Commercial Mortgage Defeasance - YouTube

Welcome to CRE Fast Five and today’s overview of  commercial mortgage defeasance. I’m Karly Iacono.  

Ok this may not be our flashiest topic to date  but it is something many investors do not understand  

so it is worth outlining. If you have ever tried  to sell a property with CMBS debt in place then  

you likely have already dealt with defeasance.  But for everyone else you may be wondering what  

defeasance, or even CMBS really even means. Simply  put, defeasance is the substitution of collateral.  

When you have a CMBS or commercial mortgage backed  security loan your debt is pooled with other loans  

and then securitized and sold to investors.  Because your loan is now a security offering, a  

certain return over time must be guaranteed to investors. You cannot simply pay it off like a traditional mortgage.  

This is where defeasance comes into play.  Defeasance is the replacement of the loan proceeds  

with government-backed securities such as treasury  bonds, that offer the same return as your loan. The collateral  

offered by the defeasance process must promise  enough cash flow to pay the original commercial  

property loan's interest and principal, so that  the lender does not end up with less money than if  

the loan had remained intact. If you have a CMBS  loan and it makes sense to sell your property free  

and clear or you want to refinance, defeasance is  likely your only option. Let’s go through the main  

steps to this process now. The first step is to  contact a defeasance consultant such as Defease  

with Ease, AST defeasance or Commercial Defeasance LLC,  of course there are others. The consultant can begin their initial review  

with as little as a property address. Details on  your mortgage such as the current loan balance,  

interest rate, amortization, term, and defeasement  provisions can be pulled from public record.  

The consultant then compares that information  to current market conditions to come up with  

a proposed market cost estimate to defease. If  you decide that defeasing the loan is the right  

choice given the cost you’ll move to step 2, notice  and deposit. Typically borrowers must give their  

loan servicer at least 60 days notice of their  intent to defease and a good faith deposit is  

required which will offset some of the costs.  Step 3 is when the consultant begins coordinating  

all of the relevant parties, the borrower, loan  servicer, securities intermediary, accountant,  

rating agency, escrow agent, and attorneys. There  are a lot of moving parts here as you can see  

so finding an experienced deafeasance consultant  is paramount. Step 4 is when the lender begins  

drafting all necessary documents. The next few  steps are very technical and revolve around your  

consultant designing a securities portfolio to  be used as replacement collateral. This portfolio  

must then be signed off on by a CPA who verifies  that the income from the securities portfolio is  

sufficient to cover the loan obligations. If the  loan is on the larger side, i.e. over $20 million,  

bond credit rating agencies like Standard &  Poor’s, Moody’s and Fitches may also have to  

approve the transaction. Once the transaction has  been fully approved and all paperwork completed,  

the closing process begins. Closing typically  occurs over two days and from a high level  

the replacement securities are purchased by  the borrower, assigned to a single purpose  

entity called the successor borrower and  ultimately held in a restricted account called 

the securities intermediary. The intermediary is  the financial institution responsible for making  

the loan payments from the cash proceeds of the  securities. Remember it’s the cash proceeds or  

return of the securities that were just purchased  that are being used as replacement collateral.  

If I lost you, just remember that defeasance  is a way to substitute collateral to fulfill  

debt obligations for loans that cannot be  prepaid. Although defeasance is a complex  

and time consuming process which requires a  team of experts to assist, it is often still worth  

pursuing. If you would like to learn more about  defeasance, feel free to reach out and I’ll help  

you find the right consultants. That was CRE  Fast Five. I’m Karly Iacono. I’ll see you soon.