DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the ratings of the Series 2021 Class A-1 $25 million variable funding notes (Class A-1 Notes) and the $225 million Series 2021 Class A-2 term notes (Class A-2 Notes, and together with the Class A-1 Notes, the Senior Notes) at BBB. At the same time, DBRS Morningstar maintained the trend for all ratings at Negative in recognition of the still-uncertain interest rate environment (albeit gradually moderating with the pace of rate increases slowing) and the possibility that rates will remain high enough at the 2026 Anticipated Repayment Date (ARD) of the Senior Notes to affect DBRS Morningstar’s assessment of the rating level of the refinance. The Senior Notes are fully amortizing with a 25-year legal maturity, issued by Vault DI Issuer LLC (the Issuer), and are backed by a portfolio of seven data centres—located in strong national data centre markets and with generally attractive power and redundancy configurations—and the long-term leases in place with the tenants of the data centres. Although leases have regular renewal points embedded within the overall term, where the lease can be terminated by either the Issuer or the tenant, DBRS Morningstar believes that lease renewal is likely. The indirect owner of the data centres is Vault Digital Infrastructure LP (Vault Digital), a joint venture owned by DIF Capital Partners (49%) and Northleaf Capital Partners (49%), two global mid-market infrastructure investors, and managed by Landmark Dividend, LLC (2%), an experienced operator with a strong track record of data centre management. DBRS Morningstar notes that the additional penalty interest tranche incurred if the Senior Notes are not successfully refinanced at the ARD is not rated.
The Negative trends are maintained despite the strong financial results achieved by the portfolio over the past 12 months, reflecting the significantly higher interest rate environment that could potentially affect the rating level of the refinance in three years’ time. Average Annualized Net Operating Income (AANOI) was $21.4 million as of June 2023, resulting in an annualized debt service coverage ratio (DSCR) of 3.22 times (x), exceeding rating-case expectations. DBRS Morningstar notes extensions have already been signed at equal or better terms for the two leases which were coming for up for renewal in 2024, while the insolvency filing last year of an unrated, private tenant was successfully concluded with the affected lease being assumed by a new tenant with no change in terms. DBRS Morningstar views these successful re-leasing events as affirming the rating case’s central thesis that lease extensions are highly likely. Minor Service Level Agreement (SLA)-related incidents in one of the sites did occur in 2022 and 2023 but did not result in any material penalties (although one case incurred a minor service-level credit).
Because of the debt structure, where a significant portion of credit risk is deferred to the refinance period in 2026, the rating of the current debt is affected by DBRS Morningstar’s view of the rating level that the refinance could achieve, the soft nature of this refinance notwithstanding. This, in turn, is highly sensitive to the forecast prevailing interest rates at the time of refinance. The current interest rate environment introduces the risk that the ascribed refinance rating could be materially deteriorated. Current market consensus and forward curves appears to suggest that the pace of interest rate increases could flatten by the end of 2023, although an easing of monetary policy is not expected until 2024. DBRS Morningstar believes that, given the expectation that the U.S. economy will slow in the second half of the year and moderate pricing pressure, there is a greater likelihood of the Federal Reserve’s peak policy rate will be below market consensus than be above (see “North America Macroeconomic Update: Resilient Economies Call For Tighter Monetary Policy,” June 20, 2023). A similar pattern of interest rate and inflation movement as the early- to mid-1980s could result in the 2026 refinance financial metrics at the low end of the current rating range, with a possibility of falling below the rating category. On this basis, and on the continuing forward-looking rate volatility and uncertainty, DBRS Morningstar is maintaining the Negative trends.
The BBB ratings continue to be underpinned by the following: (1) expected stable cash flow deriving from lease payments to the data centres; (2) the resiliency and sticky nature of the revenue stream, owing to the critical and strategic nature of the data centre assets to the tenants’ business operations; (3) strong and favourable debt package to noteholders; and (4) material upside revenue potential from unleased portions of the largest site in the portfolio. The debt and security package offers protections to noteholders typical of that expected of a well-structured project finance transaction. The primary constraints on the rating include (1) the current interest rate environment and its impact on refinance credit level, which has a significant effect on the rating of the current debt; (2) re-leasing risk of each lease at various intervals, subjecting the Issuer to the risk of tenants either opting out of their leases or obliging the Issuer to grant concessions as an inducement for tenants to remain; (3) lower or nonrated tenants; and (4) risks related to technical obsolescence or deterioration of competitive position.
The financing structure features DSCR profiles, as calculated based on DBRS Morningstar’s rating-case assumptions and revenue haircuts, with a minimum and average DSCR of 2.56x/2.78x (effectively an interest coverage ratio), and a refinance DSCR at the 5.5-year mark of 1.30x (minimum)/1.49x (average) based on DBRS Morningstar’s rating case, which incorporates the constraints and challenges of the project and the refinance interest rate as assumed at financial close. The refinance metrics, together with consideration for the minimum/average DSCRs in the first five interest-only years, are consistent with a BBB (low) rating. DBRS Morningstar has applied a one-notch uplift to account for 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. Higher refinance base rates at a level consistent with consensus forecasts would result in minimum refinance DSCRs in the 1.16x–1.20x range, commensurate with a rating at the low end of or just below the current rating level. Should the elevated interest rate environment show signs of persisting beyond 2024, DBRS Morningstar may downgrade the rating, while DBRS Morningstar may change the trends to Stable from Negative if interest rates begin to stabilize and provide greater certainty that refinance rates will support the current rating level. 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/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings
(July 4, 2023).
All figures are in U.S. dollars unless otherwise noted.
DBRS Morningstar applied the following principal methodology: Global Methodology for Rating Essential Digital Infrastructure (March 15, 2023; https://www.dbrsmorningstar.com/research/410814/global-methodology-for-rating-essential-digital-infrastructure).
The following methodologies have also been applied: DBRS Morningstar Global Criteria: Guarantees and Other Forms of Support (March 28, 2023; https://www.dbrsmorningstar.com/research/411694/dbrs-morningstar-global-criteria-guarantees-and-other-forms-of-support) and DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (July 4, 2023; https://www.dbrsmorningstar.com/research/416784/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings).
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
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.
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