KINABALU CAPITAL SDN BHD - 2018

MARC has affirmed its long-term ratings of AAA, AA and A on Kinabalu Capital Sdn Bhd’s (Kinabalu Capital) Issue 1 of RM220 million Class A, RM40 million Class B and RM20 million Class C medium-term notes (MTN). The rating agency also affirmed its MARC-1 rating on the commercial papers (CP) of up to RM280 million under the issuance. The aggregate outstanding nominal value of Issue 1 under both the MTN and CP programmes is capped at RM280 million. The outlook on all ratings is stable. As of end-November 2018, the amount outstanding under Issue 1 stood at RM185 million, comprising RM20 million Class A MTN and RM165 million CP.

Kinabalu Capital is wholly owned by MRCB-Quill REIT (MQ REIT), a real estate investment trust (REIT) which owns a portfolio of commercial buildings located within the KL Sentral area. The MTN and CP under the issuance are secured by a third-party first legal charge on Menara Shell, a 33-storey purpose-built office with a total net lettable area (NLA) of 557,053 sq ft. The ratings on the MTN and CP reflect the adequate collateral coverage provided by Menara Shell based upon MARC’s assessed capital value of RM513.7 million and loan-to-value (LTV) thresholds of 43%, 51% and 55% for the class A, B and C MTN. MARC’s assessed value for the property is derived through an income capitalisation approach using a stabilised net operating income (NOI) of RM38.5 million and a capitalisation rate of 7.5%. MARC’s collateral valuation represents a 20.7% discount to the independently appraised value for the property of RM648 million as at December 31, 2017.

The rating agency views that Menara Shell’s strategic location within the KL Sentral hub and its high building grade status would ensure fairly resilient capital value and occupancy level. This notwithstanding, the prevailing oversupply of commercial space in the Klang Valley would continue to apply downward pressure on Menara Shell’s occupancy level and rental rate. Occupancy was lower at 92% as at end-September 2018 (end-2017: 94%) with an average rental rate of RM7.57 per sq ft. NOI registered was also marginally lower at RM18.5 million for 1H2018. MARC notes that about 5.9% of its tenanted NLA will be up for renewal in 2019. In this regard, the rating agency draws comfort from the REIT manager MRCB Quill Management Sdn Bhd’s (MQM) established track record in property management; MQM had an average occupancy rate of 94.0% as at end-3Q2018 for properties under its portfolio.

Occupancy concern is also partly mitigated by the 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. Although Shell’s large single occupancy poses tenant concentration risk, the tenancy agreement terms and rental review provisions 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.

Under the issue structure, the MTN and CP are required to have a minimum debt service cover ratio (DSCR) and security cover ratio (SCR) of 1.50x throughout the tenure. As at end-June 2018, the DSCR and SCR for Issue 1 stood comfortably above the covenanted levels at 5.5x and 3.5x.

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.

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
• Long-term tenancy agreement with anchor tenant Shell, a multinational corporation.

Challenges/Risks

• High tenant concentration risk;
• Pressure on occupancy and/or rental rates due to oversupply of commercial space; and
• Refinancing risk posed by bullet repayment at expected maturity.