Questions:
Assume we have a commercial mortgage loan with the following terms:

Loan amount: $400 million.
Loan type: Floating Rate
Loan term: 2 years, with 3 1-year extension options
Interest rate: SOFR +3.25%.
Initial SOFR Cap (Strike): 8.00%
Extension period terms: If the borrower extends the loan after the initial two years, the interest rate can't go higher than either:
 the greater of the strike rate at closing 
and the rate, that when added to the spread, yields a debt service coverage of 1.20x

After the initial 2-year period, the borrower decides to exercise an extension option. 

The borrower now has an NCF of $58,800,000. SOFR is now at 9%. What is the maximum Strike value that could be implemented?

Assume the company finds a lender offering loan terms that are expected to be more favorable in the long term and decides not to exercise its extension option. However, the loan will result in a DSCR of 0.97x. Explain how the company can meet its mortgage payment obligations despite having a DSCR below 1.00x. Assume that the company's NCF will not increase in the foreseeable future.

Reference answers:
To answer this question, we need to take the "Extension period terms" into consideration.

Given that SOFR is now at 9%, the borrower's current interest rate is:
8% (Cap) + 3.25% = 11.25%

This rate would result in an annual debt service of:$400,000,000 * 11.25% = $45,000,000 

This debt service would result in debt service coverage of:
$58,800,000 / $45,000,000 = 1.31x. With the original cap in effect, the DSCR is still above 1.20x, which means the SOFR Cap can potentially be increased beyond the initial 8.00%.

To determine the maximum SOFR Cap allowed, we must first determine the Maximum Annual Debt Service:
NCF / 1.20 = Maximum Annual Debt Service $58,800,000 / 1.2 = $49,000,000

With can then determine what interest rate would result in the Maximum Annual Debt Service:
 Maximum Annual Debt Service / Loan Amount = Interest Rate
$49,000,000 / $400,000,000 = 12.25%

Since we know that Spread is 3.25%, we can then determine the Maximum Cap:
Maximum Rate - Spread = Maximum Cap

12.25% - 3.25% = 9.00%

The SOFR Cap can potentially be raised as high as 9.0%

While a DSCR below 1 means the company’s net cash flow will fall short of fully covering its debt service, it’s still possible for the company to meet its mortgage payments. One option is to use cash reserves to supplement its NCF and cover the relatively small gap in debt service. Alternatively, the company could rely on a line of credit to bridge the shortfall.