Reference no: EM133111232

DEFEASANCE PROBLEM 

Consider a commercial mortgage on a small San Jose California office building. The mortgage was originated in 2011 and was part of a CMBS deal issued in that year. The mortgage had / has the following characteristics:

• Fixed rate interest-only mortgage
• Origination date: December 2011
• Original maturity: 10 years
• Remaining maturity: 2 years
• Interest rate = 4% per annum
• Loan amount = $2.2m
• Original underwritten property value at origination = $4m
• Current property value as of 2019 = $8m
• Prepayment penalties: Defeasance required using Treasury securities.

QUESTION

1. Would this mortgage have been part of an agency CMBS deal, or a nonagency CMBS deal? How sure are you? Why?
2. Calculate the monthly payment on this mortgage.
3. The mortgage is now 8 years old. The borrower wants to pay off the existing mortgage by defeasing the loan. Treasury yields are 2%. What is the market value of the Treasury securities the borrower needs to purchase in order to defease the loan? In the real world, would there be any other costs associated with the defeasance?
4. (Assume the borrower needs to raise cash today for their latest startup idea, FidoSnap (a photo sharing service for dogs and cats), and can get a new interest-only mortgage on this property with an LTV of 70%.) Taking into account your answer from part (c), how much cash could the borrower raise today by defeasing their existing mortgage and taking out a new loan? Give a brief intuitive explanation for why they are able to raise so much cash by doing this (a couple of sentences).
5. List one other reason why the borrower might benefit from defeasing their mortgage today. Also list at least one cost for the borrower of deciding to defease the loan.
6. Imagine you are an investor who owns a low-rated tranche of the CMBS deal into which this loan was securitized. Is the decision by this borrower to defease their loan good news or bad news for you as an investor, or are you unaffected? Briefly explain your answer.