DBRS Morningstar Confirms Ratings on the Collateralized Fund Obligation Notes Issued by MCA Fund III Holding LLC

DBRS, Inc. (DBRS Morningstar) confirmed its ratings on the Class A Notes, the Class B Notes, and the Class C Notes (collectively, the Notes) issued by MCA Fund III Holding LLC pursuant to the Indenture dated October 28, 2020, between MCA Fund III Holding LLC, as the Issuer, and Wells Fargo Bank, N.A. (rated AA with a Stable trend by DBRS Morningstar), as the Trustee and Calculation Agent.

-- Class A Notes at A (sf)
-- Class B Notes at BBB (high) (sf)
-- Class C Notes at BB (sf)

The ratings on the Notes address the ultimate payment of interest and the ultimate payment of principal on or before the Final Maturity Date (as defined in the Indenture referenced above).

RATING RATIONALE/DESCRIPTION
The confirmation of the ratings of the Notes is the result of an annual surveillance review. The current transaction performance is within DBRS Morningstar’s expectation. The Final Maturity Date of this transaction is November 15, 2035.

In its analysis, DBRS Morningstar considered the following aspects of the transaction:
(1) The transaction’s capital structure and the form and sufficiency of available credit enhancement (CE).
(2) Relevant CE in the form of subordination and liquidity enhancement.
(3) The ability of the rated Notes to withstand projected collateral loss rates under various cash flow stress scenarios.
(4) The performance of underlying collateral and fund characteristics such as fund seasoning, fund type, region, and performance correlation.
(5) DBRS Morningstar’s operational risk assessment of the originator and fund manager.
(6) The legal structure as well as legal opinions addressing certain matters of the Borrower and the consistency with DBRS Morningstar’s “Legal Criteria for U.S. Structured Finance.”

The Notes are backed by a pool of diversified private equity limited partnership interests in leveraged buyout, mezzanine debt, secondaries, and venture capital in 67 private equity funds. Most of funds in the MCA III Holding LLC portfolio have entered harvesting periods (five years to eight years seasoned), meaning that fund managers are focusing on seeking opportunities to exit and generate distributions that flow back to investors.

The total portfolio net asset value (NAV) was $643 million as of August 2022, down from $688 million compared with August 2021. The decline in NAV is a net effect of a total of $31 million in capital calls and a total of $186 million in return on investments (including capital gains, return on capital, and investment income) from August 2021 to August 2022. The limited partnership interests are currently around 82.5% drawn with a $138.5 million unfunded capital commitment.

The Class A Notes and the Class B Notes have been amortizing in accordance to the target loan-to-value ratios. As of the August 2022 payment date, CE to the Notes increased since transaction inception:
-- Class A: CE increased to 71.14% from 68.09%
-- Class B: CE increased to 58.50% from 54.13%
-- Class C: CE increased to 47.36% from 43.69%

Market volatility, rising inflation, and interest rates have put pressure on the private equity market by pulling down company valuations and pausing exits and merger and acquisition activities in 2022. With the expectation of market headwinds and a potential recession in 2023, the MCA III Holding LLC portfolio was made downwards adjustment on the NAV that DBRS Morningstar considers reasonable, and also was stress tested with a slowdown in capital distributions over the next two years, in the quantitative modeling process. Each class of Notes is able to withstand a percentage of tranche defaults from a Monte Carlo asset analysis commensurate with its respective rating.

The current ratings on the Notes differ from the ratings implied by the quantitative model, which would have been higher than the confirmed ratings. DBRS Morningstar considers these differences to be a material deviation from the model. The highest achievable rating for all rated Notes is capped at A (sf) because of the exposure to the counterparty risk in the form of future capital calls. The transaction depends on the ability of CMFG Life Insurance Company to fund the future unfunded commitments.

The transaction assumptions consider DBRS Morningstar’s baseline macroeconomic scenarios for rated sovereign economies, available in its commentary “Baseline Macroeconomic Scenarios for Rated Sovereigns: September 2022 Update,” published on September 19, 2022 (https://www.dbrsmorningstar.com/research/402907). These baseline macroeconomic scenarios replace DBRS Morningstar’s moderate and adverse Coronavirus Disease (COVID-19) pandemic scenarios, which were first published in April 2020.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance (ESG) factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is Rating U.S. Collateralized Fund Obligations Backed by Private Equity (October 15, 2021), which can be found on dbrsmorningstar.com under Methodologies & Criteria.

The DBRS Morningstar Sovereign group releases baseline macroeconomic scenarios for rated sovereigns. DBRS Morningstar analysis considered impacts consistent with the baseline scenarios as set forth in the following report: https://www.dbrsmorningstar.com/research/384482.

DBRS Morningstar materially deviated from its predictive model when determining the rating actions assigned to each of the Class A Notes, the Class B Notes, and the Class C Notes, respectively, by a three or more notch differential. The material deviations are warranted, given the dependency of the transaction on the ability of CMFG Life Insurance Company to fund the future unfunded commitments.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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