MARC Ratings has affirmed its long-term ratings of AAA, AA and A on Kinabalu Capital Sdn Bhd’s Issue 3 of RM113 million Class A, RM21 million Class B and RM11 million Class C Medium-Term Notes (MTN). The outlook on all ratings is stable.

The affirmed ratings reflect the loan-to-value (LTV) ratios of the classes under the issuance that are within the LTV benchmarks MARC Ratings applies for the rating bands.

The collateral properties under the issuance are Quill Buildings 1, 3, and 4 in Cyberjaya, Selangor, as well as Lotuss Penang on Penang Island. MARC Ratings used a stabilised net operating income (NOI) of RM23.6 million based on a five-year average comprising historical NOI for 2021 and 2022, and projected NOI for 2023-2025 for each property to arrive at the collateral properties’ aggregate value of RM264.8 million under MARC Ratings’ income capitalisation approach. This represents a 23.5% discount from the properties’ aggregate market value of RM346.0 million as ascertained by independent valuers as at December 31, 2022.

Of the collateral properties, Quill Buildings 1, 3 and 4 are four-storey purpose-built offices located in the Cyberjaya Flagship Zone while Lotuss Penang is a three-storey purpose-built hypermarket located on Penang Island. Quill Buildings 1 and 4 are tenanted by DHL Asia-Pacific Information Services Sdn Bhd (DHL). Quill Building 3 is tenanted by BMW Asia Technology Centre Sdn Bhd (BMW Asia Tech), BMW Malaysia Sdn Bhd (BMW Malaysia) and BMW Credit (Malaysia) Sdn Bhd (BMW Credit) (collectively BMW Group) and Huawei Technologies (Malaysia) Sdn Bhd (Huawei Malaysia). Lotuss Penang is tenanted by hypermarket owner Lotuss Stores (Malaysia) Sdn Bhd (Lotuss Malaysia). 

The collateral properties remain exposed to high tenant concentration risk, as evident in the occupancy structure. Lotuss Malaysia accounts for 47.1% of total net lettable area (NLA); DHL 32.8%; BMW Group 9.1%; and Huawei Malaysia 4.6%. Quill Buildings 1 and 4 as well as Lotuss Penang are fully occupied, while Quill Building 3 has an occupancy rate of 68% as at end-December 2022. In terms of the tenancy lease agreements, the tenancy for Huawei Malaysia ends in 2024, while for DHL and BMW in 2025. For Lotuss Malaysia, it has a long tenancy that only expires in August 2032. 

We view the concentration and renewal risks are mitigated by the longstanding tenancy relationships of more than 18 years each, the buildings being purpose-built (Quill Buildings 1, 3 and 4) to cater to the tenants’ requirements, and the limited availability of Grade A MSC-status office buildings in the Cyberjaya vicinity. MARC Ratings also draws comfort from the expertise of Kinabalu Capital’s parent Sentral REIT and good track record of the REIT Manager, Sentral REIT Management Sdn Bhd (SRM) to mitigate occupancy and renewal risks. 

For 2022, its NOI was marginally higher at RM23.9 million although its total rental revenue remained at RM28.2 million. The higher NOI was attributed to the lower operating expenses during the year. Going forward, step-up rental rates for Lotuss Malaysia and DHL would result in marginally higher total NOI. The rental revenue could also be supported by an increased occupancy level in Quill Building 3, though this has not been accounted for in the NOI projections. On the other hand, if Huawei Malaysia whose tenancy will expire on January 31, 2024, does not renew its tenancy, there will be an impact on the NOI if no timely replacements are found. This could lead to a breach in LTV benchmarks for Class A, B and C. We understand that negotiations will commence six months prior to the expiry of the tenancy.

Under the issue structure, the MTN is required to have a minimum debt service cover ratio (DSCR) of 1.50x at all times as well as a security cover ratio (SCR) of 1.90x at all times for the MTNs under Class A and Class B. The rating case projections show that the rated MTN based on full issuance will achieve a minimum DSCR of 3.91x (without cash). The sensitivity analysis demonstrates that the collateral properties’ rental revenue would need to decrease by a significant 56% before breaching the covenanted DSCR of 1.50x. We note that Kinabalu Capital’s ability to increase its leverage in relation to the rated MTN is capped by the requirement to maintain an SCR of at least 1.50x which provides a buffer against any decline in the collateral properties’ market value. The refinancing risk is mitigated by the two-year tail period between the expected and legal maturity dates. 

The issuances have a combined limit of RM145 million under Issue 3 of Kinabalu Capital’s RM3.0 billion MTN programme. As of February 22, 2023, the amount outstanding under Issue 3 stood at RM130 million, comprising RM113 million Class A MTN and RM17 million Class B MTN.

The stable outlook assumes that the collateral properties will maintain their operational and financial performance in line with the projections that will remain supportive of the LTV ratios for the rating bands.  

The ratings may come under pressure if tenancies are terminated or not renewed, or if tenancies are renewed at rental rates that are not supportive of the NOI to maintain the LTV ratios at current thresholds.