KBRA assigns its A+ preliminary rating to QTS Thunder Managing Issuer, LLC’s proposed $3.6 billion senior secured obligations. The Outlook is Stable.
QTS and Blackstone (the sponsors) are adding five newly constructed data centers to an existing master indenture structure (MIS), creating a diversified portfolio of 12 fully contracted and stabilized data centers totaling 493.5MW across Richmond, Virginia; Phoenix, Arizona; Dallas, Texas; Columbus, Ohio; and Manassas, Virginia. The portfolio is fully leased to investment-grade hyperscale tenants under 10 triple-net (NNN) leases and two double-net (NN) leases, with initial lease terms ranging from 15 to 20 years and renewal terms ranging from 10 to 15.3 years. The incremental financing will rank pari passu with approximately $4.3 billion of existing MIS indebtedness, bringing total senior secured indebtedness under the MIS to up to approximately $7.9 billion.
The contemplated incremental financing is for the addition of five assets totaling 214.5MW across Dallas, Phoenix, and Richmond. The new notes and any related senior secured loans will be issued or incurred under the MIS framework and will rank pari passu with the existing MIS indebtedness. The debt will be secured by the shared collateral and subject to intercreditor framework.
Key Credit Considerations
(+/-) Additional Leverage and MIS Structure
The MIS structure allows the issuer to borrow additional debt through new tranches backed by new collateral being contributed at a future date. Each tranche behaves like its own individual bond, with its own amortization schedule. All tranches will share the same pledged collateral. All the debt is also cross-collateralized, and incremental debt and asset contributions are subject to rating agency confirmation (RAC).
(+) Investment-Grade Tenants
All assets are fully leased to investment-grade technology companies, with an average remaining lease term of approximately 15.2 years and average extension options totaling an additional 13.7 years. KBRA views this positively, as it supports cash flow stability and predictability.
(+/-) Refinancing Risk
As the debt is interest-only, after giving effect to the incremental financing, there may be up to $7.92 billion of outstanding pari passu debt across multiple staggered maturities. Given the stability and predictability of the lease cash flows, KBRA considers the ability of portfolio cash flows to support repayment under a hypothetical amortization assumption, as well as under a cash sweep scenario in which the debt is repaid within the available lease extension period with meaningful lease tail remaining.
(+/-) Limited O&M Exposure
The leases being added into the portfolio are NNN and NN leases. Specifically, for the NNN leases, all operating costs are passed through to the tenant, while under NN leases, power, taxes and insurance are passed through to the tenant. In all, throughout the portfolio, power costs represent about 75% of the total operating costs of the assets. About 97% of the total operating costs of the portfolio are passed on to the tenants. The issuer is not responsible for any computer servers, which are supplied and maintained by the tenant; additionally, there is minimal maintenance capital investment. All the servers housed in the facilities are the obligation of the tenant. The landlord is further subject to other service-level agreements (SLA) relating to power supply, back-up fuel supply, voltage, and environmental conditions. However, given the NNN and NN nature of the leases, most costs are passed through to the tenant, limiting cost overrun exposure and ensuring predictability of cash flows. In addition to the N+1 redundancy incorporated into the design of the facility, which helps mitigate risk of service deficiencies, KBRA notes that with over 20 years of operating history and the standardized Freedom Design, QTS has boasted a consistent track record of Five Nines (99.999%) or greater facility uptime since the Freedom Design inception and has never triggered an SLA violation leading to a termination right or event.
(+) Competitive Leases in Established Markets
All lease rates in the portfolio are below current market lease rates, based on market consultant estimates. Three of the assets are located in Richmond, Virginia, connected to the broader Northern Virginia data center ecosystem, the top data center market in the U.S. The tenant in Richmond has made significant investments in other data centers and connectivity infrastructure in proximity to Richmond, including more than 400MW of data center capacity and other tenant-owned network infrastructure. The New Albany, Ohio, facilities are located in the Columbus metropolitan area, an established data center market where the tenant has made significant data center investments. New Albany benefits from a mature fiber footprint and the ability to provide low-latency access to major Midwest and East Coast markets.
Rating Rationale
The KBRA Project Risk Score (KPRS) of Strong for the senior secured debt is underpinned by the strong credit quality of project counterparties, cash flow certainty from fully contracted data center assets, limited operations and maintenance (O&M) exposure with achievable power supply service-level requirements under a mix of NNN and NN leases, and a competitive position that supports a strong case for lease renewals. The rating is also supported by the pari passu senior secured structure, although the transaction remains constrained by refinancing risk given the significant balance outstanding at each maturity. KBRA’s rating case incorporates market lease rate escalation, operating expense and interest rate stresses, assumed day-one defaults and re-leasing haircuts for select facilities, and renewal lease rate haircuts for NAL2DC1 and NAL2DC2. These attributes, together with average rating case debt service coverage ratios (DSCR) of 1.16x during the initial lease term and 1.34x during the lease extension period, are sufficient to support the rating, even as full repayment remains reliant on lease extensions.
Outlook
The Stable Outlook reflects KBRA’s view that the project will perform in line with the rating case, with limited volatility to cash flows. KBRA could upgrade the rating if the leases are extended so that they fully cover the amortizing profile of the debt. Additionally, KBRA could lower the rating if there are significant changes in technology development or in the market that negatively impact the case for lease renewal, if tenant credit quality deteriorates, or if the portfolio composition shifts toward more tenant-favorable lease structures.
Rating Sensitivities
An upgrade is unlikely due to the transaction’s reliance on lease renewals to fully amortize the debt, as well as the fact that the lease termination fees do not fully cover the outstanding loan balance attributable to leases with termination for convenience over the life of the loan.
Consequential technology developments in the future that could hamper demand for data centers and significantly reduce lease rates could affect the likeliness of a lease renewal, which could result in a downgrade of the rating.
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Methodology
Disclosures
Further information on key credit considerations, sensitivity analyses that consider what factors can affect these credit ratings and how they could lead to an upgrade or a downgrade, and ESG factors (where they are a key driver behind the change to the credit rating or rating outlook) can be found in the full rating report referenced above.
A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the Information Disclosure Form(s) located here.
Information on the meaning of each rating category can be located here.
Further disclosures relating to this rating action are available in the Information Disclosure Form(s) referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.
About KBRA
Kroll Bond Rating Agency, LLC (KBRA), one of the major credit rating agencies (CRA), is a full-service CRA registered with the U.S. Securities and Exchange Commission as an NRSRO. Kroll Bond Rating Agency Europe Limited is registered as a CRA with the European Securities and Markets Authority. Kroll Bond Rating Agency UK Limited is registered as a CRA with the UK Financial Conduct Authority. In addition, KBRA is designated as a Designated Rating Organization (DRO) by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized as a Qualified Rating Agency by Taiwan’s Financial Supervisory Commission and is recognized by the National Association of Insurance Commissioners as a Credit Rating Provider (CRP) in the U.S.
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