Moody's To Weigh Terror Risk: Bond Ratings Could Hinge on Insurance

Moody's Investors Service is changing the way it rates real estate debt to factor in whether a property has terrorism insurance and it may ultimately downgrade bonds for buildings without coverage, a move that could increase borrowing costs and make it difficult to raise money for new projects.

Moody's said yesterday that it will evaluate commercial mortgage-backed securities (CMBS) using what it called a "grim calculus" to determine the likelihood that a building would be a terrorist target and what the land underneath the building is worth relative to the entire asset value.

In coming up with its formula, the ratings firm is attempting to establish criteria for assessing the financial risk of lending money on a building that has no terrorism insurance, an issue that has created uncertainty for commercial lenders anddelayed some real estate sales and new construction.

Large commercial policyholders have faced increased difficulty obtaining terrorism insurance after the Sept. 11 attacks, stifling the flow of capital into real estate.

"Many investors just won't buy the paper, and the few that will may be counting on the insurance becoming more available or a solution from the government," said Darrell Wheeler, a CMBS analyst at Salomon Smith Barney Inc.

Investors and real estate owners had been anticipating the release of Moody's new guidelines. Fitch Ratings is also in the process of establishing new criteria.

"It's good for business," said Richmond-based mortgage banker John B. Levy. "It's going to give people direction. It's far better than wondering what the standard is."

Tad Philipp, Moody's managing director, said the firm will hold off issuing downgrades for at least two months while it waits to see if Congress will intervene to create a federal backup for terrorism insurance or if more coverage becomes available.

"Here is a new risk that was not previously baked into our analysis, so we have no choice but to consider downgrading," he said.

Moody's will assign the loans to different risk categories with different ratings. The higher-rated deals will be those in which the land has substantial value even if the building on it is demolished by a terrorist attack.

Philipp said the new criteria mostly will affect ratings of single-asset securities for trophy or landmark properties and small pools of large loans. The least affected will be small loans for multiple properties that are packaged together.

John Garrison, managing director for John Hancock Financial Services, said downgrades could be "a disastrous turn" for the $260 billion CMBS market, which became a popular and competitive lending source driven by low interest rates during the late 1990s real estate boom.

"If Moody's nicks these deals for lack of terrorism insurance, it's going to ratchet up the expense of deals and cost of doing business," Garrison said. "A lot of people buy these securities because they're safe. It's definitely something we're watching closely."

But Steve L'Heureux, portfolio manager for AEW Capital Management, said ratings that account for terrorism insurance may not matter that much to bondholders.

"It's a little bit artificial," he said. "The bond buyers will tell you what it's worth."

He also warned that "arbitrary downgrades" may have unintended consequences and questioned whether a ratings firm can do what insurance companies have said they cannot -- assess the risk of a terrorist attack.

"Just by changing the criteria arbitrarily, you can create financial problems," he said, adding that it might be sufficient just to require borrowers to disclose whether they have terrorism insurance.

© 2002 The Washington Post Company