KINABALU CAPITAL SDN BHD – ISSUE 2 - 2018

MARC has affirmed its long-term ratings of AAA, AA and A on Kinabalu Capital Sdn Bhd’s (Kinabalu Capital) Issue 2 medium-term notes (MTN) issue of RM130 million Class A, RM25 million Class B and RM15 million Class C respectively. Concurrently, MARC also affirmed its MARC-1 rating on Kinabalu Capital’s issue of up to RM170 million commercial papers (CP). The issuance of the rated MTN and/or CP with a combined issuance limit of RM170 million is under Issue 2 of Kinabalu Capital’s RM3.0 billion CP and MTN programmes. The outlook on all ratings is stable. The amount outstanding under Issue 2 comprises RM130 million Class A MTN and RM40 million CP as at December 31, 2017.

Wholly owned by MRCB-Quill REIT (MQ REIT), Kinabalu Capital is a special purpose company incorporated to raise financing for the parent by setting up the RM3.0 billion CP/MTN programmes of which the rated issue is the second issuance (Issue 2). Issue 2 is secured by a third-party first legal charge on a portfolio of commercial properties comprising Quill Buildings 1, 2 and 4 as well as Tesco Penang, from which the rental income streams form the source of interest payments on the issuance. The collateralised buildings have a combined total net lettable area (NLA) of 650,940 sq ft and are fully occupied by multinational corporations DHL Asia-Pacific Information Services Sdn Bhd in Quill Buildings 1 and 4; HSBC Electronic Data Processing (Malaysia) Sdn Bhd in Quill Building 2; and Tesco Stores (Malaysia) Sdn Bhd in Penang. Their respective leases expire between 2019 and 2032.

The ratings on Issue 2 reflect the adequacy of collateral coverage on the programmes as reflected by the loan-to-value (LTV) ratios of each class of MTN and CP. The LTV ratios are based on MARC’s aggregate valuation of RM311.2 million for the Quill Buildings and Tesco Penang. The rating agency’s valuation represents a 20.6% discount from the total fair value of the collateral properties of RM392.0 million as appraised by an independent valuer as at December 31, 2017. During the period under review, the net operating income (NOI) improved marginally to RM28.6 million (2016: RM27.8 million) on the back of the reversal of excess provision for the construction of car parks and legal expenses from the previous year.

The current ratings are also premised on the collateral properties’ adequate security and debt service coverages as well as commendable occupancy and rental performance. The current debt service cover ratio (DSCR) and security cover ratio (SCR) stand at 3.61 times and 2.05 times, well above the covenanted 1.50 times under the issue structure. Any breach in the financial covenants will trigger the security trustee to dispose the collateral properties on behalf of CP and/or MTN holders. MARC’s sensitivity analysis reveals that collateral cashflow would be able to sustain highly stressed scenarios including a 45% reduction in overall rental revenue and a 20% increase in total operating cost simultaneously before breaching its liquidity covenants in 2021.

MARC observes that Issue 2 faces high tenant concentration risk given that the buildings are single-tenanted. Should either of the tenants in the Quill Buildings choose not to renew their tenancy upon expiry of their leases in November 2019 (Quill Building 2) and December 2020 (Quill Buildings 1 and 4), the underlying collateral’s LTV ratios would breach MARC’s benchmark. MARC, however, notes that termination risk is low given that the buildings have been purpose-built to cater to the tenants’ requirements, which include investment in infrastructure and a link bridge between Quill Building 1 and Quill Building 4.

Issue 2 is also subject to refinancing risk given the bullet principal repayment. Kinabalu Capital is expected to fund the bullet repayment by either refinancing or disposing of the collateral properties. However, the two-year tail period between the expected and legal maturity can provide an adequate time buffer for the disposal of collateral properties. Furthermore, any potential rollover risk in relation to the CP is addressed by the availability of commitment provided by investors to subscribe to the CP throughout its tenure. Any early termination risk is mitigated via the tenancy agreement terms and rental review provisions, whereby Kinabalu Capital is entitled to claim the rental income for the remaining duration of the tenancy. The rating agency also draws comfort from its REIT manager, MRCB Quill Management’s (MQM) commendable track record in managing MQ REIT property assets as reflected by a sound overall portfolio occupancy rate of 96.3% as at end-2017.

The stable outlook reflects MARC’s expectations that the actual LTV ratio on the rated issuance will remain within the LTV requirements and the collateral properties will continue to demonstrate sound performance that is supportive of the ratings.

Major Rating Factors

Strengths

• Sufficient collateral coverage demonstrated by low loan-to-value ratio; and
• Creditworthy tenants with long-standing tenancy relationship.

Challenges/ Risks

• Exposure to single tenant risk for each property;
• Downward pressure on office rental due to oversupply in Cyberjaya and Penang; and
• Refinancing risk posed by bullet repayment at expected maturity.