Morningstar DBRS Finalizes AIO Issuer 2024-1, LLC's Provisional Credit Ratings of A (low)

DBRS Limited (Morningstar DBRS) finalized the provisional credit rating of A (low) to the Issuer Rating of AIO Issuer 2024-1, LLC (the Issuer). Concurrently, Morningstar DBRS also finalized the provisional credit rating of A (low) to the Senior Notes to be issued by the Issuer. All trends are Stable.

KEY CREDIT RATING CONSIDERATIONS
The A (low) credit ratings are underpinned by: (1) expected highly stable cash flow with little operational costs and high margins owing to the triple net lease nature of the revenue, coupled with strong debt service coverage ratios (DSCRs), even in the face of significant rating-case adjustments imposed by Morningstar DBRS; (2) the resiliency and sticky nature of the revenue stream, because of the critical and strategic nature of the real estate assets to the tenants' business operations and a certain barrier to entry for competitors assembling such a real estate asset portfolio; (3) low operating costs and minimal capital maintenance requirements; and (4) the project finance debt and security package, which offers protection to noteholders and features strong investment-grade coverage ratios. The primary constraints on the credit ratings include (1) the weaker-than-average credit profile of the tenant counterparties, including almost 26% of the portfolio, which is rated as non-investment grade, and a number of nonrated or difficult to assess counterparties, somewhat offset by the strategic nature of the assets; (2) the relatively short terms of many of the tenant leases, many of which are up for renewal in any given year and subject to loss; (3) a portion of leases whose underlying projects are still in the construction or development phase and therefore exposed to a degree of noncompletion risk, which could affect lease payments; and (4) refinancing risk because of the interest-only nature of the debt and the ensuing bullet repayment.

FINANCIAL OUTLOOK
The financing features DSCR profiles, as calculated based on Morningstar DBRS' rating-case assumptions and revenue haircuts, with a minimum and average DSCR of 1.88 times (x) and 1.96x, respectively (effectively an interest coverage ratio (ICR)), and a refinance Project Life Coverage Ratio (PLCR) at the seven-year mark of 1.43x. This figure is based on Morningstar DBRS' rating case, which incorporates the constraints and challenges of the project and revenue haircuts up to 25% of base-case revenues (and in the case of renewables, reductions of up to 70% of base-case projections). Morningstar DBRS views 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 helping to offset the weaker overall credit profile of the tenant counterparties, which may otherwise be viewed as warranting a negative credit rating notch. Morningstar DBRS notes that in the exceedingly unlikely event that the Issuer continues not to manage to refinance the debt, cash flows of up to 41% lower than the rating-case assumptions are still sufficient to fully amortize debt within the legal maturity.

CREDIT RATING RATIONALE
The debt issuance is backed by a portfolio of real-property interests comprising 195 individual triple-net lease properties. Following a two-step transfer of interests process executed at close of the transaction, the Issuer now holds these real-property rights indirectly through a wholly owned special-purpose vehicle entity. This intermediate entity directly owns the majority of the property rights, and holds the remainder indirectly through additional special-purpose vehicle entities. The property rights are managed by the Parent via a Management Agreement, which was also executed with the Issuer upon close of the transaction. In this structure, the Issuer does not have direct ownership of the property leases, but 100% direct and indirect equity ownership in entities that ultimately hold the leases. Morningstar DBRS has relied upon the legal opinions of Katten, counsel to the Issuer with respect to enforceability, true contribution and substantive nonconsolidation of the transaction.

The 195 leases are located across the continental United States, with a distribution of approximately 37% leases underlying renewable energy projects (primarily wind and solar), 7% battery storage, 21% telecom-tower related, 18%% underlying data centers, 10% underlying electric vehicle chargers, and 6% outdoor advertising (i.e., billboards). Collectively, the leases have a weighted-average remaining current contract term of 24.89 years and a weighted-average contractual term of approximately 37.91 years, including periodic automatic renewals. Morningstar DBRS expects that the rate of nonrenewal (or churn rate) of billboard and telecom tower leases will be low over the life of the portfolio, and notes that this expectation is consistent with observed behaviour in Morningstar DBRS' monitored credit ratings, where churn rate has been generally low. Morningstar DBRS sees a reasonable expectation that churned telecom leases will be taken up by another party, and limits renewable-related and data center leases to their initial term only (with the exception of utility-owned facilities), regardless of the number of extensions available in the lease contract. Morningstar DBRS believes this to be consistent both with the behaviour of Morningstar DBRS' monitored data center and renewable energy credits, as well as with the useful life of such assets.

Leases are for land or property usage only, and the tenant is responsible for the construction, operation, and maintenance of all physical structures located on the property. Underlying these are the real-property interests, which consist primarily of easements, ground leases, and assignment of leases or rent. The life of the real-property interests is well in excess of the current debt term, with an average remaining life of 75.84 years. Where a potentially supervening interest in the real property interest exists (for instance, in the small number of cases where the fee owner (other than the Issuer) has an underlying mortgage and the mortgage holder has not consented to a Subordination and Non-Disturbance Agreement), the Issuer has taken a number of measures to mitigate the potential risk.

Debt servicing of the Notes relies on lease payments received by each Asset Entity, which are subsequently up streamed 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. Features include guarantees from each of the Asset Entities and the AIO Issuer Guarantor LLC, which owns 100% of the equity interests in the Issuer, security interests in all lease revenue received from tenants as well as both the Issuer's equity interest in each Asset Entity and the Guarantor's equity interests in the Issuer; a three-month interest-service-reserve account, funded either in cash or through a letter of credit; and a restricted payment test (i.e., dividend payment test) with a DSCR of 1.30x and a required minimum amortization at 1.20x. Although a small degree of residual subordination risk remains (i.e., the possibility of individual landowner default on existing mortgages or property taxes, where such fee owner is not the Issuer), Morningstar DBRS believes that the Issuer will not be structurally subordinated to any material lien or debt at the Asset Entity level.

ENVIRONMENTAL, SOCIAL, AND 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors 
In the analysis of the Issuer, the Rating Driver factors listed in the methodology are considered in the order of importance.

(B) Weighting of FRA Factors 
In the analysis of the Issuer, the following FRA factor listed in the methodology was considered more important: DSCR.

(C) Weighting of the BRA and the FRA 
In the analysis of the Issuer, the FRA carries greater weight than the BRA. 

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Project Finance (April 15, 2024), https://dbrs.morningstar.com/research/431188

Morningstar DBRS credit ratings may use of one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024; https://dbrs.morningstar.com/research/431186), which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodologies and criteria have also been applied:
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyses corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153 (April 15, 2024).

Morningstar DBRS materially deviated from its principal methodology when determining the credit ratings assigned to the Issuer and the Senior Notes. The material deviation(s) is warranted given the Issuer is a portfolio of ground leases for certain renewable power projects, data centers and telecom towers, as well as electric vehicle charging stations and billboards. The material deviation is because of the large number of counterparties, many of whom are rated either lower than the project ratings or are unrated entities; the project finance methodology generally assumes one or a small number of counterparties that are rated higher than the transaction. This deviation is basically the same as the one declared for the Global Methodology for Rating Essential Digital Infrastructure (i.e., the EdgeConneX Data Centers Issuer, LLC transaction) in 2023. Various haircuts to renewal rate assumptions were applied to cover this risk, and we expect to resolve this material deviation by incorporating guidance for such situations in the next annual review of the methodology in 2025.

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 info-DBRS@morningstar.com.

A provisional credit rating is not a final credit rating with respect to the above-mentioned securities and may change or be different than the final credit rating assigned or may be discontinued. The assignment of final credit ratings on the above-mentioned securities is subject to receipt by Morningstar DBRS of all data and/or information and final documentation that Morningstar DBRS deems necessary to finalize the credit ratings.

The credit ratings were initiated at the request of the rated entity.

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

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

These are solicited credit ratings.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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