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The data centre industry has experienced continuous growth as the widespread digital transformation of the world’s industries has driven the need for enhanced data storage and processing capabilities. For many companies, access to data centres has become a crucial part of their digital and wider organisational infrastructure, as these facilities are designed to accommodate the hardware required to perform data storage and processing functions. At a fundamental level, data centres are specialised properties specifically built to hold physical information technology (IT) infrastructure, such as computer servers and storage devices. They are intended to provide the facility, connectivity, and cool atmosphere that are essential to the efficient operation of the servers they house. Data centres are therefore of considerable importance due to these servers containing the computational software that is responsible for hosting applications, facilitating e-commerce, supporting artificial intelligence (AI), and transferring data to long-term storage, amongst other things. Key Points Growth in the data centre industry has compounded amidst the digitalisation of the world’s economies and emergence of sophisticated technologies, demanding both greater computational power and supporting digital infrastructure. The US possesses the largest and most mature data centre market, but Europe’s share of the market in terms of investment and capacity has been steadily increasing. Data centres are being financed in numerous ways to facilitate their rapid expansion. One of these options is data centre securitisation which has most commonly involved an Asset‑Backed Securities or Commercial Mortgage-Backed Securities structure. The data centre ABS market is relatively new with the first-of-its-kind asset-backed financing for data centres executed in 2018 in the US, and the first European transaction occurring at the start of 2024 with the market anticipating more to follow.
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November 7, 2024
The shipping industry, known for its cyclical nature, faces inherent credit risks from fluctuating vessel income and market values. Our market research indicates that the industry is currently at a peak stage but may enter a decline by 2025. In the past year, geopolitical events and environmental disruptions caused by unpredictable water levels have forced many vessels to take longer, more circuitous routes, lengthening average travel times and increasing operational costs, leading to an increase in freight rates. This development creates fragmentation within the sector, between losers (those who are negatively affected due to poor adaptability to changing conditions, facing possible order loss) and winners (those who can take advantage of increased freight rates and lower capacity, and can grab market share due to competitor inflexibility stemming from vessel type constraints), with the latter positioned better in capitalising on the shipping cycle at a peak stage. However, previously unfulfilled demand post-Covid, current supply constraints due to rerouting, need for regulatory compliance and energised private credit markets at a time of high freight rates and vessel market values have created a sizeable growth in standing vessel order books. Considering the timeframes of construction, ordered vessels are largely set to enter the market by the end of 2025, which is due to create a problem of overcapacity that may trigger the industry into a downturn. Given the current elevated vessel prices, companies would need to generate substantial profits consistently over the medium to long term in order to adequately justify the associated investment costs. Thus, lenders, investors and companies alike need to carefully consider credit risks, keeping in mind the very cyclical nature of the industry. Key Points Global ship finance totals approximately US$600bn, of which banks undertake 62%[1], making it the primary source of funding for the shipping industry. However, private lending has been gaining market share. Cyclical nature and credit risk: The shipping industry is highly cyclical with inherent volatility, primarily impacting credit risk through fluctuations in vessel income and market value. Current trends indicate an industry at the peak stage of the shipping cycle and likely to enter into a decline by the end of 2025. Given the current high prices of the vessels, companies would need very high profits over a moderate to long period to justify the investment costs. Trade route and fleet capacity volatilities: Geopolitical events, such as attacks on vessels in the Red Sea, and environmental disruptions, like the Panama Canal drought, have caused significant rerouting and delays, leading to increased shipping times, costs, and a 9%[2] reduction in global container shipping capacity through trade routes. However, pending order books by the industries’ largest operators are likely to introduce the issue of overcapacity as the order books actualise throughout 2024/2025. Rising operational costs: Geopolitical instability and longer shipping routes have escalated fuel, insurance, and labour costs, straining profit margins and increasing credit default risks for shipping companies. Freight rate dynamics: Recent increases in freight rates due to global capacity shortages and peak trading season demand have temporarily boosted revenues for shipping companies. Still, prolonged high costs and market instabilities continue to pose financial challenges and credit risks. Regulatory pressures: Stringent regulations, such as the IMO 2020 sulfur cap and new greenhouse gas emission targets, require substantial investments in compliance and energy efficiency by vessel owners, impacting their operational costs and potentially also, their financial stability. Compliance with regulations has the ability to strain liquidity and may increase vessel owners’ leverage, at least initially. While eventually the shipping industry will aim to pass on some of these increased costs to their customers, the pace at which this happens is likely to be more incremental, resulting in potentially lower margins for shipping companies in transition. Higher costs of regulatory compliance for shipping would disadvantage the sector versus other types of freight, but not to the degree of substitution for longer, high-capacity, intercontinental logistics, as shipping will remain the cheapest mode of transportation.
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November 7, 2024
The UK housing and residential mortgage-backed securities (RMBS) market has been navigating a complex landscape marked by elevated mortgage rates, a cost of living crisis, and shifting economic indicators. But have the tides turned? Recent house price index data published by Halifax highlighted that UK house prices have risen by 4.3% annually in August 2024, their fastest rate since November 2022.[1] This report delves into the impacts of these factors on property prices, loan demand, the broader housing market and RMBS transactions, supported by recent data and market reports from the Financial Conduct Authority (FCA) / Bank of England (BoE) and other financial institutions. Key Points Recent Market Conditions: The UK housing market has faced challenges from high mortgage rates and the cost of living crisis, which reduced property prices and loan demand. This turbulence drove a notable uptick in the value of residential mortgage arrears in recent periods, with the latter increasing 57.7% (1.28% of mortgages now in arrears, from 0.81%) from Q4 2022 to Q1 2024 and 32.0%. The value of new mortgage commitments decreased significantly in late 2023, reflecting one of the lowest levels since 2013, however more recently there are signs of recovery with new mortgage commitments increasing 11.3% from the previous quarter and 12.5% from a year earlier. [2] Mortgage Rate Trends and Impacts: Although mortgage rates are starting to show signs of decline, the high refinancing rates following the end of fixed term periods have placed additional financial strain on homeowners. This has led to an increase in residential arrears, although they remain relatively low compared to typical investment grade stresses ARC applies in RMBS transactions. Supply Constraints: The ongoing supply constraints in the UK housing market help support house prices despite economic pressures. The limited housing supply continues to create a buffer against steep declines in house prices, even as affordability declines due to high mortgage rates. RMBS Market Resilience: The UK RMBS market remains resilient despite economic challenges. Credit performance has generally been strong, in spite of the rising arrears levels noted above, and RMBS issuance across Europe increased in 2023. The resilience may be attributed to structural protections and post-GFC reforms (e.g. stress tests and heightened regulatory oversight strengthening underwriting standards) that have insulated RMBS transactions from significant performance deterioration. UK RMBS was second only to Pan-European CLOs in Q2 2024, increasing from EUR 9.2bn Q1 2024 to EUR 13.9bn in Q2 2024.[3] Emerging Trends and Future Outlook: The recent base rate cut by the Bank of England (BoE) is likely to lead to a recovery in loan demand, as FCA data prior to the cut suggests, and increased mortgage prepayments as borrowers seek to strengthen their financial position by refinancing in a cooling rate environment. Technological advances and innovative financing solutions like digital mortgage platforms, shared ownership schemes and green mortgages are expected to enhance market efficiency and create new investment opportunities. [1] Halifax House Price Index (2024)- Halifax [2] Commentary on Mortgage lending statistics Q2 2024– Financial Conduct Authority; Commentary on Mortgage lending statistics Q4 2024- Financial Conduct Authority [3] Securitisation Data Snapshot Q2 2024 (Aug 24)- AfME
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September 16, 2024
The Basel 3.1 reforms aim to address weaknesses in the original Basel III standards by revising risk-weighted asset (RWA) calculations and introducing a new output floor to improve risk measurement and comparability across firms. The final stages are intended to be implemented in the EU by January 2025, while regulators have given banks in the US and UK until July 2025[1] and January 2026,[2] respectively. On 12 September 2024, the Bank of England published the second part of the Prudential Regulatory Authority’s two near-final policy statements related to Basel 3.1. The proposals introduce changes to risk-weight calculations for rated and unrated exposures, as well as more granular classification in order to enhance risk sensitivity in both the Standardised Approach (SA) and Internal Ratings Based (IRB) approaches. Recent studies indicate that the new policies could lead to an average increase in the Tier 1 minimum capital requirements of 9.9% for EU firms by the end of the transitional period, while an even larger impact is expected to be felt in the US with an estimated rise of up to 16% in CET1 capital requirements. A new output floor will limit the benefit of IRB models by setting a minimum threshold for RWA calculations, starting at 55% of the SA output and increasing to 72.5% over four years, to prevent disproportionately low modelled risk weights. Financial institutions will face significant challenges, including increased capital requirements. If firms fail to adapt to the changing environment, capital ratios will weaken, and as a result, their credit risk profile could deteriorate. On the other hand, those banks which can successfully meet the new risk requirements could benefit from an enhanced capital buffer, reducing risk for lenders. With the new reforms reducing the advantages of IRB models, external credit ratings under the SA will become a more attractive, cost-effective, and reliable alternative for banks to minimise risk weights and ensure compliance with capital requirements regulation. [1] The PRA publishes the first of two policy statements for the implementation of the Basel 3.1 standards (Dec-23) – PRA [2] PS9/24 – Implementation of the Basel 3.1 standards near-final part 2 (Sep-24) – PRA
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September 16, 2024
INTRODUCTION ARC Ratings examines the Fund Finance market, primarily Subscription Credit Facilities (SCFs), Net Asset Value (NAV) facilities and hybrid facilities. Alongside the rising demand observed in recent years, this paper also explores the market evolution and provides insights into its future trends and developments of the Fund Finance market. The Fund Finance market saw predominant use of SCFs utilisation from 2000s to 2010s. However, in the latter part of the 2010s there has been a noticeable shift towards the adoption of NAV facilities and hybrid facilities. The expansion of alternative investments fuelled Fund Finance, despite several banks exiting this market. The increase in demand was driven by the interest in alternative investments and the entry of new lenders into the Fund Finance market. The preference among asset managers to hold onto assets for longer periods increased during the Coronavirus 2019 (COVID-19) pandemic. The heightened demand for Fund Finance introduced innovative financing solutions known as Fund Finance 2.0. These solutions provided more flexibility in provisions and cater specifically to unique needs of a fund. Market participants highlight a positive outlook for the Fund Finance market, expecting the upward trend in demand to continue as fundraising activity and macroeconomic conditions improve.
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July 12, 2024
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