KBRA releases a report examining interest rate cap (IRC) agreements and their extension requirements among U.S. floating rate single asset-single borrower (SASB) loans. The agreements are common among SASB transactions, which represent a meaningful segment of the commercial mortgage-backed securitization (CMBS) market. Over the last five years, $230 billion of CMBS issuance (45% of the total CMBS sector) has been in the form of SASBs, more than 80% of which has been floating rate.
As the Federal Reserve has effectuated the fastest pace of quantitative tightening since the early 1980s, short-term interest rates have risen sharply—so much so that nearly 75% of SASB loans in KBRA-rated transactions have current IRC agreements with strike rates below their prevailing index, typically the 1-month Term Secured Overnight Finance Rate (SOFR) or 1-month London Interbank Offered Rate (LIBOR).
The initial IRC agreements typically terminate with the initial maturity date of the related loan, commonly two years after loan origination. After the initial term, SASB loans typically feature two to five extension options of one year each. Notably, over 90% of the $109 billion outstanding principal balance of all floating rate SASB loans maturing in 2023 have extension options available to the borrower. To exercise such options, a common requirement for the borrower is to obtain an extension or replacement of the IRC agreement that complies with the terms of the related loan agreement. Such terms vary but will include parameters around the required strike rate, including minimum debt service coverage (DSC) hurdles.
This report delves into certain IRC extension requirements that are prevalent among the KBRA-rated floating rate SASB universe of 46 transactions, which we consider representative of the broader SASB market in this context. KBRA’s review of the loan agreements and other transaction documents indicated the following across the deal universe:
- Thirty-four (73.9%) have in-place IRC strike rates that are below the 1-month LIBOR or 1-month Term SOFR index rate (as applicable) as of December 23, 2022.
- Eighteen (39.1%) specify the replacement IRC strike rate to be the greater of a specified rate or sufficient to achieve a minimum debt service threshold.
- Sixteen (34.7%) require the replacement IRC strike to be based on a rate that would be sufficient to achieve a minimum debt service threshold.
- Thirteen (28.3%) provide an option for the borrower to choose a higher replacement rate cap than required if additional collateral is provided to cover the difference.
- Fourteen (30.4%) allow the borrower and lender to negotiate a different replacement IRC strike rate if the current requirement is deemed to not be available at commercially reasonable rates or at a reasonable cost.
Click here to view the report.
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KBRA is a full-service credit rating agency registered in the U.S., the EU and the UK, and is designated to provide structured finance ratings in Canada. KBRA’s ratings can be used by investors for regulatory capital purposes in multiple jurisdictions.
Roy Chun, Senior Managing Director, CMBS Surveillance
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Mimi Ophir, Senior Director, Ratings Legal
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Nitin Bhasin, CFA, Senior Managing Director, Co-Head CMBS Ratings
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Eric Thompson, Senior Managing Director, Head of Global Structured Finance
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Michele Patterson, Managing Director
+1 (646) 731-2397