9. Debt Obligations

Credit Agreement

The Company has entered into a credit agreement with Wells Fargo Bank, N.A. (as successor to Wachovia Bank, N.A.) and financed certain of its portfolio assets pursuant to the credit agreement. The Company may also utilize the undrawn amount of the lender’s revolving credit commitment to finance assets approved by the lender in its sole discretion at an advance rate of 60% of the asset’s value (as determined by the lender).

The credit agreement with Wells Fargo Bank includes the following terms:

Size: maximum revolving credit commitment of $140,000;

Maturity: maturity date of July 16, 2013; and

Interest Rate: floating rate LIBOR-based facility with interest rate on the Company’s borrowings set at one-month LIBOR plus 275 basis points.

As of December 31, 2011, the Company’s outstanding borrowings under the agreement were $70,668 and its effective financing rate was 3.6%.

The Company’s borrowings under the credit agreement are secured by a combination of first mortgage loan investments, intercompany mortgage loans on owned property investments, commercial mortgage-backed securities and a first lien on the Company’s ownership interest in the real property located in Johnston, Rhode Island.

The Company’s obligations under the credit agreement are also fully recourse to all of its other assets. In the event Wells Fargo Bank determines in its sole discretion that the value of the Company’s collateral assets has declined, including as a result of an underlying tenant credit rating downgrade or other adverse tenant-credit event, Wells Fargo Bank may require the Company to prepay a portion of its borrowings, provided that Wells Fargo Bank may not reduce the value of any of the Company’s collateral other than CMBS securities due to general credit spread or interest rate fluctuations.

The Company is required to comply with the following financial covenants under the credit agreement:

minimum liquidity (basically cash and cash equivalents) of at least $12,000;

minimum consolidated tangible net worth (basically stockholders’ equity before accumulated depreciation and amortization) of at least $360,000 plus 75% of the aggregate net proceeds from equity offerings or capital contributions after July 16, 2010;

maximum corporate leverage (basically total liabilities divided by total assets before accumulated depreciation and amortization) of 80%; and

minimum interest coverage (basically EBITDA, or net income before income taxes, interest expense, and depreciation and amortization, divided by interest expense) of 105%.

As of December 31, 2011, the Company was in compliance with the above financial covenants.

Amounts related to the Company’s credit agreement as of December 31, 2011 and December 31, 2010, were as follows:

	At December 31, 2011				At December 31, 2010
	Borrowings		Collateral Carry Value		Borrowings		Collateral Carry Value
Credit Agreement
Loans held for investment	$	1,552	$	4,111	$	6,452	$	11,195
Intercompany mortgage loans and investments in CapLease CDO (2010)		66,887		94,020		95,609		130,225
Commercial mortgage-backed securities		2,230		2,533		3,284		11,141
Owned property		–		25,494		–		26,812
Total	$	70,669	$	126,158	$	105,345	$	179,373

For the years ended December 31, 2011, December 31, 2010 and December 31, 2009, the following interest rates applied with respect to the Company’s credit agreement borrowings:

	December 31,
	2011			2010			2009
Weighted average effective financing rate		3.49	%		3.66	%		3.71	%
Average 30-Day LIBOR rate		0.23	%		0.27	%		0.35	%

Mortgage Notes on Real Estate Investments

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

	Dec 31, 2011				Dec 31, 2010
Property Level Debt - Fixed Rate	Face Amount of Debt		Carry Value of Debt		Face Amount of Debt		Carry Value of Debt		Coupon			Effective Financing Rate (1)			Maturity Date

Abbott Laboratories, Columbus, OH (2)	$	5,080	$	5,080	$	–	$	–		5.40	%		6.1	%		Oct 2016
Abbott Laboratories, Waukegan, IL		14,440		14,440		14,710		14,710		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		19,445		19,445		19,721		19,721		5.68	%		5.7	%		Jan 2016
Allstate Insurance Company, Roanoke, VA		20,702		20,702		20,996		20,996		5.68	%		5.8	%		Jan 2016
AMEC plc, Houston, TX		16,175		16,569		–		–		5.85	%		5.3	%		Apr 2016
Aon Corporation, Glenview, IL		59,274		59,274		60,870		60,870		5.23	%		5.8	%		Nov 2014
Baxter International, Inc., Bloomington, IN (2)		4,407		4,407		–		–		5.40	%		6.1	%		Sep 2016
Bunge North America, Inc., Fort Worth, TX		6,262		6,262		6,262		6,262		5.45	%		5.5	%		May 2017
Cadbury Holdings Limited, Whippany, NJ		32,559		32,559		33,237		33,237		5.26	%		5.3	%		Mar 2015
Cadbury Holdings Limited, Whippany, NJ (2)		1,727		1,727		–		–		5.26	%		6.5	%		Mar 2015
Capital One Financial Corporation, Plano, TX		19,344		19,344		19,850		19,850		5.24	%		5.3	%		May 2013
Choice Hotels International, Inc., Silver Spring, MD		26,708		26,708		28,025		28,025		5.30	%		5.3	%		May 2013
Cooper Tire & Rubber Company, Franklin, IN		17,690		17,690		–		–		5.54	%		5.8	%		May 2021
County of Yolo, California, Woodland, CA		10,332		10,332		10,332		10,332		5.68	%		5.7	%		Feb 2017
Crozer-Keystone Health System, Ridley, PA (2)		2,964		2,964		–		–		5.40	%		6.0	%		Apr 2019
CVS Corporation, Randolph, MA (2)		7,601		7,601		–		–		5.40	%		6.4	%		Jan 2014
Farmers Group, Inc., Simi Valley, CA		25,620		25,620		25,620		25,620		5.81	%		5.8	%		Jan 2017
Farmers New World Life Insurance Company, Mercer Island, WA		29,889		29,889		30,200		30,200		5.69	%		5.7	%		Jan 2016
General Motors Financial Company, Inc., Arlington, TX		26,672		26,454		27,190		26,937		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
ITT Corporation, Herndon, VA		39,764		39,764		40,393		40,393		5.33	%		5.4	%		Jun 2015
ITT Corporation, Herndon, VA (2)		2,995		2,995		–		–		5.33	%		6.4	%		Jun 2015
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		13,820		13,820		14,040		14,040		6.05	%		6.1	%		Jul 2016
Lowes Companies, Inc., Aliso Viejo, CA		41,299		41,299		41,892		41,892		5.10	%		5.4	%		Jul 2015
Lowes Companies, Inc., New Orleans, LA		8,599		9,258		–		–		5.57	%		4.7	%		Aug 2030
Lowes Companies, Inc., New Orleans, LA		7,702		8,135		–		–		5.32	%		4.7	%		Aug 2030
Lowes Companies, Inc., New Orleans, LA		433		479		–		–		5.93	%		4.8	%		Aug 2030
Nestle Holdings, Inc., Breinigsville, PA; Fort Wayne, IN; and Lathrop, CA		117,000		117,000		117,000		117,000		6.32	%		5.7	%		Aug 2012
Omnicom Group, Inc., Irving, TX		12,472		12,472		12,784		12,784		5.24	%		5.3	%		May 2013
Pearson Plc., Lawrence, KS		15,616		15,616		15,818		15,818		5.84	%		5.9	%		May 2016
The Travelers Corporation, Hartford, CT		–		–		4,856		4,925		9.80	%		5.5	%		Sep 2011
The Travelers Corporation, Hartford, CT		–		–		17,251		17,656		10.76	%		7.7	%		Oct 2011
Tiffany & Co., Parsippany, NJ		57,482		57,482		58,274		58,274		5.33	%		5.3	%		Oct 2015
Time Warner Entertainment Company, L.P., Milwaukee, WI		17,500		17,500		17,500		17,500		5.55	%		5.6	%		Dec 2016
Time Warner Entertainment Company, L.P., Milwaukee, WI (2)		2,473		2,473		–		–		5.83	%		6.8	%		Dec 2015
Time Warner Entertainment Company, L.P., Milwaukee, WI (2)		2,208		2,208		–		–		6.18	%		6.8	%		Dec 2016
TJX Companies, Inc., Philadelphia, PA		68,847		68,847		69,547		69,547		5.57	%		5.6	%		Mar 2016
T-Mobile USA, Inc., Nashville, TN		10,606		10,606		10,749		10,749		5.59	%		5.7	%		Dec 2016
United States Government (DEA), Birmingham, AL		10,922		10,922		11,086		11,086		5.23	%		5.4	%		Sep 2015
United States Government (EPA), Kansas City, KS		18,395		20,806		19,060		21,695		7.57	%		5.3	%		Oct 2022
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		18,233		18,233		18,508		18,508		5.23	%		5.3	%		Sep 2015
United States Government (NIH), N. Bethesda, MD		57,908		57,908		59,459		59,459		5.32	%		5.6	%		Sep 2015
United States Government (SSA), Austin, TX		5,217		5,217		5,297		5,297		5.23	%		5.5	%		Sep 2015
United States Government (VA), Ponce, PR		4,062		4,154		4,708		4,836		7.30	%		6.4	%		Apr 2016
Walgreen Co., Pennsauken, NJ		–		–		1,306		1,365		7.65	%		6.0	%		Oct 2016
Walgreen Co., Portsmouth, VA		2,481		2,584		2,644		2,766		7.20	%		6.2	%		Jul 2018
Total	$	969,004	$	972,924	$	925,264	$	928,429

⁽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.

(2)

The mortgage note is part of the collateral in the CDO transaction that the Company sold during the third quarter of 2011. Prior to such sale, for financial accounting purposes the mortgage note and related debt obligation were eliminated in consolidation as intercompany transactions.

The mortgage notes 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 3 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 $1,483,528 at December 31, 2011, and $1,435,087 at December 31, 2010.

Loan Agreement for Tulsa, Oklahoma Development Project

During July 2011, the Company entered into a loan agreement with Bank of Oklahoma to provide construction financing of approximately one-half of the project costs related to the development of the property in Tulsa, Oklahoma for Cimarex Energy Co. See Note 3. Pursuant to the agreement, Bank of Oklahoma has agreed to fund up to $24,000 of project costs beginning after the Company has funded an aggregate of $24,000 to the project. During the construction period, interest only will be 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). Upon completion of the project, the construction loan will automatically convert to a term loan of up to $31,000 bearing interest at a rate equal to the prevailing one month LIBOR rate plus 275 basis points and maturing in July 2018. During the term loan period, in addition to monthly payments of interest, principal will also be payable by the Company 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. As of December 31, 2011, the Company had not drawn any amounts under the loan agreement with Bank of Oklahoma.

Collateralized Debt Obligations

During September 2011, the Company completed the sale of its March 2005 CDO. For legal and accounting purposes, the sale resulted in the transfer by the Company of the various assets in the CDO trust along with the transfer of the obligation to pay debt service on the various CDO note classes. See Note 6.

Results of the CDO included in the Consolidated Statements of Operations for the years ended December 31, 2011, December 31, 2010 and December 31, 2009 were as follows:

	December 31,
	2011		2010		2009
Total revenue attributable to CDO activity	$	9,761	$	17,185	$	15,885
Total revenue attributable to CDO activity per common share		0.15		0.31		0.32
Net income attributable to CDO activity		2,151		4,961		3,557
Net income attributable to CDO activity per common share		0.03		0.09		0.07

As of December 31, 2011, the Company owned an aggregate of $2,661 face amount of Class A CDO notes and $2,000 face amount of Class B CDO notes which will continue to receive interest and principal when paid in accordance with the priority of payments specified in the CDO transaction documents. See Note 5. These securities were previously purchased by the Company on the open market during 2009 (in the case of the Class A notes) and 2011 (in the case of the Class B notes).

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 December 31, 2011, were as follows:

			Collateral
	Borrowings		Carry Value
Loans held for investment	$	19,774	$	29,598
Intercompany mortgage loans on CapLease properties		24,436		35,358
Commercial mortgage-backed securities		43,932		48,454
Total	$	88,142	$	113,410

Convertible Senior Notes

During October 2007, CapLease issued $75,000 principal amount of 7.50% convertible senior notes due 2027. 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 jointly and severally, fully and unconditionally guaranteed, on a senior unsecured basis by four of CapLease’s subsidiaries, Caplease, LP, Caplease Debt Funding, LP, Caplease Services Corp. and Caplease Credit LLC.

Since original issuance, CapLease has repurchased an aggregate of $39,991 principal amount of the notes and, therefore, as of December 31, 2011, the Company had $35,009 principal amount of convertible senior notes outstanding.

As of January 1, 2009, the Company adopted accounting guidance (codified primarily at FASB ASC 470) that retrospectively changed the accounting for the convertible senior notes. The guidance affected the accounting for the Company’s convertible senior notes by requiring the initial proceeds from their issuance to be allocated between a liability component and an equity component in a manner that results in interest expense on the liability component at the Company’s estimated nonconvertible debt borrowing rate on the date of issue. The liability component is initially recorded at a discount from the principal amount of the notes and is subsequently accreted back to the principal amount over its expected useful life as interest expense at the estimated nonconvertible debt borrowing rate is recorded. The initial bifurcation between the liability and equity components of the convertible senior notes at January 1, 2009, was $67,761 and $7,239, respectively.

The liability component of the convertible senior notes comprised the following amounts at December 31, 2011 and December 31, 2010:

	December 31,
	2011			2010
Convertible notes - principal	$	35,009		$	35,009
Unamortized debt discount		(487	)		(1,083	)
Convertible senior notes - net	$	34,522		$	33,926

The remaining debt discount is scheduled to be amortized over the next 10 months, ending in October 2012, when the Company may be required to repurchase the outstanding notes at par as described below.

The carry value of the equity component of the convertible senior notes was $6,189 at each of December 31, 2011 and December 31, 2010, with the decline from the initial bifurcation amount of $7,239 caused by the Company’s repurchase of convertible senior notes at par during 2010.

The following table summarizes the Company’s repurchases of convertible senior notes during the years ended December 31, 2008, 2009 and 2010.

Quarter Ended	Notional Amount of Notes Repurchased		Purchase Price		Gain (loss) on Extinguishment of Debt
December 31, 2008	$	3,240	$	1,179	$	1,713
March 31, 2009		5,500		2,090		2,821
June 30, 2009		12,316		6,512		4,581
September 30, 2009		1,500		949		415
March 31, 2010		2,500		2,400		(96	)
June 30, 2010		13,500		13,500		(184	)
September 30, 2010		1,435		1,435		(14	)

The notes bear interest at an annual fixed rate of 7.50% and are scheduled to mature on October 1, 2027, unless earlier converted, redeemed or repurchased. The Company’s effective financing rate on the notes, which includes the effect of the commissions and other expenses associated with the issuance of the notes, is approximately 8.1%. The Company’s effective interest rate on the liability component of the instrument as measured under the January 1, 2009 accounting guidance was 10.2%, 10.1% and 11.5%, respectively, at December 31, 2011, December 31, 2010 and December 31, 2009. The Company recorded interest expense on the convertible senior notes for the years ended December 31, 2011, December 31, 2010 and December 31, 2009 as follows:

	December 31,
	2011		2010		2009
Interest expense paid or accrued at stated interest rate of 7.5%	$	2,625	$	3,111	$	4,260
Convertible senior notes issuance costs expensed as a component of interest expense		206		250		320
Interest expense at the nonconvertible debt incremental borrowing rate of 2.5%		596		702		998
	$	3,427	$	4,063	$	5,578

Holders may require CapLease to repurchase their notes, in whole or in part, on October 1, 2012, October 1, 2017 and October 1, 2022, for a cash price equal to 100% of the principal amount of the notes to be repurchased, plus any accrued and unpaid interest.

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 initial conversion rate for each $1 principal amount of notes is 88.3704 shares of CapLease’s common stock, which is equivalent to an initial conversion price of approximately $11.32 per share. As of December 31, 2011, the if-converted value of the convertible senior notes does not exceed the principal amount of the notes. The initial 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.

Holders will also have the right to require CapLease to repurchase their notes, in whole or in part for cash, if a change of control or termination of trading occurs prior to October 1, 2012. The repurchase price will be 100% of the principal amount of the notes to be repurchased, plus any accrued and unpaid interest.

CapLease has the right to redeem the notes in whole or in part, for cash at any time or from time to time on or after October 5, 2012. Prior to October 5, 2012, CapLease may also redeem the notes to preserve its status as a real estate investment trust. The redemption price will be 100% of the principal amount of the notes to be redeemed, plus any accrued and unpaid interest.

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 8.3% 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 December 31, 2011, for the next five years and thereafter are as follows:

	Scheduled Amortization		Balloon Payments		Total
2012	$	37,729	$	152,009	$	189,738
2013		34,885		120,485		155,370
2014		31,504		60,379		91,883
2015		28,375		255,699		284,073
2016		18,835		305,769		324,605
Thereafter		39,838		108,246		148,085
Total	$	191,166	$	1,002,588	$	1,193,753