSCR) profile through final maturity in 2044. The reserve package is adequate with a debt service reserve fund equal to six months of debt service. Covenants are strong, evidenced by a forward and backward looking equity distribution test of 1.10x DSCR and required rating affirmation in order to issue additional senior parity debt.
Fitch's rating case assumes a 10% increase to O&M costs, a 5% increase to insurance costs and no special project vehicle (SPV) cost increases, per the TA's assessment of the project's realistic outside cost (ROC), for an all-in ROC of approximately 7.3%. The rating case yields solid average and minimum DSCRs of 1.2x. The project's 42% all-in O&M breakeven and all-in ROC lends to a ROC multiple of over 5x, which could be somewhat uplifted by the project's ability to rebid and adjust for increased costs at the time of each O&M contract renewal.
Fitch-rated peers include NYNJ Link Borrower LLC (BBB/Stable) and Portsmouth Gateway Group (PGG, A-/Stable), which share stronger revenue risk and similar base case DSCR profiles. PGG's higher rating is explained by its robust ROC multiple of over 16x, while NYNJ's rating is capped at 'BBB' as a result of a relatively weaker security package than peers.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action:
- Failure to obtain a finalized global settlement that adequately protects the project from further delays and provides sufficient funding to complete works within the allotted timeframe could result in a collapse of the deal and lead to a multi-notch downgrade;
- Credit deterioration of project counterparties and/or failure to maintain adequate liquidity to support obligations, which weakens risk mitigation within the project.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action:
- Achievement of a finalized global settlement that extends the construction schedule without significantly shifting risk of supervening events to the project company would result in an affirmation of the 'BBB+' rating and assignment of a Stable Outlook.
Since Fitch's last review, the project (through the Kentucky Communications Network Authority) received $110 million in bonding authority on April 14, 2018 through budget bill SB 200 to cover costs for the settlement agreement and to provide contingency for potential project costs. The borrowing authorization in SB 200 provides a mechanism for the commonwealth to pay $88 million owed under the MOU reached between the commonwealth and various project parties to address outstanding supervening events under the project agreement. Additionally, a MOU on the proposed settlement was reached on March 31, 2018 and all parties have agreed to extend the MOU validity period, which was initially set to expire on July 6, 2018, as negotiations are still ongoing. The Commonwealth has already paid $2 million of the $88 million owed under the MOU using available project liquidity. All parties are currently moving towards finalizing the global settlement terms.
A new target system completion date is expected to occur on or around October 2020, which is the agreed upon date based on the settlement agreement negotiations but is not yet the official amended target system completion date. In Fitch's view, the continued flow of availability payments and available bond proceeds will allow for operating, construction, and debt service expenses to be met so long as the project receives an extension of the system completion date. Fitch considers it imperative that the finalized settlement agreement includes a reasonable extension of the system completion date as well as the ability to trigger additional supervening events to the extent the agreed upon schedule is insufficient due to further third-party delays.
Fitch expects to receive additional details about the global settlement and related funding in the coming months as the parties move closer to finalizing settlement terms. The Commonwealth continues to be supportive of the project and pay availability payments, and there have been no material performance issues on the part of the DBJV, which should allow for resolution to be reached. A granted extension which results in an ambitious construction schedule with inadequate Commonwealth funding for cost overruns to realistically support works by the new long stop date would be considered materially adverse to the project company and would likely cause a downgrade of the rating as risk which was originally understood to be absorbed by the Commonwealth under the PA would ultimately be absorbed by the project company. Conversely, an extension of the construction schedule and a funded settlement agreement, without meaningful reallocation of risk, would result in an affirmation of the rating at 'BBB+' with a Stable Outlook.
Fitch has made no changes to the project's projected financial profile as an updated model has not yet been received. Fitch adopted the sponsor's base case as Fitch's base case and applied a 10% ROC to all O&M costs, a 5% increase in insurance costs, and no increase to SPV costs (due to view of control for such costs) in its rating case, for an all-in ROC of approximately 7.3%. As a result, Fitch's base and rating case average DSCRs are 1.3x and 1.2x, respectively. The project's model indicates the financial structure can withstand a 42% increase in O&M costs (draining the debt service reserve) before breaking even over the first 10 years of operation, which yields a ROC multiple of over 5x. The project's DSCR and ROC multiple profiles are on the cusp of 'BBB' and 'A' category in comparison to guidance within Fitch's availability payment criteria, explaining the original 'BBB+' rating.
The Next Generation Kentucky Information Highway is a modern, primarily aerial high capacity fiber network within the state of Kentucky. Fiber optic cable will span 3,393 miles and is designed to connect 1,097 sites, including K12 schools, public universities and Commonwealth facilities within Kentucky's 120 counties to high speed, high capacity broadband internet services. All secured obligations have a security interest in the borrower's right, title, and interest in its assets (subject to exclusions), including the right to availability payments and other payments due or to become due under the project agreement.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Date:||Jan 1, 2019|
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