The methodology applies to debt instruments secured by commercial real estate (CRE). This includes direct exposure to CRE loans or securitisations of CRE loans, i.e., commercial mortgage-backed securities (CMBSs), collateralised loan obligations (CRE CLOs), asset-backed securities (CRE loan ABSs), CRE debt funds or similar CRE debt structures.

The methodology can be downloaded here.

This updated methodology includes the following adjustments:

1. Amendment of our sponsor and business plan analysis

2. Deletion of the appendix on business plan analysis

3. Clarification of our modelling approach for granular CRE portfolios

4. Clarification of our collateral value calculation

5. Clarification of our definition of refinancing default probability

6. Clarification of the integration of environmental, social and governance (ESG) factors in our analysis

7. Expansion of our CMBS liability analysis

8. Introduction of an appendix on notes backed by CRE debt funds

9. Updates of our illustrative rental value haircuts, property and vacancy costs and capitalisation rates

10. Clarification of our foreclosure analysis

11. Editorial changes

Methodology highlights

• Cornerstone cash flow analysis. Cash flows of underlying collateral are key in determining the term default risk and refinancing default risk of CRE loans. Projected cash flows determine the probability of default of CRE instruments, while discounted projected cash flows determine the secured collateral value and, ultimately, the estimated recovery value.

• Yield-driven refinancing default risk. The exit debt yield¹ compared to our estimate of the all-in refinancing rate drives our assessment of the refinancing default risk. The all-in refinancing rate is a function of financing conditions, the cost of equity, the expected loss, the asset type, potential transaction-specific factors and collateral diversification.

• No mechanistic caps. We do not mechanistically limit a transaction’s maximum achievable rating as a function of sovereign, counterparty, tenant or liquidity considerations. We assess the likelihood that credit events associated with these risks will occur, their severity and their marginal contribution to expected loss.

• Transaction-specific assumptions. We tailor our assumptions to the asset type, micro location, sponsor capabilities and tenants. This enhances credit risk differentiation between transactions.

• ESG factors. We assess quantitative and qualitative ESG factors that affect CRE instruments’ creditworthiness.

The proposed changes are not expected to affect existing ratings assigned by Scope.

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

Scope invited market participants to comment by 22 September 2022 on the proposed methodology published on 22 August 2022 and did not receive any comments. Changes are limited to minor editorial amendments.

The methodology will not affect rated transactions.

1. Calculated as the ratio of total annualised cash flows generated by collateral and available for debt servicing relative to the outstanding principal balance of a CRE loan.