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The aftermath of the WTC disaster: A CMBS credit challenge

The CMBS market is facing a credit challenge as a result of the Sept. 11 attacks on the World Trade Center and the Pentagon, according to a third-quarter CMBS report by Moody’s Investors Service.

"The attacks on the World Trade Center and Pentagon, and the subsequent disruption of air travel, will have profound short-term underwriting implications for some asset classes, hotel in particular," wrote Tad Philipp, managing director at Moody’s Investors Service in New York. "It also has led to additional scrutiny of the documents and structures supporting CMBS, such as advancing and insurance, and may lead to some permanent changes in these areas."

A credit challenge

The attacks put additional stress on an already weak economy. The last major economic downturn 10 years ago helped to established CMBS. Since that time, CMBS has faced a positive credit environment. This credit challenge will put CMBS to the test.

According to the report, CMBS will meet expectations. Compared with the last major downturn, the current environment has a greater cushion and delinquencies should not reach the same levels, the report predicts. Also, the economy is in better shape than during the last recession in the early 1990s, with real estate supply and demand is more balanced.

"The years of upgrades exceeding downgrades by wide margins are likely over, with a shift to greater balance expected," Philipp wrote. "Delinquency rates on loans are expected to rise, with a resulting increase in bond defaults."

The problem sector

The hotel sector faces the most strife. After the attacks, the travel and tourism industry suffered huge drops in revenue. This comes from a sector that was already labeled as red in Moody’s "Red-Yellow-Green" scoring system prior to Sept. 11.

The hotel sector doesn’t benefit from the long-term lease structures found in other asset classes. Following the attacks, hotels experienced dramatic occupancy declines, and many hotel companies implemented emergency cost-control measures such as decreasing spending on marketing and capital expenditures. Some hotel companies have reduced employee shifts, while other companies have resorted to laying off employees.

"As a result of the extraordinary stress in the hotel sector, Moody’s will be assessing the availability of additional sources of liquidity at the individual loan level," Philipp wrote. "We will analyze hotels on a case-by-case basis, with some sectors and locations more in need of short-term liquidity than others."

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