Case: Rate cap expires before a requested loan extension

Hypothetical floating-rate extension. An $8 million interest-only loan charges a reference index plus a 3% margin, with a 1% index floor. The existing cap has an $8 million notional and a 3% strike. Assume the cap references the same index, uses the same accrual period and pays as expected; basis differences and counterparty failure are excluded.

At a 4% index, gross annual interest is $560,000. The cap pays $80,000, reducing modeled net interest to $480,000. Accepted annual property cash flow is $650,000, giving 1.354× coverage on that net interest measure. The cap expires September 30, when the initial loan term also ends.

The proposed one-year extension requires continuous cap coverage beginning October 1, an approved counterparty, an $8 million notional, and at least 1.25× stressed coverage under the lender’s stated method. These are invented conditions. An extension is not effective merely because current payments are being made.

Separate compliance from affordability

Assume a compliant twelve-month replacement with a 3% strike has a hypothetical supplied premium of $180,000. This is an input for the case, not a market quote or a calculated derivative price. Extension fees are $40,000, legal and administrative costs are $15,000, and a required new reserve deposit is $60,000.

Total immediate cash required is $295,000. The borrower has $200,000 available after protecting other obligations, leaving a $95,000 shortage. The reserve deposit remains an asset but is restricted; it still consumes cash at extension.

A cheaper hypothetical cap with a 5% strike costs $60,000. Its total extension cash use would be $175,000, fitting within the $200,000 available. That does not establish that it satisfies the coverage condition.

Test the cheaper cap at the required stress

At a 6% index, gross annual loan interest is 9% of $8 million, or $720,000. The 5% strike cap pays 1% of notional, or $80,000. Net interest is $640,000, and coverage is 1.015625×, below the fictional 1.25× requirement.

By contrast, the 3% strike cap pays $240,000 at that index. Net interest remains $480,000 and modeled coverage remains 1.354×. The cheaper premium and the weaker hedge must be assessed together.

In this matched-index, above-strike stress, maximum permitted strike is cash flow divided by principal and required coverage, less the margin: $650,000 ÷ $8 million ÷ 1.25 − 3% = 3.5%. This solves a coverage boundary only. It does not price a 3.5% cap, establish its availability or confirm other documentary conditions.

Check the effective dates before paying a premium

Suppose an alternative indication begins October 15. It leaves October 1–14 uncovered and fails the assumed continuous-coverage condition even if its strike is acceptable. At a constant 5% index, the gross 8% loan rate would exceed the matched 3% strike-plus-margin net rate by 2% during that interval.

On a stated actual/360 convention, fourteen days of this difference equals $6,222.22. That amount measures an illustrative interest exposure; paying it does not waive the contractual gap. The lender must accept the actual coverage dates and documents.

The historical Block 40 agreement, Section 2.7.1(d), illustrates why replacement-cap timing and specifications belong in an extension checklist. Its actual clauses are transaction-specific. The dates and requirements in this case are independently invented teaching assumptions.

Build an executable extension package

The borrower should obtain a current proposal identifying notional, index, strike, start and end dates, payment conventions, counterparty and premium payment deadline. The lender or authorized servicer must confirm that the proposed documents satisfy the actual loan conditions. A term-sheet summary is not a substitute for delivery requirements.

At the same time, reconcile the extension fee, reserve deposits, accrued amounts and legal costs to a dated cash ledger. If a separate contribution supplies the $95,000 base shortage, verify that it is accessible before the cap purchase and extension deadlines. Financing the premium would introduce another obligation and may need consent.

This case has no automatically acceptable option among the two supplied alternatives: one is underfunded and the other fails coverage. A workable path requires additional eligible cash, a compliant differently priced hedge, or an effective change in the extension terms. Stress calculations help identify the missing condition; they cannot create a market price or an extension right.