Just as the internet evolved from the dulcet tones of the dial-up modem (if you know then you know) to super-fibre-ultra-lightning-thunderbolt broadband, so did our usage of it. What was once a tool to send an e-mail to your parents when travelling has become our everything tool: our encyclopaedia, our virtual workplace, our news source, our connection to the outside world.

In our last piece we looked at how the increased funding requirements of data centres could be met by securitisation and how these deals should be approached - both from an investor point of view and a ratings point of view. This couldn't have been more timely; on Monday this week Moody's announced the publication of its Request for Comment in respect of its proposed methodology for data centre securitisations (RFC). The RFC makes it clear that the classification debate is unlikely to have a clear answer any time soon. Even with the publication of this RFC it is important to note that certain data centre financings (e.g. single asset / single borrower) will still primarily be rated under the CMBS criteria. 

First impressions

Although the proposed methodology is very much written from a US perspective, the scope is global in nature. This methodology will affect the UK and European markets, albeit there may be some case-by-case adjustments. The US focus is no surprise given that this is how the rating agencies tend to operate, and at present the US is the only market with a significant data centre ABS sector. Everywhere else is playing catch-up. But like a younger sibling vying for attention, it will start to catch up, and soon. That has already started.

A little history

The publication of new ratings criteria heralds a buzz of activity and change in the securitisation world. Part of the exercise of getting to know proposed new ratings criteria is working out what needs translating to fit neatly with other relevant markets – the UK and wider European ones, for example. It is also helps foster a broader understanding of how the asset class actually works. Moody's describe the structure as one where there is an overarching equity interest in an SPE which owns or leases the data centre or associated lease, but the clear focus is on establishing an annualised base rent (ABR) and on understanding the costs and capex profile. 

Any of this sound familiar? If you think so, we don’t think you’re alone.

If you remember the dial-up modem you may well remember the heyday of UK whole business securitisation (UK WBS). Whilst they may share the same name, UK WBS was quite a different beast to US WBS. They evolved separately and the US WBS model was never quite replicated in mainland Europe or the UK. 

For somewhere over a decade, UK WBS was very popular in the leveraged acquisition market, finding a home in the financing of large operating businesses with (most often) a significant real estate component (which is useful if you want a real estate mortgage to give substance to your security over operating cashflows). UK WBS also made a mark on some significant UK infrastructure. 

These deals were about generating cash flows from business operations. Operating history and heft were important, as were understanding underlying costs, cyclicality and capex requirements. Modelling and agreeing a base case / run rate EBITDA figure to form the basis of leverage and tenor was key. UK WBS is a financing tool based primarily on cashflows, with only a secondary eye kept on the traditional real estate valuations.

Are data centres really that different to the UK WBS market of its time? There are many parallels to be drawn and although we should look forward towards the opportunities in the data centre ABS markets, we can apply hard-learned past experience to help navigate (another) new asset class. Securitisation has always worked this way.

Looking forward

What this RFC does is to prompt a discussion around the metrics and provide an insight into how Moody’s evaluates these. This is an important contribution to the overall debate.  Asset types, the tenant mix, the nature of the real estate, the different types of leases found in the data centre market sub-sectors, termination rights, expected renewals, void or semi-void periods, operator strength and history, and more – all these are explored. What will be relevant to you will depend very much on the deal you want to sell. 

The good news is that the UK offers a very stable and well-tested legal regime which knows how to cope with the rating agency legal structural considerations, allowing those of you who are structuring these deals, whether you are an operator, a financier or a sponsor, to concentrate on what you do best – getting to grips with the business, the cashflows and the growth strategy. The RFC also couldn't have come at a better time. With the approaching dawn of the new UK Securitisation Regulations, the UK data centre market can forge its own path. 

The evolution of the DC-ABS as an asset in its own class is happening now.