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

DBRS, Inc. (DBRS Morningstar) confirmed its credit 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 credit 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
The confirmation of the credit 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 68 private equity funds. Most of the funds in the MCA Fund III Holding LLC portfolio have entered harvesting periods (six years to nine 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 $589.6 million as of September 2023, down from $643 million compared with August 2022. The decline in NAV is a net effect of capital calls and return on investments (including capital gains, return on capital, and investment income) from August 2022 to September 2023. The limited partnership interests are currently around 84.5% drawn with a $122.5 million unfunded capital commitment.

The Class A Notes and the Class B Notes have been amortizing in accordance with the target loan-to-value ratios. As of the August 2023 payment date, CE to the Notes increased since transaction inception:
-- Class A: CE increased to 76% from 71%
-- Class B: CE increased to 66% from 58%
-- Class C: CE increased to 55% from 47%

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 2023. With the expectation of market headwinds and a potential recession in 2024, the MCA Fund III Holding LLC portfolio made downwards adjustments 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 credit rating.

The current credit ratings on the Notes differ from the credit ratings implied by the quantitative model, which would have been higher than the confirmed credit ratings. DBRS Morningstar considers these differences to be a material deviation from the model. The highest achievable credit 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 2023 Update,” published on September 28, 2023 (https://www.dbrsmorningstar.com/research/421227). These baseline macroeconomic scenarios replace DBRS Morningstar’s moderate and adverse pandemic scenarios, which were first published in April 2020.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance 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/416784 (July 4, 2023).

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

The principal methodology applicable to the credit rating is Rating U.S. Collateralized Fund Obligations Backed by Private Equity (October 15, 2021; https://www.dbrsmorningstar.com/research/386012).

Other methodologies referenced in this transaction are listed at the end of this press release.

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.

The credit ratings assigned to each of the Class A Notes, the Class B Notes, and the Class C Notes materially deviate from the credit ratings implied by the predictive model. DBRS Morningstar typically expects there to be a substantial likelihood that a reasonable investor or other user of the credit ratings would consider a three-notch or more deviation from the credit rating stresses implied by the predictive model to be a significant factor in evaluating the credit ratings. The rationale for the material deviations is that given the dependency of the transaction on the ability of CMFG Life Insurance Company to fund the future unfunded commitments, the material deviations are warranted.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

DBRS, Inc.
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The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

-- Operational Risk Assessment for Collateralized Loan Obligations (CLOs) and Corporate Collateralized Debt Obligations (CDOs) (September 14, 2023), https://www.dbrsmorningstar.com/research/420608

-- Legal Criteria for U.S. Structured Finance (December 7, 2022), https://www.dbrsmorningstar.com/research/407008

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