KINABALU CAPITAL SDN BHD - 2017

MARC has affirmed its long-term ratings of AAA, AA and A on 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. The rating agency also affirmed its MARC-1 rating on Kinabalu Capital’s issue of up to RM280 million commercial papers (CP). The outlook on all ratings is stable.

As of end-November 2017, the amount outstanding under the issuances stood at RM185 million, comprising RM20 million Class A MTN and RM165 million CP.

Kinabalu Capital is a special purpose company incorporated by MRCB-Quill REIT (MQ REIT) to mainly raise financing for MQ REIT to part-finance its investment activities. Proceeds from Kinabalu Capital Issue 1 was utilised to partly finance the acquisition of Menara Shell. The MTN and/or CP are secured by a third-party first legal charge on Menara Shell, a 33-storey office tower owned by MQ REIT. The ratings on the MTN and CP reflect the adequate collateral coverage provided by Menara Shell based on MARC’s loan-to-value (LTV) requirements which correspond to their respective rating bands.

As at December 31, 2016, Menara Shell was valued at RM648 million by an independent appraiser. However, based on MARC’s methodology, Menara Shell is valued at RM517.4 million which represents a 20.2% discount from its appraised value. MARC used a stabilised net operating income (NOI) of about RM38.8 million and a capitalisation rate of 7.5% to derive the office tower’s value. The rating agency views Menara Shell’s strategic location within the KL Sentral transportation hub and its high building grade status would ensure fairly resilient capital value and occupancy levels. This notwithstanding, the prevailing oversupply of commercial space in the Klang Valley would continue to pose downward pressure on Menara Shell’s occupancy levels and rental rates.

Occupancy risk is mitigated by a long-term tenancy agreement with anchor tenant, Shell People Services Asia Sdn Bhd (Shell), a wholly-owned subsidiary of oil major Royal Dutch Shell plc. Shell occupies 54.7% of Menara Shell’s net lettable area (NLA) of 557,053 sq ft. While the large single occupancy poses tenant concentration risk, MARC understands that the tenancy agreement terms and rental review provisions are expected to mitigate this risk. In the event of early termination, Kinabalu Capital via its REIT trustee can claim rental revenue from its tenants for the remaining tenancy period. MARC opines that both Shell’s strong creditworthiness and its long-term tenancy period will offer cash flow stability to support the debt service requirements of the rated issuance.

As at end-September 2017, the building was about 97.0% occupied with an average rental rate of RM7.33 per sq ft (psf). MARC notes that about 25.1% of its tenanted NLA will be up for renewal in 2018. In this regard, the ability of the REIT manager, MRCB Quill Management Sdn Bhd (MQM), to maintain occupancy levels is important. MARC considers MQM’s track record as REIT manager to be adequate based on its management of 11 properties with NLA of 2.25 million sq ft, average occupancy of 96.6% and a lease renewal rate of 90.0% in 3Q2017.

Under the issue structure, the MTN and/or CP are required to have a minimum debt service cover ratio (DSCR) and security cover ratio (SCR) of 1.50 times throughout the tenure. A breach in the financial covenants will trigger the security trustee to dispose the collateral on behalf of CP and/or MTN holders. The base case cash flow projections show a DSCR of 3.31 times for the CP, while the MTN Classes A, B and C register 3.72 times, 3.13 times and 2.81 times respectively. MARC takes comfort from its sensitised cash flows which remain resilient even in the event of a 35% revenue decline and 5% increase in operating costs.

The issuances are structured on an interest-only basis with no amortisation of principal prior to their respective maturity dates. The bullet principal repayments of the CP and MTN are 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 the expected and legal maturity dates. In respect of the CP, the availability of a commitment provided by investors 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 a resilient performance that is supportive of the ratings.

Major Rating Factors

Strengths

• Strong collateral coverage evident in low loan-to-value ratio;
• Strategic position of the collateral property in Kuala Lumpur Sentral; and
• Anchor tenant is Shell, a multinational corporation, with a long-term tenancy agreement.

Challenges/Risks

• High tenant concentration risk;
• Downward pressure on rental rates of office buildings; and
• Refinancing risk posed by bullet repayment at expected maturity.