Below, Fitch Ratings, a leading global rating agency, discusses the credit implications for the commercial real estate industry in general, and commercial mortgage backed securities (CMBS) specifically, should TRIA expire. These include a review and potential downgrading of a specific set of CMBS transactions, and a broad reduction in lending, possibly leading to greater defaults and downgrades across the broader CMBS universe.
“Historically, coverage for losses related to terrorism was included in standard all-risk property damage policies, also known as casualty policies. Following the extraordinary claims that resulted from the destruction of the World Trade Center on Sept. 11, 2001, most insurance companies either stopped offering terrorism coverage or offered only limited amounts at high rates. Although many market participants believed that a private market would naturally develop to offer terrorism coverage, this did not materialize in a significant enough size to make the coverage generally available at commercially reasonable rates. Many insurance industry experts contend that a private insurance market has not developed as insurers do not have enough data to reliably estimate the magnitude of a loss due to a terrorist act. TRIA requires that all insurance companies offer terrorism coverage as part of casualty policies. This effectively provides a federal backstop which limits insurance company exposure to casualty from a terrorist event, a protection otherwise unavailable in the private market.
“Insurance coverage for terrorism is important because it helps facilitate the flow of debt capital to the real estate industry. In general, debt providers write their loan documents to place the risks and costs of property ownership with the borrower/owner. One such risk is the risk of casualty. Real estate lenders require that borrowers obtain full replacement cost insurance so that should a casualty occur, their loan can be repaid in full. However, if TRIA is not renewed, Fitch believes the market availability of terrorism insurance would be limited. If a property owner obtains insufficient insurance, the risk of a casualty resulting from terrorism is effectively transferred to the lender.
“As we experienced in late 2001, if the casualty risk were transferred to property lenders, fewer lenders would be willing to make new loans on properties which lack these insurance protections. Such restrictions in new lending could force many existing loans into default upon maturity of their insurance policies. Also, existing loans could simply become more risky as they would bear the terrorism risk previously borne by the borrower and insurance company.
“As a subset of the commercial mortgage lending industry, the CMBS industry would be directly and immediately affected if TRIA were not in place. Fitch's methodology for rating CMBS transactions assumes insurance coverage, including casualty resulting from terrorism, for the full loan amount. In fact, Fitch has declined to rate some transactions which it believed did not have adequate terrorism insurance.
“With respect to currently existing loans, if TRIA were to expire, Fitch would expect to take similar rating actions as it did in 2002, when coverage for terrorist acts was not widely available. At the time, Fitch placed 29 classes from 13 transactions on Rating Watch Negative, indicating that if coverage were not provided, we would view the underlying assets, and the bonds issued based on them, as riskier and no longer as creditworthy as their then current rating indicated. Generally these were transactions that had a single property, or several properties owned by a single borrower. Ultimately,