DBRS Limited (DBRS Morningstar) assigned a rating of BBB to the Issuer Rating, the Series 2022-V Class A-1 Variable Funding Notes (VFN), and Series 2022-1 Class A-2 Secured Data Center Revenue Term Notes with an original balance of $375 million (the 2022-1 Class A-2 Notes or the Notes; together with the VFN, the Senior Notes) of EdgeConneX Data Centers Issuer LLC (the Issuer). All trends are Stable. The VFN consists of a revolving variable-funding note with a maximum $50 million commitment that can be drawn up and down by the Issuer until the Anticipated Repayment Date (ARD). At issuance of the VFN, $13 million is available to be drawn by the Issuer, and DBRS Morningstar's assigned rating assumes this $13 million is drawn. A rating agency confirmation is required for all subsequent draws up to the maximum $50 million VFN commitment. The Notes have a 30-year legal maturity, with an initial period followed by a cash sweep of all available cash until the Notes and the VFN are either refinanced or fully paid off. Debt service of the Senior Notes is directly backed by the revenues from lease contracts and service orders from more than 140 tenants occupying a portfolio of 28 data centres, 10 of which are leased from landlords and the remaining 18 of which are under fee-simple ownership. DBRS Morningstar notes that the additional penalty interest tranche, which will be incurred if the Senior Notes are not refinanced on or prior to their ARD, is fully subordinated to the debt service of the Senior Notes (including the cash sweep) and is therefore not rated with this review. The rating assigned depends on assumptions regarding the refinancing of the Senior Notes at the ARD. While DBRS Morningstar expects the Senior Notes to be refinanced at the ARD, the principal repayment is subject to refinancing risk because of the high remaining debt leverage and related exposure to actual interest rates at time of refinance, particularly in the current interest rate environment. A refinance at a level consistent with current analyst consensus forecasts of long-term rates at the time of refinance (approximately low 3.0% as of fall 2022) would result in minimum refinance debt service coverage ratio (DSCR) commensurate with the current rating level. Should the high inflation environment and corresponding elevated interest rates show signs of persisting, leading to a greater possibility that the refinance rate will be higher than the rating case assumption, DBRS Morningstar make take a negative rating action. The rating also materially deviates from the principal methodology used as there is no specific provision in "Global Methodology for Rating Project Finance” for a very large number of counterparties with contracts that are shorter term in nature, many of whom are rated either lower than the project rating or are unrated entities. Please refer to the paragraph on material deviations in the Notes section at the end of the press release.
In the transaction structure, the Issuer does not have direct ownership of the data centres, nor is it a direct counterparty of the tenant leases; however, it does have 100% equity ownership of EdgeConneX Real Estate Holdings LLC, the entity that owns the AssetCos, which own the data centres and hold interests in the leases as lessors. The AssetCos as guarantors of the Senior Notes have pledged and assigned their interests in customer contracts as security. Where the data centre is fee-simple owned, the AssetCos grant first-priority mortgages over their respective fee-simple interests in the data centres. In addition, a leasehold mortgage is granted over the largest leased data centre. DBRS Morningstar has received true sale and substantive nonconsolidation legal opinions in support of the transaction structure.
The 28 data centres collectively support the data centre service requirements of more than 140 end tenants. DBRS Morningstar generally views both the data centre portfolio and the tenant composition positively, with the data centre facilities being in strong primary and secondary markets and occupying locations that are well suited for their function as edge data centres. The tenant base largely comprises technology companies, including telecom-related companies, whose relative stability and mature market structure complement cloud-based computing providers. The high growth rates and potential of these providers offset weaknesses, including a still-consolidating industry structure and a weaker or nonrated status. DBRS Morningstar notes that end tenant power occupancy in edge data centres is more subject to variations in end market demand than is the case with hyperscale single-tenant data centres. As a result, tenant contracts for edge data centres tend to be shorter, averaging a four- or five-year initial term prior to renewal options, and therefore more exposed to the risk of nonrenewal as tenants regularly evaluate their data capacity needs in response to the performance of their own businesses.
The BBB rating is underpinned by (1) expected stable cash flow deriving from long-term lease payments to the data centres and minimal lease churn to date, notwithstanding the increased susceptibility to variations in end market demand; (2) the expected resiliency and sticky nature of the revenue stream owing to the particularly critical and strategic nature of edge data centres to tenants’ business operations; (3) the strong and favourable debt package to noteholders. DBRS Morningstar notes that the debt and security package offers protections to noteholders typically expected of a well-structured project finance transaction. The primary constraints on the rating include (1) re-leasing risk of each lease at various intervals, subjecting the Issuer to the risk of either tenants opting out of their leases or obliging the Issuer to grant concessions as an inducement for tenants to remain; (2) lease hold data centres, where approximately 23% of revenue derives from data centres that are leased by the Sponsor, as opposed to fee-simple owned, and exposing the project to risk of nonrenewal by the landlord when the leases expire; (3) risks related to technical obsolescence or the deterioration of competitive position; and (4) lower-rated or unrated counterparty entities.
Debt servicing of the Senior Notes will rely on lease payments received by each AssetCo entity, which are deposited into the lockbox account, as described previously, and then subsequently upstreamed to the Issuer. Based on the features of the debt security package, the covenant package provides bondholders with credit protections akin to a traditional project finance transaction with features including guarantees from each of the AssetCos and the EdgeConneX Data Centers Guarantor, LLC (the Guarantor). The Guarantor owns 100% of the equity interests in the Issuer, fee-simple mortgages over the owned data centres, and security interests in all lease revenue received from tenants as well as both the Issuer’s equity interest in the entity that holds the AssetCos and the Guarantor's equity interests in the Issuer, a three-month interest service reserve account, and a restricted payment test (i.e., dividend payment test) with a required minimum amortization DSCR of 1.20 times (x).
The financing structure features DSCR profiles, as calculated based on DBRS Morningstar's rating-case assumptions and revenue haircuts, with a minimum DSCR of 1.74x, and a refinance DSCR at the 5.5-year mark of 1.30x (minimum)/1.56x (average) based on DBRS Morningstar’s rating case, which incorporates the constraints and challenges of the project. DBRS Morningstar views the metrics, combined with the soft refinance nature of the debt, in which a failure to refinance does not lead to a default but rather to a cash sweep where all cash after expenses and interest payments are swept to principal, as supportive of a BBB rating. DBRS Morningstar notes in the exceedingly unlikely event that the Sponsors do not refinance the debt for the full duration to legal maturity, cash flows of up to 17.5% lower than the rating-case assumptions (which include the assumption that none of the leasehold data centres remain in the portfolio past their ground-lease expiry dates in the mid-2030s) are still sufficient to fully amortize debt.
A persistently high inflation/elevated interest rate environment leading to a higher probability of long-term interest rates being higher than the rating-case assumption at the time of refinance could lead to a negative rating action. Conditions leading to a rating upgrade are not considered likely at this time.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Global Methodology for Rating Project Finance (September 6, 2022; https://www.dbrsmorningstar.com/research/402400/) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (April 4, 2022; https://www.dbrsmorningstar.com/research/394683), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223/interplay-of-global-corporate-finance-rating-methodologies-when-analyzing-corporate-finance-transactions.
DBRS Morningstar materially deviated from its principal methodology when determining the ratings assigned to the Issuer Rating, the Series 2022-V Class A-1 VFN, and the Series 2022-1 Class A-2 Term Notes as there is no specific provision in "Global Methodology for Rating Project Finance” for a very large number of counterparties, many of whom have contracts that are shorter term in nature (although with provisions for multiple renewals upon expiry), and many of whom are rated either lower than the project rating or are unrated entities. The methodology generally assumes a single counterparty or small number of counterparties with long-term contracts, minimal re-leasing risk, and generally high credit quality. The ratings address this by stressing historical default and contract nonrenewal rates by an appropriate factor, noting that historically for this Issuer and for the sector generally, nonrenewal of contracts are manageable given the critical nature of the service which the data centre offers to the counterparty; as well, the rating team believes that new customers will be available to contract for capacity and services in the case of either nonrenewal or customer default.
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The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
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