Infrastructure Newsletter - · PDF fileInfrastructure Newsletter ... Discussing Spreads – Construction Risk Premium ... arose largely due to similar actions taken on the project’s

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Infrastructure Newsletter October 2013

....>..Canada 5 Year Yield 1.73% ………>..Canada 10 Year Yield 2.42% ………>..Canada 30 Year Yield 3.03% ………>..

In September, the Canadian market welcomed pleasant news in the form of successful new Project

Finance issues. Unfortunately October ushered in negative news by way of credit rating events… That

being said, the negative news was offset by yet another PPP project successfully reaching substantial

completion on time and on budget. On October 8th, the Province of Quebec announced that the team of

Accès Recherche Montreal (Fiera Axium, Meridiam, Pomerleau and Verreault) achieved this feat for the

CHUM Research Centre (“CRCHUM”) project. The bonds associated to the $470M project were issued

in May 2010 and amounted to $334M. Over and above strictly reaching substantial completion, the

project is interesting as it demonstrates that even smaller, more local, contractors can successfully win

and deliver large scale PPP projects.

Discussing Spreads – Construction Risk Premium

This section builds upon the discussion most recently presented in our August 2013 edition. Every time a

project reaches substantial completion we hope to be able to extract the exact spread attributable to

construction risk. With CRCHUM having reached that point, we yet again attempt to answer this

question. Unfortunately, the answer continues to be elusive. The indexes in the following graph use the

same logic as our traditional PPP index yet separates the bonds into two pools; those that have achieved

substantial completion (blue line) and those that have yet to achieve substantial completion (red line).

Bonds are moved to the ‘post’ pool once substantial completion is achieved (their historic spreads remain

in the ‘pre’ pool) hence the volatility in the blue line. With 5 bonds now in the ‘post’ index we anticipate

that volatility will diminish.

In the opening paragraph of this section, we mention that the answer remains elusive. This is because the

data is currently not supportive, in the sense that the ‘post’ pool is 11bps wider than the ‘pre’ pool which

is clearly not what we would expect. The answer however lies in the individual components.

Post Substantial Completion Pre Substantial Completion

Name Current Weight Name Current Weight

Northwest Anthony Henday Drive 22% St Joseph Hamilton 8% Bridgepoint Hospital 21% CSEC 26%

RCMP E Division 15% St. Joseph’s Health Care 7% CR CHUM 27% Halton Health Care 17%

Forensics 16% Humber River Hospital 12%

North East Anthony Henday 17% 407 East Extension 4%

Alberta Schools Phase III (ASAP) 3%

Restigouche Hospital 2% Iqaluit Airport 4%

As explained on page 6, SNC Innisfree McGill bond qualified for

index inclusion from July 9, 2010 to October 17, 2013

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3Post Substantial Completion Pre Substantial Completion

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The graph below sheds some light as to why a current comparison between the ‘post’ pool and the ‘pre’

pool may be flawed. In the graph below we compare the simple average of three ‘post’ bonds (RCMP /

CRCHUM / Forensic – blue line), the ‘pre’ federal ‘A’ rated project CSEC (red line) and our PPP Index

(green line).

The three identified bonds in the ‘post’ pool have always been chronically wider than the index itself for

various reasons; non PC Bond eligibility, security package, nature of parties…. They collectively

represent 58% of the ‘post’ pool. CSEC on the other hand has always been tighter than the broad index

due to its federal status and ‘A’ rating and it represents 26% of the ‘pre’ pool (if we remove CSEC from

the pool, the ‘pre’ level rises by 4bps). As more projects reach substantial completion, whose bonds

coincidently are those that are more broadly held, the value of the ‘post’ index will grow and a better

assessment of the construction risk premium should start to emerge.

Discussing Spreads – The Effect of a Downgrade The October 2012 edition of our newsletter featured a section entitled “The Effect of Panic” which

profiled the events surrounding the MUHC PPP. One year later, this edition unfortunately has to yet again

table the discussion. Consider the following rating related events that occurred over the past year:

1. November 5, 2012: S&P changes the outlook on the ‘A-‘ rated MUHC PPP bond from ‘stable’ to

‘negative’

2. August 28, 2013: DBRS changes trend on the ‘A (low)’ rated MUHC PPP bond from ‘stable’ to

‘negative’

3. October 17, 2013: DBRS downgrades the MUHC PPP from ‘A (low)’ to ‘BBB (high)’ and maintains

the negative trend.

In all cases, these actions arose largely due to similar actions taken on the project’s joint equity owner and

design build contractor SNC-Lavalin. The following graph shows the daily change in spreads on the

MUHC bonds over the past year (we have specifically identified the three aforementioned events).

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In the above graph we can see that the market reacted quickly to the action taken by the agency and in

each case resulted in a widening of approximately 5bps the following day. In the following graph we plot

the spread of the MUHC PPP bonds over the past year (we should mention that through the volatility, the

spread is currently essentially at its starting point for the period in question).

The graph shows that the widening attributed to the S&P action in November 2012 quickly vanished

whereas recent DBRS actions have led to a widening that has persisted. In total, the change from ‘A (low)

– stable trend’ to ‘BBB (high) – negative trend’ caused a widening of 11bps. In our view this

underestimates the true spread differential between an ‘A-‘ and a ‘BBB+’ credit. The argument can

however be made that the downgrade was already priced in.

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To that point, in the following graph we compare the spread for MUHC (blue line) and our PPP bond

index (red line).

We can see that the two data sets diverge as of Q3 2012. The average spread difference from the first

S&P action on November 5th 2012 to October 21

st 2013 has been 28bps which is what we would expect

the difference between the two specified credit rating notches to be (this would be slightly wider if we

were to extract MUHC from the PPP index).

It should be noted that the outlook on other DBRS rated SNC related PPP projects (407 Extension and

Restigouche Hospital) have been changed from ‘stable’ to ‘negative’.

Other Financing News The renewable power sector continues to finance itself through other means than the rated bond solution.

1. Domestic & International Bank Solution: Samsung Renewable Energy and Pattern Energy

successfully financed their 150MW wind project in Ontario. The $400M facility brought together as

many as 10 domestic and international banks.

Comparable Bond Issues Spreads on corporate comparables are an important factor in determining the spread of project finance

product for three reasons.

1. First, they become the starting point for many investors looking to invest who then add for specific

realities such as construction risk premium, illiquidity premium…

2. Second, dealers often use these securities in the spread refresh mechanisms that they use at the time

of bidding.

3. Third, a number of investors in the sector manage project finance related bonds in the same book as

‘infrastructure’ corporates. As such, these corporates often become the ‘out trades’ at the time of a

new issue. ‘Out trades’ being those bonds that are sold to make room for a new issue within a

portfolio. The level of the ‘out trade’ product can have a direct impact on the success of a new issue.

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MUHC Index

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October 22, 2013

Issuer S&P’s / DBRS / Moody’s Amount Coupon Maturity Spread over Benchmark

British Columbia Ferry Services Inc.

A+ / A / -

CAD $200M

4.702% Oct. 23, 2043 +163bps over CAN 4.00% 2041

Price guidance had been set at 165bps + / - 2 bps and thus came at its tight.

Fills were reported being as low as 10%.

Post pricing, bids tightened to 160bps closing the day at 157bps.

The issue comes with a Canada Call of 41bps and a call feature at par for the final 6 months.

October 2, 2013

Issuer S&P’s / DBRS / Moody’s Amount Coupon Maturity Spread over Benchmark

407 International Inc. A / A / -

CAD $200M

4.68% Oct. 7, 2053 +158bps over CAN 4.00% 2041

Price guidance had been set at 160bps + / - 2 bps and thus came at its tight.

Fills were reported as being between 25% and 50% and bonds were placed with over 25 investors.

Post pricing, bids were as low as 156bps.

The issue comes with a Canada Call of 39.5bps and a call feature at par for the final 6 months.

A reader asked us to clarify a statement made in our last edition. Specifically whether we could confirm

the ‘potentially’ term in the following statement with regards to the Lower Mattagami bond issue:

“… in May 2011 the issuer announced that they expected to borrow a total of approximately $1.3bn over

the next few years. This new issue therefore potentially marks the last issuance for this company.”

In a discussion with a rating agency, they explained that the issuer initially announced that they will

borrow a total of $1.9bn of which $700M will be through commercial paper (“CP”). To date, the issuer

has issued $1.375bn. The rating agency expects that all CP will be rolled into bonds and thus will reach

their total of $1.9bn and this is expected by the end of 2015.

Items to Follow

On October 16th Moody’s downgraded major construction firm OHL from Ba2 to Ba3. OHL is a

major contractor on the $1.37bn CHUM project. When OHL was placed ‘under review for

downgrade’ in May 2012 the same action was quickly applied to the CHUM project bonds. The

conclusion of the review resulted in the outlook on OHL changing to ‘negative’ while the CHUM was

confirmed in October 2012 based on the strength and progress of the project itself. This may be why

spreads on CHUM only widened slightly on the most recent action against OHL as investors did not

expect the event to affect the project. Lo and behold, on October 27th Moody’s released a

confirmation that the CHUM rating would remain unchanged at ‘Baa2’ with a stable outlook.

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The Northwest Territories have reportedly reached out to the Federal Finance Minister in order to

increase the territory’s $800M debt ceiling. This request is said to have stemmed from their desire to

fund an expansion of the hydro-electric grid in order to link to mining operations.

Fitch released a brief study entitled ‘Global PPP Lessons Learned’. Some of the more interesting

statements made are:

- “The larger the project and the greater the technical complexity, the more important it becomes

that constructors and operators have the technical and financial wherewithal to bear the risk they

are taking”;

- “A well-structured grantor team and a competent concessionaire are better positioned to respond

and minimize the adverse effects to both parties”; and

- “…most governments have a large infrastructure deficit and they see PPPs as a way to facilitate

progress. This puts much needed pressure on key decision makers to plan better and hold up their

end of the bargain as much as possible”.

On October 8th, the Province of Quebec’s Health Minister stated that it is out of the question that the

Parti Quebecois (“PQ”) government deliver future projects through the PPP model. He stated during

the inauguration of the CRCHUM that, although the project may have been delivered on time and on

budget, the government must now monitor if the model delivers on its promised advantages and

whether or not these advantages surpassed the drawbacks.

The Provincial Liberal leader, Philippe Couillard, quickly responded that the government should not

outright reject the PPP model. He went on to state that it is not in the interest of the government to

completely ignore a potential solution.

Amid rumored elections in Quebec, a poll published on October 12th showed Liberals slightly ahead

of the PQ, the current party in power (36% vs. 34% respectively). These numbers are largely

unchanged since August (PQ up 2% and Liberals stable). Meanwhile, the CAQ (third party of

importance in the current parliament) has lost ground at 17%. An internet based poll conducted on

October 20th placed the Liberals at 38% with the PQ at 34%. Analysts have scaled back probabilities

of a December election.

PPP Spread Index

The Casgrain PPP index provides a broad view of credit spread trends for ‘A’ range PPP credit. The index

now includes fifteen eligible bonds; none of which represent more than 19% of the index. The index

currently finds itself at 177bps (this was 181bps when last published). A full description of the

methodology used is in the August 4th 2010 edition, available upon request.

It should be noted that spread data for the MUHC PPP as of October 18th 2013 have been removed from

the index as they no longer meet the ‘A’ range rating requirement.

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Current levels for Casgrain index included bonds are:

Name 1 Project Spread

(bps)

Benchmark Current

Weights

(%)

Issue Date Issue

Spread

(bps)2

NorthwestConnect Northwest Anthony Henday Drive 174.84 Canada 2029 6 08/07/2008 180

Plenary Health Bridgepoint Bridgepoint Hospital 163.79 Canada 2037 6 08/11/2009 298

Green Timbers RCMP E Division 195.28 Canada 2029 4 04/22/2010 281

Access Recherche Montreal CR CHUM 191.30 Canada 2033 8 05/20/2010 325

CSS FSCC Forensics 205.03 Canada 2037 4 06/17/2010 315

Plenary Health Hamilton St Joseph Hamilton 174.88 Canada 2033 6 11/30/2010 225

Plenary Properties LTAP CSEC 161.72 Canada 2033 19 01/25/2011 200

ITS SJHC St. Joseph’s Health Care 185.92 Canada 2033 5 03/08/2011 210

Hospital Infrastructure Partners Halton Health Care 175.36 Canada 2033 12 07/26/2011 205

Plenary Health Partners Humber Humber River Hospital 174.00 Canada 2029 9 09/20/2011 212

Capital City Link Group North East Anthony Henday 173.42 Canada 2033 12 05/08/2012 189

407 East Development Group 407 East Extension 191.34 Canada 2033 3 05/15/2012 203

ABC Schools Partnership Alberta Schools Phase III (ASAP) 182.60 Canada 2033 2 09/12/2012 185

Rainbow Hospital Partnership Restigouche Hospital 209.31 Canada 2029 2 08/02/2013 210

Arctic Infrastructure Partnership Iqaluit Airport 182.61 Canada 2037 3 09/09/2013 185

As per PC Bond dated October 21st 2013 1 SNC Innisfree McGill bond qualified for index inclusion from July 9, 2010 to October 17, 2013 2 versus curve

Current levels for non-Casgrain index included bonds are in the following table. These bonds have been

omitted due to structural differences that affect their underlying spread (MUHC = BBB+, CHUM = BBB,

Humber = Bullet).

Name Project Spread

(bps)

Benchmark Issue Date Issue

Spread

(bps)*

SNC Innisfree McGill MUHC 211.93 Canada 2037 07/08/2010 292

Health Montreal Collective CHUM 228.07 Canada 2037 06/07/2011 315

Plenary Health Partners Humber Humber River Hospital 176.41 Canada 2041 09/20/2011 189

As per PC Bond dated October 21st 2013 * versus curve

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By way of information, we include below the short term PPP related bonds.

Name Project Spread

(bps)

Maturity Issue Date Issue

Spread

(bps)*

Access Recherche Montreal DBFM - CR CHUM --- October 2013 05/20/2010 215

Health Partners Markham BF – Markham Stouffville Hospital --- January 2013 12/01/2010 170

Plenary Health Hamilton DBFM - St Joseph Hamilton --- December 2013 11/30/2010 127

Plenary Properties LTAP DBFM - CSEC 90.66 August 2014 01/25/2011 113

Plenary Health Partners Humber DBFM - Humber River Hospital 83.25 May 2015 09/20/2011 139

407 East Development Group DBFM - 407 East Extension 76.78 December 2015 05/15/2012 138

Rainbow Hospital Partnership Restigouche Hospital --- October 2014 08/02/2013 150

As per PC Bond dated October 21st 2013

* versus curve

It is our thesis that PPP bond investors will become broader project finance investors. As such, we include

below power sector project bonds.

Name Project Type Spread

(bps)

Benchmark Issue Date Issue

Spread

(bps)*

St-Clair Holding Solar 305.00 Canada 2041 09/18/2012 297.0

Brookfield Kwagis Run-of-River Hydro 197.36 Canada 2021 10/29/2012 205.0

Spy Hill Natural Gas Peaking 173.45 Canada 2029 01/16/2013 180.5

Comber Wind 272.52 Canada 2023 02/19/2013 301.4

North Battelford Natural Gas Baseload 203.02 Canada 2023 09/20/2013 205.0

As per PC Bond dated October 21st 2013

* versus curve

Casgrain Distribution Lists

Casgrain provides other mailings via distribution lists that you may want to join. Please inform us should

you wish to receive any of the following:

Short Term Investments: Casgrain provides a bi-weekly offering which highlights all short term

investments that Casgrain can offer (perhaps for your treasury purposes).

PPP Indicative Runs: Casgrain now provides weekly indicative credit spread runs to institutional

investors for many PPP bonds.

New Issue Monitor: On a monthly basis, Casgrain puts forth a document that looks at all corporate

bond and preferred share issuance by Canadian entities or in Canadian dollars.

Provincial Insider: Casgrain produces a weekly document that looks at current borrowing conditions

for the Canadian Provinces.

ABCP Mailings: Following the ABCP standstill in August 2007, Casgrain differentiated itself and

brought advisory services to numerous clients that held third party ABCP. To date, Casgrain has

traded over $1 billion MAV Notes (restructured third party ABCP) in the secondary market. Casgrain

provides regular mailings on all ABCP / MAV related news.

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LEGAL NOTICE

This was prepared by Casgrain & Company Limited and Casgrain & Company (USA) Limited (collectively "Casgrain") for informational purposes only. Information herein has been obtained from sources believed to

be reliable, but Casgrain does not warrant its completeness or accuracy. The value of securities may be adversely affected by changes in market prices, interest rates, exchange rates, and other factors. Prices and

availability are subject to change without notice. Information regarding past performances is not indicative of future results.

Any products or services mentioned herein are made available only in accordance with local law (including applicable securities laws) and only where they may be lawfully offered for sale. Securities mentioned herein

may not be suitable for all investors. The recipient of this information must make its own independent decision regarding any securities mentioned herein. For securities recommended by Casgrain, Casgrain may sell to

or buy from customers as principal or agent and may have a long or short position in the securities mentioned herein.

To Canadian Residents: Casgrain & Company Limited is a Canadian registered investment dealer and is a member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection

Fund.

To US Residents: Casgrain & Company (USA) Limited, a wholly-owned subsidiary of Casgrain & Company Limited, is a US registered brokerdealer and is a member of the Financial Industry Regulatory Authority and

the Securities Investor Protection Corporation.

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Infrastructure Newsletter - · PDF fileInfrastructure Newsletter ... Discussing Spreads – Construction Risk Premium ... arose largely due to similar actions taken on the project’s