Note 10. Debt Obligations

9 Months Ended

Sep. 30, 2013

10. Debt Obligations

Credit Agreements

Credit Agreement with Wells Fargo Bank, N.A.

During June 2012, the Company entered into a senior secured revolving credit agreement with Wells Fargo Bank, N.A. The agreement authorizes the Company to borrow up to $100,000 from time to time from Wells Fargo Bank. This credit agreement is the Company’s primary short-term borrowing facility.

During June 2013, the Company entered into an amendment to the credit agreement with Wells Fargo Bank. The amendment temporarily increases the Company’s aggregate borrowing capacity under the revolving credit agreement to up to $150,000 (from up to $100,000). The additional $50,000 in aggregate borrowing capacity will remain available to the Company until December 21, 2013, provided that the Company may extend the increased capacity for an additional six months until June 21, 2014, subject to the payment of an extension fee and the satisfaction of certain other routine conditions.

The credit agreement with Wells Fargo is for a three year term scheduled to mature on June 28, 2015, although the Company has an option to extend the term for one additional year subject to the payment of an extension fee and the satisfaction of certain other routine conditions. The Company is obligated to pay interest on its borrowings pursuant to the agreement at a floating rate of LIBOR plus 275 basis points. The Company may select a one month, three month or six month interest period for its LIBOR-based borrowings.

As of September 30, 2013, the collateral pool consisted of 21 real properties: the 11 Kroger grocery store properties the Company owns located in GA, TN and KY, the two multi-tenant properties the Company owns in Omaha, NE, the property the Company owns in Columbus, OH leased to Abbott Laboratories, the property the Company owns in Bloomington, IN leased to Baxter International, Inc., the property the Company owns in Louisville, KY leased to Michelin North America, Inc., the two properties the Company owns in Englewood, CO (one leased to Comcast Corporation and the other to Pulte Mortgage LLC), the property the Company owns in Plano, TX leased to Capital One Financial Corporation, the property the Company owns in Ashland, VA leased to Vitamin Shoppe Industries Inc. and the property the Company owns in Malvern, PA leased to Teva Pharmaceuticals Industries Limited. Advance rates on these properties are generally equal to 60% or 65%, depending on the property, of the lender’s as-is appraised value. The Company is authorized to add additional real estate properties to the collateral pool over time subject to the lender’s approval of the property, and the Company has done so and expects to continue to do so as it adds additional real estate properties and as mortgage debt matures on properties the Company currently owns. The Company is also authorized to remove assets provided it repays any associated borrowings at par.

The Company’s borrowings are a recourse obligation, and CapLease has guaranteed all obligations of its various subsidiaries that act as borrowers under the agreement and own the real property that comprises the initial collateral pool.

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Maximum Leverage: The Company’s total indebtedness divided by the capitalized value of its portfolio based on an 8.0% capitalization rate may not exceed 77% initially and declining to 70% over the agreement term.

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Minimum Fixed Charge Coverage: The Company’s adjusted EBITDA (as defined in the credit agreement) divided by its fixed charges (basically interest expense, principal payments, net of principal received, and preferred dividends) may not be less than 100% initially increasing to 105% over the agreement term. For this purpose, EBITDA excludes non-recurring gains and losses and stock-based compensation and is adjusted to remove the impact of straight-line rents.

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Minimum Debt Yield: The Company’s total net operating income (as defined in the credit agreement) divided by total liabilities may not be less than 9% initially increasing to 9.75% over the agreement term. For this purpose, total net operating income includes interest income on the Company’s loans and securities and rental revenues are adjusted to remove the impact of straight-line rents.

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Minimum Interest Coverage Ratio: The Company’s adjusted EBITDA divided by interest expense may not be less than 140% initially increasing to 150% over the agreement term.

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Minimum Tangible Net Worth: The Company’s tangible net worth (basically stockholders’ equity before accumulated depreciation and amortization) may not be less than 85% of such tangible net worth as of June 29, 2012 plus 80% of net proceeds of any future equity issuances.

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Maximum Dividends: Cash dividends to CapLease shareholders may not exceed the greater of (i) the amount required to maintain REIT status and avoid the payment of income or excise tax and (ii) 95% of adjusted funds from operations (as defined in the credit agreement). For this purpose, funds from operations excludes non-recurring gains and losses.

As of September 30, 2013, the Company was in compliance with the above financial covenants.

Credit Agreement with KeyBank N.A.

During October 2012, the Company entered into a senior secured credit agreement with KeyBank National Association, pursuant to which KeyBank made a $10,000 term loan to the Company. The proceeds of the term loan were utilized to repay in full and terminate a predecessor senior secured credit agreement with Wells Fargo Bank, N.A., entered into in July 2010.

The credit agreement with KeyBank is for a three year term scheduled to mature on October 12, 2015, although the Company has two successive options to extend the maturity date, in each case for one additional year, subject to the payment of an extension fee and the satisfaction of certain other routine conditions. The Company is obligated to pay interest on its borrowings pursuant to the agreement at a floating rate of LIBOR plus 300 basis points. The Company may select a one month, two month or three month interest period for its LIBOR-based borrowings.

The collateral pool consists principally of fully amortizing mortgage notes on various real properties owned by the Company. Debt service on those notes is funded directly by rent paid by the tenant, and is expected to fully amortize the outstanding principal balance of the KeyBank loan over the loan term.

The Company’s borrowings are a recourse obligation, and CapLease has guaranteed all obligations of its subsidiary that acts as borrower under the agreement and owns the notes that comprise the collateral pool.

The Company made various customary representations and warranties and affirmative and negative covenants pursuant to the credit agreement, and agreed to various customary events of defaults. The Company also agreed to various financial covenants which it is required to be in compliance with during the term of the credit agreement. The financial covenants, as well as the representations and warranties, affirmative and negative covenants, and events of default, closely conform to those included in the Company’s senior secured credit agreement with Wells Fargo described above.

As of September 30, 2013, the Company was in compliance with the financial covenants under the KeyBank credit agreement.

Borrowings and collateral carry values related to the Company’s credit agreements as of September 30, 2013 and December 31, 2012, were as follows:

	At September 30, 2013				At December 31, 2012
	Borrowings		Collateral Carry Value		Borrowings		Collateral Carry Value
	Unaudited		Unaudited
Wells Fargo Bank Credit Agreement
Owned properties	$	121,000	$	247,101	$	58,056	$	133,530
KeyBank Credit Agreement
Loans held for investment		1,347		2,150		1,414		2,277
Intercompany mortgage loans on CapLease properties		4,929		7,179		6,410		9,765
Commercial mortgage-backed securities		1,622		3,117		1,776		3,210
Total	$	128,898	$	259,547	$	67,656	$	148,782

For the three and nine months ended September 30, 2013 and September 30, 2012, the following interest rates applied with respect to the Company’s credit agreement borrowings:

	For the three months ended September 30,						For the nine months ended September 30,
	2013			2012			2013			2012
	(unaudited)			(unaudited)			(unaudited)			(unaudited)

Weighted average effective financing rate		3.9	%		4.9	%		3.9	%		4.2	%
One-Month LIBOR rate		0.18	%		0.24	%		0.20	%		0.25	%

Mortgage Notes on Real Estate Investments

The Company has financed many of its owned real properties with first mortgage debt. The Company’s mortgage notes payable are summarized in the following table:

	Sep 30, 2013				Dec 31, 2012
Property Description	Face Amount of Debt		Carry Value of Debt		Face Amount of Debt		Carry Value of Debt		Coupon			Effective Financing Rate (1)			Maturity Date
	Unaudited		Unaudited
Abbott Laboratories, Waukegan, IL	$	13,753	$	13,753	$	14,056	$	14,056		5.11	%		5.2	%	Aug 2015
Aetna Life Insurance Company, Fresno, CA		16,043		16,043		16,043		16,043		5.63	%		5.7	%	Dec 2016
Allstate Insurance Company, Charlotte, NC		18,926		18,926		19,156		19,156		5.68	%		5.7	%	Jan 2016
Allstate Insurance Company, Roanoke, VA		20,149		20,149		20,394		20,394		5.68	%		5.8	%	Jan 2016
AMEC plc, Houston, TX		15,820		16,060		15,977		16,284		5.85	%		5.3	%	Apr 2016
Aon Corporation, Glenview, IL		56,043		56,043		57,522		57,522		5.23	%		5.8	%	Nov 2014
AT&T Services, Inc./MetroPCS Communications, Inc., Richardson, TX		20,306		20,306		20,546		20,546		4.60	%		4.8	%	Jun 2022
Becton, Dickinson and Company, San Antonio, TX		10,000		10,000	–		–			3.95	%		4.2	%	Apr 2023
Breinigsville, PA (Nestle); Fort Wayne, IN (Vacant); and Lathrop, CA (Del Monte)		105,287		105,287		105,305		105,305		6.32	%		6.8	%	Feb 2014
Bunge North America, Inc., Fort Worth, TX		6,262		6,262		6,262		6,262		5.45	%		5.6	%	May 2017
Cadbury Holdings Limited, Whippany, NJ		31,287		31,287		31,848		31,848		5.26	%		5.3	%	Mar 2015
Cadbury Holdings Limited, Whippany, NJ		834		834		1,227		1,227		5.26	%		6.5	%	Mar 2015
Capital One Financial Corporation, Plano, TX	–		–			18,767		18,767		5.24	%		5.3	%	N/A
Choice Hotels International, Inc., Silver Spring, MD	–		–			25,189		25,189		5.30	%		5.3	%	N/A
Cimarex Energy Company, Tulsa, OK		30,853		30,853		17,688		17,688	LIBOR+275			Floats			Jul 2018
Con-Way Freight, Inc. , Ann Arbor, MI		29,488		29,305	–		–			4.00	%		4.1	%	Sep 2022
Cooper Tire & Rubber Company, Franklin, IN		17,090		17,090		17,355		17,355		5.54	%		5.8	%	May 2021
County of Yolo, California, Woodland, CA		10,332		10,332		10,332		10,332		5.68	%		5.8	%	Feb 2017
Crozer-Keystone Health System, Ridley Park, PA		2,417		2,417		2,662		2,662		5.40	%		6.0	%	Apr 2019
CVS Caremark Corporation, Randolph, MA		7,018		7,018		7,275		7,275		5.40	%		6.4	%	Jan 2014
Exelis, Inc. (formerly ITT Corporation), Herndon, VA		38,356		38,356		39,014		39,014		5.33	%		5.4	%	Jun 2015
Exelis, Inc. (formerly ITT Corporation), Herndon, VA		1,613		1,613		2,233		2,233		5.33	%		6.4	%	Jun 2015
Farmers Group, Inc., Simi Valley, CA		25,620		25,620		25,620		25,620		5.81	%		5.9	%	Jan 2017
Farmers New World Life Insurance Company, Mercer Island, WA		29,259		29,259		29,538		29,538		5.69	%		5.7	%	Jan 2016
General Motors Financial Company, Inc., Arlington, TX		25,700		25,545		26,128		25,947		5.28	%		5.5	%	Sep 2017
Invesco Holding Co. Ltd., Denver, CO		43,700		43,700		43,700		43,700		6.03	%		6.1	%	Jul 2016
Johnson Controls, Inc., Largo, FL		16,200		16,200		16,200		16,200		5.48	%		5.5	%	Jan 2017
Koninklijke Ahold, N.V., Levittown, PA		13,404		13,404		13,588		13,588		6.05	%		6.1	%	Jul 2016
Lowes Companies, Inc., Aliso Viejo, CA		40,193		40,193		40,681		40,681		5.10	%		5.4	%	Jul 2015
Lowes Companies, Inc., New Orleans, LA		8,117		8,689		8,330		8,938		5.57	%		4.8	%	Aug 2030
Lowes Companies, Inc., New Orleans, LA		7,259		7,634		7,454		7,854		5.32	%		4.7	%	Aug 2030
Lowes Companies, Inc., New Orleans, LA		410		449		420		462		5.93	%		4.8	%	Aug 2030
Omnicom Group, Inc., Irving, TX	–		–			12,144		12,144		5.24	%		5.3	%	N/A
Pearson Plc., Lawrence, KS		15,236		15,236		15,404		15,404		5.84	%		6.0	%	May 2016
Praxair, Inc., The Woodlands, TX		22,440		22,440		22,440		22,440		3.70	%		3.9	%	Aug 2022
Tiffany & Co., Parsippany, NJ		56,000		56,000		56,655		56,655		5.33	%		5.3	%	Oct 2015
Time Warner Cable Enterprises LLC, Milwaukee, WI		17,500		17,500		17,500		17,500		5.55	%		5.6	%	Dec 2016
Time Warner Cable Enterprises LLC, Milwaukee, WI		1,819		1,819		1,991		1,991		6.18	%		6.8	%	Dec 2016
Time Warner Cable Enterprises LLC, Milwaukee, WI		1,464		1,464		1,910		1,910		5.83	%		6.8	%	Dec 2015
TJX Companies, Inc., Philadelphia, PA		67,537		67,537		68,118		68,118		5.57	%		5.6	%	Mar 2016
T-Mobile USA, Inc., Nashville, TN		10,336		10,336		10,456		10,456		5.59	%		5.7	%	Dec 2016
United States Government (DEA), Birmingham, AL		10,615		10,615		10,751		10,751		5.23	%		5.4	%	Sep 2015
United States Government (EPA), Kansas City, KS		17,216		17,216		18,180		18,180		3.23	%		3.8	%	Mar 2023
United States Government (FBI), Albany, NY		10,137		10,137		10,137		10,137		5.50	%		5.7	%	Nov 2016
United States Government (FBI), Birmingham, AL		17,719		17,719		17,946		17,946		5.23	%		5.3	%	Sep 2015
United States Government (NIH), N. Bethesda, MD		54,996		54,996		56,281		56,281		5.32	%		5.6	%	Sep 2015
United States Government (SSA), Austin, TX		5,069		5,069		5,134		5,134		5.23	%		5.5	%	Sep 2015
United States Government (VA), Ponce, PR		2,812		2,853		3,367		3,428		7.30	%		6.4	%	Apr 2016
Walgreen Co., Portsmouth, VA		2,166		2,237		2,306		2,390		7.20	%		6.2	%	Jul 2018
WorleyParsons Limited, Houston, TX		19,525		19,525		19,525		19,525		4.00	%		4.3	%	Jan 2023
Total	$	994,326	$	995,326	$	1,010,754	$	1,012,075

(1) The effective financing rate is the Company’s approximate borrowing cost, including the effect of hedge gains or losses and other deferred financing costs associated with the related borrowing.

During August 2012, the Company extended the mortgage debt on the Breinigsville, PA, Lathrop, CA and Fort Wayne, IN properties for up to five years inclusive of one 18-month extension option and two one year extension options. The face amount of the note and the note coupon of 6.32% were not modified by the extension. Pursuant to the extension option provisions of the note, the Company may not extend the loan maturity date beyond August 2015 unless it has fully leased the Fort Wayne, IN property. The extension option rights if exercised also require the Company to make the following principal payments on the note:

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$7,500 during the first extension option term;

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$7,500 during the second extension option term; and

●

$5,000 during the third extension option term.

Since the terms of the extended loan are deemed for financial accounting purposes to be not substantially different to the original loan, the Company accounted for the extension as a modification on its financial statements. See “Deferred Fees and Costs” under Note 3 above. Total transaction costs incurred in connection with the extension were $1,626, including $710 of fees paid to the lender to obtain the extension and expenses paid on the lender’s behalf which were added to debt issuance costs for the loan and increase the Company’s effective financing rate of the loan. The remaining $916 of advisory costs related to the extension were charged to earnings during the quarter ended September 30, 2012.

The mortgage notes in the above table are non-recourse to the Company subject to limited non-recourse exceptions and are secured by the respective properties and an assignment of the relevant leases on the properties. See Note 4 regarding the separate and distinct nature of the Company’s SPEs. The Company’s book value before accumulated depreciation and amortization on owned properties encumbered with mortgage debt aggregated $1,599,217 at September 30, 2013, and $1,627,788 at December 31, 2012.

The Company has classified its loan agreement related to the Cimarex Energy Co. property in Tulsa, OK as a component of “Mortgages on real estate investments” on the Company’s Consolidated Balance Sheet. The Company entered into the loan agreement with Bank of Oklahoma during July 2011, to initially provide construction financing of approximately one-half of the project costs related to the development of the property and subsequently, upon completion of construction, provide term financing of the Company’s investment in the property. During the construction period, interest only was payable by the Company to the lender each month at a rate equal to the prevailing one month LIBOR rate plus 300 basis points (subject to a 4.00% floor).

During the nine months ended September 30, 2013, the construction loan was converted to a floating rate term loan bearing interest calculated monthly at a rate equal to the one month LIBOR rate plus 275 basis points and maturing in July 2018. Final funding of the loan which increased the total amount advanced under the loan to $31,000 also occurred during the nine months ended September 30, 2013. During the term loan period, in addition to monthly payments of interest, the Company is also obligated to pay principal to the lender based on a 25-year amortization period. Subject to customary non-recourse exceptions, the lender’s recourse in the event of a default of the loan is limited to the property and the other assets of the Company’s joint venture entity that owns the property.

Also during the nine months ended September 30, 2013, the Company entered into a swap agreement with Bank of Oklahoma related to the debt on the Cimarex property. The swap agreement is structured to fix the interest rate payable on the Company’s borrowings under the loan agreement with Bank of Oklahoma at 4.10% annually during the full five year term loan period. See Note 13.

Loan Agreement for The Woodlands, TX Development Project

During August 2013, the Company entered into a loan agreement with Amegy Bank National Association related to the speculative office building project described at Note 4 above. The loan agreement provides that the lender will advance up to $17,000 to fund project costs during the construction period beginning after the full $17,000 of equity is contributed by the Company and its developer partner. The lender has also agreed to advance another $6,800 of loan proceeds upon the satisfaction of certain leasing and debt service conditions.

The loan with Amegy Bank is for a three year term scheduled to mature on August 19, 2016, although the Company has successive options to extend the term for one additional year each subject to the payment of an extension fee and the satisfaction of certain debt service and other conditions. Until the scheduled maturity date in August 2016, interest only will be payable to the lender on outstanding borrowings at a floating rate of LIBOR plus a LIBOR spread. The LIBOR spread will be 295 basis points until the property achieves debt service coverage of 1.40 to 1.00, at which point it will be 225 basis points. The Company may select a one month, three month or six month interest period for its LIBOR-based borrowings. Liability for the obligations under the loan agreement is limited to the Company’s special-purpose subsidiary that owns and is developing the property. As of September 30, 2013, the Company had not borrowed any amounts under the loan agreement with Amegy Bank.

Secured Term Loan

During December 2007, the Company completed a secured term loan with KBC Bank, N.V. The Company transferred a pool of assets into a wholly-owned special purpose entity, called CapLease 2007-STL LLC, and issued debt to the lender secured by the assets in the pool. The Company retained all of the equity in the special purpose entity and, therefore, is entitled to all residual cash after the payment of scheduled principal and interest on the debt. The lender’s debt is structured to be senior to the Company’s equity. For example, all principal payments on the assets transferred to the SPE will be paid to the lender until the secured term loan is repaid in full. The Company is in a first loss position in the event of a payment default or loss on any of the SPE assets.

The interest coupon on the loan is fixed at 5.81% annually until the loan matures in January 2018. The Company’s effective financing rate on the loan is approximately 6.0% annually (inclusive of hedge and closing costs). The loan is non-recourse to the Company, subject to limited non-recourse exceptions.

Amounts related to the secured term loan as of September 30, 2013, were as follows:

	Borrowings		Collateral Carry Value
Loans held for investment	$	14,308	$	20,289
Intercompany mortgage loans on CapLease properties		11,067		23,017
Commercial mortgage-backed securities		35,279		46,533
Total	$	60,654	$	89,839

Convertible Senior Notes

During October 2007, CapLease issued $75,000 principal amount of 7.50% convertible senior notes due 2027. As of September 30, 2013, CapLease had $19,210 principal amount of convertible senior notes outstanding. The notes represent general unsecured recourse obligations of CapLease and rank equally in right of payment with all of its other existing and future obligations that are unsecured and unsubordinated.

The notes are scheduled to mature on October 1, 2027, unless earlier converted, redeemed or repurchased. Holders were entitled to require CapLease to repurchase their notes, in whole or in part, on October 1, 2012 (the “initial put date”), for a cash price equal to 100% of the principal amount of the notes to be repurchased, plus any accrued and unpaid interest, and remaining note holders may require CapLease to repurchase their notes on subsequent put dates of October 1, 2017 and October 1, 2022, at the same price.

CapLease has the right to redeem the notes in whole or in part, for cash at any time or from time to time. The redemption price will be 100% of the principal amount of the notes to be redeemed, plus any accrued and unpaid interest.

The Company recorded interest expense on the convertible senior notes for the three and nine months ended September 30, 2013 and September 30, 2012 as follows:

	For the three months ended September 30,				For the nine months ended September 30,
	2013		2012		2013		2012
Interest expense paid or accrued at stated interest rate of 7.5%	$	361	$	657	$	1,076	$	1,963
Convertible senior notes issuance costs expensed as a component of interest expense		-		59		1		172
Interest expense at the nonconvertible debt incremental borrowing rate of 2.5%		-		164		-		485
Total convertible senior notes interest expense	$	361	$	880	$	1,077	$	2,620

For financial accounting purposes and because the notes may be converted into equity in the future, the Company was required to bifurcate the proceeds from the original issuance of the notes between a liability component and an equity component and record interest expense on the liability component at the Company’s estimated nonconvertible debt borrowing rate on the date of issue. The liability component was initially recorded at a discount from the principal amount of the notes and was subsequently accreted back to the principal amount over the expected useful life of the notes as interest expense at the estimated nonconvertible debt borrowing rate was recorded. As of the initial put date of October 1, 2012, the liability component of the notes had accreted back to the full principal amount of the notes and, therefore, during the three and nine months ended September 30, 2013, the Company was no longer recording interest expense beyond the stated interest rate on the notes.

The carry value of the equity component of the convertible senior notes was $6,189 at each of September 30, 2013 and December 31, 2012, and is included as a component of “Additional paid in capital” on the Company’s Consolidated Balance Sheet.

The holders may convert their notes into cash, shares of CapLease common stock, or any combination thereof, at CapLease’s option, under certain circumstances, including in connection with certain change of control events defined in the note indenture (each, a “change of control”) or a transaction that results in CapLease’s common stock or other securities into which the notes are convertible not being approved for listing on a U.S. national securities exchange (a “termination of trading”). Upon conversion, if CapLease does not elect otherwise, it will settle its conversion obligation in shares of its common stock.

The conversion rate for each $1 principal amount of notes is 88.3704 shares of CapLease’s common stock, which is equivalent to a conversion price of approximately $11.32 per share. As of September 30, 2013, the if-converted value of the convertible senior notes is less than the principal amount of the notes. The conversion rate will be adjusted for certain events, including in the event CapLease makes any quarterly cash dividend in excess of $0.20 per share.

The convertible senior notes are convertible into CapLease common stock at the option of the holders in connection with the closing of the Merger described in Note 2 above.

Trust Preferred Securities

In December 2005, the Operating Partnership issued $30,000 in aggregate principal amount of fixed/floating rate preferred securities through its wholly-owned subsidiary, Caplease Statutory Trust I. The trust preferred securities represent an unsecured subordinated recourse debt obligation of the Company and require quarterly interest payments calculated at a fixed interest rate equal to 7.68% per annum through January 30, 2016, and subsequently at a variable interest rate equal to LIBOR plus 2.60% per annum. The securities must be redeemed on January 30, 2036, and may be redeemed, in whole or in part, at par, at the Company’s option, at any time. The Company’s effective financing rate on the trust preferred securities, inclusive of deferred issuance costs, is approximately 7.7% per annum.

Scheduled Principal Payments on Debt Obligations

Scheduled principal amortization and balloon payments for all of the Company’s outstanding debt obligations as of September 30, 2013, for the next five years and thereafter are as follows:

	Scheduled Amortization		Balloon Payments		Total
3 months ending December 31, 2013	$	7,864	$	–	$	7,864
2014		35,780		165,666		201,446
2015		29,639		378,373		408,012
2016		19,661		272,614		292,275
2017		14,059		100,721		114,780
Thereafter		36,963		172,679		209,642
Total	$	143,966	$	1,090,053	$	1,234,019

- Definition

The entire disclosure for information about short-term and long-term debt arrangements, which includes amounts of borrowings under each line of credit, note payable, commercial paper issue, bonds indenture, debenture issue, own-share lending arrangements and any other contractual agreement to repay funds, and about the underlying arrangements, rationale for a classification as long-term, including repayment terms, interest rates, collateral provided, restrictions on use of assets and activities, whether or not in compliance with debt covenants, and other matters important to users of the financial statements, such as the effects of refinancing and noncompliance with debt covenants.

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CapLease, Inc. 10-Q