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Data centres are a rapidly growing asset class in the esoteric landscape, which presents a variety of new risks to be analysed. This report provides an overview of the challenges faced in data centre investments and examples of how they are typically mitigated to promote greater cash flow stability. In this Guide: Obsolescence risk: a crucial consideration that helps distinguish data centres from other forms of commercial real estate (CRE) securitisation. It is driven by key factors such as those displayed in Figure 1. ARC scores these factors as Low/Average/High/Very High risk, and weights the aggregate obsolescence score in the order of significance illustrated in Figure 1.[1] Data centres that are less vulnerable, and least likely to become obsolete will have; reliable access to power and fibre optic networks, efficient cooling methods and adequate back‑up systems. Lease renewal risk acutely affects the stability of future cash flows, especially in turnkey data centres with higher tenant churn, but is presently mitigated by burgeoning demand that overshadows supply. However, renewal risk poses a future threat as hastening construction increases alternatives for tenant relocation. Concentration risk in large facilities can be counteracted by a creditworthy customer base. Concentrated revenues can also increase utilisation risks if hyperscale/wholesale tenants fail to use capacity, however, this can be neutralised by avoiding usage-based contracts.
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February 27, 2025
Despite their smaller size, middle-market companies[1] have a significant impact on global employment[2], innovation, and economic growth. They are often major employers, contribute significantly to GDP, drive innovation and support the creation of supply chains across industries. At the same time, middle-market companies often face challenges when it comes to accessing financing. Being less known and perceived as more risky by investors make debt financing expensive and difficult. But does the perception that a smaller company inherently carries higher credit risk than a larger one reflect the economic reality? Gaining a deeper insight into the unique features of the industry in which companies operate and their business models sharpens the evaluation of an entity’s cash flow volatility and its ability to meet its financial obligations. Contrary to the common belief and as explained further in this report, an entity’s smaller size doesn’t always limit its credit quality. Let’s delve into the details. KEY POINTS Why size and scale can be an advantage: Large size typically benefits credit quality through strong competitive position, economies of scale, robust bargaining power with suppliers, solid financial flexibility and affordable capital. While these features are credit-supportive, their relevance varies with the industry dynamics. Small size has benefits that are overlooked: While smaller companies are often seen as risky compared to larger ones, their size offers unique benefits. Agility, quicker decision‑making, ability to customise can enhance their credit quality. Size matters less in resilient industries: In resilient, low-volatility industries, middle-market companies can compete on par with larger ones, especially if they maintain conservative financial profiles. Defensive industries, with high barriers to entry, low competition, limited cost risk, support predictable earnings, making size a less important factor in analysing credit quality. Strong revenue and margin visibility override concerns related to small size: Factors like niche market position, predictable revenue from long-term contracts and flexible cost structures provide stability and protection against demand, price, and cost risks. When these features work together, size becomes less important, and factors like financial policy and management strategy take centre stage in assessing credit quality.
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February 27, 2025
Sample calculation of RWAs shows rated securitised portfolio of shipping vessels can achieve improved capital treatment in various scenarios versus corporate shipping exposures With the implementation of Basel 3.1 approaching, banks must make critical decisions regarding the management of their shipping portfolios. Securitisation offers a viable path forward, reducing risk weights and enabling continued investment in fleet renewal. Key Points Shipping exposures are inherently risky and typically fall within the non-investment grade category. The traditional market approach has been to leave these exposures unrated, thereby applying a 100% risk weight. Securitisation techniques can enhance diversification and, with other forms of credit enhancement, could potentially elevating it to investment grade and resulting in lower associated risk weights. Investment grade securitisations can achieve risk weights as low as 90% for BBB+ ratings or 65% for A ratings, providing banks with substantial capital relief.
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February 27, 2025
ARR loans are gaining popularity as a financing tool as technology continues to disrupt industries. The distinct nature of borrowers issuing ARR loans—high-growth companies with negative profitability—makes them particularly interesting to rate. In this report, we outline five specific areas from our Non-Financial Corporates Methodology for assessing their creditworthiness, each explained in detail as you read on. KEY POINTS Revenue visibility: The foundation of ARR loans is predictable recurring revenue. Our analysis emphasises the importance of forecasting revenues, combining top-down and bottom-up approaches. Key factors such as industry fundamentals, competitive position, customer retention, lifetime value, contract lengths, and churn rates provide deeper insights into revenue growth. Timeline and likelihood of turning to positive EBITDA: A key milestone in ARR lending is the “flip date,” when leverage shifts from an ARR-based to an EBITDA-based metric. Borrowers are expected to achieve positive EBITDA by this point. Our analysis focuses on the borrower’s ability to expand margins through scaling its business, supported by our base case ARR forecast and cost sensitivities, considering factors like cost structure, operating leverage, discretionary investment flexibility, and the impact of R&D costs on profitability and cash flows. Failure to meet this target raises concerns about financial sustainability. Debt accrual vs. expected ARR growth: The sustainability of debt levels relative to revenue growth is a crucial financial risk indicator. A rising debt burden—especially when fuelled by PIK (payment-in-kind) interest—coupled with lagging revenue growth is the first sign of credit quality deterioration, even before covenant breaches or liquidity concerns. Degree of sponsor support: The financial and strategic backing from private equity sponsors plays a key role in mitigating risks. A strong sponsor with a track record of supporting portfolio companies through market cycles and covenant breaches is considered credit-positive. Focus on recoveries: Recovery analysis is particularly important for entities at the lower end of sub-investment grade. To assess recovery, enterprise value (EV) is applied to a debt waterfall analysis under a hypothetical default scenario. To avoid the use of overly optimistic multiples presently featured in the software and development markets, through-the-cycle valuation multiples from the technology sector are used to estimate EV and adjusted for factors such as size, industry, growth rates, margins, and competitive positioning.
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February 27, 2025
Case study explores how diversified portfolios in shipping finance can lead to significantly lower risk of default and increase the potential for investment grade ratings Key Points This case study analyses several shipping securitisation possibilities: a typical single loan secured by a single vessel, a concentrated portfolio of 20 vessels across 10 sub-types, and a more diversified portfolio representative of the global fleet with 100 vessels. The study shows that by using a securitisation structure backed by a diversified portfolio, the risk of default and loss rate versus the typical funding option of single loan, single vessel model significantly reduces. The case study also demonstrates that an investment-grade rating is achievable for a shipping securitisation with appropriate credit enhancement. Table of modelling outcomes based on ARC’s hypothetical case study
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February 13, 2025
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