If TRIPRA Is Scaled Back, History Might Shed Light On The Impact To CMBS

Primary Credit Analyst: Larry D Kay, New York (1) 212-438-2504; larry.kay@standardandpoors.com Secondary Contact: Tracy Dolin, New York (1) 212-438-1325; tracy.dolin@standardandpoors.com CMBS: Peter J Eastham, Lead Analytical Manager, New York (1) 212-438-5908; peter.eastham@standardandpoors.com CMBS Surveillance: Barbara A Hoeltz, Analytical Manager, New York (1) 212-438-3621; barbara.hoeltz@standardandpoors.com Investor Relations: Ted J Burbage, New York (1) 212-438-2684; ted.burbage@standardandpoors.com Ernestine Warner, New York (1) 212-438-2633; ernestine.warner@standardandpoors.com

Table Of Contents
Imminent Defaults, Delinquencies, And Interest Shortfalls Could Rise Terrorism Insurance Requirements Could Vary By State And Property

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If TRIPRA Is Scaled Back, History Might Shed Light On The Impact To CMBS
The Terrorism Risk Insurance Program Reauthorization Act (TRIPRA), which provides federal reinsurance for large-scale insurance claims stemming from terrorism, expires at the end of 2014. Although we expect Congress to renew it, the new version might contain significant changes, including what we expect to be scaled-back coverage. If history is any guide, commercial mortgage-backed securities (CMBS) credit and liquidity issues could develop if TRIPRA is not renewed or is cut back substantially. Either could cause a property's insurance premium to jump, leading to declines in property net operating income and value. And the longer the uncertainty of reenactment, the perceived risk of unaffordable or unavailable insurance increases, which could negatively affect property valuations. In addition to potentially shrinking a CMBS loan's underlying collateral value and triggering a negative credit event, liquidity issues could also develop. This could arise if a borrower fails to maintain the required insurance coverage and the master servicer decides to force-place the insurance. This happened after the attacks of Sept. 11, 2001 (9/11), when lenders force-placed insurance to protect their interest in the loan collateral. Various CMBS trusts incurred legal expenses as they enforced the lenders' rights that the borrowers provide an appropriate level of terrorism insurance. These expenses reduced the amount of available distributable interest, which caused liquidity interruptions and interest shortfalls in CMBS trusts. CMBS issuance could also fall, as occurred in 2002, when it 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, according to a Sept. 19, 2002, release from The Real Estate Roundtable. CMBS issuance resurged in 2003, jumping by 50% after the Terrorism Risk Insurance Act (TRIA), the first incarnation of the government terrorism backstop program, was signed into law in November 2002. Could it also be that CMBS borrowers are preparing for the scale back or expiration of TRIPRA, especially in locations such as New York City, where there is a higher perceived risk of a terrorist attack? In the first quarter of 2014, we have been asked to look at close to $4 billion of New York City office collateral that is intended for securitization compared with $5 billion for all of 2013. We would expect that the longer the reenactment is delayed, the metro areas that might be viewed as more prone to a terrorist attack will see increased CMBS financing activity.

Imminent Defaults, Delinquencies, And Interest Shortfalls Could Rise

In the post-9/11 era, the cost of terrorism insurance has fallen. 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. According to a 2013 Marsh & McLennan Terrorism Risk Insurance report, before the 2005 extension of TRIA, of the 50 commercial property insurers that were polled, 34 (68%) confirmed they would have excluded terrorism coverage after Dec. 31, 2005, if TRIA was not extended past that date.

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If TRIPRA Is Scaled Back, History Might Shed Light On The Impact To CMBS

Existing loan collateral could run into technical default if a borrower is unwilling or unable to pay for post-TRIPRA insurance coverage. Typically, a master servicer is responsible for ensuring that the borrower adheres to the insurance provisions in the loan documents. If a borrower fails to maintain the required insurance coverage, the master servicer is generally obligated to obtain the insurance as required by the loan documents. Often, forced-place insurance is used to protect a lender's interest in loan collateral, but its enforcement could lead to liquidity interruptions and interest shortfalls in CMBS trusts. An example of liquidity disruptions came about after 9/11, when master servicers passed through terrorism-related legal expenses to CMBS trusts. These unanticipated expenses reduced the amount of available distributable interest, resulting in interest shortfalls to certificate classes. The expenses were incurred when legal counsel enforced the lenders' rights to ensure that the borrowers provide an appropriate level of terrorism insurance. In addition, we also saw one case where a borrower sued the master servicer for requiring the purchase of terrorism insurance. In this case, the servicer decided to pass through the legal expenses to the CMBS deals that were subject to the lawsuit. There could be other CMBS trust-related consequences of higher insurance costs. 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. As a result, they would likely request from the master servicer some form of loan modification relief. 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. Borrowers recognized that under most pooling and servicing agreements, a special servicer typically has far more authority than the master servicer in modifying a loan. A borrower could also let a loan go delinquent, causing a special servicing transfer. The transfer to special servicing could provide the borrower with a forum to request a change in the loans payment or other material terms.

Terrorism Insurance Requirements Could Vary By State And Property

Since 9/11, most commercial lenders have required terrorism insurance to secure mortgage loan collateral. To preserve a property's cash flow, annual terrorism premium caps are common. However, based on our review of several New York City properties' premium cap requirements, they could vary significantly by asset, vintage, and latitude that a borrower may or may not have in its loan documents. For example, the mortgage collateral in the GS Mortgage Securities II 2005-ROCK transaction consists of the Rockefeller Center complex, which is located in the heart of midtown Manhattan. The borrower is required to maintain terrorism insurance up to an annual premium cap. If, at a future date, the borrower is unable to obtain terrorism insurance for less than the annual premium cap, the borrower is permitted to determine the optimal coverage available for a premium equal to the premium cap. In such circumstances, the servicer's approval of the borrower's determination will not be required. In the COMM 2014-BBG transaction, the mortgaged collateral consists of a trophy class A office building in mid-town Manhattan. The borrower in this deal is not required to pay insurance premiums for terrorism coverage exceeding the "terrorism premium cap." The terrorism premium cap is defined as the greater of: The product of the rate of $0.10 per $100 multiplied by the lesser of (1) the outstanding principal balance and (2) the

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If TRIPRA Is Scaled Back, History Might Shed Light On The Impact To CMBS

sum of the full replacement cost and/or the rental loss and the business interruption insurance required. Two times the annual insurance premium that is payable at such time for the all-risk and business interruption insurance coverage required according to the loan agreement. State regulators of large urban areas, including New York, require insurers to offer terrorism coverage within standard commercial property policy forms irrespective of TRIPRA's reauthorization. States Requiring Terrorism Coverage In Standard Commercial Property Policy Forms Irrespective Of TRIPRA Reauthorization
Alaska California Georgia Hawaii Illinois Iowa Maine Missouri New York North Carolina Oregon Washington West Virginia Wisconsin

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