Scope downgrades the rating of the credit-linked note (Inhaberschuldverschreibung) issued by Herrenhausen Investment SA via its Compartment I to BBB-_SF, from BBB_SF.

Rating rationale
Today’s downgrade reflects the portfolio’s weaker credit quality, caused by a slight deterioration in asset quality and the prepayment of high-quality assets. The portfolio now includes a higher proportion of assets with a credit quality equivalent to non-investment grade. The rating action also factors the increased portfolio concentration vis-a-vis the unchanged credit enhancement level as a result of the pro-rata amortisation of the transaction.

The rating is supported by the health of the German commercial real estate (CRE) market, on which Scope has a stable outlook. In addition, the first loss piece in the transaction can absorb 94% of the expected losses from the assets exhibiting a non-investment grade credit quality.

The stable credit profile of Deutsche Hypothekenbank Actien-Gesellschaft, the account bank and holder of the notes’ cash collateral, has no negative impact on the notes’ current rating.

Collateral performance and portfolio loan-by-loan analysis
Since closing, the reference portfolio has amortised by 47.3%, down to EUR 715.7m, including EUR 400.7m of loan prepayments. Most of the amortisation was from loans which Scope considers to be of investment grade quality. The portfolio currently includes 92% of German CRE loans.

Scope’s loan-by-loan credit estimates, based on information as of February 2016, suggest an average portfolio credit quality (considering default probabilities and expected recoveries) of BBB-, one notch lower than when Scope last monitored the transaction in May 2015.

Based on the latest performance report dated February 2016, there have been no defaults in the underlying portfolio since closing of the transaction. The share of assets classified as non-investment grade under Deutsche Hypothekenbank’s internal scale has increased to 25.6%, up from 21.8% as of the last monitoring date. In addition, the weighted average loan-to-value (LTV) ratio increased to 65.7%, up from 63% at the last monitoring date. This is partly offset by an increased weighted average debt service coverage ratio (DSCR) of 185%, up from 174% as of the last monitoring date.

Modelling assumptions
Scope has modelled the reference portfolio loan by loan using a Monte Carlo simulation, and has taken the credit enhancement of the credit-linked note into account. For each loan, Scope modelled a specific default probability (inferred from the credit estimate assigned to the loan over its weighted average life), a specific recovery upon default and asset correlations between the loans.

To assess a single loan's credit quality, Scope has considered the tenant quality, the property profile and the loans’ LTV at maturity. The analysis has also accounted for the amortisation profile, information on each loan and borrower, and available credit enhancements embedded in each of the loans.

As a result of the increased portfolio concentration, Scope has analysed the possible market value decline for the properties related to the loans, which affects the loans’ probability of refinancing and recovery upon default. Scope’s market-value-decline-assumptions range from 5% to 20%. These assumptions depend on the loans’ time to maturity and reflect the current stability of the German CRE market, but also its current prices, which are above historical levels, subject to a reversion of recent value gains towards long-term historical prices.

Scope has assumed for the outstanding portfolio an average default probability of 39.8% for a weighted average life of 5.7 years. This assumption is the result of the high probabilities of refinancing failure, driven by Scope’s long-term market-value-decline-assumptions.

Scope has assumed an average portfolio recovery rate of 95.5%, based on detailed assumptions on the properties’ market value declines and accounting for distressed sale discounts of 10% to 15%, liquidation costs of 10% to 12.5%, and an absolute recovery rate cap at 98% loan by loan.

Scope has applied pairwise asset correlations ranging from 5% to 45%, which incorporates a common factor and considers the property type and location, as well as the exposure size reflecting a more concentrated portfolio than at closing.

Rating-change drivers
The rating can be affected positively, if the largest-sized and worst-quality assets in the portfolio are prepaid.

The rating can be negatively affected if the German CRE market deteriorates and refinancing conditions change adversely. In addition, an erosion of credit enhancement from portfolio losses will also reflect negatively on the rating.

About the issuer
Herrenhausen Investment SA is a bankruptcy-remote SPV under Luxembourg law. Its Compartment I currently has a EUR 31.6m credit-linked note outstanding, which is synthetically exposed to the mezzanine credit risk of a EUR 715.7m commercial real estate portfolio originated by Deutsche Hypothekenbank. The risk transfer is achieved by means of the issuer’s fully funded bilateral guarantee to Deutsche Hypothekenbank. The bank is the major counterparty in this transaction, the servicer, the payer of the guarantee payment and most importantly the cash account provider.

Please see the initial rating report for Herrenhausen Investment S.A. - Compartment I - Inhaberschuldverschreibung, published by Scope 16 May 2014 in conjunction with the Scope’s General Structured Finance Rating Methodology, published August 2015, and the Rating Methodology for Counterparty Risk in Structured Finance Transactions, published August 2015.
 

Regulatory and legal disclosures

Important information
Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013

Responsibility
The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Executive Board: Torsten Hinrichs (CEO), Dr. Stefan Bund, Dr. Sven Janssen.
The rating analysis has been prepared by Sebastian Dietzsch, Lead Analyst. Guillaume Jolivet, Committee Chair, is the analyst responsible for approving the rating.

Rating history
Instrument ISIN Date Rating action Rating
DE000A1ZFBA0; 25.03.2014; Preliminary; (P) BBB_SF
DE000A1ZFBA0; 16.05.2014; Initial; BBB_SF
DE000A1ZFBA0; 29.01.2015; Affirmation; BBB_SF
DE000A1ZFBA0; 22.05.2015; Affirmation; BBB_SF

Information on interests and conflicts of interest
The rating was prepared independently by Scope Ratings but for a fee based on a mandate of the issuer of the investment, represented by the management company.
As at the time of the analysis, neither Scope Ratings AG nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings AG or any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of information for the rating
Quarterly performance reporting (latest February 2016), individual underlying asset information (latest February 2016), legal transaction documentation, third party valuation reports and expert opinions.
Scope Ratings considers the quality of the available information on the evaluated entity to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.
 

Examination of the rating by the rated entity prior to publication
Prior to publication, the rated entity was given the opportunity to examine the rating and the rating drivers, including the principal grounds on which the credit rating or rating outlook is based. The rated entity was subsequently provided with at least one full working day, to point out any factual errors, use of confidential information, or to appeal the rating decision and deliver additional material information. Following that examination, the rating was not modified.

Methodology
The methodology applicable for this rating is “General Structured Finance Rating Methodology”, dated August 2015 in combination with the “Rating Methodology for Counterparty Risk in Structured Finance Transactions”, published August 2015, available on www.scoperatings.com. The historical default rates of Scope Ratings can be viewed on the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml A comprehensive clarification of Scope’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.

Conditions of use / exclusion of liability
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