Got questions? We have answers. Take a look at some of our most
commonly asked questions.
What are the benefits of engaging Defease With Ease®?
Since facilitating our first CMBS defeasance back in 2000, we have consistently remained the first choice in the industry among real estate owners, brokers and attorneys. We put our unparalleled experience and deep relationships to work on every defeasance to make sure it closes on time. Our origination group will explain the defeasance process, provide an initial cost estimate, and work with the customer to answer all questions.
We assign a knowledgeable, dedicated, experienced deal manager to actively manage every transaction and push it towards the customer’s desired closing date. In fact, we made our mark coordinating large, multi-loan, portfolio defeasances across several servicers to close on the same day, but we’re just as well known for giving that same attention and level of service to the customer with a small balance loan. Smaller balance loans are just as important to us as they are to the customers that need to defease them in order to sell or refinance.
We believe in consistent communication throughout the process to manage our customer's expectations regarding timing and cost. While in some cases our fee may be nominally higher than another's, we also work harder than anyone else. Read what our clients say about us and make sure you Defease With Ease®. You really do get what you pay for, so in this rapidly changing lending environment, it’s more important than ever to make sure you engage the best in the business to get your transaction closed quickly and correctly while your source of funds is committed to close.
What is defeasance?
Defeasance is a substitution of collateral. A portfolio of qualified government securities is structured such that the redemption of principal and interest from the securities will produce sufficient cash flow to make the remaining loan payments as they come due. The securities are pledged to the lender in exchange for the lender’s release of the real estate from the lien of the mortgage. Conduit loan defeasances involve many parties, require a number of deliverables, and take about thirty (30) days to complete. Contact us to start the process.
How do I know if my loan requires defeasance?
Most commercial real estate loans originated after 1998 contain a defeasance provision, but you should check your loan documents to be sure. The two to four page defeasance section typically can be found in either the note, the mortgage or the loan agreement (if your documentation includes a separate loan agreement). We can help you determine if your loan contains a defeasance provision, if you contact us.
When can I defease my loan?
Most defeasance provisions in existing loans prohibit defeasance for the lesser of (a) three years from the date the loan closed, or (b) two years from the date the loan was securitized by the lender. However, this “lock-out period” can vary from loan to loan, so it is important to review your loan documents to determine the lock-out period that applies to your specific loan. Note that the second prong of the lock-out period is based upon when the loan was securitized (i.e. transferred by the lender to a REMIC trust); not the date the loan closed. Contact us, and we can help you determine when the lender securitized your loan.
How much does a defeasance estimate cost?
One of our experienced team members will be happy to provide you with a cost estimate at no charge, if you contact us. The most accurate estimate can be attained by having one of our originators review the applicable sections in your loan documents. We provide written estimates promptly and are happy to answer all of your questions. You may also visit our online calculator to run your own estimate. It includes helpful prompts, but you can always call us for assistance.
How will I know what securities to buy?
If you engage us to facilitate your defeasance, we will create and optimize a securities list based upon the defeasance requirements in your loan documents. The defeasance provisions in most loan documents require that the securities be direct obligations of the United States that mature as close as possible to the date on which the proceeds will be needed for a payment under the note. The securities also cannot be callable or subject to early redemption. A typical defeasance transaction involves the purchase of a portfolio of anywhere from five to fifty securities, depending on the length of the remaining term of the loan. The substitute collateral for a defeasance is typically a mix of T-Bills, T-Notes and STRIPS, unless the loan documents permit agency debt.
Who is involved in a defeasance?
Depending on the size of the loan and the complexity of the transaction, there could be as many as 25 different parties involved, including an accountant, loan servicer, securities broker-dealer, securities intermediary, successor borrower, escrow agent, purchaser and purchaser’s lender or refinance lender, rating agencies, and all of their respective attorneys. For every defeasance, the borrower will need to engage its own attorney to represent it in all aspects of the transaction, including for the purpose of reviewing and negotiating the defeasance documents, explaining the defeasance documents to the borrower, and issuing an enforceability opinion. We also encourage every borrower to seek the advice of its own accountant regarding the impact of the defeasance on the borrower’s specific tax and accounting situation.
How much does a defeasance cost?
Every defeasance has two cost components: (1) transaction costs, and (2) the cost of the securities that comprise the substitute collateral. The transaction costs consist of the fees of the various parties involved, which generally range from $45,000 to $65,000, in the aggregate (excluding borrower’s counsel’s fee), if the borrower takes advantage of our network of experienced third party service providers. The transaction costs vary depending upon the size of the loan, the complexity of the transaction (i.e. a partial defeasance or a New York-style defeasance), and the fees charged by the servicer of the loan and their legal counsel
However, the single biggest cost component is the securities purchase. Borrowers should be aware that some securities brokers include significant fees for themselves in the price of the securities without separately disclosing those fees. Securities purchases that are conducted as a so called "competitive bid" process are particularly susceptible to this type of fee gouging, because brokers (including large, well-respected institutional brokers) traditionally make money by including as much mark up in the securities cost as they can get away with. That’s why Commercial Defeasance pioneered a less expensive, more transparent approach to the securities purchase – a nominal, fixed broker fee that is disclosed up-front in writing.
Why does Commercial Defeasance prefer to use a broker-dealer that charges a nominal, fixed fee for the securities purchase when other facilitators tout a “competitive bid” process?
Our defeasance volume is so much greater than any other facilitator (even large, well-known institutions) that broker-dealers are willing to work for our customers for a fixed fee of $1,500 - $5,000 (depending on loan size) over the broker's cost to obtain the securities directly from the market makers. Some of the same broker-dealers from whom others get their “competitive bids” actually have politely declined to work on our defeasances, because they could not or would not limit their fee to the fixed fees we require for the amount of work required to deliver a defeasance portfolio.
While the name "competitive bid" process may sound appealing, the reality is that broker-dealers would much prefer to handle a few hundred million dollar trades for large fees from their other customers than perform the 10 – 40 relatively small trades required for a defeasance for one small fee. If they’re going to do all the extra work required by a defeasance portfolio, they want to get paid big fees for it. As a result, a "competitive bid" process for a defeasance portfolio can yield bids from brokers that are not interested in buying a defeasance portfolio, unless it commands a hefty premium. In the end, the "competitive bids" can include undisclosed mark ups of $20,000, $25,000 and $35,000 on a $3 million defeasance, so the lowest bid is padded with a $20,000 broker fee.
Contrast the “competitive bid” with the fixed $2,500 fee that would have been charged for the same transaction by a broker-dealer working for a nominal, fixed fee. Even if the competitive bid process happens to yield a reasonable fee once in a while, it will rarely, if ever, result in a broker fee that is less than our negotiated, fixed fee, so why even take a chance? That’s why Commercial Defeasance believes a low, fixed, pre-negotiated broker fee obtains the best result for the customer.
Why couldn't I go directly to a broker and purchase the securities myself?
You could, but we don't recommend it. If the broker fails to deliver just one security in the portfolio, the defeasance cannot close, which means the sale or refinance closing has to be rescheduled. In addition to cost considerations, it's important to use a broker with significant defeasance experience. The real estate closing is just too important to take a chance on a broker who is not used to the rigors of a defeasance closing.
Why might someone else produce a defeasance cost estimate with a lower securities cost?
There is a limited universe of securities available that qualify for a defeasance portfolio, so there shouldn’t be a lot of difference in an initial securities cost estimate. If another estimate is lower than ours, the difference can be attributed to one or more factors, including a difference in the date and time of the estimates (securities costs change by the second), an error in the code for another calculator or an incorrect input, an attempt to “low-ball” the estimate in order to get your business, or a questionable assumption built into the estimate. For example, some estimates assume that the securities are bought the day the estimate is given rather than on the target defeasance date, which means the cost estimate is artificially reduced by the amount of interest that the borrower would earn on the securities from the date of the estimate through the target closing date had the borrower actually bought the securities on the date of the estimate (even though the securities won’t actually be purchased until just prior to the scheduled defeasance closing date).
We strive to provide the most accurate cost estimate for the most efficient securities portfolio available. Our goal is to provide realistic pricing up front and update that pricing for you periodically, so you’re not surprised at closing by unexpected cost increases due to market movement since the last estimate. If you’re interested, an affiliate of Commercial Defeasance can help you lock in the securities cost in advance of closing, so the cost won’t be subject to market fluctuation during the defeasance process. Contact us for more information.
How long will it take to defease my loan?
The defeasance provisions in the loan documents typically require that you give your loan servicer 30 to 60 days prior written notice of your intent to defease. Some servicers are willing to expedite the process but may charge an additional fee. In emergency situations, we have closed defeasances in less than a week with the hard work and cooperation of all parties, but it’s best to try to comply with the notice requirement in the loan documents, if at all possible.
Can I use my own attorney to defease my loan?
Yes. You will need to engage your own attorney to represent you in all aspects of the defeasance transaction, including reviewing, explaining and negotiating the defeasance documents, rendering a due authorization/enforceability opinion, preparing release documents, and providing borrower organizational documents. You may desire to use the attorneys who were involved in the original loan closing, provided that their level of service was satisfactory and they are, or can become, proficient with the defeasance documents.
Can I use my own accountant for the defeasance?
You are encouraged to use your own accountant for accounting and tax advice that is specific to your situation, but the loan servicers usually require that the accountant's report delivered for each defeasance be issued by a "Big 6" accounting firm. Even if the servicer allows you to use your own accountant for the report, it typically can be done cheaper, more reliably and more efficiently by an accounting firm that is already experienced in issuing such reports in a format that has been approved by the servicers and rating agencies on other transactions.
What is meant by the "residual" associated with a defeased loan?
The securities portfolio for a defeased loan should be as efficient as it practicably can be (i.e. there should be just enough cash generated by the securities to make the remaining payments as they come due). However, there may be value in the pledged collateral account, after the loan is paid in full, from “float” or from a “par repayment provision”. That potential remaining value, whether from float or from a par repayment provision, can be referred to generally as “residual.”
What is "float"?
While we strive to make every securities portfolio as efficient as practicable, in most cases, there simply are not securities that mature on the day of each and every remaining scheduled payment date for the loan that is being defeased. As a result, the cash that the securities intermediary receives from the portfolio of securities is swept, in accordance with the typical servicer’s account agreement, into a AAA rated money market fund or other permitted investment that earns interest until the money is needed for a scheduled loan payment. This interest is sometimes referred to as "float." Because float varies depending upon interest rates and because the bulk of any float is earned after redemption of the last maturing security in the portfolio (because of its size and reductions in the efficiency of the securities market further out on the yield curve), the amount of float generated by a defeasance portfolio can fluctuate significantly.
Why does the Accountant's Report ignore float when determining if the securities portfolio will generate sufficient cash to make the remaining principal and interest payments?
Defeasance provisions typically require that all remaining loan payments be satisfied by the principal and interest payments from the U.S. government securities that constitute the substitute collateral. Consequently, servicers and rating agencies require the accountant to confirm the sufficiency of the cash flows without regard to reinvestment income (sometimes called float).
The rationale for this approach is that, while the payments on the government securities are predictable and certain, reinvestment income or float is dependent on future interest rates which are unpredictable and subject to volatility. Theoretically, reinvestment income could be zero or could be negative if the selected money market fund were to break the dollar as happened with the Reserve Primary Fund in September 2008. Consequently, loan servicers and rating agencies have always strictly enforced the requirement in the original loan documents that the sufficiency of the collateral be determined based only upon the principal and interest payments generated directly by the government securities
What is a “par repayment provision”?
The original promissory note for the loan may contain a provision whereby the loan can be prepaid during a stated period (usually three months) prior to the maturity date of the loan without the payment of any prepayment penalty or premium. In other words, a loan that may be repaid at par just prior to maturity can be said to have a “par repayment provision.” Depending upon the language in the original loan documents, a loan may have no par repayment option at all, it may have a par repayment option that is negated after defeasance, or it may have a par repayment option that survives defeasance
A par repayment provision that survives defeasance can create value in the pledged collateral account, if the loan documents also require that the defeasance collateral consist of securities sufficient to make all remaining payments through the maturity date. In such cases, securities and/or cash could remain in the account after prepayment of the loan.
Who receives the “residual”?
Typically, the borrower's loan documents state that all rights and obligations under the promissory note, as well as the government securities must be assigned to the successor borrower. The defeasance documents are drafted by the loan servicer's counsel to comply with this and other requirements in the borrower's loan documents. The defeasance documents state that any float is held for the benefit of the lender as part of the pledged collateral, until the successor borrower fulfills its obligations under the loan and the loan is paid in full. At that time, the residual, if any, is delivered to the successor borrower. The defeasance documents also require that the successor borrower account for the defeased loan and the securities, file tax returns in its own name, and maintain its status as a special purpose, bankruptcy remote entity. We understand the reason for these lender requirements is to minimize the risk that the defeasance collateral could become part of the borrower’s (or its parent’s) bankruptcy estate Moreover, by assigning all rights and obligations under the loan and defeasance collateral the borrower may be able to fully deduct the defeasance premium (the amount by which the securities cost exceeds the outstanding balance) fully in the year the defeasance occurs. For more information on this benefit follow this link and consult your tax professional. Additionally, the fees charged at the defeasance closing are intended to cover the costs of assuming the defeased loan (negotiating defeasance documents, and obtaining enforceability opinion, bankruptcy non-consolidation opinion, good standing certificates, independent director services, and successor borrower formation, if applicable) but it doesn't cover the successor borrower’s ongoing expenses for the remaining term of the loan (monthly loan and securities accounting, annual tax return preparation and filing, annual secretary of state fees, annual independent director fees, etc.). Therefore, the successor borrower relies on potential residual to reimburse costs and expenses incurred in maintaining the successor borrower and the loan for the remaining term of the loan, as well as to provide an incentive to do so.
Can’t the successor borrower agree to share some of the residual with the borrower, if the residual is estimated to significantly exceed the successor borrower's costs?
Additionally, any estimate of the residual value is just that - an estimate. The defeasance document constraints mentioned above limit the successor borrower’s ability to enter into any sort of arrangement whereby it shares actual residual with the original borrower after the loan is paid off, even if it turns out that the residual significantly exceeds the successor borrower’s expenses. In addition to triggering a default under the defeasance documents, there are potentially significant negative tax implications related to the borrower’s deduction of the defeasance premium, if the borrower (or its parent) were to enter into such an agreement. However, Commercial Defeasance now has access to another alternative for borrowers commencing the defeasance process. Through a new program, a borrower who engages Commercial Defeasance to facilitate its defeasance may be eligible to receive a payment at closing that equates to the present value of a percentage of the estimated future residual (a “PV Payment”).* A PV Payment may avoid the tax, accounting and defeasance document issues associated with a residual sharing arrangement.
*PV Payments are sponsored by an upstream parent of the successor borrower, and not by Commercial Defeasance. Commercial Defeasance does not receive residual or have the ability to share residual with original borrowers. The PV Payment option may be changed or discontinued at any time, without notice, in the program provider’s sole discretion. Interested borrowers should contact us for details and eligibility requirements. Commercial Defeasance is not a tax or legal advisor, so you should discuss all tax and accounting implications with your own attorney or accountant.
How do I know if my pending transaction is eligible for a PV Payment?
Interested borrowers should inquire about the possibility of a PV Payment prior to closing. The successor borrower retains sole discretion to determine whether your transaction is eligible for a PV Payment, and to determine how much that payment may be. As prepayment provisions vary from loan to loan, they can only be evaluated by reviewing the borrower's original loan documents. Therefore, we will need to receive copies of the note, security instrument and loan agreement before it can be determined whether any purported prepayment rights meet the eligibility requirements for a PV Payment. There are a number of variables that affect the estimated residual (loan size, remaining term to maturity, monthly payment date, loan coupon, future market interest rate projections, discount rates, etc.), so it is important to understand that, while one loan may not be eligible for a PV Payment, the next loan might be. Note, too, that any PV Payment is based on an estimate of future value. The actual future value cannot be determined until after the loan is paid in full and will be lower or higher than the estimate upon which a PV Payment is based.
What is a Partial Defeasance?
Often, multiple properties serve as collateral for a single commercial real estate loan. If an owner wants to release one or more of those properties for a sale or refinance without defeasing the entire note, a partial defeasance may be an option. However, the right to obtain the release of individual properties is typically negotiated when the loan is originated and specific provisions are added outlining the requirements for the partial release
A partial defeasance releases one or more properties encumbered by the loan and leaves the other properties in place as collateral for the remaining debt. In a partial defeasance, the original note will be split into a “Defeased Note” and an “Undefeased Note” with identical terms (except for amount). The amount of the “Defeased Note” will be a calculated amount based on the portion of the loan amount allocated to the properties to be released, which may include a premium on the allocated value of the released properties. For example, a typical partial defeasance provision might require the Defeased Note to be in an amount equal to 120% of the portion of the loan amount that is allocated to the released properties to protect against the lender being under-collateralized on the Undefeased Note (for example, if the best assets are the ones being released). After a partial defeasance, a securities portfolio secures the Defeased Note, the balance of the Undefeased Note is set at the undefeased balance of the Original Note (i.e. the outstanding principal balance of the original note on the defeasance closing date minus the amount of the Defeased Note), and the Undefeased Note is secured by the remaining real estate.
Partial defeasance provisions vary immensely from loan to loan and can be very complicated. Please contact us if you are considering, or need help with, a partial defeasance.
What is a “New York-style” defeasance?
Many states, including New York, have significant mortgage recording taxes on real estate transactions. A “New York-style” defeasance is designed to limit the amount of mortgage recording tax paid by the Borrower, in the context of refinancing, to the tax due on the positive difference between the new loan amount and the old loan amount. The idea is that the Borrower already paid mortgage recording tax on the old loan amount and shouldn’t have to pay it again on that same amount. To accomplish a New York-style defeasance, (i) the existing Lender/Trustee assigns the existing loan (including the original note and mortgage) to the New Lender, (ii) the New Lender assigns a mirror note back to the existing Lender/Trustee in the amount of the then current balance of the existing loan, (iii) and the mirror note is defeased like any other loan. Most lenders in New York are now familiar with this process and will agree to participate, because all of the documents are drafted by the servicer’s counsel handling the defeasance (for an additional nominal fee relative to the recording tax savings). Done correctly, the Borrower will pay recording tax only on the difference between the outstanding principal balance of the existing note and the principal amount of the new loan (i.e. the new money).
In many cases, borrowers are now adding New York-style defeasance language to their new loan documents to ensure servicer cooperation when the time comes to refinance. It’s also worth noting that New York-style defeasances can be done in other states, such as Maryland, and even in certain counties that have higher mortgage recording taxes. It’s just called a New York-style defeasance, because it was first done in New York pursuant to the Advisory Opinion of the State of New York Commissioner of Taxation and Finance in response to Petition No. M991230A dated February 25, 2000. Here’s a link to the opinion… http://www.tax.ny.gov/pdf/advisory_opinions/mortgage/a00_1r.pdf
Why can’t we (the Borrower) just use our Lender to hedge? What value do you provide?
In most cases, the borrower will use its lender to hedge. We ensure that when borrowers hedge with their lenders 1) they implement hedging strategies that are custom tailored to their needs, 2) they fully understand the mechanics, benefits, and risks of the strategy, 3) they get fair pricing and terms, stronger covenants, and transparency. We can also help explore hedging with providers other than a borrower’s direct lender.
What type of situations/clients best suit your services?
Most commonly, variable rate borrowers are the primary end user for interest rate hedges. This typically includes single asset real estate borrowers, REITs, corporations, non-profits, and municipalities. This can include hedging a new term debt facility, or bidding out a swap termination in conjunction with a refinance or sale of an asset.
What products/services do you offer that would be useful for commercial real estate owners?
We advise numerous real estate owners on the development and implementation of interest rate hedging solutions. This may include an interest rate swap, cancellable swap, interest rate cap, or interest rate collar. Our goal is to structure hedges that achieve borrowers’ objectives and getting those hedges implemented at aggressive levels. We also assist these borrowers in terminating interest rate hedges at aggressive levels.
How is your fee collected?
In most cases we can structure our fee within a hedging transaction so our clients do not have to pay out of pocket today. For some products, such as interest rate caps, we charge an up-front fee to auction the product to several dealers.
I own a portfolio of commercial real estate. Is hedging something I should think about only when a lender forces me to put a hedge in place or are there strategies I can employ to save or even make money?
We work with many clients that are not required to hedge, but do so electively. In low rate environments borrowers should extend the size and duration of hedges to effectively “dollar-cost-average”. In high rate environments borrowers should reduce the size and duration of hedges to lock in gains. We do not advocate trading these products proprietarily, but do recommend that borrowers evaluate their hedging positions on a regular basis.
Instead of talking in terms of managing interest rate risk, can I think of hedging as a way to help manage cash flows in my real estate portfolio?
While interest rate hedges can protect against rising interest rates for long periods of time, they can also be highly structured (e.g., fluctuating coupons) to provide customized cashflows that coincide with projected capital events in the future.
Are all Yield Maintenance penalties calculated the same way?
No. Prepayment provisions in loan documents vary significantly from lender to lender and loan to loan. Each provision specifically dictates yield maintenance methodology, index references for the discount rate, timing for when to identify the reference rate, and calculation of the discount rate, among other details. There is no standard provision used by lenders. In fact, a savvy drafter can make subtle changes to a yield maintenance provision that dramatically effect the amount of the prepayment penalty a borrower pays upon prepaying the loan. Many lenders have a handful of models that they force each yield maintenance provisions into even if it’s not exactly accurate. As a result, lenders can come up with prepayment penalties that are not exactly tied to the specific language, which means their calculation could be lower or higher than one tailored to the specific yield maintenance provisions in the loan documents.
What are some different basic types of Yield Maintenance methodologies?
Some common examples of different methodologies that are all referred to generically as Yield Maintenance are (i) the Net Present Value of future payments method, (ii) the interest differential times PV factor method, (iii) the Net Present Value of interest differential based on prepaid balance method, (iv) the Net Present Value of interest differential based on amortizing balance, and (v) the Yield Maintenance Penalty = the cost of a defeasance portfolio method. Within each of these five common categories, there can be myriad iterations resulting from small language tweaks and interpretations.
If my loan has a Yield Maintenance Provision, can I ever pay it off at par or at a discount like I could with a defeasance provision?
Chances are you can never prepay a CMBS loan at a par or at a discount with any Yield Maintenance prepayment provision. Yield Maintenance provisions typically have a minimum 1-3% prepayment floor that is triggered if the calculation results are below the floor. In other words, most yield maintenance provisions require the borrower to pay the greater of the yield maintenance penalty or a percentage of the loan balance (usually 1-3%).