Available Funds Cap

Available Funds Cap

An Available Funds Cap is a contractual provision commonly found in commercial mortgage-backed securities (CMBS) and certain floating-rate commercial real estate loans. It serves as a limit on the interest rate payable to investors or lenders, ensuring that the interest obligation does not exceed the actual net income generated by the underlying mortgage pool or asset.

Detailed Description

In the context of commercial finance, the Available Funds Cap (frequently referred to as a Net WAC Cap) acts as a structural safeguard. It prevents a scenario where the interest owed to certificate holders or senior lenders is greater than the interest actually collected from the underlying commercial borrowers. This mechanism is essential for maintaining the financial integrity of a securitization trust or a structured loan facility.

The primary characteristics and functions of an Available Funds Cap include:

• Net Interest Calculation: The cap is typically derived from the Weighted Average Coupon (WAC) of the mortgage loans in the pool, minus specific administrative expenses. These expenses often include servicing fees, trustee fees, and operating expenses.
• Protection Against Basis Risk: In floating-rate commercial mortgages, a mismatch can occur between the interest rate index used for the loans (such as SOFR) and the rate promised to investors. If the index rises sharply, the Available Funds Cap ensures the trust only pays out what it has actually received in cash flow.
• Interest Shortfalls: When the market interest rate exceeds the Available Funds Cap, a "cap shortfall" occurs. Depending on the specific terms of the Pooling and Servicing Agreement (PSA), these shortfalls may be deferred, extinguished, or paid out later if funds become available, though they often result in a lower yield for the investor during that period.
• Subordination Impact: While the cap protects the trust as a whole, it impacts different classes of bondholders differently. Junior tranches are usually the first to experience the effects of an Available Funds Cap, though in severe interest rate environments, even senior tranches may be capped.
• Credit Considerations: Rating agencies closely examine the Available Funds Cap when assigning ratings to commercial mortgage bonds. A cap that is likely to be triggered frequently may result in a lower credit rating for the affected certificates due to the uncertainty of the interest yield.

Essentially, the Available Funds Cap ensures that the payout obligations of a commercial mortgage structure remain aligned with the actual performance and cash flow of the underlying real estate collateral, protecting the vehicle from insolvency due to rising interest rates.