DBRS Morningstar Confirms EdgeConneX Data Centers Issuer, LLC at BBB, Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating, the rating on the Series 2022-V Class A-1 Variable Funding Notes (VFN), and the rating on the 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) at BBB. All trends are Stable. DBRS Morningstar confirmed the credit ratings pursuant to the performance of the portfolio, which is currently achieving a debt service coverage ratio (DSCR) of 2.60 times (x) per the provisions of the Trust Indenture, exceeding rating-case projections. The rating actions also account for projected lease revenues, which DBRS Morningstar considers to be meeting expectations particularly in regard to the high rate of renewal of lease contracts expiring in 2023, supporting the core rating these of stable and sticky lease revenues. DBRS Morningstar also notes that many such renewals appeared to be completed at higher than rating-case forecasts for escalation, primarily because of the current high inflation environment. This increase should be relatively structural in nature, carrying through the remainder of the lease terms. The stability of tenant rent revenues was also enhanced with the Issuer's purchase of a data centre, which it had previously leased, turning it into a fee-simple fully owned facility. DBRS Morningstar considers revenues derived from leased facilities to be less stable as there is no certainty that the landlord will renew the lease upon expiry. The purchase of this data centre thus stabilizes revenue from this facility. DBRS Morningstar notes that the Issuer has used the incremental debt capacity enabled by the additional revenue associated with this data centre to draw the remainder of the VFN beyond the $13 million drawn in 2022; however, there continues to be a marginal increase in projected minimum and average DSCRs post-refinance, which are now projected at 1.37x and 1.62x, respectively.

The confirmed credit ratings depend on assumptions regarding the refinancing of the Senior Notes at the Anticipated Repayment Date (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 future long-term rates (approximately high 3.0% as of fall 2023) would result in a minimum refinance 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 may take a negative credit rating action. 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 credit ratings also materially deviate from the principal methodology used as there is no specific provision in "Global Methodology for Rating Essential Digital Infrastructure” for a very large number of counterparties with shorter-term contracts, 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.

The Issuer’s revenues are directly backed by the revenues from lease contracts and service orders from more than 140 tenants occupying a portfolio of 28 data centres, nine of which are leased from landlords and the remaining 19 of which are under fee-simple ownership. 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 of many tenants. DBRS Morningstar notes that end tenant power occupancy in edge data centres is more vulnerable to variations in end market demand than 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; and (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) leasehold 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.

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 1.37x (minimum)/1.62x (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 repay principal, as supportive of a BBB rating. DBRS Morningstar notes in the exceedingly unlikely event that the Sponsor does 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 assumptions at the time of refinance could lead to a negative credit rating action. Conditions leading to a credit rating upgrade are not considered likely at this time.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors 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).

Notes:
All figures are in U.S. dollars unless otherwise noted.

DBRS Morningstar applied the following principal methodologies:
-- Global Methodology for Rating Essential Digital Infrastructure (March 15, 2023); https://www.dbrsmorningstar.com/research/410814/global-methodology-for-rating-essential-digital-infrastructure
-- DBRS Morningstar 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

The following methodology has also been applied:
-- 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.

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 Note as there is no specific provision in "Global Methodology for Rating Essential Digital Infrastructure” 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 credit 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 credit rating team believes that new customers will be available to contract for capacity and services in the case of either nonrenewal or customer default.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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 credit ratings are under regular surveillance.

Information regarding DBRS Morningstar credit ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at [email protected].

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