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

DBRS, Inc. (Morningstar DBRS) upgraded 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 (the issuer) as follows:

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

The Notes were issued pursuant to the Indenture dated October 28, 2020, between MCA Fund III Holding LLC, as the Issuer, and Wells Fargo Bank, N.A. (credit rating of AA with a Stable trend from Morningstar DBRS), as the Trustee and Calculation Agent.

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

Morningstar DBRS' credit ratings on the applicable classes address the credit risk associated with the identified financial obligations in accordance with the relevant transaction documents. Where applicable, a description of these financial obligations can be found in the transaction's press release at issuance.

Morningstar DBRS' long-term credit ratings provide opinions on risk of default. Morningstar DBRS considers risk of default to be the risk that an issuer will fail to satisfy the financial obligations in accordance with the terms under which a long-term obligation has been issued.

CREDIT RATING RATIONALE/DESCRIPTION
The credit rating action is a result of Morningstar DBRS' annual review of the transaction performance. The credit ratings on the Notes were upgraded based on the following:
-- Material updates to the Global Methodology for Rating Debt Issued by Investment Funds, Appendix III: U.S. Collateralized Fund Obligations Backed by Private Capital (CFO Methodology). The framework of the updated CFO Methodology resulted in an output that suggests one- to two-notch upgrades on the credit ratings for the applicable classes.
-- Morningstar DBRS' annual review of the transaction performance where we noted significant deleveraging, strengthened credit enhancement, and diversification and seasoning of the underlying portfolio. Furthermore, future capital distributions will flow sequentially to all classes of Notes as the transaction reaches the Clean Up Amortization Date in November 2024. In combination, these factors were supportive of the credit ratings upgrades.

The current transaction performance is within Morningstar DBRS' expectations. The Final Maturity Date is November 15, 2035.

In its analysis, Morningstar DBRS 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 asset group, fund manager (GP) performance, fund region, fund seasoning, capital calls, unfunded commitment, portfolio diversification, and fund-level leverage.
(5) Morningstar DBRS' 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 the Morningstar DBRS' "Legal Criteria for U.S. Structured Finance" methodology.

As of the August 2024 Distribution Date Report, the Notes are backed by a portfolio of diversified private capital limited partnership (LP) interests across 68 funds with a total portfolio net asset value (NAV) of $544.5 million. Three funds were excluded due to a zero NAV. The LP interests are approximately 86.1% drawn with $109.7 million remaining in unfunded capital commitment.

The portfolio provides exposure to a broad range of underlying assets in leveraged buyout, mezzanine debt, real estate and natural resources funds. There are a total of 56 unique managers (GPs) in MCA III Holding LLC portfolio, most of which are evaluated as Average under the Fund Manager (GP) Review and Assessment process. All the funds in the portfolio are in the exit or liquidation stage (seven to ten years seasoned), which implies that fund managers are focusing on seeking opportunities to exit and generate distributions that flow back to investors.

The Class A and B Notes have been deleveraging in accordance with the predetermined Target LTV schedule. The transaction will enter the Clean Up Amortization Period on November 16th, 2024, triggering a sequential paydown for Class A Notes, Class B Notes and Class C Notes. As of the August 15, 2024, Credit Enhancement to the Notes increased since August 2023:
-- Class A: CE increased to 82.26% from 76.70%
-- Class B: CE increased to 74.50% from 66.50%
-- Class C: CE increased to 61.31% from 54.49%

Morningstar DBRS analyzed this transaction using a cash flow sampling approach under the new analytical framework from the updated "Global Methodology for Rating Debt Issued by Investment Funds Methodology - Appendix III: U.S. Collateralized Fund Obligations Backed by Private Capital" (CFO Methodology). The projected Capital Calls, Distributions and Net Asset Values (NAV) for each underlying fund in the collateralized fund obligation (CFO) portfolio are evaluated based on the historical performance of a randomly drawn fund with similar characteristics. The sampling is conditioned on each fund's Asset Group (e.g., Private Equity, Venture Capital, etc.), Capital Calls to date, and age, and are adjusted based on Fund Manager (GP) Review and Fund Region, and diversification. These results are then aggregated at the portfolio level, weighting by the size of each fund's contributing share to the overall portfolio to reflect the total cash flow available to the Private Capital (PC) CFO. This process is repeated for a number of trials to generate a distribution of outcomes at the portfolio level, with rating stress levels generated by applying the Idealized Default Table.

Because the exposure to the counterparty risk in a form of future capital calls remains as a contingent risk, the transaction has some dependency on the ability of CMFG Life Insurance Company (CMFG) to fund the future unfunded commitments. As a result, the evaluation of CMFG at A (high) is constraining to the credit rating on Class A Notes, Class B Notes and Class C Notes.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental/Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

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

The principal methodology applicable to the credit ratings is Global Methodology for Rating Debt Issued by Investment Funds - Appendix III: U.S. Collateralized Fund Obligations Backed by Private Capital (October 14, 2024; https://dbrs.morningstar.com/research/441191/global-methodology-for-rating-debt-issued-by-investment-funds)

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

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.

Morningstar DBRS 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.

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The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

Legal Criteria for U.S. Structured Finance (April 15, 2024; https://dbrs.morningstar.com/research/431205)

For more information on this credit or on this industry, visit dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.