Longer Problem $1$: Commercial mortgages and defeasance $(15$ points$)$

It is $2019,$ and you work in finance for a large international media company. Your firm took out

a $$500m$ amortizing fixed$-$rate commercial mortgage on your U$.$S$.$ corporate headquarters two

years ago. The coupon rate on the mortgage is $5\%,$ and the loan initially had a $25$ year

amortization period, and a $10$ year balloon payment. $($Note: Since two years have passed, this

balloon payment will now occur in eight years time$).$ Mortgage payments are monthly.

a$.$ How likely is it that this loan was financed through the CMBS market? Explain. How

would this loan be financed otherwise?

b$.$ What if this mortgage had been originated eight years ago instead $-$ would your answer

to part $($a$)$ be different?

c$.$ Calculate the monthly payment on this mortgage. Also calculate the current face value

on this mortgage.

After a boozy lunch with some Wall Street mortgage bankers, your boss tells you that he has

heard financing is easily available now, and that it would be possible to obtain new fixed$-$rate

commercial mortgage financing on the corporate headquarters at a lower interest rate of $4\%.$

He tells you to look into the costs and benefits of refinancing the existing mortgage to take

advantage of lower rates.

Looking at the mortgage contract, you notice that in order to refinance, you will be required to

defease the existing mortgage. Assume that current long term Treasury yields are $3\%,$ and the

yield curve is flat. Also assume that if you refinance now, the new mortgage would have the

same initial contract terms as the loan you currently have $($i$.$e$.25$ year term, $10$ year balloon

payment$)$

d$.$ Assuming you refinance the mortgage in a way that involves a zero up$-$front net cash

payment. In other words, when you refinance, you borrow exactly as much as it costs to

defease the old mortgage. Under this approach, what would your new monthly

payments be$?$ Explain intuitively the reason why your monthly payment went up or

down relative to your calculation in part $c.$

e$.$ Given this answer from part d$,$ do you recommend defeasing the loan to take advantage

of the lower market rates$/$why$?$