The methodology applies to debt instruments secured by commercial real estate (CRE). This can be direct exposure to CRE securities or securitisations of CRE securities portfolios i.e. commercial mortgage-backed securities (CMBS) or collateralised loan obligations (CRE CLOs).

A link to the CRE security and CMBS/CRE CLO rating methodology is available here or on www.scoperatings.com.

Scope’s methodology offers a unique cashflow framework to analyse the credit risk of commercial real estate secured debt. It focuses on an asset-specific cashflow analysis to assess a CRE security’s probability of default, its estimated recovery and the extent of any resulting expected loss.

Methodology highlights

• Cornerstone cash flow analysis. The analysis considers cashflows from the underlying collateral as key in determining term default risk and the refinancing default risk of CRE securities. Projected cashflows determine the probability of default of CRE securities, while discounted projected cash flows determine the secured collateral value and ultimately the estimated recovery value.
   
• Yield-driven refinancing default risk. The CRE portfolio’s exit debt yield compared to Scope’s estimated all-in refinancing rate drives refinancing default risk. The all-in refinancing rate is a function of financing conditions, the cost of equity, minimum expected regulatory loss, minimum debt amortisation and collateral-specific add-ons.
   
• Sponsor and business plan analysis. This recognises the essential role played by real estate sponsors by giving credit to their business plans, their quality and the sustainability of those plans.
   
• Diversification benefit. This acknowledges the benefit of diversification in CRE. Diversification provides cashflow stability, reducing term default risk. It also positively impacts refinancing default risk by reducing the estimated all-in refinancing rate.
   
• No mechanistic caps. Scope ratings are not mechanistically constrained by sovereign, counterparty, tenant quality or liquidity caps. Scope does assess, however, the likelihood that credit events associated with these risks will occur, their severity and their marginal contribution to expected loss.
   
• Transaction-specific assumptions. Scope applies asset-specific assumptions to its CRE framework. Assumptions differ according to asset type and micro location, the sponsor’s capabilities and the tenancy to allow better credit risk differentiation between transactions.

The CRE security and CMBS/CRE CLO Rating Methodology complements the General Structured Finance Rating Methodology and should be read in conjunction with the Methodology for Counterparty Risk in Structured Finance.

Scope invited market participants to comment until 7 August 2020 on the proposed methodology published on 8 July 2020 and did not receive any comments. Changes are limited to minor editorial amendments.
The methodology will only affect a limited number of rated transactions with limited expected rating impact. Affected ratings will be placed under review as soon as Scope has completed its impact assessment and they will be monitored within six months.

Analyst Conference Call

Scope Ratings will present a case study illustrating its new CRE security and CMBS methodology in a telephone and web conference call in September 2020. Details will follow and market participants will be invited to ask questions.