CMBS in Jeopardy If TRIA is Curtailed

NEW YORK CITY—Add CMBS to the key aspects of commercial real estate that would be undermined by a Congressional failure to maintain the present level of the Terrorism Risk Insurance Program Reauthorization Act, which provides federal reinsurance for large-scale claims related to terrorism and which expires at year's end. So says Standard & Poor's in a new report, which says that although Congress is expected to reauthorize TRIPRA, it's possible that there will be significant changes, including scaled-back coverage.

“If history is any guide, CMBS credit and liquidity issues could develop if TRIPRA is not renewed or is cut back substantially,” writes Larry Kay, primary credit analyst at S&P. “Either could cause a property's insurance premium to jump, leading to declines in property net operating income and value.” He adds that the longer a cloud of uncertainty hangs over renewing TRIPRA, the greater the perceived risk of “unaffordable or unavailable insurance increases,” which could negatively affect property valuations.

Not only could a scaled-back or defunct TRIPRA potentially shrink a CMBS loan's underlying collateral value and triggering a negative credit event, liquidity issues could also develop, Kay writes. “This could arise if a borrower fails to maintain the required insurance coverage and the master servicer decides to force-place the insurance.”

He cites the example of history: following 9/11, “lenders force-placed insurance to protect their interest in the loan collateral,” according to Kay's report. As a consequence, various CMBS trusts incurred legal expenses in the course of enforcing the lenders' requirement that the borrowers provide an appropriate level of terrorism insurance. These expenses reduced the amount of available distributable interest, causing “liquidity interruptions and interest shortfalls in CMBS trusts,” he writes.

CMBS issuance could also fall, as happened in the months following the 9/11 attacks, when CMBS issues dropped by almost 25% from 2001 levels. “It was during this time that more than $15.5 billion worth of real estate projects in 17 states were stalled or canceled because of a continuing scarcity of terrorism insurance,” Kay writes, citing a Sept. 19, 2002, release from the Real Estate Roundtable. “CMBS issuance resurged in 2003,” rebounding by 50% after the Terrorism Risk Insurance Act, the first incarnation of the government terrorism backstop program, was signed into law in November '02.

“In the post-9/11 era, the cost of terrorism insurance has fallen,” writes Kay. “TRIA and its successor, TRIPRA, have helped stabilize commercial real estate markets by making terrorism coverage available and more affordable. However, if TRIPRA is not reauthorized, the number of property insurers willing to continue offering terrorism insurance is likely to decrease, and higher pricing for terrorism insurance could result.”

A 2013 Marsh & McLennan Terrorism Risk Insurance report, issued before the 2005 extension of TRIA, found that among the 50 commercial property insurers that were polled, 34, or 68%, confirmed they would have excluded terrorism coverage after Dec. 31, 2005, if TRIA was not extended past that date. And there could be other CMBS-related consequences of higher premiums, Kay writes.

For example, “Borrowers could cry wolf and contact the master servicer, claiming they're unable to make debt-service payments in light of higher terrorism insurance premiums,” writes Kay. As a result, borrowers would likely request “some form of loan modification relief” from the master servicer. “By putting the master servicer on notice of a possible payment default, a loan could be sent over to special servicing under the guise of an imminent default.”