KINABALU CAPITAL SDN BHD - 2016

MARC has assigned long-term ratings of AAA, AA and A to Kinabalu Capital Sdn Bhd’s (Kinabalu Capital) issue of RM220 million Class A, RM40 million Class B and RM20 million Class C medium- term notes (MTN) respectively. Concurrently, the rating agency has assigned a MARC-1 rating to Kinabalu Capital’s issue of up to RM280 million commercial papers (CP). The rated MTN and/or CP issuance are subject to a combined issuance limit of RM280 million. The outlook on all ratings is stable.

Wholly owned by MRCB-Quill REIT, Kinabalu Capital was incorporated to raise financing for its parent. The rated MTN and/or CP (or the rated issuance) will be the first issuance under Kinabalu Capital’s MTN programme and CP programme (notes programmes) with a combined limit of RM3.0 billion. Proceeds from the rated issuance will be advanced to MRCB-Quill REIT to part-finance the acquisition of Menara Shell, a 33-storey office tower in KL Sentral, for RM640 million. The rated MTN and/or CP will be secured by a third party first legal charge on Menara Shell, while rental income from the building will form the principal source of debt service. MARC’s ratings on the rated MTN and CP reflect the adequate collateral coverage provided by Menara Shell based on the rating agency’s loan-to-value (LTV) requirements corresponding to their respective rating bands.

The rating agency has valued Menara Shell at RM513.7 million, about 19.7% lower than the building’s market value of RM640 million as at June 20, 2016. MARC used a stabilised net operating income of RM38.5 million and a capitalisation rate of 7.5% to derive Menara Shell’s value. MARC believes Menara Shell’s strategic location within the KL Sentral transportation hub and high building grade with Leadership in Energy and Environment Design (LEED) status would ensure fairly resilient capital value and occupancy levels. Nonetheless, the rating agency notes that there is looming oversupply of commercial properties in the Klang Valley, which could result in downward pressure on capital values and rental rates.

Menara Shell, which has a net lettable area (NLA) of 557,053 sq ft, commenced full operations in February 2014, and has to date achieved a 99.9% occupancy rate. The building’s average rental rate of RM7.40 per sq ft as at August 31, 2016 is comparable with its peers. Of the NLA, anchor tenant Shell People Services Asia Sdn Bhd (Shell), a wholly-owned subsidiary of oil major Royal Dutch Shell plc, occupies 304,673 sq ft, or a sizeable 54.7% as at August 31, 2016 under a 15-year tenancy agreement expiring in 2028. The large single occupancy poses tenant concentration risk; however, the terms of the tenancy agreement and rental review provisions mitigate this risk. In the event of an early termination, Kinabalu Capital via the REIT trustee would be able to claim rental revenue from its tenants for the remaining tenancy periods. MARC regards Shell’s strong creditworthiness and the long-term tenancy period to offer cash flow stability to support the debt service requirements of the rated issuance.

MARC notes that a significant 25.1% of its tenanted NLA will be up for renewal in 2018. In this regard, the ability of MRCB Quill Management Sdn Bhd (MRCB Quill Management), the REIT manager of MRCB-Quill REIT to maintain occupancy levels is crucial. MARC draws comfort from MRCB Quill Management’s established track record in property management; it registered a lease renewal rate of 87% and recorded an average occupancy rate of 97.2% for MRCB-Quill REIT’s property portfolio in 1H2016.

The base case projections show that the rated MTN and/or CP will achieve a minimum debt service cover ratio (DSCR) of 3.26 times (without cash). MARC’s sensitivity analysis demonstrates a moderate degree of resilience with respect to the DSCR level by assuming severe occupancy deterioration; under this circumstance, Menara Shell’s rental revenue would need to decrease by a significant 40% before breaching the covenanted DSCR of 1.50 times under the terms of the rated issuance. MARC also notes Kinabalu Capital’s ability to increase its leverage in relation to the rated MTN and/or CP is capped by the requirement to maintain a security cover ratio of at least 1.50 times which provides a buffer against a decline in Menara Shell’s market value.

The issuances are structured on an interest-only basis with no amortisation of principal prior to their respective maturity dates. The bullet principal repayment of the CP and/or MTN is expected to be funded by proceeds from refinancing or the disposal of Menara Shell. The refinancing risk is mitigated by the two-year tail period between expected and legal maturity dates. In respect of the CP, the availability of a commitment provided by investors to subscribe to the CP throughout the expected tenure would address any potential rollover risk.

The stable outlook reflects MARC’s expectation that the actual LTV ratio on the rated issuance will remain within the LTV requirements and Menara Shell will continue to demonstrate resilient performance that is supportive of the ratings.

Major Rating Factors

Strengths

• Strong collateral coverage;
• Strategic positioning of the collateral property in Kuala Lumpur Sentral; and
• Multinational corporation Shell occupies majority space under long-term tenancy.

Challenges/Risks

• Tenant concentration risk;
• Downward pressure on office rental rates in the Klang Valley; and
• Refinancing risk posed by bullet repayment at expected maturity.