The industry earned a major victory in June when Treasury Secretary John Snow announced extension of the “make available” provision in the Terrorism Risk Insurance Act of 2002 (TRIA). President George W. Bush signed TRIA into law in November 2002 as a temporary federal reinsurance program, allowing a transitional period for the private property and casualty markets to stabilize.
TRIA requires that property and casualty insurance companies that operate commercial lines “make available” terrorism coverage on terms that are on a par with losses arising from events other than terrorism. This mandate was put in place because of the insurance industry's broad exclusion of terrorism coverage from all risk policies following the events of 9/11.
The “make available” provision will remain in effect through Dec. 31, 2005, coinciding with the expiration date of the federal reinsurance program. The Mortgage Bankers Association and its industry partners continue to work with the Coalition to Insure Against Terrorism (CIAT) to extend the program.
TRIA's Profound Impact
The federal backstop cautions against future terrorist acts that could be catastrophic. Other countries such as Israel, Spain and the United Kingdom implemented federal backstops after catastrophic terrorist events hit those areas.
TRIA kept ratings agencies from lowering ratings on loans in the commercial mortgage-backed securities () market, it allowed commercial-mortgage borrowers to obtain terrorism insurance coverage at a reasonable cost, and it satisfied terrorism insurance requirements of commercial servicers.
MBA's survey results, released in June, are indicative of what would happen should TRIA go away. Respondents estimated that absent mandatory availability of terrorism insurance under TRIA, only 20% of their collective portfolios would have terrorism coverage in place — a reduction of 76% or nearly $425 billion.
MBA's survey results demonstrated the efficacy of the “make available” provision. Respondents serviced nearly one-third of the $2 trillion in commercial real estate debt outstanding. Insurance specialists at every servicer stated they expected that if the “make available” provision were not extended, terrorism endorsements currently in place would be cancelled or excluded.
TRIA requires that the Treasury Secretary report to Congress on the study's results no later than June 30, 2005. MBA will work with the Treasury Department and CIAT to ensure the Treasury is aware of TRIA's effectiveness in providing stability to the markets.
REMIC Modernization Bill Debuts
The CMBS market emerged in the early 1990s following the savings & loan crisis. Though less than 20 years old, the CMBS market has earned acceptance among industry participants as a viable finance vehicle, as well as a key source of liquidity.
The Tax Reform Act of 1986 authorized a new tax entity known as a real estate mortgage investment conduit (REMIC) for the sole purpose of issuing mortgage-backed securities (MBS). The intent was to tax MBS on the basis of their economic substance but allow flexibility in structuring securities transactions. The REMIC legislation would remove obstacles to issuing multi-class securities collateralized by interests in real estate. This furnished a vehicle for minimizing double taxation from a pooling of mortgages through tax law that grants transparency.
To avoid a taxable event, REMICs must meet certain requirements. Primarily, pools for REMICs must be static, i.e., no loan substitutions. Ironically, while the 1986 tax act intended to provide flexibility in structuring MBS, the property owner often was restricted in changing terms of the original transaction and in changing the property.
However, this could trigger a taxable event; and typically an expensive tax opinion is required to ensure this is not the case to avoid threatening investors' returns. REMIC is the primary vehicle elected for domestic CMBS issuance.
A task force, created through MBA's Commercial Real Estate/Multifamily Finance Board of Governors (COMBOG), found that the REMIC rules had not kept pace with business, limited a borrower's ability to make market-dictated decisions benefiting the property's value and promoted amendments to ensure transactional efficiencies without the need for costly tax opinions.
The proposed REMIC Modernization Act of 2004 would update the REMIC tax code rules to give borrowers the flexibility to modify the collateral securing commercial mortgages held in REMICs. Changes would enhance property owners' ability to upgrade property after securitization of the mortgage and eliminate tax opinions.
The Joint Tax Committee determined there would be a minimal effect on tax revenues — $11 million over 10 years — that would result from passage of this legislation. It also would support the underlying collateral, securing CMBS as a strong investment vehicle for investors. The industry will continue to work for REMIC modernization legislation to enhance commercial property values and liquidity in the CMBS market.
Jonathan L. Kempner is the president and CEO of the Mortgage Bankers Association.