While CMBS bondholders were buoyed up by the market-wide belief that insurance would most likely cover nearly $1 billion of commercial mortgage bonds linked to destroyed World Trade Center properties, there is still a disturbing level of ambiguity in the language of the insurance policies, analysts said.
This has led market observers to wonder whether servicers are committed to advancing payments to bondholders for the long-term.
Rating agency analysts and lawyers were poring over prospectuses and scrutinizing documents last week related to two CMBS deals involving buildings destroyed or damaged in the Sept. 11 terrorist attacks on the WTC, GMAC Commercial Securities Inc. Series 2001-WTC, for $563 million, and Banc of America Large Loan Inc. Series 2001-7WTC, for $383 million. The former deal is secured by a first leasehold mortgage lien on the office portions of 1, 2, 4 and 5 World Trade Center, and the latter deal is indirectly secured by a leasehold interest in 7 World Trade Center.
While both GMAC and Banc of America made statements last week saying that the September disbursements to investors would be paid on schedule, they noted that further monthly servicer advances would be made "subject to recoverability" of the proceeds from the insurers. The problem is, the language of the insurance policies is vague and can be interpreted in different ways; while terrorism is not excluded from the list of covered causes of damages, there is also no explicit mention of it, particularly in the BofA transaction.
"Both GMAC and BofA said they would advance subject to them feeling it is recoverable, and I'm pretty sure that's what the market wanted and needed to hear," said Darrell Wheeler, CMBS strategist at Salomon Smith Barney. "This vindicates that the CMBS servicer advancing mechanism does work, which is the key point. But there still could be a number of months before we know the timing of the realization of proceeds and whether people will be paid out at par or have to continue to fund through an extensive cleanup or reconstruction procedure."
Perhaps because of this uncertainty, Moody's Investors Service put the BofA 2001-7WTC deal on rating watch for downgrade last Wednesday. Market sources seemed to expect this, as it is an easy method to caution the market from trading the bonds and gives the rating agencies time to gather information regarding whether the servicer is intending to advance.
The BofA situation is a little more uncertain, sources said. GMAC clearly required the borrower, Silverstein Properties, to obtain terrorism insurance for the WTC 1, 2, 4 and 5, which was part of its deal, GMAC 2001-WTC. A press release from GMAC last week assured investors that the company had syndicated 22 insurance companies to provide insurance in the amount of $580 million so that the bonds are covered. In addition to the press release, GMAC also held a press conference to address investors' concerns.
In the BofA situation, however, there has been less information distributed regarding the interpretation of the insurance-policy language, and the inclusion of terrorism as a covered liability is not specifically indicated.
Although the company issued a brief press release last Wednesday stating that terrorism is not excluded from the policy, market players were frustrated that the firm took more than a week after the tragedy to formally address the issue with investors.
Furthermore, word on the Street is that the situation became so delicate that the servicing on the transaction was transferred from the normal servicing staff at Banc of America to the investment banker on the deal. "To my knowledge, I've never in my life heard of an investment banker servicing a mortgage transaction of any kind," said a source close to the transaction.
What makes the BofA situation even more uncertain is that there is a provision in the ground lease that requires the lessee to rebuild the property in the event of a total casualty. This means the insurance may involve a replacement clause to rebuild in order to claim. The bank is currently working with the Port Authority of New York & New Jersey and the borrowers on this issue.
Regardless of how the policy is interpreted, there is a consensus in the market that there will be prolonged litigation of these claims, sources said.
"It's going to be interesting to see how the process will work out," said Lipkee Lu, a CMBS portfolio manager at Deerfield Capital Management. "Eventually the insurance policy is going to pay the bondholder but if the process is dragged out, then there will definitely be an impact on where single asset deals get priced in the future...the issue is how long it takes for the bondholder to actually get paid."
"It's still not clear whether BofA as servicer will advance going forward," added Eduardo Hernandez, one of the Fitch analysts looking at the deal. "The servicer needs to do more analysis to determine whether they will recover their money. The insurance policy is still going to be interpreted, and they have to decide whether proceeds will pay down the bonds."
How insurance works
Borrowers are typically required to obtain at least one of a variety of insurance options. One kind is called "all-risks" or hazard/property insurance, which pays the full appraised value of the property in the event that it is destroyed or suffers partial damage. It normally includes damage from fire, water or windstorms, and typically does not include damage from earthquakes or terrorism.
In fact, since the first bombing of the World Trade Center in 1993, commercial property insurance has excluded terrorism, and borrowers have had to buy what's called the "terrorism rider", which is very expensive and usually only obtained for trophy properties such as the WTC, the Empire State Building or the GM building, etc. Sources indicate that it not yet clear whether the BofA deal included a terrorism rider.
The second type of insurance obtained is called business interruption insurance, which means that if, for whatever reason, the tenants cannot use their space and as a result are not paying rent, the insurer will pay the amount of rent that would have otherwise been received. The BofA deal included business interruption coverage for up to twelve months, not to exceed $89.5 million.
There are also miscellaneous insurance coverage options, such as boiler insurance to cover the heating and cooling plants, or special flood insurance and elevator insurance.
Virtually all insurance policies exclude coverage for acts of war and riots, or civil insurrection.
Market participants say the GMAC transaction looks as if it is fully insured. "The only issue is, will all 22 participants in the insurance syndicate agree to pay?" said a CMBS analyst. "There may be several months of delay before the amount payable is paid out and the problem is, will they all agree that this is covered by the policy and is payable?"
For the BofA deal, further clarification is still needed for the 7 World Trade Center property, sources said. But this does not only pertain to this particular deal. Part of the problem is that, generally, the servicer documentation usually verifies that a building is insured, but does not describe the details.
"One problem is that master servicers generally only have accord forms providing evidence of insurance, but do not have the actual policies," said Richard Parkus, head of CMBS research at Deutsche Bank. "In order to determine whether acts of terrorism are excluded, servicers need to obtain the full insurance policies from the borrower, which can take time and cause delays. We expect that this will change going forward."
The future of single-asset deals
Some analysts say that the current situation will lead to more thorough due diligence on large-loan and single-asset deals, particularly for "trophy" properties such as the World Trade Center. However, investors feel that there is no need to become alarmed about future single-asset CMBS transactions.
"I think it is a bit overblown. Making a judgment based on this event is way too extreme," said Michael Hoeh, a CMBS portfolio manager at Dreyfus Corp. "This is a once-in-a-century event, and the reality of it is that this stuff is insured, for the most part. Investors may be more cautious when they look at large loans, but the reality is that large loans are the best investments in large urban areas. They are cleaner deals."
Large loans are generally much better underwritten, have better quality properties and sponsors and better credit quality tenants, according to Deutsche Bank's Parkus. Additionally, single-asset and large loan deals often price 10-20 basis points wider than regular conduit deals, which may provide relative value opportunities for investors willing to diversify at the portfolio level.
Further, analysts said that the subordination levels on these deals are much, much higher than they are in conduit deals and they price cheaper.
However, more attention is expected to be paid to deals with high profile trophy properties or large assets in general. Sources say that a distinction should be made between very symbolic landmark buildings and regular large-loan and single-asset properties, which can be non-descript.
The immediate reaction to the tragedy was that the spreads on large-loan and single-asset deals widened out compared to conduit deals, which is good for investors from a relative-value standpoint. But the market's appetite for single-asset deals is likely to be determined by upcoming deals in the market.
"The next few deals that enter the market will be a good gauge of what the market's reaction to these issues will be," said Deerfield's Lu.